A Case for Percentage Commission Contracts: The Impact of a “Race” Among Agents (P.3)

and agents, agents are involved in searching for new listings as well as for buyers for
their existing listings. Although agents compete for new sellers, they spend no time
or effort selling listings of other agents (each agent tries to sell her own listings
only). However, externalities exist in that the arrival rate of buyers at one listing
depends on the effort of other agents on their own listings. Williams proves that in
equilibrium a percentage commission contract may evoke first-best effort level from
the agent in that the agent spends the same effort selling each client’s asset and sets
the same reservation price as she would for her own assets.2 The first-best outcome
in Williams (1998) cannot be obtained, however, if the agents are allowed to
compete to sell each other’s listings. Furthermore, William’s first-best outcome is not
efficient for it relies on the agents’ competition for new clients. Agents’ effort to
obtain new clients is a socially wasteful activity because time spent searching for
new listings has a private value to an agent but no value to sellers (and other agents).
Our paper differs from Williams (1998) in two aspects. First, the agents in our
model compete to sell any of the listings within the MLS. Second, due to the
externalities created by this competition among the agents to sell listings, the
percentage commission system in our model could result in an efficient outcome.
Thus, it is interesting that while the externalities among agent effort levels to sell
existing listings eliminate the possibility of a first-best solution in Williams’ model,
these externalities are essential in our model to achieve the first-best solution. This is
due to the fact that each agent in Williams’ model equates her marginal productivity
of effort spent with each listing to her marginal productivity of effort spent searching
for new listings, and the two marginal productivities are proportional to the
commission rate so that the optimal effort expended for each client is independent of
the commission rate. In contrast, in our model the agent’s optimal effort choice
increases with the commission rate, and the negative externality created by
competition among agents becomes necessary to achieve the first-best outcome.
The aspect of our model that the commission rate is a key determinant of agents’
effort levels will also enable us to examine the efficient commission rate when a
percentage contract is used by the seller.
There is one other critical feature of our model. We allow sellers to have access to
the MLS system. That is, a seller can list his property with the MLS system without
promising the listing agent a percentage commission. We make this assumption in
order to focus on the incentives created by a percentage commission structure once
the listing is created.3
The significance of the current study is that it attempts to offer a possible
explanation for the existence of the frequently observed percentage sales
commission contract when agents must compete to earn the proffered sales
commission. We show that it is possible that a percentage contract can elicit
efficient broker effort under our assumptions. However, we also show that the
commission rate at which first-best effort levels are achieved varies with the asset
2 The assumption here is that the seller delegates the choice of the reservation price to his broker.
3 As is well known, the competition among agents for new listings is a socially wasteful activity under the
MLS system and it is one of the sources of inefficiencies in Williams’ model. Recently, sellers in different
regions of the USA have begun listing properties on the MLS through agents for a fixed fee. The resulting
listing contract typically promises a percentage commission to any agent who brings a ready, willing and
able buyer.

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