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The Principal-Agent Relationship in Real Estate Brokerage Services

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  • Michael A. Arnold

Abstract

This article investigates the principal-agent relationship between the owner of a house and her real estate broker. The principal's (owner's) problem is to design a contract that induces the agent (broker) to adopt a selling strategy that maximizes the owner's expected return. A sequential search model is utilized to analyze this principal-agent relationship. Three different systems for paying the broker are considered: fixed-percentage commission, flat-fee, and consignment. Both the discount factors of the owner and the broker and the net costs of ownership incurred while attempting to sell the house play a central role in determining the nature of the optimal contract. The analysis demonstrates that the fixed-percentage commission system is the only one of the three systems considered that can induce a first-best, incentive-compatible contract. A numerical analysis provides insights regarding the effect of the fixed-percentage commission system on competition in the real estate brokerage industry. Copyright American Real Estate and Urban Economics Association.

Suggested Citation

  • Michael A. Arnold, 1992. "The Principal-Agent Relationship in Real Estate Brokerage Services," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 20(1), pages 89-106.
  • Handle: RePEc:bla:reesec:v:20:y:1992:i:1:p:89-106
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/1540-6229.00573
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    References listed on IDEAS

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    1. Salant, S.W., 1990. "For Sale by Owner: When to Use a Realtor and How to Price the House," Papers 90-14, Michigan - Center for Research on Economic & Social Theory.
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    Cited by:

    1. Ken Johnson & Thomas Springer & Christopher Brockman, 2005. "Price Effects of Non-Traditionally Broker-Marketed Properties," The Journal of Real Estate Finance and Economics, Springer, vol. 31(3), pages 331-343, November.
    2. Rutherford, R.C. & Springer, T.M. & Yavas, A., 2005. "Conflicts between principals and agents: evidence from residential brokerage," Journal of Financial Economics, Elsevier, vol. 76(3), pages 627-665, June.
    3. Simon Loertscher & Andras Niedermayer, 2008. "Fee Setting Intermediaries: On Real Estate Agents, Stock Brokers, and Auction Houses," Discussion Papers 1472, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Timothy E. Jares & James E. Larsen & Thomas S. Zorn, 2000. "An Optimal Incentive System For Real Estate Agents," Journal of Real Estate Research, American Real Estate Society, vol. 20(1), pages 49-59.
    5. Jonathan Wiley & Leonard Zumpano & Justin Benefield, 2011. "The Limited-Service Brokerage Decision: Theory and Evidence," The Journal of Real Estate Finance and Economics, Springer, vol. 43(3), pages 336-358, October.
    6. Terrence Clauretie & Nasser Daneshvary, 2008. "Principal–Agent Conflict and Broker Effort Near Listing Contract Expiration: The Case of Residential Properties," The Journal of Real Estate Finance and Economics, Springer, vol. 37(2), pages 147-161, August.
    7. Xun Bian & Bennie D. Waller & Abdullah Yavas, 2017. "Commission Splits in Real Estate Transactions," The Journal of Real Estate Finance and Economics, Springer, vol. 54(2), pages 165-187, February.
    8. Derek Stacey, 2012. "Information, Commitment, and Separation in Illiquid Housing Markets," 2012 Meeting Papers 401, Society for Economic Dynamics.
    9. Bruce, Donald & Santore, Rudy, 2006. "On optimal real estate commissions," Journal of Housing Economics, Elsevier, vol. 15(2), pages 156-166, June.
    10. Chang-Tai Hsieh & Enrico Moretti, 2003. "Can Free Entry Be Inefficient? Fixed Commissions and Social Waste in the Real Estate Industry," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1076-1122, October.
    11. John D. Benjamin & G. Donald Jud & G. Stacy Sirmans, 2000. "Real Estate Brokerage and the Hosting Market: An Annotated Bibliography," Journal of Real Estate Research, American Real Estate Society, vol. 20(1), pages 217-278.
    12. Xun Bian & Geoffrey K. Turnbull & Bennie D. Waller, 2017. "Client Externality Effects of Agents Selling Their Own Properties," The Journal of Real Estate Finance and Economics, Springer, vol. 54(2), pages 139-164, February.
    13. Oz Shy, 2012. "Real Estate Brokers and Commission: Theory and Calibrations," The Journal of Real Estate Finance and Economics, Springer, vol. 45(4), pages 982-1004, November.
    14. repec:spr:jstada:v:4:y:2017:i:1:d:10.1186_s40488-017-0067-2 is not listed on IDEAS
    15. Thomas Miceli & Katherine A. Pancak & C. F. Sirmans, 2000. "Restructuring Agency Relationships in the Real Estate Brokerage Industry: An Economic Analysis," Journal of Real Estate Research, American Real Estate Society, vol. 20(1), pages 31-47.
    16. Rudolph, Patricia M., 1998. "Will Mandatory Licensing and Standards Raise the Quality of Real Estate Appraisals? Some Insights from Agency Theory," Journal of Housing Economics, Elsevier, vol. 7(2), pages 165-179, June.
    17. Bian, Xun & Waller, Bennie D. & Turnbull, Geoffrey K. & Wentland, Scott A., 2015. "How many listings are too many? Agent inventory externalities and the residential housing market," Journal of Housing Economics, Elsevier, vol. 28(C), pages 130-143.
    18. Ying Li & Abdullah Yavas, 2015. "Residential Brokerage in Hot and Cold Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 51(1), pages 1-21, July.
    19. Sirmans, C. F. & Turnbull, Geoffrey K., 1997. "Brokerage Pricing under Competition," Journal of Urban Economics, Elsevier, vol. 41(1), pages 102-117, January.
    20. Vickie L. Bajtelsmit & Elaine Worzala, 1997. "Adversarial Brokerage in Residential Real Estate Transactions: The Impact of Separate Buyer Representation," Journal of Real Estate Research, American Real Estate Society, vol. 14(1), pages 65-76.
    21. Jonathan Wiley & Justin Benefield & Marcus Allen, 2014. "Cyclical Determinants of Brokerage Commission Rates," The Journal of Real Estate Finance and Economics, Springer, vol. 48(1), pages 196-219, January.
    22. Lu Han & William C. Strange, 2014. "Bidding Wars for Houses," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 42(1), pages 1-32, March.
    23. John D. Benjamin & G. Donald Jud & G. Stacy Sirmans, 2000. "What Do We Know About Real Estate Brokerage?," Journal of Real Estate Research, American Real Estate Society, vol. 20(1), pages 5-30.
    24. Nasser Daneshvary & Terrence Clauretie, 2013. "Agent Change and Seller Bargaining Power: A Case of Principal Agent Problem in the Housing Market," The Journal of Real Estate Finance and Economics, Springer, vol. 47(3), pages 416-433, October.
    25. John D. Benjamin & Peter T. Chinloy, 2000. "Pricing, Exposure and Residential Listing Strategies," Journal of Real Estate Research, American Real Estate Society, vol. 20(1), pages 62-74.

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