Academic journal article Real Estate Economics

Renegotiation of Listing Contracts, Seller Opportunism and Efficiency: An Economic Analysis

Academic journal article Real Estate Economics

Renegotiation of Listing Contracts, Seller Opportunism and Efficiency: An Economic Analysis

Article excerpt

Thomas J. Miceli [*]

When a property owner engages a real estate broker to sell his or her property, the parties enter into a listing contract which entitles the broker to a commission if a ready, willing and able buyer is found before the contract expires. While a limit on the duration of the contract provides the broker with an incentive to work hard to find a buyer, it also creates the potential for seller opportunism. In particular, sellers have an incentive to renegotiate a lower commission as the end of the contract approaches. The paper concludes that, from an efficiency perspective, courts should generally enforce such renegotiations, given that transaction costs between brokers and sellers are ordinarily low.

When a property owner engages a real estate broker to sell his or her property, the parties enter into a listing contract which, in most cases, gives the broker an exclusive right to sell the property. Under this arrangement, the broker earns a commission, usually calculated as a percentage of the sale price, upon procuring a ready, willing and able buyer on terms acceptable to the seller. [1] However, the broker's right to the commission is conditional on a sale occurring (or a buyer being procured) during the term of the contract; if a buyer has not been located before the contract expires, the broker is not entitled to compensation. The next section discusses why a limitation on the duration of listing contracts is effective in inducing brokers to act in the interests of sellers. [2]

While a listing contract of limited duration may prevent broker shirking, it also creates the potential for opportunistic behavior by the sellers vis-a-vis the brokers. One form of opportunism consists of attempts by the sellers to avoid paying the commission altogether by waiting until the listing contract expires before accepting the offer of a buyer procured by the broker. In response to this problem, courts have allowed brokers to include provisions in listing contracts--called extension clauses--to protect against this problem. Extension clauses typically state that if a sale takes during a specified period of time (say, six months) after the original contract has expired, and to a buyer procured by the broker during the original contract, then the commission is payable to the broker. Such a provision makes it costlier for buyers and sellers to bargain around listing contracts by increasing the amount of time they must wait before completing the sale. To be an effective deterrent, the extension clause mu st be long enough that the present value of the joint costs to the buyer and seller of waiting until the clause runs out just exceed the commission. The courts have generally enforced extension clauses when the broker can prove that a particular buyer was introduced to the seller. [3]

The second form of seller opportunism arises from the time limitation on listing contracts. A seller may attempt to negotiate a lower commission rate as the end of the contract approaches, using the threat of expiration to coerce the broker into accepting. In contrast to the first form of opportunism, however, this second form creates the potential for efficiency gains. The courts should generally enforce renegotiations of this sort provided that transaction costs between brokers and sellers are low.

Apart from the efficiency aspects of commission renegotiations, the analysis implies that actual commissions paid by sellers may be considerably less uniform than an examination of initial contract rates would suggest. [4] It follows that evidence on the true uniformity of commission rates (or lack thereof) can only be gathered by examining amendments to initial listing contracts. Inferences about whether commission rates are supra-competitive cannot be made based solely on initial rates, since the latter may reflect anticipated reductions later in the contract period.

Contract Length and Broker Shirking

Listing contracts between a seller and a broker routinely specify a negotiable termination date, at which time the broker's exclusive right to sell the property ends. …

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