A Shirking Theory of Referrals

Damien Eldridge ()

No 2007.05, Working Papers from School of Economics, La Trobe University

Abstract: 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.

Keywords: EDIRC; Provider-Institution:; RePEc:edi:smlatau (search for similar items in EconPapers)
Pages: 44 pages
Date: 2007-11
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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