Online Reviews and the Survival of New Firms

Abstract

Studies on new business survival find that many ventures fail in their first or second year, and as much as half of them fail by year five. To be successful, entrepreneurs must sort many challenges, from securing financing to managing daily operations. The rising popularity of online review platforms adds a new challenge for new business owners. They now need to manage their online reputation effectively. In this paper, I examine the effect of ratings obtained in Yelp (a popular online review platform) on new restaurant survival in New York City. To establish a causal relationship between ratings and business survival, I take advantage of the way Yelp reports average ratings. This platform rounds average ratings in half-star increments. Thus, a restaurant that obtains an average rating of 3.75 will appear as a 4 stars restaurant, while a restaurant that obtains an average rating of 3.74 will appear as a 3.5 stars restaurant. This allows me to estimate the effect of a half-star difference in rating for two establishments with very similar ratings. Using a regression discontinuity design, I estimate that a half-star rating increase is associated with a decrease of 4% in the probability of failure by year two. This is a large effect, considering that 14% of restaurants in my sample fail in their first two years.

Publication
In Work in Progress.
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