Moral Hazerd:

Problem 5: Moral Hazard (PrincipalAgent Problem) Consider a rm that hires people to load and unload shipping trucks. The company cannot perfectly observe whether each individual worker works or shirks (i.e., not do their job), all the rm can observe has an insignicant effect on the overall outcome for the firm The firm does however care about the effort level of their pool of workers so they do want to induce them to actually work. Due to the fact that the single worker has no measurable impact on the outcome for the firm, the company cannot make wage o'ers contingent upon the outcome. The only thing a rm can do is to o'er a xed wage and then re any worker they observe to be shjrking. Their observation is imperfect though and so the rm only observes a worker shirlcing with some probability. The rm also occasionally makes mistakes and even res workers who were working. The structure of the game is that: (l) the rm offers a wage contract, (2) the worker choose to accept or reject (if they reject they receive some level of reservation utility = 10 and the rm receives 0), (3) If the worker chose to shirk he is fired with probability p=0.5 and has no effort cost while if the worker did not Shirk there is no chance that he will be red, but he pays an effort cost e=5. (4) If a worker gets red, he does not receive his wage but instead receive his reservation utility of E = 10. The utility for a worker in any state is simply the wage he receives less the cost of any effort. Assume the firm's revenues are such that they can protably pay the wage required to induce high effort but they lose money if all their workers shirk a. Begin with a simpler case in which we will assume that the rm could actually contract on effort level. What wage contract would the rm offer to a worker if the rm wants to elicit high effort? For the following parts, reassert all the original structure under the assumption that effort level is unobservable! b. What are the conditions that must be satised to elicit high effort? 1. What is the lowest wage that satises IR condition? 2. What is the lowest wage that satises both conditions? 3. Do the wages you found in b.1 and b.2 differ. If yes, why? If no, why? (Briey explain it). c. (*Small bonus question) Besides ring a person who shirks, what else can the rm when designing contracts in order to elicit high effort? Be very brief