Implicit Employment Contracts: The Limits of Management Reputation for Promoting Firm Productivity

Journal of Accounting Research, Forthcoming

46 Pages Posted: 30 Jul 2007 Last revised: 25 Oct 2015

See all articles by Jeffrey Hales

Jeffrey Hales

University of Texas at Austin - Department of Accounting

Michael G. Williamson

University of Illinois at Urbana-Champaign - Department of Accountancy

Date Written: July 29, 2009

Abstract

Implicit employment contracts are a common way to motivate firm productivity but also require that employees trust management to be fair when allocating post-production firm resources between employees and owners. We use an experiment to study the problem of motivating firm productivity, which depends on levels of both owner investment and employee productive effort, when managers have an incentive to favor the owner's interests over those of the employee. Drawing on research in psychology and behavioral economics, we argue that reputation formation is necessary but not sufficient for promoting firm productivity if manager compensation is highly sensitive to how much the owner is allocated after production occurs. Consistent with our predictions, allowing reputation formation does lead to greater firm productivity and higher payoffs for all firm members, but only when manager pay is relatively insensitive to the owner's ex post allocation. In addition to offering testable empirical implications, our theory and results are important because they can help explain why executive compensation is, in practice, surprisingly insensitive to owner returns, particularly when executives are responsible for maintaining long-term implicit employment contracts.

JEL Classification: M40, M46, J33

Suggested Citation

Hales, Jeffrey and Williamson, Michael G., Implicit Employment Contracts: The Limits of Management Reputation for Promoting Firm Productivity (July 29, 2009). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1003692 or http://dx.doi.org/10.2139/ssrn.1003692

Jeffrey Hales

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States
512-471-2163 (Phone)
512-471-3907 (Fax)

Michael G. Williamson (Contact Author)

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

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