Document Type



Employer reputational costs - that is, the loss in value of the firm's reputational assets if the firm reneges on its promises to workers, both express and implied, - has played an important role in the economic literature of employment contracts, but this factor has itself generated little sustained analysis. Reputation is often offered as a late-appearing deus ex machina explaining why opportunistic behavior by employers even in internal labor markets is likely to be relatively unimportant.

This standard explanation for the enforceability of implicit labor contracts in internal labor markets is problematic for at least three reasons. It assumes a well-functioning market in information about past and projected firm behavior, for a loss in employer reputation can only occur if job applicants from the external labor market are able readily to distinguish between "opportunistic" behavior (where, say, a termination of employment reflects an employer's reneging on implied promises of deferred compensation or late-career immunity from close monitoring of performance) and legitimate behavior (where a discharge reflects an appropriate response to shirking on the job or unforeseen business conditions). Second, the reputational-loss account is a static one; it assumes that employers in the first period (when they make the implied promise of deferred compensation or late-career job security) are in the same product market position in the later period (when they are expected to perform these implied promises). If the employer in the later period has disappeared, operates in a different product market, or has a need for workers with a different skill mix than in the first period, it will become even more difficult for job applicants in the external labor market to evaluate whether the firm's past behavior is a good predictor of their probable job experience with that firm. Finally, the explanation also makes certain problematic assumptions about how workers process information.

The deficiencies of the standard explanation require either a reconsideration of implied labor market theory, or if implied labor market arrangements remain economically desirable an identification and possible strengthening of institutions that might enhance the firm's reputational costs in breaking promises to workers.

Date of Authorship for this Version

January 2009