A factory owner wants his workers to produce as many widgets as they can, so he pays his workers based on how many widgets they produce. However, in order to make sure that the workers do not rush and produce a large number of poorly-made widgets, he checks the widgets at random at various stages of their manufacture. If a defect is found in a widget, the pay of the entire section of the factory responsible for that defect is docked. How is this factory owner seeking to solve the agency problem in this case?

Question

Quizplus · Accepted Answer

The factory owner is using incentives (pay based on widget production) to try and align the interests of the workers with his own. However, to ensure that the workers do not sacrifice quality for quantity, he also establishes a system of penalties (docked pay for defects) to hold the workers accountable for any mistakes made. This helps to mitigate the agency problem by reducing the likelihood of moral hazard (workers taking risks that benefit them at the expense of the principal) and ensuring that the workers are working in the way that the principal desires.

A Factory Owner Wants His Workers to Produce as Many