Ripoffs, Lemons, and Reputation Formation in Agency Relationships: A Laboratory Market Study

Authors

  • DOUGLAS V. DEJONG,

  • ROBERT FORSYTHE,

  • RUSSELL J. LUNDHOLM

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    • Assistant Professor, Associate Professor, and Ph.D. student, respectively, at the University of Iowa. We would like to thank the Department of Accounting at the University of Iowa for providing the funds for the experiments, and W. Uecker and participants of the Accounting Workshops at the University of Iowa and University of Oklahoma for their comments and suggestions. Financial support for DeJong was provided, in part, by the Arthur Young Faculty Fellow Program at the University of Iowa.


ABSTRACT

This paper examines the effect of the moral hazard problem in an agency relationship where the principal cannot observe the level of service provided by the agent. Using data from laboratory markets, we demonstrate that the presence of moral hazard leads to shirking by agents. However, this “lemons” phenomenon occurs only about one-half of the time. While there is evidence of reputation effects in these markets, seemingly reputable agents are often able to use opportunities for false advertising to their advantage and “ripoff” principals.

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