The Interaction of Explicit and Implicit Contracts: A Signaling Approach

25 Pages Posted: 2 Apr 2012 Last revised: 9 May 2014

See all articles by Marc Gürtler

Marc Gürtler

University of Braunschweig - Institute of Technology, Department of Finance

Oliver Gürtler

University of Cologne

Date Written: March 30, 2012

Abstract

We analyze the interaction of explicit and implicit contracts in a model with sel fish and fair principals. Fair principals are willing to honor implicit agreements, whereas sel fish principals are not. Principals are privately informed about their types. We investigate a separating equilibrium in which principals reveal their type through the contract o er to the agent. If this equilibrium is played, explicit and implicit contracts are substitutes. Since the agent learns the principal's type, a sel fish principal has to rely on explicit incentives. A fair principal, by contrast, can eff ectively induce implicit incentives and hence does not need to use explicit incentives. Interestingly, if a sel fish principal can rely on more e ffective explicit incentives, a fair principal becomes more likely to be able to separate from the selfi sh type and, hence, to make better use of implicit incentives. In this sense, there is a strategic complementarity between explicit and implicit incentives.

Keywords: explicit contracts, implicit contracts, separating equilibrium, substitutes, strategic complementarity

JEL Classification: D82, D86, M52

Suggested Citation

Gürtler, Marc and Gürtler, Oliver, The Interaction of Explicit and Implicit Contracts: A Signaling Approach (March 30, 2012). Available at SSRN: https://ssrn.com/abstract=2031582 or http://dx.doi.org/10.2139/ssrn.2031582

Marc Gürtler (Contact Author)

University of Braunschweig - Institute of Technology, Department of Finance ( email )

Abt-Jerusalem-Str. 7
Braunschweig, 38106
Germany

Oliver Gürtler

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

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