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The Incentive Effects of Flat-Fee and Percentage Commissions for Real Estate Brokers
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This paper analyzes the incentive affects of flat-fee and percentage commission systems from the perspective of the economic theory of agency. Under a plausible set of assumptions the systems provide equivalent incentives. However, the relative desirability of the two systems depends upon the pricing strategy employed and factors specific to the individual. In general, neither system perfectly aligns the interests of the agent with those of the property-owner. A surprising result of the analysis is that the optimal listing price when an agent is employed may be below the first-best price. The first-best price, or residual maximizing solution to the principal-agent problem from the perspective of the property-owner, is the solution that would occur if the agent's interests were perfectly aligned with those of the principal. This study suggests that the use of a percentage versus a flat-fee commission may be due to information costs rather than price discrimination on the part of brokers. Copyright American Real Estate and Urban Economics Association.
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... More broadly, this paper contributes to studies on the compensation structure and contract design between a principle and agent. For example, while agents may exert greater effort in market transactions for themselves than they do for others, the findings provide supportive evidence of the benefits of correctly crafted incentives discussed in the compensation/management literature (e.g., Holmström, 1979;Yinger, 1981;Zorn and Larsen, 1986;Holmström, 2017). Furthermore, the findings I present introduce a new puzzle for real estate research. ...
... Moreover, data on non-MLS rental contracts are costly to collect, which strains the opportunity to compare and contrast the performance of rentals arranged by owners vs rentals arranged by brokers in a similar manner that Hendel et al. (2009) evaluate the value of real estate agents in the ownership market. However, if the agent's compensation is a fixed amount and agents generally use an industry norm to define the commission rate, the agent may not undertake the additional search effort when he or she does not own the property since the additional search effort will not be compensated (Zorn & Larsen, 1986). In contrast, when the agent rents her own property, the additional search effort makes economic sense and may choose to list and subsequently lease the rental property at a higher price, since it generates a positive net benefit for the agent-owner. ...
This paper examines the principle-agency problem between landlords and real estate agents using novel data on rental contracts. Real estate agents are found to obtain higher contract rents by approximately 1% more for themselves (and family members) than for other landlords, which is economically small. The results suggest that the principle-agency program with real estate agents is less of a concern in the rental market than the ownership market. The reason potentially relates to the commission structure, the relatively low effort associated with finding a tenant, the landlord’s ability to evaluate an agent’s performance, and reputation concerns from repeated interactions.
... Yinger (1981) finds that the MLS reduces agents' commissions and search effort while Li and Yavas (2015b) note that introducing an MLS system reduces the number of brokers but increases the effort each broker expends. Some others find that the agency problem-where real estate brokers receive only a small fraction of the sale price as commission-leads to reduced effort on the part of brokers (Anglin & Arnott, 1991;Fisher & Yavas, 2010;Geltner et al., 1991;Zorn & Larsen, 1986). Miceli (1991) and Miceli et al. (2007) conclude that the commission split structure whereby the listing We begin with a set of brokerage firms, N, where each brokerage is denoted by a node i. Nodes are connected by directed links, which represent the trading relationship between brokerage firms and are denoted by g ij ; g ij = 1 if there is a directed link from nodes i to j, meaning that brokerage i previously sold a commercial property to brokerage j and g ij = 0 otherwise. ...
We explore how trading networks among commercial real estate brokerage firms are formed, and the effects of network structure on centrality, assortativity and power in the six largest commercial real estate markets in the United State. Fitting the dynamic network formation model developed by Jackson and Rogers American Economic Review, 97(3), 890-915, (2007) to U.S. commercial real estate transaction data (2003–2016), we calculate the importance of network search relative to random search for commercial real estate brokerage firms. We observe that in general approximately 67% of trades of commercial properties are made through network searches. Network search is more important during the global financial crisis (2008–2010). The trading networks also show geographic heterogeneity as network search is most important in Chicago (79.7%), but relatively less important in Boston and Los Angeles (56.2% and 58.2%). Finally, brokerage firms with many trading partners are more likely to trade with those with fewer partners (negative assortativity) creating conditions for power asymmetry between firms.
Miceli (1989), in a search for the optimal time to allow a broker to market property, posits that the principal (seller) may use the length of the listing contract to motivate the agent (listing broker) to better align incentives. Expanding slightly on Miceli, this work predicts that longer time allotted the broker to market residential property will decrease broker effort, resulting in lower search intensity and eventually a longer marketing span for property, ceteris paribus. This prediction is borne out across three empirical modeling methodologies commonly used in time-on-market studies.
Prior research documents that real estate agents sell residential properties they personally own faster and/or for a higher price than their client-owned listings. This finding is often explained in one of two ways: a) agents engage in shirking behavior when the principal cannot observe them directly (i.e., when selling a client-owned property) or b) agents listen to their own advice about how to best sell a property (i.e., when selling a property owned by the agent). To uncover the better explanation, the current study analyzes a sample of income-producing residential real estate. Sellers of income-producing real estate are likely more experienced and should recognize (and act on) good advice from an agent when it is given. That is, there should be less information asymmetry between agents and owner/clients of income producing residential properties. Thus, the agent-owned income-producing properties in our sample should not differ from client-owned income-producing properties along the dimensions of price or marketing time if agents are simply better at taking their own advice relative to the general public populating samples in related prior works. The absence of such differences in the present study suggests the price and marketing time effects observed in prior studies may be best attributed to information asymmetry rather than shirking.
We investigate two mechanisms that plausibly curtail agency costs in the homeowner‐listing agent relationship. Empirically, we find that differences in compensation structures across brokers effectively mitigate agency costs, while additional training associated with licensure made little, if any, difference. The evidence is consistent with managers/partners of a brokerage (principal brokers) having stronger incentives to internalize potential reputational spillovers for their brokerage offices. For identification, we exploit the timing of brokers’ incentives changing using a difference‐in‐difference (“within agent”) approach. Further, in a triple‐difference specification that leverages a setting where local reputational incentives are most instrumental, we find the clearest evidence of agency cost mitigation among principal brokers of non‐franchise, locally‐owned brokerages.
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We generalize the classic Williams (1998 RFS) brokerage model by introducing diffused effort and asset heterogeneity. The term ”diffused effort” refers to the fact that an agent can cross‐utilize effort spending on one listing to another. One counterintuitive finding in Williams' paper is the absence of the agency problem. As a special case in our model, we recover the agency problem. We demonstrate the positive externality due to the diffused effort and show it depends on the agent's inventory size. Hence, there is a trade‐off between agents' effort committed to existing listings and expanding network size by soliciting new listings.
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This paper focuses on how brokerage practices in the markets for commercial real estate investment assets and residential development land in England generate different possibilities for and patterns of opportunistic behaviours. Drawing upon previous research and analysis, the paper examines the nature of the brokerage market in both sub-markets. An interactionist model of the determinants of ethical judgement in the context of the brokerage sector is created. Based upon an interview survey of brokers and principals, the findings of an exploratory empirical study are discussed. Whilst there are challenges in defining, observing and measuring opportunistic behaviours, it is concluded that a number of different unethical practices have become routine rather than exceptional in the markets for institutional-grade real estate assets and residential development land.
The commission split between real estate agents and their affiliated firms represents an important incentive mechanism. A study of 1,477 agents indicates that total commission revenue generated during the year affects the subsequent commission rate more than volume of residential sales or transactions. Profit sharing and independent franchise firms offer higher ending commission splits while larger firms offer lower commission splits. The ending commission split for commission agents compared to agents on a 100% payout contract, however, is not influenced as much by profit sharing, firm characteristics, and the economic environment.
In this paper we draw on recent progress in the theory of (1) property rights, (2) agency, and (3) finance to develop a theory of ownership structure for the firm.1 In addition to tying together elements of the theory of each of these three areas, our analysis casts new light on and has implications for a variety of issues in the professional and popular literature, such as the definition of the firm, the “separation of ownership and control,” the “social responsibility” of business, the definition of a “corporate objective function,” the determination of an optimal capital structure, the specification of the content of credit agreements, the theory of organizations, and the supply side of the completeness-of-markets problem.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.
This study explores the role of the real estate broker in the housing market. A model of the demand for broker services by both sellers and buyers is developed and conditional logit estimates are presented. Evidence relating to the effects of the brokerage industry on housing market transactions also is presented. Brokers do not seem to affect the prices of the houses they sell. But they do influence the level of housing consumption by buyers. Copyright American Real Estate and Urban Economics Association.
This paper explores a simple economic search model, and various brokerage cost assumptions, to derive brokerage pricing implications for three dimensions of the home transaction: (1) level of home price, (2) new relative to existing home sales, and (3) co-op relative to non-co-op sales. The model incorporates time-on-market (the price-time tradeoff) as an important element in home brokerage (search)
It is argued that relative search cost differences imply that commission rates will be lower (1) on sales of higher-priced homes, (2) on sales of new relative to existing homes and (3) on non-co-op relative to co-op sales. A main contribution of the paper is the presentation of considerable supporting evidence showing variation in actual home brokerage commission rates according to these three variables.
This paper examines the functioning of the market for brokerage services for residential real estate. The central issue addressed is whether the manner in which brokerage services have traditionally been provided and priced is consistent with efficiency. In approaching this question, the paper first describes the activities usually associated with the brokerage function and develops criteria for the efficient provision of brokerage services. After the structural characterisitcs and pricing practices of the brokerage industry are analyzed, a model of brokerage firm competition is developed. The principal finding is that the traditional absence of price competition among brokers may have led to an inefficiently large commitment of resources to the brokerage industry, supported by excessive rates for consumers of brokerage services. These results stem from the way that competitive pressures emerge when price competition is largely suppressed. Copyright American Real Estate and Urban Economics Association.
