Work environment and moral hazard

We consider a firm’s provision of safety and health measures (working conditions) in a hidden action agency problem in which effort and working conditions interact in multiplicatively separable (neutral) manner in the cash flow process. Under this common formulation, the firm under supplies working conditions and effort at its second best, regardless of the share of accident damages borne by the firm. At this optimum, increases in the damage share paid by the firm decrease the compensation to the agent so as to render working conditions and effort unchanged. Shifting the damage share then does not impact the firm’s or the agent’s welfare. We show that direct regulation of working conditions can improve total surplus, but that the regulation of the damage share is ineffectual. Under first order approximations, we also examine the effects of changes in the hazard level of the job and the efficiency of working conditions. Finally, we show that our results can be changed if the neutral interaction between effort and working conditions is violated.