Applied Economics, 2000, 32, 349-356 Moral hazard, competition and contract design: empirical evidence from managerial, franchised and entrepreneurial businesses in Norway ARNE NYGAARD* and INGUNN MYRTVEITJ Norwegian School of Management, School of Marketing, Schous Plass 8, P. Box 4676 Sofienberg, 0506 Oslo, Norway and %Norwegian School of Management, Department of Economics, Elias Smiths vei 15, Postboks 580, 1301 Sandvika, Norway Agency theory emphasizes the role of ownership, control and incentives in encourag- ing managers to improve efficiency. Owners often tie managers to contracts that reduce conflict of interest between owners and managers. The differences between alternative business ownership structures have been investigated. According to theory, we expect managers with an outcome-dependent dealer contract to be more efficient than managers with a more integrated and less performance based employee dealer contract. We also analyse how competitive pressure might reduce the moral hazard problem and therefore affect contract design. Berle and Means (The Modern Corporation and Private Property, Macmillan, New York, 1932) long ago stated that the market mechanism could constrain the agency problem. Even so, this problem has scarcely been investigated empirically. This paper also considers the contractual effect of potential monitoring costs, education and relationship age in a model tested on data from 175 dealer contracts in a multinational oil company. I. THEORETICAL PERSPECTIVE The actors in classical economic theory maximize self- interest. The corporation is a profit-maximizing entity. Recent research on labour markets has introduced agency theory. Agency theory describes the firm as a set of explicit and implicit contracts, which regulate transactions between actors (Alchian and Demsetz, 1972). Explicit contracts are written contracts that can be enforced by law. In contrast, implicit contracts are tacit agreements enforced by such mechanisms as norms, trust, commitment or values (Bailey, 1974; Gordon, 1974; Azariadis, 1975). Economic actors in contractual relations typically have conflict of interest. They relate to each other in a complex environment of incomplete information. The combination of bounded rationality, information asymmetry and oppor- tunism makes nearly all contracts incomplete. In this paper we study the classical case of principal- agent contracts in which an owner of a trademark - the principal (P) - has delegated operative responsibility to a manager - the agent (A). This includes decisions concern- ing operation and maintenance of invested capital. The owner and the manager might have different objectives, and the manager can take actions which affect the owner's welfare and which he cannot (completely) observe. Both researchers and practitioners have focused on how these problems can be solved by using a combination of incen- tives and control. Moral hazard and monitoring costs Classical economic theory assumes that owner maximizes profit. Employee managers, however, will maximize their own self-interest by taking an increasingly larger portion of whom correspondence should be addressed. Applied Economics ISSN 0003-6846 print/ISSN 1466-4283 online © 2000 Taylor & Francis Ltd 349