Can Competition Reduce Moral Hazard? A Laboratory Experiment

Abstract

Moral hazard aggravates mistrust between principals and agents and leads to economic inefficiency. Although literature has investigated if competition can reduce moral hazard, the evidence is mixed at best. This thesis examines the existence of moral hazard in a lab setting, and then tests if introducing competition can reduce moral hazard. In addition, we test for the effects of two types of competition - competition against others and competition against own past performance (self-competition). We also test if the results for competition are different for men and women, and whether they vary by the gender of their competitor. We find that a participant who performs under competition is 19.2 % less likely to have moral hazard than one who performs under a fixed wage setting without competition. Self-competition is more effective than competition against others in motivating individuals to perform better. This effect is greater for women who are 15.1 % less likely to have moral hazard than men. Both men and women are less likely to display moral hazard when competing against someone of the same gender than when they compete against the opposite gender. Performance based contracts can be used to incentivize employees to better their performances to meet either preset targets or their best performance in the past. Where possible, competition against the same gender can be introduced to achieve similar improvements in performances.