The Misallocation of Ethical Workers

Abstract

Do markets allocate ethical workers efficiently? We study environments in which worker moral type affects not only the private disutility of a job but also the externality generated by production. In such settings, the standard compensating-differentials efficiency result breaks down: workers who are most averse to harmful conduct may be socially valuable not only in beneficial sectors but also inside harmful-sector firms, where they can mitigate harm or increase the likelihood that wrongdoing is exposed. We show that decentralized markets need not deliver that allocation, and that harmful-sector firms have an incentive to worsen it by designing compensation that rewards harmful conduct and screens out workers who would restrain it. Policies that lower the private cost of mitigation can backfire by strengthening the screening incentive, so that the composition of the harmful sector worsens even as mitigation becomes cheaper. By contrast, direct regulation of the screening instrument avoids this feedback and yields a policy trade-off between privately valued output and external harm. Joint with Michael Vlassopoulos.