Pay-for-performance (P4P) pricing schemes such as pay per click and pay per action have increased in popularity in Internet advertising. Meanwhile, pay-per-impression (PPI) schemes persist, and several publishers have begun to offer a hybrid mix of PPI and P4P schemes. Given the proliferation of pricing schemes, this study examines the optimal choices for publishers. The authors highlight two-sided information asymmetries in online advertising markets and the consequent trade-offs faced by a high-quality publisher using P4P schemes. Pay-for-performance schemes enable a high-quality publisher to reveal its superior quality; however, such schemes may incur allocative inefficiencies stemming from inaccurate estimates of advertiser qualities. The authors identify conditions under which a publisher may opt for a PPI, P4P, or hybrid scheme and, in doing so, provide theoretical explanations for the observed variations in the pricing schemes and the increasing popularity of hybrid schemes. Using a new “uncompromised” equilibrium refinement, the authors find that the hybrid scheme can emerge as an equilibrium choice in a variety of conditions. In addition, they provide prescriptive guidelines for firms choosing between different pricing schemes.
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