1. Stakeholder Awareness in Sustainable Construction Gunther Maier, Sabine Sedlacek

2. 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.

3. 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?

4. 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

5. 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?

6. Structure  Introduction  The principal agent problem  Real estate development  Where are potential agency problems – examples  The role of green building institutions  Conclusions

7. 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

8. 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)

9. 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.

10. Principal agent literature  Eisenhardt (1989) distinguishes between 1.Positivist agency theory 2.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)

11. 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)

12. 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: Completion and formal opening Stage 8: Property, Asset, and Portfolio Management Developer

13. 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 PublicUser The develop ment team Capital markets

14. Real estate development  The development team Developer General Contractor Architect Builder Engineers Investors Banks Marketing Appraisers Sub-contractors Professionals RE Agents

15. 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 buildings  size of the development team has expanded  roles of some professionals have changed  higher complexity has generated the need for better educated / more experienced professionals

16. 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?

17. 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

18. 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

19. 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

20. 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

21. 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.

22. 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

23. 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.