In the early 1990s, lawsuits charged Sears with massive fraud in its auto repair centers, alleging that mechanics were convincing customers that they needed expensive repairs when, in fact, they were unnecessary. Sears entered into a multimillion-dollar agreement to settle the case out of court. In addition, in a bid to win back business it had lost during the highly publicized case, Sears announced that its sales staff would no longer be paid on commission.
a. In your view, were the abuses by the mechanics a result of adverse selection, moral hazard, or both?
b. The management of Sears stated that it was unaware of the abuses. What are the incentives for management to monitor its employees to prevent such wrongdoing?
c. What is the disadvantage of ending the commission system?