Why are Firms Challenging Conventional Wisdom on Moral Hazard? Revisiting the Fair Wage-Effort Hypothesis

Economic theory regarding moral hazard at work is somewhat at odds with recent business evidence. Whereas firms in economically and technologically stable environments could apparently follow conventional wisdom when trying to reduce moral hazard through tight supervision and incentive packages, the increasingly innovative and competitive environment is pushing firms to follow human resource practices that explicitly and consciously make managers more vulnerable to opportunistic conducts. We explain this paradox through a generalization of Akerlof and Yellen’s fair-wage effort hypothesis. We argue there is a tradeoff between the effort that firms can capture from their workers (controllable effort) and the level of discretionary effort that employees can offer, upon which the particular excellence and innovative performance of the firm relies. We test our proposition on a wide dataset composed of 2,896 workers. After controlling for several firm and industry traits, evidence confirms the potential role of moral hazard as an opportunity for excellence at work