This paper considers the enforceability of employment contracts when employees' performance cannot be verified in court so that piece-rate contracts are not legally enforceable. Part I shows that there exists a variety of self-enforcing implicit contracts, modelled as perfect equilibria in a repeated game, and characterizes all the wage and performance outcomes that can be implemented. Implementation requires a strictly positive surplus from employment, the form of the contract depending on how this surplus is divided between firm and employee. Piece-rate contracts, and contracts with an informally agreed bonus, can be made self-enforcing but the use of severance pay and bonding does not extend the set of implementable allocations. The resulting contracts resemble actual labor contracts more than do the contracts in standard principal-agent models. Part II analyses market equilibrium with these contracts, also modelled as perfect equilibria in a repeated game, and shows that many such equilibria exist. Unfilled vacancies and unemployed workers can co-exist despite the existence of contracts that are potentially mutually beneficial. For those jobs that are filled, any division of the potential surplus is possible so that the market can have, at the same time, involuntary unemployment and vacancies that are unfilled despite filled jobs earning positive profits. As a criterion for selecting equilibria, a notion of renegotiation proofness is applied. Then either all workers are employed or all jobs filled but any division of the potential surplus is still possible. The paper explores what further restrictions on beliefs give rise to a Walrasian outcome, in which all the potential surplus goes to the short side of the market, and to an efficiency wage type outcome, in which the potential surplus goes to the long side.

Treatment for depression is complex, requiring decisions that may involve trade-offs between exploiting treatments with the highest expected value and experimenting with treatments with higher possible payoffs. Using patient claims data, we show that among skilled doctors, using a broader portfolio of drugs predicts better patient outcomes, except in cases where doctors' decisions violate loose professional guidelines. We introduce a behavioral model of decision making guided by our empirical observations. The model's novel feature is that the trade-off between exploitation and experimentation depends on the doctor's diagnostic skill. The model predicts that higher diagnostic skill leads to greater diversity in drug choice and better matching of drugs to patients even among doctors with the same initial beliefs regarding drug effectiveness. Consistent with the finding that guideline violations predict poorer patient outcomes, simulations of the model suggest that increasing the number of possible drug choices can lower performance.