The Market for Reputations as an Incentive Mechanism

Can an active market for firm reputations provide their owners with incentives to exert effort even when these owners have finite horizons? This paper shows that rational agents exert effort even at the end of their finite active career to reap the benefits of selling their firm's good reputation. The market for reputations will always be active in equilibrium if shifts of firm ownership are not observable. Furthermore, market forces equalize the incentives of young and old agents, implying that age does not affect effort. As a result, the anonymous separation of "entity" (firm) from "identity" (owner) may be socially beneficial: if shifts of ownership become public information then the market for reputations can collapse, causing some incentives to disappear. It is also shown that a market for reputations cannot perfectly sort good agents from bad ones.