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Reputational Incentives for Restaurant Hygiene

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1 Reputational Incentives for Restaurant Hygiene
Ginger Zhe Jin University of Maryland Phillip Leslie Stanford University

2 How does reputation work?
Consumers do not know quality ex ante Consumers learn and form beliefs (=reputation) Consumer beliefs drive consumer choice in the next period Reputation motivates sellers to provide high quality

3 Empirical studies of reputation
Demand Borenstein & Zimmerman (1988) Hubbard (2002) Gompers and Lerner (1998) Brickley, Coles and Linck (1999) Price effect Gorton (1996) eBay reputation studies We focus on supply-side effects Does reputation cause firms to provide high quality? No need to control for consumer prior belief Borenstein and Zimmerman (1988) find a small negative effect of a plane crash on the airline demand, suggesting weak reputational incentives. However, as the authors note, the strength of reputational incentives depends on consumers prior beliefs. A mild response may imply (i) consumers are unresponsive or (ii) consumers have a strong prior belief that includes the expectation of an occasional crash. Hubbard (2002) examines whether a low failure rate of a smog check firm attracts more demand. He uses an individuals past experience at a particular firm as a proxy for consumers prior beliefs. In the absence of a model of consumer learning, it is unclear if this approach adequately controls for consumers prior belief. Cross-sectional demand estimation is conducted in many other industries. For example: Gompers and Lerner 1998: better fund performance, more fundraising by venture organizations. Brickley, Coles and Linck 1999: the better a CEO performs, the better is the CEO’s prospect of serving on the board of directors post retirement. Gorton 1996: in the free banking era of 1800s, lenders demand higher returns from banks without established reputation.

4 Restaurant hygiene January 16, 1998, LA county restaurant inspectors start issuing hygiene grade cards A grade if score of 90 to 100 B grade if score of 80 to 89 C grade if score of 70 to 79 score below 70 actual score shown Grade cards are prominently displayed in restaurant windows Score not shown on grade cards


6 Question In Jin & Leslie (2003) we show that grade cards cause restaurants to improve hygiene => before grade cards there is a shortage of information to consumers Before grade cards, about 25% of restaurants had A-grade hygiene Why have good hygiene if consumers cannot really tell the difference?

7 Reputational incentives
Some restaurants are able to form reputations for good hygiene Depends on underlying factors that affect consumer learning chain affiliation => possible free-riding for franchisees degree of repeat customers in local region => regional clustering in hygiene quality

8 Examples of repeated customers
Brickley & Dark 1987 restaurants close to free way exits have fewer repeated customers may be a poor measure in LA county Residential vs. tourist area Snug Harbor: 93/ 92/ 90 Blue Rose Cafe: 59 / 82/ 72/ 74 Snug Harbor diner in Santa Monica, on Wilshire, that would have almost all repeat business Blue Rose Cafe diner-like place on Venice boardwalk that would have many tourists

9 Alternative explanations
Regional differences in willingness-to-pay for hygiene quality Exogenous restaurant heterogeneity Manager preferences Hygiene cost differences

10 Data and Identification
We observe more information than consumers do All hygiene inspection outcomes in LA county from July 1995 to Dec => hygiene quality Restaurant name, location, chain affiliation and owner identity => variations in consumer learning Grade cards introduced in Jan 1998 Exogenous policy change Grade cards eliminate informational differences across restaurants

11 Basic evidence - chain affiliation
A premise of our approach is that there are systematic differences in hygiene quality across restaurants. These differences occur in two dimensions: chain affiliation regional clustering

12 Basic evidence - regional clustering

13 Region clustering before GC

14 Regional clustering after GC

15 Santa Monica before GC Upper 1/3 Lower 1/3

16 Regressions for chain affiliation:
Before GC only: (kitchen sink) Before and after GC:

17 Kitchen sink regression before GC

18 Chain locations in Santa Monica

19 Full sample with restaurant FE

20 Due to cost differences?

21 Our solution is the mean score after grade cards
Assume that two restaurants in the same city with same post-GC score, have the same hygiene cost function See if the difference in their pre-GC score is related to chain affiliation

22 Regress sB on sA

23 Test of regional clustering
Before GC: After GC: Regional effects before GC: Regional effects after GC:

24 Test 1: Absolute differences in regional effects
Assuming α3=0 implies If rj=r, then We reject equality with 99% confidence

25 Test 2: relative differences in regional effects
Allowing for α3 ~=0 If rj=r, then Estimate with and without restriction: We reject rj=r with 99% confidence

26 Extensions The chain effect may be smaller in regions with a high degree of consumer learning pass absolute differences test for chains fail relative differences test for chains absolute regional effects change less for chains than for non-chains Franchisee free-riding may be smaller in regions with a high degree of consumer learning Tests fail to support this hypothesis

27 Conclusion We analyze reputational incentives by testing supply-side implications The results indicate Chain affiliation is an effective source of reputational incentives A small degree of franchisee free-riding Regional differences in the degree of consumer learning impact hygiene quality for independent restaurants Large impact of grade cards suggests low degree of consumer learning for most restaurants

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