Reputation for Quality

We propose a model of firm reputation in which a firm can invest or disinvest in product quality and the firm's reputation is defined as the market's belief about this quality. We analyze the relationship between a firm's reputation and its investment incentives, and derive implications for reputational dynamics. Reputational incentives depend on the specification of market learning. When consumers learn about quality through perfect good news signals, incentives decrease in reputation and there is a unique work–shirk equilibrium with ergodic dynamics. When learning is through perfect bad news signals, incentives increase in reputation and there is a continuum of shirk–work equilibria with path‐dependent dynamics. For a class of imperfect Poisson learning processes and low investment costs, we show that there exists a work–shirk equilibrium with ergodic dynamics. For a subclass of these learning processes, any equilibrium must feature working at all low and intermediate levels of reputation and shirking at the top.