Skip to main content
SpringerLink
Log in

Residential real estate brokerage as a principal-agent problem

  • I. Information and Uncertainty in Brokerage and Appraisal
  • Published:
The Journal of Real Estate Finance and Economics Aims and scope Submit manuscript

Abstract

We analyze the terms of the brokerage contract between a house seller and his agent, using the established literature on the principal-agent problem. Considering the influence of moral hazard and adverse selection, we predict a number of features of the contract. Many of these features are not present in observed contracts. To account for this discrepancy, we discuss certain aspects of the real estate market which are not included in the standard principal-agent model but may explain the difference. Standard principal-agent theory neglects important contract design considerations, namely robustness and costs of complexity. In general, the commission contract performs poorly by failing to allocate risk efficiently or to provide agent incentives. It favors established agents and precludes contractual diversity. Finally, we contrast the brokerage contract for real estate with the dealership contract for used cars, but find no compelling answer as to why there are few used house dealers.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Allen, F. “On the Fixed Nature of Sharecropping Contracts,” Economic Journal, Vol. 95, (1985), 30–48.

    Google Scholar 

  • Arnott, R. and Stiglitz, J. “The Welfare Economics of Moral Hazard.” In Risk, Information and Insurance: Essays in the Memory of Karl H. Borch, ed. by H. Loubergé, Norwell, MA: Kluwer Academic Publishers, 1990.

    Google Scholar 

  • Arrow, K. Aspects of the Theory of Risk Bearing. 1965. Helsinki: Yrjo Jahnssonin Saatio.

    Google Scholar 

  • Boyer, M. and Dionne, G. “An Empirical Analysis of Moral Hazard and Experience Rating”, Review of Economics and Statistics, Vol. 73, (1989), 128–134.

    Google Scholar 

  • Braverman, A., and Stiglitz, J. “Sharecropping and the Interlinking of Agrarian Markets,” American Economic Review, Vol. 72, (1982), 695–715.

    Google Scholar 

  • Carney, M. “Costs and Pricing of Home Brokerage Services,” AREUEA Journal, Vol. 10, (1982), 331–354.

    Google Scholar 

  • Carroll, W. “Fixed Percentage Commission and Moral Hazard in Real Estate Brokerage,” Journal of Real Estate Finance and Economics, Vol. 2, (1989), 349–365.

    Google Scholar 

  • Collette, M. “Sub-Agency in Residential Real Estate Brokerage: A Proposal to End the Struggle with Reality,” Southern California Law Review, Vol. 61, (1988), 399–457.

    Google Scholar 

  • Cooper, R., and Ross, T. “Product Warranties and Double Moral Hazard,” Rand Journal of Economics, Vol. 16, (1985), 103–113.

    Google Scholar 

  • Diamond, P. “Aggregate Demand Management in Search Equilibrium,” Journal of Political Economy, Vol. 90, (1982), 881–894.

    Google Scholar 

  • Diamond, P. and Rothschild, M. Uncertainty in Economics: Readings and Exercises, 1988, Academic Press, San Diego, revised edition.

    Google Scholar 

  • Dionne, G. and St-Michel, P. “Workers' Compensation and Moral Hazard,” (1988), University of Montreal Working Paper No. 8831, Montreal, Canada.

  • Doiron, J., Shilling, J. and Sirmans, C. “Owner versus Broker Sales: Evidence on the Amount of the Brokerage Commission Capitalized,” Real Estate Appraiser and Analyst, (1985), pp. 44–48.

  • Farrell, J. “Moral Hazard as an Entry Barrier,” Rand Journal of Economics, Vol. 17, (1986), 440–449.

    Google Scholar 

  • Federal Trade Commission. The Residential Real Estate Brokerage Industry, Volumes I and II, 1983, U.S. Government Printing Office, Los Angeles.

    Google Scholar 

  • Frew, J. and Jud, D. “Who Pays the Real Estate Broker's Commission?,” Research in Law and Economics, Vol. 10, (1987), 177–187.

    Google Scholar 

  • Guesnerie, R. “Hidden Action, Moral Hazard and Contract Theory.” In vol. 2, J. Eatwell, M. Milgate and P. Newman, eds. The New Palgrave Dictionary of Economics, New York: MacMillan, 1987, 646–651.

    Google Scholar 

  • Hart, O. and Holmstrom, B. “The Theory of Contracts.” In T. Bewley, ed., Advances in Economics, 1987, 75–106.

  • Holmstrom, B. “Moral Hazard and Observability,” Bell Journal of Economics, Vol. 10, (1979), pp. 74–91.

    Google Scholar 

  • Holmstrom, B. and Milgrom, P. “Aggregation and Linearity in the Provision of Intertemporal Incentives,” Econometrica, Vol. 55, (1987), 303–328.

    Google Scholar 

  • Horowitz, J. “The Role of List Price in Housing Markets: Why Sellers Ask for Less than They Can Get?” (1988), University of Iowa working paper No. 88-10, Iowa City, Iowa.

  • Howitt, P. and McAfee, P. “Costly Search and Recruiting,” International Economic Review, Vol. 28, (1987), 89–107.

    Google Scholar 

  • Jacquemin, A., and Slade, M. “Cartels, Collusion and Horizontal Merger.” In R. Schmalansee and R. Willig, eds., ch. 7 of The Handbook of Industrial Organization, New York: North Holland, 1989.

    Google Scholar 

  • Jenkins, A.W. Home, Sweet Home: Real Estate Brokerage in Canada, Vancouver, Canada: The Fraser Institute, 1989.

    Google Scholar 

  • Jensen, M. and Meckling, W. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics, Vol.3, (1976), 305–360.

    Google Scholar 

  • Jewitt, I. “Justifying the First Order Approach to Principal-Agent Problems,” Econometrica, Vol. 56, (1988), 1177–1190.

    Google Scholar 

  • Jud, D. “Real Estate Brokers and the Market for Residential Housing,” AREUEA Journal, Vol. 11, (1983), 69–82.

    Google Scholar 

  • Knoll, M. “Uncertainty, Efficiency and the Brokerage Industry,” Journal of Law and Economics, Vol. 31, (1988), 249–263.

    Google Scholar 

  • Kreps, D. A Course in Microeconomic Theory, Princeton, N.J.: Princeton University Press, 1990.

    Google Scholar 

  • Marvel, H. and McCafferty, S. “The Political Economy of Resale Price Maintenance,” Journal of Political Economy, Vol. 94, (1986), 1074–1095.

    Google Scholar 

  • McAfee, R.P. and McMillan, J. “Bidding for Contracts: A Principal-Agent Analysis,” Rand Journal of Economics, Vol. 17, (1986), 326–338.

    Google Scholar 

  • McAfee, R.P. and McMillan, J. “Competition for Agency Contracts,” Rand Journal of Economics, Vol. 18, (1987), 296–307.

    Google Scholar 

  • Miceli, T. “The Optimal Duration of Real Estate Contracts,” AREUEA Journal, Vol. 17, (1989), 173–188.

    Google Scholar 

  • National Association of Realtors. Agency Task Force: Final Report, Chicago, Illinois, 1986.

  • Owen, B. “Kickbacks, Specialization, Price Fixing and Efficiency in Residential Real Estate Markets,” Stanford Law Review, Vol. 29, (1977), 931–967.

    Google Scholar 

  • Pauly, M. “Overprovision and Public Provision of Insurance,” Quarterly Journal of Economics, Vol. 88, (1974), 44–61.

    Google Scholar 

  • Rees, R. “The Theory of Principal and Agent: Parts I and II.” In J.D. Hey and P.J. Lambert, eds, Surveys in the Economics of Uncertainty, New York: Basil Blackwell Ltd., 1987.

    Google Scholar 

  • Rothschild, M. and Stiglitz, J. “Equilibrium in Competitive Insurance Markets,” Quarterly Journal of Economics, Vol. 90, (1976), 629–649.

    CAS  Google Scholar 

  • Schmalansee, R. The Economics of Advertising, London: North-Holland, 1972.

    Google Scholar 

  • Schroeter, J. “Competition and Value of Service Pricing in the Residential Real Estate Brokerage Market,” Quarterly Review of Economics and Business, Vol. 27, (1987), 29–40.

    Google Scholar 

  • Stevenson, B. Home Book of Quotations, tenth edition, New York: Dodd, Mead and Co., 1967.

    Google Scholar 

  • Stiglitz, J. “Risk-sharing and Incentives in Sharecropping,” Review of Economic Studies, Vol. 41, (1974), 219–255.

    Google Scholar 

  • Wachter, S. “Residential Real Estate Brokerage: Rate Uniformity and Moral Hazard,” Research in Law and Economics, Vol. 10, (1987), 189–210.

    Google Scholar 

  • Wu, C. and Colwell, P. “Equilibrium of Housing and Real Estate Brokerage Markets under Uncertainty,” AREUEA Journal, Vol. 14, (1986), 1–23.

    Google Scholar 

  • Yinger, J. “A Search Model of Real Estate Broker Behavior,” American Economic Review, Vol. 71, (1981), 591–605.

    Google Scholar 

  • Zorn, T. and Larsen, J. “The Incentive Effects of Flat Fee and Percentage Commissions for Real Estate Brokers,” AREUEA Journal, Vol. 14, (1986), 24–47.

    Google Scholar 

  • Zumpano, L. and Hooks, D. “The Real Estate Brokerage Market: A Critical Reevaluation,” AREUEA Journal, Vol. 16, (1988), 1–16.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. University of Windsor, N9B 3P4, Windsor, Ontario, Canada

    Paul M. Anglin

  2. Boston College, 02167, Chestnut Hill, MA, USA

    Richard Arnott

Authors
  1. Paul M. Anglin
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Richard Arnott
    View author publications

    You can also search for this author in PubMed Google Scholar

Rights and permissions

Reprints and permissions

About this article

Cite this article

Anglin, P.M., Arnott, R. Residential real estate brokerage as a principal-agent problem. J Real Estate Finan Econ 4, 99–125 (1991). https://doi.org/10.1007/BF00173119

Download citation

  • Issue Date:

  • DOI: https://doi.org/10.1007/BF00173119

Keywords

Search

Navigation