The Perils of Moral Hazard

An Illustrative Model of Three Cases of Worker Reimbursement 

Since output is fixed, the firm s economic problem is to minimize the sum of labor costs and safety costs. In this example, each foreman is paid 100,000 and each construction laborer is paid 40,000. Each accident costs 30,000 in terms of replacement labor and capital costs. These are the only costs associated with on-the-job accidents. Initially, suppose a workers compensation system is in place that only pays some of the lost wages after the waiting period, though the firm s HRM practices allow workers to use their sick-day benefits to replace their lost wages for the first three days following an injury. Hence, injured workers bear some costs of workplace injuries, though not any costs associated with the waiting period. 

Number of foremen Number of laborers Accidents Wage/salary costs ( ) Accident costs ( ) Total costs ( ) 

Even though the firm could construct its buildings without any accidents by hiring five foremen, it does not choose to do so. The additional costs (in terms of foremen s wages) do not justify the additional gains from producing with no injuries. It is not optimal to reduce the injuries to zero. Indeed, in each of the three cases we examine in Table 1.1, it is cheaper to allow some injuries than it is to do away with all injuries. 

HRM Practices Can Worsen Incentive or Moral Hazard Problems 

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