Mitigating Agency Problems by Advertising, with Special Reference to Managed Health Care

Abstract

An agency conflict arises when consumers rely on middlemen for product recommendations. Although consumers want the middlemen to recommend the most suitable product, the middlemen may earn a higher profit if the consumer buys another product. One setting where this conflict arises is the managed health care market. Managed health care providers have an incentive to spend too little on prescription drugs. We investigate whether pharmaceutical manufacturers can use advertising to mitigate this agency conflict. Although advertising may induce health care providers to offer socially efficient medications, drug companies may not choose the socially efficient level of advertising. It will also pay for drug companies to inform consumers if they will not benefit from some drug, as this will increase the price that those who will benefit will be willing to pay.