Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry

Abstract

U NLESS quality is apparent at the point of sale, the market must find ways to ensure the delivery of high-quality products; otherwise, producers have incentives to sell low-quality goods at high-quality prices, thereby assuring a degenerate equilibrium.1 Various solutions to this problem have been proposed, most revolving around bonding mechanisms.2 For bonds to work, however, consumers must react to the delivery of less-than-promised quality.3 In general, the faster consumers detect and react to delivery of low-quality products, the more efficient the market is in delivering high-quality products.4 Despite its prominence in the theoretical literature, direct evidence of consumer response to less-than-promised quality is rarely measured. This is a shortcoming presumably attributable to the difficulty of measuring both the difference between expected and actual product quality and