Reputational Incentives for Restaurant Hygiene

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

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

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 1998 => 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

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=rwith 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