Trust and Contracting

Prior research has shown that trust has a positive effect on the economic welfare of nations. We investigate this result by analyzing the effect of endowed trust on agency problems within organizations. We find that firms located in U.S. counties where trust is more prevalent suffer less from agency problems and display higher profitability and higher valuation. In addition, these firms utilize lower power compensation schemes and are less likely to fire their CEOs, while they take a harsher view of ethical breaches. Overall, our results suggest that trust is an effective way of mitigating moral hazard problems