Implicit Agreements Research Articles

The Interaction of Explicit and Implicit Contracts: A Signaling Approach

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.

The Interplay of Formal and Relational Contracts: Evidence from Movies

This article empirically examines the interplay of formal and relational contracting in the Spanish movie industry. Using institutional knowledge, I extend the existing theory on explicit and implicit contracts to include learning, a critical element of contracting in the movie industry. Subsequently, I show results consistent with the theory using a unique data set from a Spanish movie exhibitor with detailed information on the use of formal contracts and ex post contractual adjustments. My results show that distributors are more likely to use formal contracts for movies of higher expected value. Consistent with well-established results of the relational contracting literature, distributors use formal contracts to deter exhibitors’ opportunistic behavior since their reneging temptations from implicit agreements are strongest for this type of movies. Conditional on using a formal contract, I find that ex post renegotiation is more likely to occur when the movie performs below expectations.

The interaction between explicit and relational incentives: An experiment

We consider repeated trust game experiments to study the interplay between explicit and relational incentives. After having gained experience with two payoff variations of the trust game, subjects in the final part explicitly choose which of these two variants to play. Theory predicts that subjects will choose the payoff dominated game (representing a bad explicit contract), because this game better sustains (implicit) relational incentives backed by either reputational or reciprocity considerations. Our main findings are that cooperation is indeed more likely in the payoff dominated game. Moreover, indefinite repetition increases both cooperation rates and the likelihood with which the payoff dominated game is chosen. Overall we conclude that available explicit incentives indeed do affect relational contracting and, anticipating this, agents may choose weak explicit incentives to facilitate implicit agreements.

Public Information, IPO Price Formation, and Long‐Run Returns: Japanese Evidence

ABSTRACTThe price formation process of JASDAQ IPOs is more transparent than in the United States. The transparency facilitates analysis of important issues in the IPO literature—why offer prices only partially adjust to public information and adjust more fully to negative information, and why adjustments are related to initial returns. The evidence indicates that early price information conveys the underwriter's commitment to compensate investors for acquiring and/or disclosing information. Offer prices reflect pre‐IPO market values of public companies and implicit agreements between underwriters and issuers that originate well before the offering. Underadjustment of offer prices is substantially reversed in the aftermarket.

The Medium of Exchange, Control Loss and Wealth Effect on Suppliers in Mergers and Acquisitions

I examine the corporate control implications of the financing decision in mergers for bidder suppliers. Specifically, I hypothesize that reallocation of control rights from bidder management to target management and block-holders through stock financing in mergers, especially non-diversifying ones, has negative value implications for bidder suppliers due to the nature of incomplete contracting. Because future contingencies are hard to predict, intense trading relationships between the bidder and its suppliers are often governed by implicit agreements. Since the ability of management to deliver on implicit agreements with suppliers is closely related to their controlling power, corporate decisions that dilute managerial power such as stock financing in M&A transactions will have an adverse impact on the firm's suppliers. To the extent that bidder suppliers cannot influence the choice of target, the target ownership structure and the medium of exchange in mergers, the financing decision of bidder would constitute an exogenous shock to bidder suppliers, and provides an ideal setting to examine value implications on bidder suppliers of corporate control changes in the bidder. In support, I find that bidder suppliers affected by non-diversifying mergers suffer strong negative announcement returns of -1.04% in stock offers, but not in cash offers. Moreover, the announcement returns of bidder suppliers become more negative with larger control rights transfer to target management and institutional block-holders in stock offers. Bidder suppliers, however, can rely on higher percentage of sales to the bidder to mitigate the adverse impact of stock financing. In contrast, these effects are not observed for bidder suppliers affected by stock financing under diversifying mergers. These findings remain robust to controlling for the use of over-valued equity using the bidder's accruals and run-up in stock price. Furthermore, bidder suppliers face lower retention likelihood, albeit weakly, when stock financing is used over cash financing under circumstances where there is control rights transfer to target block-holders. Lastly, under non-diversifying mergers, bidder suppliers affected by stock financing and are dismissed experience worse performance post-merger.

Contracts as Threats: On a Rationale for Rewarding A While Hoping for B

Contracts often reward inefficient tasks and are not enforced ex post. We provide a new explanation based on the relationship between explicit contracts and implicit agreements, distinguishing the ex-ante decision to sign a contract from the ex-post decision whether to apply it. We show that it is often optimal to have overcontracting - contractual clauses requiring costly, inefficient, verifiable tasks (A) - not enforced in equilibrium. Overcontracting facilitates relational contracting on efficient non-contractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. The model also explains why stipulated damages must be moderate in size. These results apply independently of whether B is a `productive' task or a 'bribe'.

Market growth through mergers and acquisitions: The role of the relationship marketing manager in sustaining performance

This research suggests that firms considering a merger and acquisition strategy need to pay attention to the relationship marketing managers of the target firm and the implicit agreements that have kept them with the target firm. The results of this study convey that the joint activity of maintaining the implicit contracts and retaining the relationship marketing managers have a stabilizing and positive impact on the productivity of subordinate marketing employees. These employees are a key success factor that enables the target firm to function effectively after the acquisition.

Principles for Resolving Conflicts Between Trade Secrets and the First Amendment

Preliminary and permanent injunctions are routinely granted in trade secret cases without offending the First Amendment, and this is as it should be. In ordinary trade secret cases, injunctions merely require parties to abide by express or implicit agreements they have made, respect the confidences under which they acquired secrets, and refrain from wrongful conduct vis-a-vis the secrets. Occasionally, those who want to disclose trade secrets invoke the First Amendment as a defense to claims of trade secrecy misappropriation. Courts and commentators have taken varying positions on issues pertinent to these defenses, including whether trade secrecy law are categorically immune (or nearly so) from First Amendment scrutiny and whether preliminary injunctions forbidding disclosure of informational secrets should be considered prior restraints on speech. This article offers a set of principles for mediating the tensions that occasionally arise between trade secrets and the First Amendment. Part I seeks to explain why conflicts between trade secrecy law and the First Amendment have thus far been relatively rare. It discusses limiting principles of trade secrecy law that mediate most free-speech-related tensions likely to arise when someone wants to disclose information that another claims as a trade secret. Part II suggests that more conflicts between trade secret and First Amendment interests may occur, in part because of the increased use of mass-market licenses to keep information secret that would otherwise be lawful to acquire and disclose. It considers proposals to strengthen trade secret rights in response to threats to trade secrets posed by the global communications medium of the Internet. The stronger trade secret rights become, the more likely they are to come into conflict with First Amendment interests. Part III criticizes the California Supreme Court's decision in DVD CCA v. Bunner for, among other things, its implicit adoption of the categorical immunity theory and its reliance on DVD CCA's assertion of property rights in its secrets in rejecting Bunner's First Amendment defense. Part IV concludes that even though preliminary injunctions in informational trade secret cases are prior restraints, they are generally justified in ordinary cases. Yet the heavy presumption against prior restraints should apply to cases in which third parties who obtained the secret without wrongdoing seeks to disclose it publicly. Part IV considers a number of other First Amendment due process issues, such as whether the burden of proof in third-party disclosure cases should be higher than in the normal trade secret cases and whether appellate review of constitutionally relevant facts should be de novo when First Amendment defenses have been raised. Part IV proposes several principles to assist courts in grappling with First Amendment defenses in trade secrecy cases.

Genetically Modified Food Standards as Trade Barriers: Harmonization, Compromise, and Sub-Global Agreements

GMOs have brought new concerns into an already challenged world trading system. This paper considers the jointly enodogenous formation of GMO-related standards and sub-global trading agreements. Standards are understood as tolerance levels for GMOs. Sub-global trading agreements may be either formal agreements between countries sanctioned by the WTO, or they may be implicit agreements, e.g. a developing country accepting the U.S. standards.We develop a theoretical model of standard formation and agreement formation. In autarky, national standards reflect the preferences of domestic consumers. The possibility of gains from trade encourages countries to modify their standards to facilitate trade with other countries having similar standards. Whether or not a country engages in trade depends on the magnitude and nature of the gains from trade--e.g. economies of scale, greater variety for consumers, etc.--and the degree of standard modification required for trade. If the gains from trade are sufficient, countries will compromise or harmonize standards to achieve these gains. In the case of countries of similar size (bargaining power), compromise may be feasible. In the case of countries of different size, harmonization of the smaller country's standard to that of the larger country may be more likely. The case of the European Union's de facto prohibition on trade in GMOs is represented as a case in which the gains from trade are insufficient to catalyze a compromise position. Analogously, the North American refusal to restrict or prohibit GMOs indicates that the gains from trade with Europe are insufficient to compensate for this change in standard. In the absence of a common global standard, countries with similar preferences cluster into smaller clubs to capture at least some gains from trade.

Banks and the world’s major banking centers, 2000

We update earlier articles on the determinants of interpenetration of financial centers by banks and analyze the substantial changes that have occurred between 1990 and 2000. First, the number of banks and the number of offices in other centers has fallen by over 20 percent since 1990. Second, aggregate interconnectedness has held steady between 1990 and 2000, though there is an increasing asymmetry. Third, Tokyo has lost rank as a center, while Hong Kong and Singapore have continued to gain importance. Fourth, Frankfurt, rather than gaining importance with the advent of the euro, has apparently lost importance. Lastly, some explicit or implicit agreements between banks from different countries not to compete in each other's markets have continued to wane, though intra-European interpenetration remains relatively low. JEL no. F30, G15, G21

Driving Forces of Informal Sanctions

"Informal sanctions are a major determinant of a society’s social capital because they are key to the enforcement of implicit agreements and social norms. Yet, little is known about the driving forces behind informal sanctions. We systematically examine the determinants of informal sanctions by a large number of experiments. Our experiments allow us to identify the relative importance of three major potential factors: (i) strategic sanctioning for selfish reasons, (ii) non-strategic sanctions driven by spitefulness, and (iii) non-strategic sanctions that are driven by the violation of fairness principles. In addition, the observed sanctioning patterns provide insights into the relevance of different fairness principles.nOur findings show that the violation of fairness principles is the most important driving force of sanctions but, in addition, a non-negligible part of the sanctions is driven by spitefulness. We find surprisingly little evidence for strategic sanctions that are imposed to create future material benefits. While non-strategic sanctions are of major importance in our experiments, strategic sanctions seem to play a negligible role. Within the class of fairnessdrivennsanctions the motive to harm those who committed unfair actions seems mostnimportant."

Enforcement of Implicit Employment Contracts through Unionization

In a world in which employment contracts are incomplete, it is costly for a firm to establish credibility for honoring implicit terms of employment agreements. By monitoring the employment relationships between the firm and its workers, the labor union may provide the workforce with valuable information regarding the firm's adherence to these implicit agreements. Thus, the union provides a signaling mechanism that allows workers to coordinate their actions in order to discipline the firm for a breach of the implicit contract. This mechanism enhances the firm's credibility when forming employment contracts and facilitates increased employment levels.

Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law

Conventional legal and economic analysis assumes that opportunistic behavior is discouraged and cooperation encouraged within firms primarily through the use of legal and market incentives. This presumption is embodied in the modern view that the corporation is best described as a nexus of contracts, a collection of explicit and implicit agreements voluntarily negotiated among the selfishly rational parties who join in the corporate enterprise. In this article we take a different approach. We start from the observation that, in many circumstances, legal and market sanctions provide at best imperfect means of regulating behavior within the firm. We consider an alternate hypothesis: that corporate participants often cooperate with each other not because of external constraints, but because of internal ones. In particular, we argue that the behavioral phenomena of internalized trust and trustworthiness play important roles in encouraging cooperation within firms. In support of this claim, we survey the extensive experimental evidence that has been produced over the past four decades on human behavior in This evidence demonstrates that internalized trust is a common phenomenon; that it is at least in part learned rather than innate; and that different individuals vary in their inclinations toward trust. Most important, the experimental evidence indicates that decisions whether or not to trust others are in large part determined by social context rather than external payoffs. By altering social context - subjects' perceptions of others' beliefs, expectations, likely actions, and relationships to themselves - experimenters can reliably produce everything from nearly universal trust, to an almost complete absence of trust, in subjects in social dilemmas. In other words, most people behave as if they have two personalities or preference functions. One is competitive and self-regarding. The other is cooperative and other-regarding. Social framing is key in triggering when the cooperative personality emerges. These behavioral findings carry important implications for corporate law. For example, in this article we demonstrate first that the phenomenon of trust offers insight into the substantive structure of corporate law and particularly the nature and purpose of that elusive legal concept, fiduciary duty. In the process, it adds weight to the claims of anticontractarian corporate scholars who argue against the notion that corporate officers and directors should be free to contract out of their fiduciary duty of loyalty. Second, the experimental evidence on trust sheds light on how corporate law works, by suggesting how judicial opinions in corporate cases direct corporate officers' and directors' behavior not only by altering their external incentives but also by changing their internalized preferences. This possibility helps explain the notoriously puzzling relationship between the duty of care and the business judgment rule. Third, trust highlights the limited power of law by explaining how cooperative patterns of behavior can sometimes develop within firms even when external incentives, such as legal sanctions, are unavailable or ineffective. In the process, it underscores the dangers of the contractarian approach by suggesting how an excessive emphasis on external sanctions - including formal contract and even the rhetoric of contract - may be not only ineffective but counterproductive, serving to undermine trust and trustworthiness within the firm.

From the Invisible Handshake to the Invisible Hand? How Import Competition Changes the Employment Relationship

Does import competition alter the extent to which employers, after negotiating workers’ wages upon hire, subsequently shield those wages from external labor‐market conditions? If increased competition induces a switch away from these wage implicit agreements, then (1) the sensitivity of workers’ wages to the current unemployment rate should increase as competition increases and (2) the sensitivity of workers’ wages to the unemployment rate prevailing upon hire should decrease. Using exchange‐rate movements to generate exogenous variation in import competition, I find evidence supporting both of these predictions. I show that increased financial pressures on employers is one mechanism driving these effects.

Employment Contract Law

This essay discusses nonunion employment contracts. It describes several important contract doctrines that have significantly eroded the once virtually irrefutable employment-at-will presumption. Two factors appear to determine whether employees receive protection against discharge: (1) jurisdictional variation among liberal, conservative and centrist states, and (2) the definiteness and specificity of any alleged assurances of job security. Recently, scholars have also debated the normative question of whether the at-will rule is a desirable default, offering various economic arguments in support of a just cause regime. The essay questions whether the existence of implicit agreements for career employment justifies making such informal agreements legally enforceable. Workers cognitive limitations and strategic problems such as signaling and adverse selection produce ambiguous behavioral predictions, and thus they too provide an uncertain basis for reform. A nascent empirical literature has begun to provide valuable information about actual contract practices. Thus, for example, arguments based on adverse selection must confront the inconvenient fact that a significant number of employers (government agencies, unionized firms, and about 15% of nonunion employers) contract for legally enforceable just cause protection. Other important empirical work has raised doubts about the extent of workers legal knowledge. The essay concludes that more and better evidence on these questions is needed to justify displacing the current at-will default.

GATT, Dispute Settlement and Cooperation: A Reply

This paper analyzes GATI' and its dispute settlement procedure (DSP) in the context of a supergame model of international trade featuring both explicit and implicit agreements. An explicit agreement, such as OAT!', may be violated at some positive cost in addition to retaliatory actions that might be induced by the violation. We interpret this cost as arising from 'international obligation, a phenomenon frequently mentioned in the legal literature on GAY!'. We focus on how international obligation affects two aspects of GAIT-DSP: unilateral retaliation and the effect of inordinate delays in the operation of DSP. Marie Thursby Dan Kovenock Department of Economics Department of Economics Krannert Graduate School of Management Krannert Graduate School Purdue University of Management West Lafayette, IN 47907 Purdue University and NBER West Lafayette, IN 47907

The Governance of Exclusive Territories When Dealers can Bootleg

A transaction cost approach is used to investigate a manufacturer's policy towards exclusive territory dealers who bootleg (sell across their assigned territories). We show that optimal enforcement policies will generally tolerate some level of bootlegging. This tolerance is a natural consequence of the transaction cost principle that institutional arrangements are not fully enforceable, and that self-enforcing implicit agreements will require some degree of tolerance. The actual degree of tolerance is determined by (a) the importance of reseller services, (b) the reduction in margin realized from surreptitious sales, and (c) the resellers' beliefs about the manufacturer's long-run commitment to the channel. We also show that deploying exclusive territories is beneficial to the manufacturer because it safeguards reseller services and permits resellers to capitalize on their superior local information. However, the latter effect is contingent on being able to convince resellers of the manufacturer's long run commitment to the channel.

Dishonored contracts: Accounting and the expropriation of employee pension wealth

There has been growing public disquiet in the U.S. and in the U.K. about takeovers aimed at seizing the excess in employee pension plans. Some critics have argued that expropriation of the accounting income lodged in the takeover target's pension surplus has been a primary motivation for these takeovers. Specifically, two questions have been raised about such transactions: first, whether such terminations violate implicit agreements with employees, and thus usurp the latter's legitimate claim to the pension surplus. Second, whether management's betrayal of employee trust increases contracting and monitoring costs in the economy at large. Financial reporting appears to exacerbate these problems: GAAP, under FAS 36, overstated the pension excess by undervaluing pension liabilities; the latter being calculated on an accumulated benefit basis rather than a going concern (“economic”) basis. Reporting this amount underscores the amount that could be expropriated by reneging on implicit pension agreements via a takeover and termination. This study suggests that the prospect of capturing pension excesses motivated a significant number of takeovers between 1981 and 1985. FAS 87 changed pension disclosure requirements after 1986 and thus remedied some, but not all, of the technical deficiencies of FAS 36. This change affirms, rather than refutes, the primary thesis of this study, however: that accounting is a malleable and contested social practice that is best understood (theorized) as a product of struggle and conflict, not as a faithful representation that unproblematically reflects an underlying, “eternal” economic truth. The study shows that, insofar as pension terminations that abrogate implicit contracts are encouraged by the prospects of seizing the accounting income lodged in the pension surplus, questions should be raised about accounting's partisanship in such distributional disputes.

The Moral Sense

The central problem for social science is to explain social order. How do people manage to live together? One can discern two ways of answering that question. The first view is normative and communal: people learn from their culture customs that provide an internal compass guiding them to act in ways that minimize conflict and ensure comity. The second view is rationalistic and individualistic: order is created by explicit and implicit agreements entered into by self-seeking individuals to avert the worst consequences of their predatory instincts. In the first view, order is natural and prior to any social contract or government institution; in the second, it is contrived and dependent on agreements and sanctions. Rules are obeyed in the first case because they have moral force, in the second because they convey personal advantage. In the first view, compliance is automatic and general; in the second, it is strategic and uncertain.The normative view has been under heavy attack for several decades for at least three reasons: it seems to imply a complacent functionalism; it appears to minimize or deny the value of conflict; and it lacks the theoretical power found in the assumption that people always seek their own interests. I believe that one can grant, up to a point, all of these objections and still be left dissatisfied with the alternative, namely, that social order is contrived, based on calculation, and dependent on individual assent.

Cartel Stability in an Exhaustible Resource Model

A simple oligopolistic common-pool exhaustible resource game is considered. By analysing punishment strategies, including optimal punishments, it is possible to determine which cartel agreements are implementable in a non-cooperative play of the game. Joint-profit-maximizing allocations are sustainable for sufficiently low discounting, but in general it is shown that no folk theorem exists for this model. In particular, for sufficiently high elasticities of demand, it is shown that optimal punishments are not sufficiently severe to enforce most stationary symmetric extraction paths, thus confirming the hypothesis that sufficient market power is needed for a cartel to be stable. A simple common-property exhaustible resource model in a discrete-time, infinite-horizon framework will be considered. By looking at 'punishments' levelled against firms that deviate from an implicitly agreed extraction path, it is possible to examine the extent to which different allocations can be supported as non-cooperative equilibria. We shall pay particular attention to the question of whether punishments can be severe enough to sustain implicit agreements that maximize joint profits, and to the idea (Pindyck 1979) that cartel stability depends crucially upon market power. This non-cooperative approach to the question of cartel stability has been used by Porter (1983) in a repeated oligopoly model with imperfect information (see also Green and Porter 1984). While we assume perfect observability here, the model is compli- cated by the existence of a state variable in the form of the resource stock; moreover, we shall apply the idea of optimal punishments in this dynamic model. (Abreu et al. (1986, 1990) have looked at general properties of the equilibrium set in the Green-Porter model.) What we find is that, by considering a more general strategy space than that conventionally studied, cooperative extraction rates are sustainable in equilibrium, for low enough discount rates, in contrast to the 'over-extraction' results often obtained. Moreover, in this model the predictions concerning the range of possible sustainable equilibria as the discount rate approaches zero are sharp. While the cooperative solution belongs to the set of equilibria for low discount rates, constant symmetric extraction paths below the maximum possible rate fail to be sustainable in the limit if the elasticity of demand is sufficiently high.' Thus, for low discount rates only extraction rates close to the cooperative rate are sustainable together with 'disagreement equilibria' which involve very high extraction rates. These results are in sharp contrast to those obtained from repeated games where in the limit the range of equilibria is very large. The difference is explained by the existence of a state variable in the form of a declining stock of the resource. These results are also in contrast to what can happen in our model when the demand elasticity is lower: all constant symmetric extraction paths may be sustainable for low enough