The interaction of explicit and implicit contracts: A signaling approach

We analyze the interaction of explicit and implicit contracts in a model with selfish and fair principals. Fair principals are willing to honor implicit agreements, selfish principals are not. We investigate a separating equilibrium in which principals reveal their type through the contract offer to the agent. Explicit and implicit contracts are shown to be substitutes. Since the agent learns the principal's type, a selfish principal must rely on explicit incentives. A fair principal, by contrast, can effectively induce implicit incentives and does not need to use explicit incentives. We also find a strategic complementarity between explicit and implicit incentives.