We have seen why the employer finds it in his interest to delegate to an employee discretion over a subset of the organization's productive activity. This chapter explores the ways the employee can use this discretion to increase his own welfare at the employer's expense and how the employer imposes constraints that limit his costs of this behavior. By connecting an employee's actions or results of his actions with the rent he derives from his employment, these constraints establish the incentives on the employee that the employer controls. Given the employee's discretion over resource allocation and these constraints, the employee's equilibrium resource allocation behavior can be analyzed in the short and long run.

Employees' resource diversions are introduced and the information required for an employer to make inferences about diversions is described. The alternative types of resource responsibility available to employers to limit resource diversions are then considered. After discussing the possible influence of employees' benefits from their resource diversions on the organization's labor supply, we consider how employees' cash salaries are established. Finally, the employer's selection of a type of responsibility to impose on an employee is analyzed.

Employees' resource diversions

This section defines employees' resource diversions and considers the costs and productivity of information that an employer can use to make inferences about diversions.

When an employee's utility function does not contain a variable for his employer's welfare, the employee has the motivation to use his discretion over resources delegated to him to increase his utility at the employer's expense.