SFB 303 Discussion Paper No. A - 327

Author: Bös, Dieter, and Wolfgang Peters
Title: When Employees Free Ride. A Theory of Inefficiency
Abstract: The crucial problem of inefficiency, in our view, is related to the employees' non-cooperative behavior, in more popular words to their free riding, to their unwarranted reliance on the activities of the others. If the others are already working busily, an employee may reduce his working load in order to enjoy more leisure. However, since all employees think like that, the result necessarily is inefficient production of the firm.
As in any principal-agent setting, the principal will try to reduce free-riding behavior by stipulating an incentive wage which causes employees to work harder. However, he is impeded by his inability to observe the precise extent of effort of any single employee. He can only observe the result of the employees' joint activity, measured for instance by output. Hence he cannot condition the employees' incomes on their effort, but only on output or some other observable variable. This incompleteness of the contract enables the employees to free ride.
The paper is organized as follows. In section 2 we present the model and we define in which way the principal in uninformed about the agents' effort, preferences, and abilities. The principal applies a linear incentive-pay schedule which is known to the employees whose non-cooperative Nash behavior is analyzed in section 3. We show the consequences of the employees' free riding for the productive efficiency of the firm. Special results, in particular for comparative static analysis, are presented for the case of identical employees. In section 4 we go back to the principal's decision which anticipates the employees' Nash equilibrium. We show that the principal operates in a cost-minimizing way. The following section 5 presents a simulation analysis. Here we also compare the productive efficiency of private and of public firms.
Creation-Date: May 1991
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