Question

Consider the relationship between a restaurant manager, who supervises the servers in the restaurant, and a restaurant server.

i) Who is the principal and who is the agent in this case, and what is the moral hazard problem? Explain how tipping can help to alleviate the moral hazard problem in this case.

ii) Suppose that the restaurant now institutes a policy where instead of having customers choose the amount to tip, all customers now have to pay a flat 15% service charge. In terms of dealing with the moral hazard problem, would the restaurant manager be in favor of this policy? Would the servers be in favor of this policy?

Answer 1

1. Principal is the manager and agent in the above case are restaurant servers. The moral hazard problem is servers not working as per the expectation of the manager. Tipping will increase their performance and servers will work more efficiently and thus moral hazard problem will be reduced in this case.

2. Yes, manager will favor this policy as this will be added in the restaurant revenue. However, servers will not favor this policy as they will get a fixed amount out of the tax and not personal income from the customers. Thus, to improve performance personal tipping is better.