|M.Sc Student||Elkin Kosta|
|Subject||Labor Relations and the Role of Courts|
|Department||Department of Industrial Engineering and Management||Supervisor||Dr. Benjamin Bental|
|Full Thesis text|
The model is a combination between Kvaloy & Olsen (2010) and Bental & Demougin (2006). Kvaloy & Olsen described a relationship between two risk neutral parties which is affected by moral hazard. The contract between the parties is subject to litigation. The probability of court enforcement is determined by the resources spent on contracting. Bental & Demougin (2006) also consider labor relations under moral hazard. The contracts which emerge depend on the capital endowment of the economy and evolve dynamically as the economy grows.
Here we consider a single good economy where output is produced through an interaction between risk-neutral households and firms. Firms borrow capital at a given interest rate and employ workers. The employment relationship is subject to moral hazard, where effort is not directly contractible. The contract between the employer and the worker implicitly promises payment if there is evidence that the worker has exerted effort. That evidence becomes stronger as effort increases. Nevertheless, the employer may refuse payment. In that case the worker may present the effort-related evidence to a court. The employer provides counter-evidence. The strength of that counter-evidence depends on the employer's investment in legal apparatus. Since that investment is also not contractible, there is moral hazard also on the side of the employer. The court weighs the evidence presented by both sides and makes a decision whether payment is to be made. We use an example to solve the ensuing game focusing in particular on effort choice and legal expenditure.
We further introduce a social planner who may instruct courts to place more or less weight on the respective parties' evidence, and ask how changes in the policy affects effort, investment and legal expenditure.