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A Shirking Theory of Referrals

  • Damien S Eldridge

    ()

    (Department of Economics and Finance, La Trobe University)

Many service industries, including the medical and legal professions in some countries, display a gated structure. Rather than approaching a final producer directly, a consumer will first seek a referral from an intermediary. In this paper, we provide one possible explanation for such an industry structure. If the outcome of a transaction depends on producer effort, which is unobservable and unverifiable, then the market may fail to generate a Pareto optimal outcome. This is the standard moral hazard problem. If consumers had a long-run relationship with producers, this type of market failure might be avoided. However, in some industries, consumers will only have a short-run relationship with producers. A gate-keeping intermediary may provide an opportunity for reputation effects to apply in such a setting. By aggregating many potential consumers, gate keeping intermediaries can create an artificial long-run relationship between a consumer and a producer. This long-run relationship reduces the incidence of shirking on the part of the producer.

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File URL: http://www.latrobe.edu.au/__data/assets/pdf_file/0017/130904/2007.05.pdf
File Function: First version, 2007.05.pdf
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Paper provided by School of Economics, La Trobe University in its series Working Papers with number 2007.05.

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Length: 44 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:ltr:wpaper:2007.05
Contact details of provider: Web page: http://www.latrobe.edu.au/economics

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