Monitoring cost, disutility of effort and the forcing employment contract

Abstract

If the state of nature is not observable, ex post, but work effort is, contracts between the risk neutral firm and the risk averse workers will stipulate the level of effort which will be monitored to ensure its delivery. In this paper it will be shown that when effort is stipulated and monitored, workers will be paid solely by a fixed wage payment independent of output. The size of the wage payment will depend on the level of effort stipulated, the marginal rate of substitution of effort for income and the cost of monitoring, provided that the cost is not prohibitively high.