The Economics of Trust and Reputation

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Luis M B Cabral, Professor of Economics at New York University, theorized in “The Economics of Trust and Reputation” that trust and reputation play an important role in the success of a company.


According to Cabral, trust is established between an organization and its stakeholders through regular interactions that produce consistent results. Cabral suggests there is a positive relationship between trust and the price customers are willing to pay for a product or service — the higher the trust, the more customers are willing to pay. In addition, the more consistent transactions that take place between a seller and a buyer, the harder it is to break any trust previously built between them (whether good or bad).


Cabral’s theory also explains how “investing in reputation” can pay off for a company. He suggests there is a negative relationship between reputation and the amount of money the company must invest in improving their reputation. As reputation increases, company leaders can invest incrementally less into building their reputation without hurting the progress they’ve made.


According to Cabral, therefore, high trust and reputation can together help companies earn higher profits. Not only can a company increase the price of its products and services, it can also decrease its expenses (the amount of money invested in reputation management).


For Cabral, a company’s success hinges on consistency. As stated earlier, inconsistency will most likely decrease the trust and reputation the company has built between itself and its stakeholders. This damage, in turn, decreases the price customers are willing to pay for its products and services. It also increases the amount of money the company must invest in order to restore its reputation.1


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