Psychological Contracts and Their Impact on Business Outcomes

Busy workplace environment symbolising psychological contracts

In this guide we aim to help managers in understanding psychological contracts in order to navigate their work environment more effectively and foster positive relations across the company.

What is a psychological contract?

A psychological contract is essentially an unwritten agreement between an employee and employer. It captures the silent expectations and perceptions that both parties have towards each other beyond the formal, written employment contract. These can include expectations about job security, career progression, and the work environment.

Why is it important?

Grasping the concept of a psychological contract is key for anyone managing a team or running a business. When expectations are met, employees tend to be more engaged, productive, and loyal.

However, if a psychological contract is broken, it can lead to dissatisfaction, low morale, and high turnover. Understanding this dynamic helps employers maintain a stable and motivated workforce, which is crucial for achievingbusiness goals.

Components of psychological contracts

A psychological contract has two main elements: explicit and implicit.

Explicit elements are the clear, voiced expectations that are often discussed during job interviews or performance reviews, such as salary, work hours, and specific job duties.

Implicit elements are the unspoken, often assumed expectations that are not formally communicated but are believed to be part of the agreement. These might include hopes for promotion, expectations of a supportive work environment, or long-term job security.

What are the 4 types of psychological contracts?

Understanding the different types of psychological contracts can help employers manage their teams more effectively.

Transactional psychological contract

A transactional psychological contract is characterized by specific, short-term, and economic-focused agreements. It typically involves clear-cut expectations regarding salary, work hours, and specific job responsibilities.

This type of employment contract is less about emotional or personal commitment and more about the exchange of work for pay. Employees under a transactional contract often expect fair compensation for their efforts but may not seek or receive much beyond their outlined duties.

Transitional psychological contract

Transitional psychological contracts occur during periods of change within the organization, such as restructuring or significant shifts in market conditions. These contracts are dynamic and involve understanding from both parties that roles and expectations are subject to change.

Employees are expected to adapt to new conditions and may often take on different or additional responsibilities temporarily. Managing these contracts well requires clear communication about changes and mutual flexibility.

Balanced psychological contract

Balanced psychological contracts represent a mix of professional and personal engagement between the employer and the employee. These contracts include fair economic exchange (like transactional contracts) but also incorporate elements of support, such as career development opportunities and recognition.

Employers under a balanced contract are expected to invest in the employee's growth and well-being, and in return, employees are motivated to perform well and commit to the organization’s goals.

Relational psychological contract

Relational psychological contracts are built on long-term relationships that involve high levels of trust and loyalty. These contracts are less about specific economic exchanges and more about ongoing mutual support and commitment.

Elements like job security, supportive work environment, and personal recognition play significant roles. Employees with a relational contract often feel a deep connection to their workplace and are highly engaged and committed. They expect their employer to care about their personal and professional well-being and offer stability and support in return for their dedication.

How are psychological contracts formed?

A psychological contract begins to take shape the moment an employee joins a company. The formation of these contracts is generally a three-step process:

Initial expectations: When new employees start at a company, they bring with them a set of initial expectations about their role, career development, and work-life balance, which are influenced by the job description, recruitment process, and the overall employer brand.

Mutual agreement: Throughout the early days of employment, through discussions with line managers and team members, these expectations are subtly matched with the employer’s expectations regarding job performance and organizational behavior.

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Reinforcement: Over time, through consistent management actions, company policies, and feedback mechanisms, these initial expectations are reinforced, adjusted, or reshaped to form a solid psychological contract.

A psychological contract may evolve as business strategies and employee roles change. For example, a shift in market conditions might lead the company to alter its strategic direction, which can affect employee roles, expectations, and perceptions.

Similarly, career development opportunities such as promotions or new project assignments can reshape an employee's psychological contract. It's crucial for employers to communicate changes effectively to prevent psychological contract breaches, which can negatively impact employee engagement and job satisfaction.

Psychological contract and employee engagement

A psychological contract plays a critical role in shaping an employment relationship that fosters strong employee engagement.

Impact on employee motivation

The health of a psychological contract directly influences employee motivation. When employees perceive that their psychological contract has been honored, they often show higher job satisfaction, are more committed, and exhibit a deeper engagement with their work.

Conversely, a broken psychological contract can lead to a lack of motivation and dissatisfaction, as the employee may feel that the mutual exchange relationship promised at hiring is not being upheld. Thus, ensuring these contracts are fulfilled is a crucial task for effective human resource management.

Influence on employee retention

A psychological contract also plays a pivotal role in employee retention. Employees whose expectations about job security, managerial support, and recognition are met are less likely to leave the organization.

This fulfillment reduces turnover intentions and builds a positive employment relationship, contributing to a stable and committed workforce. By maintaining a continuous dialogue about worker expectations and providing career development opportunities, employers can prevent contract breaches and foster a loyal employee base.

Psychological contract and organizational outcomes

The impact of the psychological contract extends beyond individual employees, significantly influencing broader organizational outcomes.

Enhancing organizational performance

A well-managed psychological contract enhances organizational performance by aligning employee expectations with the company’s goals.

When employees understand and agree with what is expected of them and what they can expect in return, they are more likely to be motivated, productive, and committed to the organization’s success. This alignment reduces conflicts and misunderstandings, fostering a cohesive work environment that can achieve higher performance levels.

Driving innovation and adaptability

Psychological contracts also play a crucial role in fostering an environment conducive to innovation and adaptability. When employees feel secure and supported, they are more likely to take creative risks and embrace changes necessary for innovation.

Additionally, when the psychological contract includes flexibility, employees are encouraged to adapt to new challenges and opportunities, helping the organization stay competitive in a rapidly changing market.

Common challenges in managing psychological contracts

Managing psychological contracts effectively presents several challenges that can impact the employment relationship and organizational dynamics.

Mismatched expectations: One of the most common challenges is the mismatch between what employees believe they were promised and what employers think they have promised. This misalignment can lead to psychological contract breaches, resulting in dissatisfaction and disengagement.

Communication gaps: Inadequate communication can foster misunderstandings, allowing employee expectations to go unmet. Without clear, ongoing communication, employees and employers may find themselves with very different views of their agreement.

Changes in organizational priorities: Shifts in business strategies or changes in management can alter the terms of psychological contracts. Such changes can be perceived as contract breaches if not managed sensitively, affecting trust and commitment.

Individual differences: The subjective nature of psychological contracts means they can vary dramatically between individuals, even in the same role and organization. Managing these individual differences requires a nuanced approach to ensure all employees feel their specific expectations are being met.

Invisible terms: Because psychological contracts are unwritten and often unspoken, identifying and addressing all the elements of the contract can be challenging. Employers may inadvertently breach these invisible terms, damaging the employment relationship.

Best practices in managing psychological contracts

business people sitting and working at office desk

Effectively managing psychological contracts is crucial for maintaining harmonious employment relationships and ensuring organizational success.

Role of HR in psychological contracts

The strategic role of human resources in developing and maintaining psychological contracts is critical. HR professionals must ensure that both employee expectations and organizational goals are clearly communicated from the outset.

This involves systematically reviewing job descriptions, the onboarding process, and continuous communication channels to keep both sides of the employment relationship informed and aligned. The term psychological contract refers to these unspoken yet impactful elements that HR must navigate to prevent psychological contract breaches and ensure mutual trust and commitment.

Training and development

Training leaders and managers to recognize and effectively manage psychological contracts is essential. Human Resource Management journals often highlight the importance of equipping managers with the skills to understand and respond to the dynamic nature of employee expectations.

This training helps prevent contract breaches by fostering a responsive leadership style that can adapt to changing employee needs and organizational priorities. Through effective training programs, leaders learn to maintain a balance between meeting organizational goals and fulfilling employee expectations, thus enhancing overall job satisfaction and engagement.

Legal and ethical considerations

While a psychological contract is not a legal contract, there are significant legal and ethical considerations in dealing with them. It is vital for organizations to understand that breaches of psychological contracts, while not legally binding, can lead to serious ethical issues and damage to the employer brand.

Ethical management of these contracts involves transparency, fairness, and integrity in dealing with employee expectations and managing changes within the company. Organizations must strive to uphold the spirit of these agreements to maintain a positive and productive work environment, minimizing the risks of contract breaches and their consequent impacts on employee morale and turnover intentions.

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Adeptly navigating psychological contracts is pivotal for cultivating a healthy and effective workplace. As the term psychological contract describes, these agreements play a crucial role in shaping interactions between employees and employers, directly impacting job satisfaction and organizational performance.

Addressing the unique aspects of each type of psychological contract can significantly mitigate the risk of psychological contract breach, a topic often highlighted in human resource management journals.

By strategically managing these nuanced agreements, employers not only uphold their commitments but also enhance overall employee engagement and drive the success of their organization.

This approach ensures a robust alignment between employee expectations and organizational goals, fostering a cooperative and thriving work environment.

Rinaily Bonifacio

Written by:

Rinaily Bonifacio

Rinaily is a renowned expert in the field of human resources with years of industry experience. With a passion for writing high-quality HR content, Rinaily brings a unique perspective to the challenges and opportunities of the modern workplace. As an experienced HR professional and content writer, She has contributed to leading publications in the field of HR.


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