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

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  • JEFFREY HALES
  • MICHAEL G. WILLIAMSON

Abstract

Implicit employment contracts are a common way to motivate firm productivity but also require that employees trust management to be fair when allocating postproduction firm resources between employees and owners. We use an experiment to study the problem of motivating firm productivity, which depends on levels of 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 concerns can more effectively promote firm productivity when manager compensation is relatively insensitive to how much the owner is allocated after production occurs. Consistent with our predictions, we find that reputation concerns 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.

Suggested Citation

  • Jeffrey Hales & Michael G. Williamson, 2010. "Implicit Employment Contracts: The Limits of Management Reputation for Promoting Firm Productivity," Journal of Accounting Research, Wiley Blackwell, vol. 48(1), pages 51-80, March.
  • Handle: RePEc:bla:joares:v:48:y:2010:i:1:p:51-80
    DOI: 10.1111/j.1475-679X.2009.00352.x
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    1. Thornock, Todd A., 2016. "How the timing of performance feedback impacts individual performance," Accounting, Organizations and Society, Elsevier, vol. 55(C), pages 1-11.
    2. Luft, Joan, 2016. "Management accounting in the laboratory and in social context: Four contrasts, 1975–2014," Accounting, Organizations and Society, Elsevier, vol. 49(C), pages 9-20.
    3. van Pelt, Victor, 2019. "A dynamic view of management accounting systems," Other publications TiSEM 782413b7-2830-4e6d-bc4c-3, Tilburg University, School of Economics and Management.
    4. Xiaotao (Kelvin) Liu & Yue (May) Zhang, 2015. "Effects of Target Timing and Contract Frame on Individual Performance," European Accounting Review, Taylor & Francis Journals, vol. 24(2), pages 329-345, June.
    5. Lisa-Marie Wibbeke & Maik Lachmann, 2020. "Psychology in management accounting and control research: an overview of the recent literature," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 31(3), pages 275-328, September.

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