Moral Hazard and the Company Expense Account

You’re in a buffet line and although you’ve already stuffed yourself, you think about getting another plate. On one hand you probably don’t need another serving. But then you think “I already paid for it, so I might as well get some more.” Perhaps you, being the health-conscious person that you are, avoid going back for a second (or third) helping. But most people will inevitably return to the buffet. Is this because portion sizes in America are sky high? Perhaps. But it also can be explained by an economic theory known as moral hazard. Moral hazard is a phenomenon that explains that people make decisions differently when they are protected from some of the consequences of their actions. In the case of the buffet, people are protected from the cost of an additional plate because they prepaid for the meal, regardless of their portion. Moral hazard shows up everywhere. Do you treat rental cars as well as you treat your own? Are tenured professors as likely to care about course evaluation as those still hoping for tenure? And what about corporate expense accounts? Chances are you’re more likely to buy that filet mignon when the boss is paying for it. Of course most expense accounts have limits, but how efficient are those limits? Because a limit exists, there’s a high likelihood that people will utilize the expense account up to the limit, not actually based on the person’s need.

While this is more a theoretical exercise than a proposal to amend corporate reimbursement strategy, expense accounts should be managed more effectively. When people don’t bear the full responsibility of their actions, they are likely to behave differently, which results in outcomes that aren’t socially optimal. Thus by somehow forcing employees bear some cost (monetary or not) of expense accounts, corporations are likely to see a drop in expenditure without a loss in happiness for its employees.

Eliminating moral hazard can benefit not just expense account providers but a whole host of industries and sectors. When consumers of a good are different than the people who pay for the good, moral hazard is likely present. College students are more likely to order another round of drinks if they do so with mom and dad’s credit card. Although moral hazard will still appear unless the person paying is the person receiving the good, the goods recipient should feel some cost. In the case of the college student, a hearty guilt trip or reprimanding could suffice. For expense account holders, more knowledge (or reminders) about nutritional values might prevent him or her from ordering dessert with dinner.

Although economics is largely based on mathematics, it is still a social science. In trying to understand how the world works, economics must dissect individuals’ actions to try to make sense of trends and behaviors. Thus studying the theory behind individual decision-making can help to better understand how people act as it pertains to economics. And hopefully it can figure out a way to make people think twice about going back for seconds at the buffet.