A Case for Percentage Commission Contracts: The Impact of a “Race” Among Agents (P.2)

percentage commission contract is inefficient. This paper attempts to investigate the
efficiency of a percentage commission structure in a multiple listing service (MLS)
environment by using a model with multiple agents.
In standard principal-agent problems, the issue at hand is how to align the
interests of the agent with those of her principal, the seller. If an agent’s effort level
is unobservable by the seller, or at least unobservable by the courts enforcing the
contract, the principal’s problem is to design a commission contract in which the
commission depends on an observable outcome and in which higher levels of effort
by the agent are duly rewarded (known as the incentive compatibility constraint).
The standard solution to the positive externalities created by a percentage
commission structure is the “net listing” in which the seller receives a fixed payoff
from the sale of the property and the difference between the selling price and this
fixed amount goes to the agent. Thus, the agent receives 100% of any marginal
benefits from her effort levels. In contrast, a percentage contract only offers the agent
a portion of any benefits accruing to the seller, hence creating positive externalities.
As a result, the percentage contract evokes less than the optimal levels of agent
effort. The inability of percentage contracts to provide sufficient agent incentives is
argued by Zorn and Larsen (1986), Anglin and Arnott (1991), Yavas (1995a) and
Rutherford et al. (2004), among others.
This paper offers a model of search under a percentage commission structure
where multiple agents compete to sell the seller’s (principal’s) asset. The first agent
to procure a buyer receives the entire commission while the other agents obtain zero
commission. We will show that this type of winner-take-all races creates negative
externalities, hence resulting in more than the efficient level of agent search
intensity.1 We then prove the principal result of the paper: The positive externalities
created by the percentage commission structure can serve to exactly offset the
negative externalities created by the race among the agents, hence resulting in
efficient effort levels.
This paper is related to two recent papers. Yavas and Colwell (1999) consider a
dual moral hazard problem in which both the seller and the agent are involved in
searching for a buyer. Their paper suggests that depending on the way the client’s
and the agent’s effort levels interact with each other in determining the matching
probability, a diverse set of commission structures may align seller and agent
interests. This study differs from Yavas and Colwell (1999) in that the seller does not
explicitly exert effort in selling the property, but more than one selling agent may
exert effort towards that end. Thus, the efficiency results here do not rely on the
specification of the seller’s and agent’s search technologies, but rather is a direct
result of the competition among the agents.
Williams (1998) is the most relevant paper to the current study. Williams (1998)
extends the analysis of the previous studies in the literature by explicitly considering
the impact of the competition arising between agents on the efficiency of a
percentage commission contract. Williams finds that a percentage contract
commission may in fact align agent efforts with seller interests under a specific set
of assumptions in an MLS environment. In his equilibrium model with many sellers
1 This is similar to the result obtained in the R&D literature where each firm expends too many resources
on developing a new patented product (see Mortensen 1982).

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