Stakeholder Awareness in Sustainable ConstructionGunther Maier, Sabine Sedlacek

Introduction

Motivation: Previous work on the role of Green Building Councils as

third party governance institutions (presented at ERES in Milano, published in Energy Policy)

Main argument: developer and investor are potentially locked in a prisoners’ dilemma over the quality of a building. This hampers the construction of good quality buildings.

Underlying reason for this situation: imperfect information about the quality of a building.

Main result: Green Building Certificates can help overcome this blockage.

Introduction

Motivation: The situation between the developer and the investor

that we viewed as a two party game, can also be viewed as a principal agent situation: The investor (principal) wants to own a good quality

building The quality of the building is determined by the developer

(agent) Can the investor compensate the developer in such a way

that a good quality building will be built? Aren’t there numerous other such relationships in real

estate development? – What does the literature say?

Introduction

Motivation: What role does / can the green building movement play

in this relationship? Can it be a mediator in principal-agent-situations

throughout real estate development (like in our simple case)?

First results: Very little can be found in the literature

Web of Knowledge: Most hits not relevant

Search terms # of hits“Real estate development” 790“Real estate development” + “agent” 36“Real estate development” + “agency” 30“Real estate development” + “moral hazard” 3“Real estate development” + “adverse selection” 4

Introduction

Correct title: Principal-agent problems in real estate

development Questions:

Why isn’t real estate development viewed more from an agency theoretic perspective?

Can agency theory provide insights into the processes of real estate development?

Can green building institutions mediate in principal agent problems in real estate development?

Is there a potential research agenda?

Structure

Introduction The principal agent problem Real estate development Where are potential agency problems –

examples The role of green building institutions Conclusions

The principal agent problem

The principal agent problem is a problem of imperfect, asymmetric information

The effort of the agent influences the utility of the principal

The effort of the agent cannot (perfectly) be observed by the principal because of random influences

The effort is a dis-utility to the agent

The agent will try to maximize his own utility

The principal agent problem

Incentive problem: How can the principal design a compensation system which motivates the agent to act in the principal‘s interest (i.e. input sufficient effort so that the principal’s utility is maximized)?

Moral Hazard issues: “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.” (Krugman, 2009)

The principal agent problem

Adverse selection issue: When a market mechanism selects the “bad” business partners (and de-selects the “good” ones). E.g. in insurance: individuals with high risk (e.g.

smokers) buy health insurance, individuals with low risk do not higher costs for insurance company increased premium increased adverse selection.

Can the insurer differentiate prices between groups? issues of discrimination, racism, sexism, etc. in case of imperfect correlation between observable characteristics and risk.

Principal agent literature

Eisenhardt (1989) distinguishes between1. Positivist agency theory2. Principal agent research

Positivist agency theory: Identifies situations where principal and agent may

have conflicting interests Main focus: Owners and managers of large public

corporations Interested “why certain contractual relations arise”

(Jensen, 1983)

Principal agent literature

Principal agent research Concerned with a “general theory of principal agent

relationships” Mathematically oriented, microeconomic foundation Optimal contracts under specific constellations

(information, risk aversion)

Real estate development

Stages Stage 1: Inception of an idea

Stage 2: Refinement of the idea

Stage 3: Feasibility

Stage 4: Contract

negotiation

Stage 5: Formal

commitment

Stage 6: Construction

Stage 7: Completio

n and formal

opening

Stage 8: Property,

Asset, and Portfolio

Management

Developer

Real estate development

Roles of the developer Developer – Public: Planner, promoter,

negotiator, provider Developer – Capital

markets: Promoter, negotiator,

borrower, investment partner Developer – development

team: Employer, client, manager

Developer – user: Analyst, creator, promoter,

provider

Devel-oper

Public

User

The develop

ment team

Capital markets

Real estate development

The development team

DeveloperGeneral Contractor

Architect Builder

Engineers

Investors Banks

Marketing

Appraisers Sub-contractors

ProfessionalsRE Agents

Real estate development

The Real Estate Development Process ……is a sequence of steps from idea of the project to

the physical construction (Stage1-8)…not linear…increased specialization due to greater

complexity especially in sustainable buildingssize of the development team has expandedroles of some professionals have changedhigher complexity has generated the need for

better educated / more experienced professionals

Real estate development

Diverse stakeholder groups Interconnected interdependent structures Requires effective information exchange Clear communication ( Cole 2011: improved

cooperation, dialogue, partnering, inclusion, public involvement)

Can such a network work when different interests and stakes are involved?

Potential agency problems

Incentive problems: Throughout the value added chain of real estate

development: Developer – General contractor – Builder – Professionals –

sub-contractors Profit sharing, risk sharing Fixed price contract, input (cost) based contract,

performance based contract Firms – workers

Implementing the agreed qualities Avoiding accidents, damage, liabilities – insurance

Potential agency problems

Incentive problems: Throughout the value added chain of real estate

development: Developer – Architect

Costs vs. reputation – type of contract Architect – Builder & Professionals

Form vs. costs of implementation Developer – Marketing

Costs vs. form (marketability) Marketing – Real Estate Agents

Effort in sales activities

Potential agency problems

Moral hazard issues: Estimated vs. settled costs / early vs. late phase of the

development process downward biased cost estimates to “get the job” or to

get the project approved / upward biased settled costs for higher profit Developer – Investor Developer – General Contractor General Contractor – Builder, Professionals, Engineers, Sub-

contractors

Potential agency problems

Moral hazard issues: Appraisal

Marketing, Developer, Investor may push for biased appraisal (depending on interests)

External appraisers may consent for the benefit of future business

Potential agency problems

Adverse selection issues: Fixed price or lowest price sub-contracting generates

adverse selection problems Selection of sub-contractors who are economically

weak (“need the cash”) or willing to use illegal procedures (black labor, tax evasion, excessive risk, etc.)

Sub-contracting and special purpose corporations may be used to hide or isolate this issue.

The role of green building institutions

Green building certificates establish an additional overall quality standard for a development project Specify quality indicators Push for more coordination between the actors –

integrated planning Green building certificates add additional actors

Auditors, Consultants, Certifying institution Additional possibilities for agency problems

Green building certificates add complexity to the development project Additional possibilities for agency problems

Conclusion

Theoretical analysis: The structure of real estate development allows for

numerous relations that may be subject to agency problems due to incomplete and asymmetric information.

Anecdotal evidence suggests that these problems are of relevance

It makes sense to research real estate development projects, agents, and contracts from an agency perspective. How are specific relations organized in general? Focus on development projects with severe problems.