Abstract
We study a firm with ethical employees who can adopt a profitable working practice that may harm their customers. Their response to this dilemma reflects their compensation contract as well as their ethical willpower. We identify optimal compensation contracts under utilitarian and deontological (duty-based) ethical standards. With utilitarian employees, and irrespective of employee willpower, a profit maximising firm with sophisticated customers generates the ethically best outcome. Organizational culture emerges as an equilibrium phenomenon. If the firm is a partnership, if sales commissions are hidden, or if customers are naive the firm may use bonuses to create a culture of malpractice.
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