354 • Chapter 10 • Information and Value Creation
3.To minimize multitasking, certifiers should measure quality at the most aggregated level possible. For example, instead of reporting cardiac surgery outcomes, they should report outcomes for patients with heart disease.
4.Certifiers should complement outcome measures with process and input measures.
5.When appropriate, report card scores should be risk adjusted.
THE CERTIFIER MARKET
Certifiers create value for consumers by helping them find the best sellers. Certifiers may be able to extract some of this value for themselves by charging for their services. Some firms, including Consumers’ Union and Angie’s List, receive most of their revenue from certification services. Other firms offer certification as a complement to their primary business. Newspapers and magazines publish movie reviews to sell subscriptions and increase advertising revenues. In a remarkable example of complements, Michelin Tires published the first Michelin Guide in 1900 to encourage drivers to tour France by car.
Nowadays, many e-businesses offer certification as a complement to their core business. Amazon provides user reviews of the books, DVDs, and the cornucopia of other goods and services that it sells. Amazon’s web site is so convenient that few customers who find favorable reviews of a product at Amazon will search elsewhere for a better price. OpenTable.com allows diners to easily make reservations while offering extensive customer reviews. OpenTable does not charge diners for its services, and instead makes its money from restaurants, which pay a fee per reservation equal to about 1 percent of the dining bill. Amazon, OpenTable, and countless other web sites also make money by collecting and selling information about the habits of their users. This information can facilitate the matching of consumers and sellers, as we describe below.
Some certifiers succeed because their reviews are interesting to read, even if they are often highly idiosyncratic and do not always reflect mainstream tastes; film critics like Roger Ebert and Dave Kehr come to mind. Whether or not they are entertaining, most certifiers rely on a reputation for accuracy, as consumers will ignore those certifiers whose recommendations do not square with personal experience. Going hand- in-hand with accuracy, certifiers must also be unbiased. Unfortunately, bias can creep into certification, either intentionally or inadvertently.
Certification Bias
Certifiers depend on their reputations for neutrality, and the recommendation of a highly regarded certifier can cause consumers to reevaluate their own opinions about a seller, potentially changing the fortunes of a seller or even transforming an entire industry. Consider the following two examples. Japanese carmakers did not make major inroads into the U.S. market until the 1970s, when they garnered top ratings in Consumer Reports. Thanks to favorable reviews, Japanese automakers’ combined market share in the United States rose from 3 percent in 1970 to 20 percent in 1980.19 California table wines were considered cheap substitutes for French wine until California vintners swept the “best in category” awards at the Paris Wine Tasting of 1976, where 9 of the 11 judges in the blind tasting were French. Sales of California wines took off, as did prices.
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Consumers may be concerned when business relationships create a potential conflict of interest between certifiers and the firms they certify. Conflicts of interest may arise in one of two ways. First, certifiers may require data from the firms they certify. Second, certifiers may be paid directly by the firms they certify. Often the two occur simultaneously. For example, audiophile magazines such as Stereophile or China’s Audio Technique rarely issue negative product reviews. Many readers suspect that these magazines depend on audio manufacturers to provide products for testing and for advertisements and are therefore reluctant to bite the hands that feed them. One reason why Consumer Reports is so well respected is that it does not print outside advertising or accept free product samples.
Conflicts of interest are a great concern in the financial certification market. When a publicly traded company wishes to borrow money, it issues bonds. The U.S. Securities and Exchange Commission, the European Economic Commission, and other financial regulatory agencies require that all public bonds receive a rating from a certified agency. The three largest agencies certified to rate bonds issued by U.S. corporations are Moody’s, Standard and Poors, and Fitch Ratings. Corporations that wish to issue bonds must choose one of these three agencies for certification. The chosen agency gets detailed information about the bond-issuing company, and the rating it issues determines the interest rate that the corporation must pay to bond buyers.
Prospective bond purchasers expect that bond ratings will be unbiased, but numerous studies indicate that conflicts of interest may compromise the bond-rating market. These concerns were heightened during the financial crisis of the late 2000s. Conflicts of interest may arise in bond markets because certifiers compete to be chosen by bond issuers. Bond issuers want the most favorable rating in order to hold down financing costs, and certifiers may be tempted to issue generous ratings in order to curry favor with sellers. Indeed, the presence of multiple certifiers may encourage a “race to the bottom,” as certifiers use generous ratings to try to land bond-rating business.
Similar concerns about conflict of interest arise in the brokerage market. Investment banking firms such as Goldman Sachs make money by underwriting new stock issues, but they also sell investment advice. Research shows that “buy” recommendations made by analysts affiliated with underwriting firms tend to be overoptimistic compared with recommendations by independent analysts.20 Moreover, overly optimistic analysts within underwriting firms tend to advance up the career ladder more rapidly. This research suggests that underwriters may curry the business of firms seeking to issue new stock by making optimistic forecasts. This is not necessarily bad for investors, provided they know about the conflict of interest and discount the forecasts accordingly.
Consumers should be skeptical of most certifiers, at least until they have proven to be neutral and accurate. But successful certifiers face a strategic dilemma: they can “cash in” on their reputation by investing less in accuracy or by taking “bribes” from sellers in return for biased reviews. Consider that after Consumer Reports admitted inaccuracies in recent tests of child safety seats, consumers chalked this up to a well-intentioned mistake and the magazine lost no subscribers. With so much good will behind it, the temptation for Consumer Reports to deliberately underinvest in accuracy, or to accept covert side payments in exchange for favorable reviews, must be great. To date, there is no reason to believe that Consumer Reports has succumbed to such temptation.
Consumer Reports is the dominant rater of automobiles and other consumer goods because consumers believe it is the most accurate and reliable rater. Competition among certifiers to be deemed the most accurate does not always lead them to issue unbiased reviews. A good example is provided by stock analysts. Investors delegate responsibility for picking stocks to analysts, who receive a commission based on the