The Optimal Disclosure Policy When Firms Offer Implicit Contracts

Abstract

Firms often motivate their workers with implicit incentive contracts. Since these contracts are sustained through the threat of future retaliations by the workers, their sustenance hinges on the worker's observability of the game's history. When a long-lived firm hires a sequence of short-lived workers, the coexistence of old and young generation of workers facilitates the observability of history. The old communicates the history to the young. Turnover adversely affects the observability of history, because the old worker may leave the firm before communicating the history to the young. But if workers are better matched with their prospective employers, efficient turnover can also enhance profit by maximizing the matching gains available for up front extraction. Disclosure of the workers' productivity information to outside labor market affects turnover by mitigating adverse selection in turnover. Thus, the optimal disclosure policy trades off matching efficiency in turnover with the sustainability of implicit contracts. I formalize this trade-off, and characterize the optimal disclosure policy. There are three main results: (i) opaqueness can be strictly optimal only for the firms with moderate reputation concerns, (ii) in equilibrium, an opaque firm's profit may decrease with its reputation concern, and (iii) opaqueness is less likely to be the optimal policy when the matching gains are high.