Reputations and Implicit Contracts

Coen Teulings and Martijn Huysmans ()
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Coen Teulings: Utrecht University
Martijn Huysmans: Utrecht University

Chapter 7 in The Microeconomics of Market Failures and Institutions, 2025, pp 181-209 from Springer

Abstract: Abstract When information is unverifiable, complete contracts relying on outside enforcement are infeasible. Then, the institution of self-enforcing implicit contracts based on reputations serve as a second-best alternative. This institution relies on the condition for cooperation discussed in Chap. 1. We discuss vacancy equilibria, where the principal moves last and captures the surplus, as well as unemployment equilibria, where it is the other way around. Kaldor-Hicks efficiency requires the side with the best reputation to move last. Reputations therefore expand the scope of credible implicit contracts. Indeed, half the market capitalization of the companies with the best reputations is accounted for by the value of their reputation. We discuss how occupational pride undergirds an independent judiciary, whose judgement is not driven by profit maximization, but by a positive evaluation of their judgement by their fellow judges.

Date: 2025
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DOI: 10.1007/978-3-031-74987-2_7

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