QUALITY UNCERTAINTY AND ADVERSE SELECTION IN SPONSORED SEARCH MARKETS

Abstract

Sponsored search mechanisms, where advertisers bid for placement to be\nas close to the top in the listing of search results, are the fastest\ngrowing among online search models. Sponsored search in popular search\nservices such as Google and Yahoo! employ an auction mechanism wherein\nfirms can bid, for a better placement in the (sponsored) search results,\non relevant keywords used by consumers in their search process. This\nprovides an unprecedented opportunity to test some of the predictions of\nearlier research relating quality and advertising, in the online\nsetting. While sponsored search mechanisms have been gaining popularity,\nthey can potentially introduce a bias in the listing of search results.\nIn particular, sponsored search mechanisms that enable low quality\nbidders to be placed at the top of the search listings can adversely\naffect consumer welfare. Our study uses data from online sponsored\nsearch auctions to examine the relationship between advertisers' quality\nand their bidding strategies. Specifically we seek to understand if\nadvertisers' bidding strategies differ across products characterized by\ndifferent degrees of quality-uncertainty. Our results indicate that\nthere are significant differences in the bidding strategies of sellers\nof search goods as compared to sellers of experience and credence goods,\nand that there is significant adverse selection in product categories\ncharacterized by greater uncertainty. We discuss the implications of our\nfindings for consumers, advertisers, and intermediaries and provide\ndirections for future research in this emerging context.