In an employment context, moral hazard arises when an employer cannot perfectly observe the level of effort an employee exerts. Because the employee's actions are hidden, they may have an incentive to shirk or put in less effort than they would if they were fully monitored, especially if their compensation is not directly tied to their output. This is a classic example of the principal-agent problem, where the agent (employee) acts in their own self-interest, which may not align with the interests of the principal (employer).