A Theory of Irrelevant Advertising: An Agency-Induced Targeting Inefficiency

Ad targeting technology has enabled a highly personalized delivery of online ads. Behind this development is the belief that better targeting will lead to more relevant ads. This paper challenges this lay belief by showing that irrelevant advertising can arise not necessarily from technological imperfection but also from the incentive problem embedded in the ad agency-advertisers relationship. We first demonstrate that the ad agency serving multiple advertisers may strategically allocate an ad impression to a lesser-matched, sometimes totally irrelevant, niche advertiser because future impressions can match better with the mainstream advertiser. We further find that, without a contractual obligation to serve both advertisers, the agency may not deliver completely irrelevant ads to consumers. However, another type of inefficiency can arise where the agency may not send any ad to potentially interested consumers who have a strictly positive match probability with advertisers. These inefficiencies arise due to contractual restrictions, either contractual obligations or budget constraints, when the agency serves multiple advertisers. As such, we endogenize the advertisers’ contractual requirement choices and show how the contractual obligation(s) can arise in equilibrium. Finally, we show that irrelevant ads will not disappear simply because more impressions are available in the market. Our analysis suggests that as the number of impressions increases, the irrelevant ads can persist, but the probability of receiving irrelevant ads decreases.