Design, analysis and simulation of an optimal wage contract in firms

Abstract

PurposeThe purpose of this paper is to analyze and solve the problem of moral hazard in firms because of asymmetry information between firms and workers and to contract upon the workers' shiftless actions.Design/methodology/approachBased on principle‐agent theory and human resource management practice, an optimal dynamic wage contract model is designed. By applying simulation technology, the dynamic wage contract model is compared to the general static wage contract model and the affects made by the optimal dynamic wage contract to workers and firms are analyzed.FindingsAccording to the consequences of simulation, the dynamic wage contract has better characteristics and is more practical than the static one. In the dynamic wage contract, the current action of a worker has a persistent effect on the future outcome. It is proved that the dynamic wage contract is optimal to the firm. The optimal dynamic wage contract is renegation‐proofness. It not only can incentive workers to work hard and help the firm achieve Pareto efficiency, but also can smooth the firm's incentive costs and reduce the risk born by workers.Originality/valueThe paper provides some reasonable conclusions for the human resource management in firms.