| Summary: | Online reputation mechanisms are emerging as a promising alternative to more
established mechanisms for promoting trust and cooperative behavior, such as legally
enforceable contracts. As information technology dramatically reduces the cost of
accumulating, processing and disseminating consumer feedback, it is plausible to ask
whether such mechanisms can provide an economically more efficient solution to a
wide range of moral hazard settings where societies currently rely on the threat of
litigation in order to induce cooperation. In this paper we compare online reputation to
legal enforcement as institutional mechanisms in terms of their ability to induce
cooperative behavior. Furthermore, we explore the impact of information technology
on their relative economic efficiency. We find that although both mechanisms result in
losses relative to the maximum possible social surplus, under certain conditions online
reputation outperforms litigation in terms of maximizing the total surplus, and thus the
resulting social welfar
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