Essays on implicit contracts

This dissertation presents an attempt to integrate state-contingent labor and loan contracts in explaining the effects of firm's financial decisions on its employment level and analyzing the fluctuations of employment over the business cycle. As such we propose a model by incorporating incomplete capital markets into the conventional implicit labor contract model. First, the case of symmetric information is studied. In this case, the state of nature is uncertainty, ex ante, to the firm, workers and creditors. The realization of the state of nature can be observed by these three parties, ex post. Then, the case of asymmetric information where only the firm, not the workers nor the creditors, observes actual state of nature ex post is examined. The proposed model shows that in both cases the results are similar to those of implicit labor contract model. The optimal labor and loan levels are productively efficient in each state with symmetric information. With asymmetric information, underemployment and underinvestment occur in unfavorable states; however, the optimal employment and investment levels are productively efficient in good states. In particular, the proposed model demonstrates that fluctuations in the employment level are affected by the firm's financial decisions and tend to have a smaller amplitude than those in capital utilization. A side benefit of using this model is the ability to explain of real business cycles such that employment and real wages are procyclical with output.