Why Are Capitalists the Bosses?

This paper addresses the question: why does capital typically hire labor rather than the other way around? It models a situation in which a capitalist (owner of money capital) can choose between lending out his capital for production and using it to set up production under his own supervision. It is demonstrated that the moral hazard of potential borrowers, on account of limited liability, provides the capitalist with the incentive to become a firm-owner, supervising hired labor. The capitalist's choice is endogenized in terms of his opportunity cost of time. It is argued that moral hazard, with respect to the use of borrowed capital, is an important determinant of the social hierarchy in the workplace. Copyright 1989 by Royal Economic Society.