Employee Fraud and the Statute of Limitations in a Search and Matching Model

ABSTRACT

This paper integrates employee fraud into a Mortensen‐Pissarides search and matching model to analyze labor market dynamics under imperfect legal enforcement. We introduce a time‐dependent punishment structure where the offender's effective liability is governed by the statute of limitations. We characterize both short‐ and long‐run equilibria, showing that the deadline for punishability creates temporal distortions in job creation incentives. Our results indicate that while judicial super‐efficiency can eliminate crime in the short run, fraud may persist in the long run if the expected return exceeds the opportunity cost of employment. Crucially, we identify a viability condition for the legal economy under which the decentralized equilibrium exhibits structural underemployment, driven by the market's inability to internalize the moral hazard of crime. Finally, we demonstrate that a job creation subsidy can restore the socially optimal level of employment and endogenously reduce crime rates by raising the value of formal contracts.