The Incentive Effects of Flat‐Fee and Percentage Commissions for Real Estate Brokers

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.