Monitoring and prudence

We analyze the impact of monitoring on workers’ effort in a workplace setting where employers can precisely measure total output but cannot perfectly observe the single worker’s contribution. While traditional models highlight the efficiency gains of monitoring, we explore an alternative scenario where risk neutral firms forego monitoring, shifting all income uncertainty to risk-averse workers. We establish the conditions under which the absence of monitoring can yield higher profits than its presence. We also show that when workers’ coefficient of absolute prudence is higher than their coefficient of absolute risk aversion, total output is higher in a no-monitoring setting.