Gildas Marot- Cadet Thomas

Master 2 e-Business

Shadow of the future

or
an analyze of
«How effective are online reputation
mechanisms?»
Gary E Bolton, Elena Katok and Axel Ockenfels
May 2002

«On peut tromper une fois 1000 personnes, mais on ne peut pas
tromper 1000 fois une personne.»
Emile Gravier, La Cité de la peur (1994)
Introduction 3

Review of litterature 3
"Does a seller's e-commerce Reputation Matter?" Melnik, M.I and J. Alm 3

"The role of Institutions in the revival of trade: the law merchant, Private
judges, and the champagne fairs" Milgrom, North and Weingast 3

" Experimental games for the design of reputation management system"

C.Keser 4

"ERC: A Theory of Equity, Reciprocity and Competition." Bolton, G.E and A.

Ockenfels (2000). 4

"Trust among Strangers in Internet Transactions: Empirical Analysis of e-

Bay's Reputation System" Resnick, P. and Zeckhauser 4

“Evidence of the Effect of Trust Building Technology in Electronic Markets:

Price Premiums and Buyer Behavior.” Ba, S. and P.A. Pavlou (forthcoming). 5

“The Coevolution of Trust and Institutions in Anonymous and Non-

anonymous Communities.” Güth, W. and A. Ockenfels (forthcoming). 5

“Reputation in Auctions: Theory and Evidence from eBay.” Houser, D. and J.

Wooders (2001). 6

Current paper : "How Effective are Online Reputation Mechanisms?"

6
Game presentation 6

The game design 6

Result of the  three market experimental design: 7

Analysis of the results: 8

Some Criticism about this study: 11

Conclusion 11

Addressed to Professor Masclet and Professor Denant-Boèmont 2

Introduction
We try to analyze the article "How Effective are Online Reputation
Mechanisms?" written by Gary E Bolton, Elena Katok and Axel Ockenfels in May
2002.

This article explain in what extent the feedback mechanisms is mitigate the
moral hazard problems associated with auction markets on internet.

This problem come from the fact that seller could not send the product to his
buyer when he receive the money if he is not honest, so their is a problem of
trust for the buyer. It's a Prisoner's dilemma, a feedback mechanisms may
solve it.

First we analyze few references of the authors, then we present the game and
his result, then we try to analyze this study and make few criticism.

We realize this table in order to reveal some equilibrium on the stranger

market.

Buyer/ Ship no Ship

Seller

Buy 0,5 ; 0,5 0 ; 0,7

Don't Buy 0,35 ; 0,35 0,35 ; 0,35

We observe that it is a Prisoner's dilemma which conduct to no transaction.
This is understable considering the one-shot effect. The reputation mechanism
is here to solve this problem.

Review of litterature
"Does a seller's e-commerce Reputation Matter?" Melnik, M.I and J. Alm
Working paper, Georgia

They examine the willingness to pay for a mint condition US $5 Gold coin on e-
Bay in 1999. They wanted to know if the seller's reputation have an impact on
the price of the product. They finally managed after their studies to the
conclusion that a good reputation have positive impact on the product price.
It's mean that if you have a good reputation you can set a price higher.

"The role of Institutions in the revival of trade: the law merchant, Private judges, and
the champagne fairs" Milgrom, North and Weingast
Economics and politics

In this paper, the authors works on the law merchant. This law was applied by
gild of merchant in medieval time. This law solves the classic prisoner's
Addressed to Professor Masclet and Professor Denant-Boèmont 3
dilemma. In this dilemma, each merchant have incentive to cheat the other if
there is only one transaction. In the case of repeated interaction, it would be
honest dealing if they adopt the "tit-for-tat" strategy: "if you cheat me i will
punish you". The "tit-for-tat" becomes "tit-for-tat" adjusted: it's mean that if
you cheat a merchant, you will be punished by the next merchant you deal
with. It is obvious, that kind of mechanism works only on community where
everybody knows everybody. This mechanism works well because it is
profitable to cheat the cheater and if you not punish the cheater, you will be
punished.

" Experimental games for the design of reputation management system" C.Keser
Dr Keser realized this experiment in order to quantify the increase in trust
produced by two versions of reputation management systems. He used the
long run reputation management system ( seller history of notation) and a
short run reputation system (buyers see only the last notation). The doctor
used experimental economics which involved 320 students. Keser underline
thank to his experiments that a reputation mechanisms increase the number of
transaction but he also remark that the long run reputation is more efficient
than the short run. The trust and truswothiness are both increased by more
than 50% while they are only rose by more than 30% in the short run
mechanism.

"ERC: A Theory of Equity, Reciprocity and Competition." Bolton, G.E and A.

Ockenfels (2000). 
American Economic Review, 90, 166-193.

This study explain how and why people collaborate on a market where the
relative standing is important. It explain that the strategic situation can be
deduce from two of the most elementary games: ultimatum and dictator.
Taken together, these games have a flash point where self-interest is
subjugated to concern for relative standing. But what is this concern for
relative standing? Is it altruism, equity, or reciprocity? And there is a second
deeper question: Why should people care about relative standing? This study
speculate that the answer to the first question is ‘reciprocity’ and that the
answer to the second question has to do with biology. Several experimental
studies cast doubt on the proposition that people care about distribution in a
way that we would expect an altruist to care. The same evidence suggests that
people are willing to sacrifice little to defend equity as a principle. The authors
suppose that evolution has molded human for successful group living. People
may then have a propensity to contribute to the group, because a successful
group contributes to their own individual biological success. In our case, it
means that sellers are fair-play.

"Trust among Strangers in Internet Transactions: Empirical Analysis of e-Bay's

Reputation System" Resnick, P. and Zeckhauser
Draft paper prepared for NBER workshop.

The authors realized this study in order to answer to the question : why buyers
trust unknown sellers in the vast electronic garage sale ? They used data from
Addressed to Professor Masclet and Professor Denant-Boèmont 4
e-Bay on 1999 which represent million of items. Finally they underlined two
facts. The first one was there is a hight rate of providing evaluate, that may
explain why buyers trust sellers who have good reputation.The other fact they
observed was the extreme rarely of neutral or negative evaluation. The last
one was named the High Courtesy Equilibrium which involved that when
buyers rate, they rate positively or they don't evaluate at all. More over this
phenomenon is strengthen on platform like e-Bay which allow sellers to rate
buyers. That means a seller will rate positively the buyer in order to be rated in
the same way.

“Evidence of the Effect of Trust Building Technology in Electronic Markets: Price

Premiums and Buyer Behavior.” Ba, S. and P.A. Pavlou (forthcoming).
MIS Quarterly.

This study show that the mechanism of feedback is equivalent to a reputation

built between two partner but it certainly be weaker.

This article suggest that seller's reputation, reflected through his feedback
profile, plays a very important role in buyer trust building.

Moreover this study suggest that people who have a better reputation could
sell their goods to a higher price.

“The Coevolution of Trust and Institutions in Anonymous and Non-anonymous

Communities.” Güth, W. and A. Ockenfels (forthcoming).
Jahrbuch für Neue Politische Ökonomie, 20, Tübingen: Mohr Siebeck.

This article analyze how the institutional environment drives the evolution of
trust and trustworthiness through the evolution of moral preferences. I explain
that modern online communities that are cheaply connected via electronic
communication channels may imitate small group detection technologies
Addressed to Professor Masclet and Professor Denant-Boèmont 5
through sophisticated computerized feedback systems and thus partly crowd
out legal institutions.

“Reputation in Auctions: Theory and Evidence from eBay.” Houser, D. and J.

Wooders (2001).
Working Paper, University of Arizona.

This article examine the effect of reputation on price in a data set drawn from

the online auction site eBay. Our main empirical result is that seller, but not

bidder, reputation has an economically and statistically significant effect on

price.

Current paper : "How Effective are Online Reputation

Mechanisms?"
Game presentation
The Study on which we focus on is «How Effective are Online Reputation
Mechanisms». This study was realized by Gary E Bolton, Elena Katok and Axel
Ockenfels. The goal of this paper is to measure the effectiveness of online
reputation mechanisms and to regard the behavior that they induce. To realize
this study they have 144 participants who have incentive to participate by
cash.

In order to measure the effectiveness of reputations mechanisms, the authors

focused on the shipping. They set 3 kind of game:

• Stranger Market: it’s a market with no reputation system. It is use as

reference
• Reputation Market: it's market with a reputation mechanism which track
seller's history of shipping. This history is available for prospective buyers.
• Partner market: it's market with no reputation mechanisms but when the
same people interact together all the time.

The game design

They set a game with 16 traders playing during 30 rounds. In each round, they
matched 2 players together: one buyer and one seller. The role assignment
(buyer or seller) is random but is restricted by the fact that each trader is
buyer half time and seller half time.

Addressed to Professor Masclet and Professor Denant-Boèmont 6

 to understanding differences in transaction behavior across markets (we find substantial
differences) is how buyers react to information about the sellers they are paired with. If buyers
Figure 1. The buyer-seller encounter
discriminate between sellers who have been trustworthy in the past and those who have not been,
Buyer's Choice 1. The role assignment is pick randomly
then sellers will have an incentive to be trustworthy. For this reason, we look at buyer behavior
buy not buy between buyer and seller
in some depth.
Seller's Choice 2. Buyer choose to buy or not one item
ship not ship Buyer earns $0.35 at a fixed price
Seller earns $0.35
3.1 Treatment effects 3. The seller choose to ship the product
Buyer earns: $0.50 $0
Seller earns: $0.50 $0.70 or topatterns.
keep the These
buyer’s money
The major treatment effects have to do with trading can be measured
4. The player are paid
three ways: efficiencyor the percentage of potential transaction completed (Figure 2), trust or
Figure 1 illustrates the buyer-seller encounter. Game moves and payoffs can be
the percentage
nterpreted in the following way. Both of
the buy
seller orders givenare(Figure
and the buyer endowed3),
withand trustworthiness
$0.35, which is or the percentage of shipped
he payoff when noitems,
trade takes place. The seller
conditioned on buy offers an item(Figure
orders for sale at4).
a price $0.35three
In all whichfigures, the treatment data has been
Result of the  three market experimental design: 
has a value of $0.50 to the buyer. The seller’s cost of providing the buyer with the item, costs
This experimental
aggregated investigation test three different market type. Let's view
across sessions.
associated with executing the trade, shipping, handling etc., as well as production costs,7 is
results on each market.
$0.20. So each successfully completed trade increases efficiency by creating a consumer surplus
Figure 2. Efficiency measured as how often the gain from trade is realized, by round
of $0.15 and a $0.15 profit for the seller. If the buyer chooses to buy the item, he sends his
100%
endowment of $0.35 to the seller, who then has to decide whether to ship the item, or whether to
90%
keep both the money and the item. If
80%the seller does not ship the item he receives the price plus
70%
his endowment of $0.35 for a total of $0.70. If he ships, he receives the price minus the costs
60% Partners
Efficiency

plus his endowment for a total of $0.50,

50% whereas the buyer receives his value of the item. If the Reputation
40% Strangers
buyer chooses not to buy the item, both
30%
players keep their endowment.
Under the assumption that the
20% buyer-seller encounter is one-shot, the seller, once he
10%
eceives the money from the buyer, has
0% no pecuniary incentive to be trustworthy and to ship the
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
tem. Anticipating this, the buyer may not trust the seller, so that trade does not take place, even
Round
hough it would make everybody better off. This is the basic dilemma online reputation

mechanisms are designed to solve.

Production costs • The

where strangers
either market:
the seller only produces the item once he knows the demand, or the product is
produced before the buyer’s decision is known but costs are not sunk (e.g., when the item can be resold at a price
qual to production On
costs). this market the realized trade is less than 50%
in first periods and fall to
less than 10% at the middle of the game with a mean of 14,3%.
6
Trust, measured as the percentage of buying per round, start at about 70% on
the beginning to fall at less than 20% at the end with a mean of 37,1%.

Trustworthiness, measured as percentage

11 of shipping per round, is very
variable during the game, with a mean of 35,7%.

• The reputation market:

On this market the realized trade is between 30% and 60%.

Trust decrease from 80% to 40% in the ten first period and become very
variable after.

Trustworthiness is higher than 50% except on the last two periods.

Addressed to Professor Masclet and Professor Denant-Boèmont 7

• The partners market:
On this market the realized trade is very stable at about 70%, it only decrease
on the last two periods.

Trust is also very stable at more than 80%.

Trustworthiness is higher than 80% except on the last two periods.

For all those variable there is a end game effect, player know there is a high
chance of deviation because they wouldn't have to trade with this players after
the end of the game.

Below all the means of different variables on different markets.

MEANS trade trust trustworthiness

strangers 14,3 % 37,1 % 35,7 %

reputation 40,7 % 55,6 % 72,8 %

partners 73,9 % 83,3 % 88,5 %

Analysis of the results: 

After they collected all the data from their experiments they made a probit
model which explain the buyers trust and to know if the variable are
significant.

The main coefficients which interest us are the TOTALSHIPreputation,

TOTALNOSHIPreputation, CBHS, CBNH, SHIPLASTreputation and
NSHIPLASTreputation.

With TOTALSHIPreputation and TOTALNOSHIPreputation, we watched

that a "bad reputation" is more impacting than a good reputation.

We noticed also with the table that the last ship is very important, in fact when
the seller ship the last order it has a significant impact on the buyers trust ( O,
212 to 0,06 for SHIPLASTreputation against TOTALSHIPreputation).

Addressed to Professor Masclet and Professor Denant-Boèmont 8

 Table 2. Random effects probit models, buyersa
Maximum likelihood estimates (and two-sided p-values) for buyer behavior
Dependent variable = “1” for buy
Independent variable Model 1 Model 2 Model 3
CONSTANT 0.533 0.347 0.524
(.0040) (.0185) (.0001)
REPUTATION -0.020 0.200
= 1 if buyer is from reputation treatment, and 0 else. (.9473) (.4347)
PARTNERS 0.963 1.48 0.852
= 1 if buyer is from partners treatment, and 0 else. (.0001) (.0000) (.0011)
TOTALSHIPreputation 0.0616
= number of seller ships prior to last order. (.0014)
TOTALNOSHIPreputation -0.124
= number of seller no ships prior to last order. (.0144)
SHIPLASTreputation 0.212
= 1 if reputation seller shipped last order, and 0 else. (.2111)
NSHIPLASTreputation -0.646
= 1 if reputation seller did not ship last order, and 0 else. (.0005)
SHIPLASTpartners 1.330
= 1 if seller in partners shipped last order, and 0 else. (.0000)
NSHIPLASTpartners -.697
= 1 if seller in partners did not ship last order, and 0 else. (.0100)
CBSH 0.045 -0.005b
= number of past times item was shipped to buyer. (.0180) (.8386)
CBNH -0.412 -0.386b
= number of past times buyer bought but not shipped. (.0000) (.0000)
ROUNDstrangers -0.062
= round in strangers treatment, and 0 else. (.0000)
ROUNDreputation -0.019
= round in reputation treatment, and 0 else. (.0006)
ROUNDpartners 0.006
= round in partners treatment, and 0 else. (.4806)
LAST2ROUNDstrangers -0.151 -0.390 -0.404
= 1 if round 29 or 30 in strangers treatment, and 0 else. (.6414) (.1649) (.1671)
LAST2ROUNDreputation -0.903 -0.944 -0.974
= 1 if round 29 or 30 in reputation treatment, and 0 else. (.0000) (.0000) (.0000)
LAST2ROUNDpartners -1.15 -1.200 -1.322
= 1 if round 29 or 30 in partners treatment, and 0 else. (.0000) (.0000) (.0000)
RHO 0.399 0.456 .444
(random effects) (.0000) (.0000) (.0000)
Number of observations 2160 2160 2160
Log-likelihood -1087.77 -1056.57 -988.67
!2 p-value .0000 .0000 .0000
a
Analogous estimates for fixed effects linear models are given in Appendix B.
b
History for Partner’s buyers does not include last transaction.

In the and
reputation same way as
strangers, weindicated
can also notice
by the what
treatment we named
dummy a "loss
PARTNERS, confident
but controlling foreffect"
with the CBHN. It's mean that when you were disappointed in the past by one,
end-game
two or effects the trust
even more shownfrom
cheating by partners
sellers, isyou
remarkably
have somestable over time:
difficult The sellers
to trust
after.
ROUNDpartners coefficient is small and not significant. ROUNDreputation is also small, but

14

Addressed to Professor Masclet and Professor Denant-Boèmont 9

condition their buying decision on shipping history. (Models in Table 2, to be discussed in a

moment, show this more formally.)

Figure 5. Marginal trust conditioned on last feedback across treatments*

20%
Strangers Reputation Partners

marginal effect on probability of trust

10%

0%

-10%
untrustworthy
trustworthy
-20%

-30%

-40%

-50%

* The base rate (the zero line) is the average buy over all encounters for each
treatment separately (37.08 percent in strangers, 55.56 percent in reputation
and 83.22 percent in partners).

This kind of conditional buying is rational since the seller’s history has predictive power
In order to measure the improvement in trust, the author compared Stranger
for his future
Market andperformance.
ReputationTable 3 presents
market. Theya random effect probit
remarked that for
thesellers. We can see that
last feedback is very
important
shipping the onlast the
time reputation market
both a reputation and than
partneron the stranger
market market.
seller received a buy Buyers
order is atrust
with a probability of 33 % if seller no ship the last time and rose to 65% if the
significant
seller shippredictor
the last of whether
time. theSo seller will do so this
the reputation time. (The
mechanism may coefficient
improve for the
number of transaction.
LASTSHIPstrangers is significant as well but with a negative sign.) Further, a last decision to
ship is more highly predictive of shipping this time in partners than in reputation markets (two-
They
tailed pcompared also
= 0.0121, Wald the Partner Market and the Reputation Market in order to
test).
see what is good and what is wrong. Comparing to the partner market, the
feedback do not work perfectly on the reputation market. They explained that
by the fact that when you send a feedback on the reputation market it profit to
everybody. When you send a signal on a partner market, it will benefit only to
the one who sent it. In fact we can16consider that the signal is a public good
and people , so people have to deal with free-riding problem. We can say that
feedback in reputation market is costly than in the partner one. An other thing
which can explain the less efficiency of reputation market is the fact that seller
history is diluted by the own buyers history.

Concerning the pay-off, there is a positive correlation between the trust and
the payoffs. That mean the payoffs are higher in reputation market than in the
stranger market.

Addressed to Professor Masclet and Professor Denant-Boèmont 10

 Some Criticism about this study: 
Figure A1. Buyer screen

We have few criticism to do about this

study.

First of all, players see a feedback of all

previous transaction of their temporary
partners. Results might be different if they
see a global grade which is more common
in reality even if people can see all
feedback by a second click. Not all buyer
go to see the historical of their seller
which is very different because when you
build your trust on a grade you don't know
if the seller had a good behavior in his last
transaction, maybe because you don't care or you don't think about this...

An other criticism could be that this study don't care about the price of the
exchanged product, a buyer would spend more time to inspect his seller
feedback history if he want to buy to him a 1000$ good whereas for a 10$
good the opportunity cost is to high.

If a product is very rare, if only one seller sell it and if a buyer really want it he
may risk his money30
even if the seller haven't got a good feedback history.

The study venture the hypothesis that post a feedback is not beneficial to the
buyer. It neglect the social aspect of the Internet. It's socially enhancive for
people to produce information, it's one of the major motor of web 2.0.

Conclusion
After this study the authors take away two main fact. They conclude first that a
market works better with a reputation system. This observation is strengthen
by the strong end game effect which involved that their some strategies played
during the game. The second point which they keep in mind is the public
characteristic of the feedback that explain why the partner market works
better than the reputation one.

Authors also noticed that there may be newbies problems due to the non-cost
of change your identity on internet. There is also the emotional side with
revenge effect and people generally stopped their choice when they are
satisfied and not when they reach optimum choice.

Addressed to Professor Masclet and Professor Denant-Boèmont 11