How Do Consumers Motivate Experts? Reputational Incentives in an Auto Repair Market

Moral hazard exists in expert service markets because sellers have an incentive to shade their reports of buyers' condition to increase the short-run demand for their services. The California vehicle emission inspection market offers a rare opportunity to examine how reputational incentives work in such a market. I show that consumers are 30% more likely to return to a firm at which they previously passed than one at which they previously failed, and that demand is sensitive to firms' failure rate across all consumers. These and other results suggest that demand incentives are strong in this market because consumers believe that firms differ greatly in their consumer-friendliness and are skeptical even about those they choose. Weak demand incentives in other expert service markets are not a direct consequence of moral hazard, but rather its interaction with switching costs and consumers' beliefs that firms are relatively homogeneous