Why Are There Explicit Contracts of Employment?

In this paper we explain the prevalence of explicit contracts of employment, particularly those that embody high- rather than low-powered incentives and clauses that supersede the common law defaults. Our analysis is based on an understanding of two fundamental problems that arise when agency relationships are established between a worker and firm. The first is that agency relationships often require the creation of specific property rights in order for firm owners to realize productive efficiencies of scale or scope from agency. The second is that the economic characteristics of the agency relationship, which generally entail the transfer of specific "process rights" to agents, are often quite different from the nature of agency characterized in and supported by the common law. The implication is that implicit employment contracts supported by the common law are incapable of effectively governing employment relationship characterized by these two problems. Thus, explicit contractual provisions are required in the employment relationship.