Do negative externalities affect platform membership conditions? The impact of moral and regulatory legitimacy on platform governance

When allowing third parties to join their platforms, platform owners run the risk of attracting harmful third-party complements. Existing literature considers that low-quality offerings negatively affect cross-side user satisfaction and attractiveness, ultimately harming the platform's reputation and stability. However, recent events show that negative externalities from third-party offerings can also motivate platform sponsors to adapt their membership conditions. Existing platform literature does not explain the underlying theoretical mechanisms. In this paper, we examine why platform sponsors adjust the conditions that govern third parties joining their platforms in response to negative externalities. We apply legitimacy theory to a critical case on a payment transaction platform. We find that negative externalities affect both moral and regulatory legitimacy, which in turn motivate the platform sponsor to adjust the conditions under which third parties may join the platform.