Microeconomics: Theory and Applications with Calculus, 4e

19.6 Checks on Principals

Because employers (principals) often pay employees (agents) after work is completed, employers have many opportunities to exploit workers. For example, a dishonest employer can underpay after falsely claiming that a worker took time off or that some of the worker’s output was substandard. Employers who provide bonuses can underreport the firm’s output or profit.

Efficient contracts prevent or reduce such moral hazard problems. Requiring a firm to post a bond can be an effective method of deterring the firm’s opportunistic behavior. For example, a firm may post bonds to ensure that it has the means of paying current wages and future pensions.

A firm cannot act opportunistically if information is symmetric because it ...