Robust Regulation of Labour Contracts

TL;DR

This paper develops a robust regulation framework for labour contracts under moral hazard, balancing efficiency and worker protection by minimizing worst-case regret in uncertain environments.

Contribution

It introduces a regulation approach that guarantees fair worker compensation while maintaining incentive compatibility despite uncertainties.

Findings

Minimum piece rate regulation reduces worst-case regret.

The regulation balances fairness and incentive compatibility.

Robust regulation improves overall contract efficiency.

Abstract

We study the robust regulation of contracts in moral hazard problems. A firm offers a contract to incentivise a worker protected by limited liability. A regulator restricts the set of permissible contracts to (i) improve efficiency and (ii) protect the worker. The regulator faces uncertainty about both the worker's actions and the firm's production cost, and evaluates regulations based on their worst-case regret. The regret-minimising regulation mandates a minimum piece rate compensation for the worker. This rule simultaneously guarantees a fair share for the worker and preserves enough contractual flexibility to provide incentives.