Customers' Complaints and Quality Regulation

This paper studies the informativeness of customer complaints and their potential as a regulatory tool in contexts in which quality is not verifiable and consumers cannot (fully) appropriate the benefits of their complaints. The conventional wisdom about complaints is that the smaller the number of customers that complain, the better the market is performing. However, its theoretical foundations are unclear. On one hand, consumers may be well informed about the quality of the service they received and hence, more complaints may be indicative of lower quality. On the other hand, empirical evidence suggests that complaints are driven by expectations as well as by actual quality. Hence, consumers' complaint decisions are based on the difference between the qualitythey received and some reference point. Combined with the existence of different degrees of free riding, this implies that consumers' incentives to complain may vary across markets and along time. As a result, more complaints may reflect higher expectations or lower free riding incentives and not lower quality. This paper identifies conditions under which complaints may help overcome the regulators' lack of information about the firm's investment. It is shown that consumer complaints are not always informative and that this lack of informativeness can be worsened by the repeated interaction between the firm and the consumers. Furthermore, the paper shows that the absence of a reference point results in the proportion of complaints being independent of the realised level of quality(and hence, even less informative).