Overcompliance, labeling, and lobbying: The case of credence goods

This paper presents a model of quality choice in the case of credence goods, i.e., when consumers cannot observe quality even after purchase. It shows that firms may voluntarily overcomply, i.e., produce high quality, even when doing so implies giving up short-run profits. This generalizes results on reputation effects derived in the IO literature for the case of experience goods. The crucial assumptions of the model are that there is a positive degree of monitoring of firms' claims and a positive probability that the firm is of an "honest type," i.e., always prefers to produce high quality. The result also helps explain why we see phenomena such as firms voluntarily overcomplying with environmental standards, food safety laws, etc. It is shown that overcompliance is more likely when consumers learn about all (positive and negative) monitoring results than when consumers only find out about firms that have been found cheating, as is often the case in practice. I further show that even firms that pretend to be producing high quality while really producing low quality may have an incentive to lobby for stricter monitoring. This helps explain, for example, why firms in Europe and the United States lobby for the implementation of voluntary environmental audits, third-party labeling agencies or other disclosure strategies.