Hiring an employee's friends is good for business: Overcoming moral hazard with social networks

Abstract

In settings where financial incentives are costly to implement, we explore the use of employee referrals to reduce worker moral hazard. Employers can exploit referrer-worker social preferences towards each other by conditioning the referrer rewards on worker effort. In order to test this theory, we design a laboratory experiment with employers, referrers and workers using information on real friendship relationships extracted from Facebook. The design allows us to pin down the effect of social preferences between worker and referrer in reducing worker moral hazard. Our main result is that workers put in higher effort when referrals are used relative to anonymous hiring. The experimental evidence suggests that directed altruism is a plausible mechanism underlying referrer and worker choices.