Managerial Economics and Strategy, 2/e

15.5 Using Monitoring to Reduce Moral Hazard

Often when a firm cannot use piece rates or reward workers contingent on the firm’s success, the employer pays fixed-fee salaries or hourly wages. As we’ve seen, employees who are paid a fixed salary have little incentive to work hard if the employer cannot observe shirking. And if an employer pays employees by the hour but cannot observe how many hours they work, employees may inflate the number of hours they report working. A firm can reduce such shirking by intensively supervising or monitoring its workers. Monitoring eliminates or at least reduces the asymmetric information problem: Both the employee and the employer know how hard the employee works. If the cost of monitoring workers is low enough, ...