1. The Way Things Used to Work: Reputational Theory and Its Demise

This chapter introduces the traditional theory of reputation in financial markets and gives a few examples of why that theory no longer seems to be accurate. First, it describes the old economic model of reputation, which argues that simple cost-benefit analysis ordinarily should discourage financial firms from acting fraudulently or dishonestly. This is especially relevant in financial markets: Rational individuals will not invest unless they trust that their money will be safeguarded, and this trust can be cultivated only by means of government regulation or a good reputation.

Second, this chapter shows how companies in the manufacturing and consumer goods sectors develop a ...

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