Trust and Adaptive Learning in Implicit Contracts

Abstract

We study effects of trust in implicit contracts. Trust changes whenever the principal honors or dishonors an implicit contract. Usually a higher discount rate lowers the value of trade in an agency. We show that a sufficiently high level of (ex ante) trust can offset this effect. Strategies of principals representing unique equilibria are endogenously derived given different levels of agents.bounded rationality. These strategies mirror a subset of the class of trigger strategies which is exogenously entered into previous implicit contracting models. Therefore our results offer some justification for using that conventional approach. Implications for performance evaluation are discussed.