CFDP 1422

Moral Hazard


Publication Date: May 2003

Pages: 36


We interpret workers’ confidence in their own skills as their morale, and investigate the implication of worker overconfidence on the firm’s optimal wage-setting policies. In our model, wage contracts both provide incentives and affect worker morale, by revealing private information of the firm about worker skills. We provide conditions for the non-differentiation wage policy to be profit-maximizing. In numerical examples, worker overconfidence is a necessary condition for the firm to prefer no wage differentiation, so as to preserve some workers’ morale; the non-differentiation wage policy itself breeds more worker overconfidence; finally, wage compression is more likely when aggregate productivity is low.


Overconfidence, Worker morale, Wage-setting policies

JEL Classification Codes:  J31, D82


Published in Journal of Monetary Economics (May 2005), 52(4): 749-777 [DOI]