Trust and Adaptive Learning in Implicit Contracts

We study e¤ects 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 su¢ ciently high level of (ex ante) trust can o¤set this ef- fect. Strategies of principals representing unique equilibria are endogenously derived given di¤erent 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 o¤er some justi…cation for using that conventional approach. Implications for performance evaluation are discussed.