Moral Hazard and Sorting in a Market for Partnerships

This paper incorporates two-sided moral hazard in an otherwise frictionless matching market for partnerships and examines how unobservability of the effort choices of the matched partners impacts the equilibrium sorting patterns. We find that the direction of this impact depends on whether unobservable effort and observable type are complements or substitutes: when they are complements (i.e.marginal products of effort are increasing in types), moral hazard favors negative sorting, and, conversely, when effort and type are substitutes, moral hazard favors positive sorting.