Employment and Investment by the firm Under Asymmetric Information

Anna Maria Menichini and Peter Simmons

Discussion Papers from Department of Economics, University of York

Abstract: This paper considers the joint investment and labour contracts (employment and wage compensation) for a firm which has private information over its expost revenues. There is costly state observation for investors in the firm; workers can free ride on any investors state observation. The commitment contract uses investor auditing to prevent the firm cheating. Without commitment auditing by investors (possibly random) and cheating by the firm (possibly random) are chosen in a Nash equilibrium after the contract specifying loan size, employment and state contingent repayments has been signed. A main result is that without commitment there may be a negative correlation of wage and investor compensation.

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