Are labor contracts efficient to combat fraud?

The purpose of this paper is to approach the issue of fraud prevention by using the theory of incentives to design a mechanism that makes employees to reveal their true type, that is, their willingness or ability to combat corruption. Based on this information, the manager may propose particular contracts for different types of employee.

The mechanism design approach assumes that the manager or the principal is entrusted with the power of making the employees agents – to provide effort. This methodology is adapted to assess the efficiency of the labor contracts to prevent fraud.

The paper shows that the labor contracts are efficient to combat fraud when the type of the employee, measured by his/her willingness to cope with fraud prevention is known by the manager. If this worker's private information not available for the manager, then the contract is not efficient due to the problem of hidden information that leads to a moral hazard. Only a second‐best solution is attained in this case.

The labor contracts are subject to the problem of hidden information.

This is a theoretical result that points out the importance of using labor contracts in order to stimulate workers to cope with fraud prevention.

The paper presents an attempt to apply an incentive theoretic approach to evaluate the efficiency of the labor contract scheme of combating fraud. Also, it reveals the fragile points of such an approach and how to overcome them.