Selecting and Remunerating Advertising Agencies: A Signaling Theoretical Perspective

Abstract

Advertising agencies have historically received a major share of their compensation as a commission or on the basis of one or more fee structures. However, during the last few years, agencies are under heavy pressure to demonstrate their accountability and prove the value of their contribution to the advertiser, by using some performance-based compensation. However, there are some conflicts between the advertiser and the agency mainly because of different objectives and risk preferences, which leads to favor of different courses of action. So far, most studies conducted with the aim of resolving these conflicts and reconciling the interests of both parties have relied on agency theory, but failed to lead to a stable equilibrium for both parties. In this study, we offer a theoretical model based on signaling theory, which leads to a stable optimal solution for both parties. We critically examine the motivations and conflicts arising in the evolvement of a suitable remuneration system and the means of resolutions available to both parties for a satisfying contract. Also, we develop an auction theoretical model for selecting full-service advertising agencies considering the interdependencies among evaluation criteria. Our findings provide practical guidelines for ad agency selection and compensation.