R. Jurca and B. Faltings
Reputation mechanisms offer an effective alternative to verification authorities for building trust in electronic markets with moral hazard. Future clients guide their business decisions by considering the feedback from past transactions; if truthfully exposed, cheating behavior is sanctioned and thus becomes irrational.
It therefore becomes important to ensure that rational clients have the right incentives to report honestly. As an alternative to side-payment schemes that explicitly reward truthful reports, we show that honesty can emerge as a rational behavior when clients have a repeated presence in the market. To this end we describe a mechanism that supports an equilibrium where truthful feedback is obtained. Then we characterize the set of pareto-optimal equilibria of the mechanism, and derive an upper bound on the percentage of false reports that can be recorded by the mechanism. An important role in the existence of this bound is played by the fact that rational clients can establish a reputation for reporting honestly.