IT-enabled Monitoring and Labor Contracting in Online Platforms: Evidence from a Natural Experiment

Two-sided online platforms are typically plagued with hidden information (adverse selection) and hidden actions (moral hazard), limiting market efficiency. Situated in the context of the increasingly popular online platforms for labor contracting (herein referred to as “online labor markets”), this paper investigates whether the implementation of an IT-enabled monitoring system mitigates moral hazard in online platforms by providing direct information on workers’ effort. Our identification hinges on a natural experiment at Freelancer when it first introduced an IT-enabled monitoring system for time-based projects but not for fixed-price projects in February 2014. Based on a unique dataset comprising 6,464 fixed-price projects and 3,120 time-based projects matched on observable characteristics, we employ a difference-in-differences (DID) approach to identify the treatment effect of the monitoring system implementation on various outcomes from both the employer (demand) side and the worker (supply) side, including employers’ worker choice, workers’ entry decisions and reputation premium. We observe that the implementation of the monitoring system lowers the employers’ preference for bidders with a high effort-related reputation in time-based projects, and thus reduces reputation premiums and lowers the entry barrier for workers who have not yet established a reputation on the platform. However, there is no significant change in employers’ preference for bidders with a high capability-related reputation. Further, using fixed-price projects as the control group, the implementation of the monitoring system increased the number of bids on time-based projects by 23.7% (primarily from bidders with no prior experience on the platform) and reduced the transaction price in time-based projects by 6.9%. Our results indicate a partial substitution relationship between reputation systems and monitoring systems, and suggest that IT-enabled monitoring systems have a significant effect on alleviating moral hazard, reducing agency costs, and intensifying supply-side platform competition.