Monitoring Workers as a Screening Device.

This paper presents a model of trade-off between employee moral hazard and adverse selection. When productivity is unobservable and heterogeneous, a firm can use the information extracted from shirking (moral hazard) to alleviate the problem of adverse selection and improve its pool of workers. This generates equilibrium shirking and monitoring even if any shirking can be eliminated using employee bonds. The point is demonstrated in a model in which performance bonds serve as an incentive device and in another model in which efficiency wages serve this purpose.