Mistreating Workers Isn't Always Efficient

In this paper we develop a simple model in which some employees are thieves and will steal from their employers if given the opportunity. Firms can counter this threat through practices such as locking employees inside their factories or requiring them to submit to searches. We show that the number of locked firms will be (weakly) greater than the number that would be chosen by a social planner. The reason is that in contrast to the social planner, an individual honest worker (i.e., a non-thief), when deciding whether to switch from a locked to an unlocked firm, does not take account of the fact that an additional honest worker in an unlocked firm raises the unlocked firm wage for everyone else. We also show that, under certain conditions, a ban on locked factories can increase total welfare, and under other (more stringent) conditions can increase the total welfare of honest workers