Optimal Deterrence when Judgment-Proof Agents Are Paid In Arrears—With an Application to Online Advertising Fraud
Executive Summary — It is commonplace for large entities (both advertisers and ad networks) to enter into relationships with numerous small agents such as Web sites, blogs, search syndicators, and other marketing partners. For example, one well-known affiliate network boasts more than a million affiliates promoting offers from the network's hundreds of merchants, and Google contracts with numerous independent Web sites to show Google's "AdSense" ads. Although these advertising agents are often small, they can take advantage of technology to claim payments they have not earned. In practice, the legal system cannot offer meaningful redress to an aggrieved advertiser or ad network. This paper argues that delayed payment offers a more expedient alternative—a sensible stopgap strategy for use when primary enforcement systems prove inadequate. Key concepts include:
- Online advertising markets are one of many markets where agents may be effectively unreachable through the legal system.
- Online advertising contracts presently lack any institution by which the payment structure can enforce good practices.
- Improving detection technology remains the preferred deterrent of online advertising fraud.
- Appropriate selection of a payment delay can achieve the benefits offered by contingent payment in other markets.
I develop a screening model with delayed payments and probabilistic delayed observation of agents' types. I derive conditions in which a principal can set its payment delay to deter bad-type agents and to attract solely or primarily good-type agents. Through the savings from excluding bad agents, the principal can increase its profits while offering increased payments to good agents. I apply the model to online advertising markets widely perceived to be a hotbed for fraud. I estimate that a leading affiliate network could have invoked an optimal payment delay to eliminate 71% of fraud without decreasing profit.