Academic journal article Real Estate Economics

Residential Real Estate Brokerage Efficiency and the Implications of Franchising: A Bayesian Approach

Academic journal article Real Estate Economics

Residential Real Estate Brokerage Efficiency and the Implications of Franchising: A Bayesian Approach

Article excerpt

Determining the efficiency of real estate brokerage firms is an important question due to its far-reaching implications for optimal firm structure and public policy. Previous attempts to analyze efficiency and the implications of franchising within the residential real estate industry supply no consensus on this issue and employ techniques that introduce bias in the efficiency estimates. Understanding the characteristics of this market is crucial for worthy and reliable recommendations to policymakers. We calculate real estate brokerage efficiency by firm type with the goal of correctly analyzing the influence of franchising on firm efficiency.

We calculate residential real estate brokerage efficiency conditional on whether the brokerage is a franchised firm or independent by examining X-inefficiencies, a concept originally proposed by Leibenstein (1966). Leibenstein argues that firms operate sub-optimally for two fundamental reasons. First, allocative inefficiency occurs when a firm fails to allocate resources in the most efficient manner. And second, technical inefficiency occurs when a firm sub-optimally utilizes its resources given their allocation. Two firms may have the same resource allocation, yet one firm produces less output than the other does. The difference between potential utilization of resources and actual resource employment is termed X-inefficiency. Leibenstein argues that the majority of X-inefficiency losses arise from inadequate motivation by firm management. He argues that the manager's motivation levels are linked to the structure and competitiveness of the market in which a firm operates. More recently, X-inefficiency has been defined as deviations from an efficient frontier response surface that is attributable to a misallocation of resources or the lack of effective utilization of current resources. This misallocation and misuse of resources represents the firm's inefficiencies.

Over the years, such notions as monopoly, cartel and price fixing, as well as excessive commissions, have been associated with this market - implying inefficiency and less than competitive behavior. In contrast, other early studies found that this market is relatively efficient (Schroeter 1987; Knoll 1988; Carroll 1989; Anderson, Lewis and Zumpano 1999).

Of the many studies that found the industry to be relatively inefficient, some had limited access to micro-level cost data for real estate firms and/or used techniques that fail to allow for accurate efficiency estimation. Among those who found the brokerages to be inefficient, Miller and Shedd (1979), Yinger (1981) and Crockett (1982) had limited data sources, and Anderson et al. (1998) used data envelopment analysis (DEA), an estimation technique that contains significant bias in the firm efficiency estimates. Others, including Zumpano, Elder and Crellin (1993) and Zumpano and Elder (1994), estimate a translog cost function with a single error term to model the true production function for the residential real estate industry. This methodology also estimates firm efficiency inaccurately because, as with DEA, measurement error is misinterpreted as inefficiency, biasing inefficiency estimates. Because the overall efficiency results are rather mixed, it is difficult to make a conclusive and quantitative statement about the economics of franchising.

Aside from the discrepancy concerning estimation, structural changes have recently influenced the real estate brokerage market ultimately affecting the product mix, the agency and brokerage arrangements and the legal liability of real estate brokerage firms. Consequently, earlier literature on the market may no longer be relevant, leaving some of the same persistent questions unanswered.

The purpose of this paper is to provide insight into the real estate brokerage franchising issue via current and accurate efficiency estimates for residential real estate brokerage firms. In a Bayesian context, we are capable of calculating group efficiency for franchised firms and independent firms using a single stochastic frontier. …

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