Radner (1991) began a dynamic game theory which is introduced into the principal-agent theory, demonstrated in case of repeat agency relationship, in addition to remuneration incentives, professional reputation with implicit incentives for agents.
Fama (1980) proposed manager of market competition as an incentive mechanism for groundbreaking ideas. In the complete market mechanism hypothesis, the implicit incentives can be used as an incomplete substitute for explicit incentives. He believes that in the long run, even if these are not based on output explicit incentive contract, reputation effects will encourage managers to work hard to improve their reputation in the managers’ market. Thereby, it will increase the value of future human capital in a long-term management which is manager ‘moral hazard’.
Holmstrom (1982) improved Fama, when he stated that a research manager for the future could be considering the current level of hard work incentives. In the model, the manager’s capability was assessed through observation of past performance to reflect changes. Holmstrom came to the conclusion that, despite the reputation mechanism revealing the manager’s ability, the extent of the manager’s efforts decreased over time. In order to achieve efficiency, this requires the manager’s ability to fluctuate over time. Fama’s views only in the case of future earnings not discounted and at a risk-neutral manager level are established. However, even if meet the above conditions, there is a transient learning effect and technology is nonlinear, it will lead to inefficiency. Holmstrom further deepens the reputation mechanism, and discussed the role of the conditions, noting the applicability and limitations of reputation mechanisms.
However, Navneet and Hui (2001) expanded Holmstrom model, they studied how to establish the optimal explicit incentive contract in the presence of implicit incentives. They found that only when the agent can affect the performance reward, and it does not affect the performance of the risk, it can be established the optimal incentive contract. However, in fund manager’s agency problems, these optimal incentive contracts assumptions do not hold, and fund managers can simultaneously manipulate fund performance and performance risks.