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The Principal‐Agent Relationship in Real Estate Brokerage Services

Michael Arnold ()

Real Estate Economics, 1992, vol. 20, issue 1, 89-106

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.

Date: 1992
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