A Shirking Theory of Referrals

Abstract

Many service industries, including the medical and legal professions in some countries, display a gated structure. Rather than approaching a …nal producer directly, a consumer will …rst seek a referral from an intermediary. In this paper, we provide one possible explanation for such an industry structure. If the outcome of a transaction depends on producer e¤ort, which is unobservable and unveri…able, then the market may fail to generate a Pareto optimal outcome. This is the standard moral hazard problem. If consumers had a long-run relationship with producers, this type of market failure might be avoided. However, in some industries, consumers will only have a short-run relationship with producers. A gatekeeping intermediary may provide an opportunity for reputation e¤ects to apply in such a setting. By aggregating many potential consumers, gatekeeping intermediaries can create an arti…cial long-run relationship between a consumer and a producer. This long-run relationship reduces the incidence of shirking on the part of the producer.

A Learning Theory of Referrals

“…The reason for this is the presence of a positive information externality. Finally, we conclude by comparing the results of this paper with those that we obtained in Eldridge ( [14]) and with some features of actual health care markets.…”

“…This industry structure was largely driven by the demands of patients, although there may have been some circumstances in which the presence of GPs improved the welfare of both patients and specialists. While we provided an explanation for the gated structure of some professional service industries in Eldridge ( [14]), that explanation did not provide a rationale for regulations that encouraged such a structure. In this paper, we have provided a rationale for such regulations.…”

“…In this paper, we have provided a rationale for such regulations. However, while patients in the model employed in Eldridge ( [14]) had an incentive to repeatedly seek a referral for the treatment of non-chronic diseases, patients in the model employed in this paper will seek a referral at most twice. The reason for this di¤erence relates to the underlying market failure.…”

A Shirking Theory of Referrals

“…There is a related literature that uses reputation to explain the existence of institutions, primarily …rms 18 , unions 19 and retailers 20 . This literature builds on earlier work examining the extent to which reputation e¤ects and market forces provide an incentive for parties to exert e¤ort when such e¤ort is costly and unobservable.…”

“…Except in very restrictive circumstances, the market failure can at best be only partially mitigated. For This paper is a modi…ed version of Chapter 2 of the author's PhD dissertation (Eldridge [18], [19]). The author would like to thank Peter Bardsley, Suren Basov, Stephen Donald, Ken Hendricks, Preston McAfee, David Sibley, Max Stinchcombe, Andrew Whinston and Tom Wiseman for helpful advice and comments.…”