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Efficiency and Robustness of Binary Feedback
Mechanisms in Trading Environments with
Moral Hazard
Paper 170
Chris Dellarocas
January 2003
E ciency and Robustness of Binary Feedback Mechanisms in
Trading Environments with Moral Hazard
Chrysanthos Dellarocas ∗
January 23, 2003
Abstract
This paper oers a systematic exploration of online feedback mechanism design issues in
trading environments with opportunistic sellers, imperfect monitoring of a seller's eort level,
and two possible transaction outcomes (corresponding to high and low quality respectively),
one of which has no value to buyers. The objective of feedback mechanisms in such settings is
to induce sellers to exert high eort and, therefore, to maximize the probability of high quality
outcomes. I study a practically signi cant family of mechanisms that resembles aspects of the
one used by online auction house eBay. These feedback mechanisms solicit binary ratings of
transaction outcomes as either positive or negative and publish the sums of ratings posted by
buyers on a seller during theN most recent periods. My analysis nds that such binary feed-
back mechanisms can induce high average levels of cooperation that remain stable over time.
Surprisingly, their e ciency cannot be improved by summarizing larger numbers of ratings or by
publishing a seller's detailed feedback history. I further examine the robustness of these mecha-
nisms to incorrect or incomplete feedback as well as to strategic changes of online identities. The
theoretical outcomes predicted by this paper are consistent with empirical observations and oer
theory-backed explanations to hitherto poorly understood phenomena such as the remarkably
low fraction of negative feedback on eBay.
∗Address: MIT Sloan School of Manageme