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IIPM Knowledge Centre > Human Resource > Managing Psychological Contract

World over, employee retention or ‘talent retention’ is a major concern for the organisations, both in private and public sectors. This research is an attempt to study the probable co-relation between employee retention and psychological contract.

By Dipankar Sarkar

“Across corporates, coaching sessions at many companies have become a routine for executives as budget forecasts and quota meetings.”
Investor’s Business Daily.

Employee retention has been a major concern of organisations all over the world. Although there has been a common trend among organisations to outsource work that is routine and non-core, retaining people at strategically important positions remains a major concern. There is an enormous body of research to study employee retention, the factors that most significantly influence an employee’s decision to continue to work at a particular organisation and the factors that influence an employee’s decision to leave. A study done by J Hale in 1998 had shown that as high as 86% of the employers under the study experienced difficulty in attracting critical people and 58% experienced difficulty in retaining them. Abasi and Hollman (2000) found that employee turnover may jeopardise strategic plans to achieve organisational objectives. They had shown that when an organisation loses its critical people, there might be a number of impact like reduction in overall level of innovation and quality of customer service. In a research conducted by Hale (1998), organisations under the study indicated cost of recruitment of a new employee to be about 50-60% of the first year’s remuneration and up to 100% in case of a specialised high-skilled position. In another study done by Fitz-enz (1997), it was found that on an average a company loses approximately $1 million with every 10 top managerial and professional employees leaving the organisation. This study also indicated that when all direct and indirect costs are considered, the total turnover cost of an exiting employee ranges from a minimum of one year’s remuneration and benefits to two years’ remuneration and benefits. Now, that’s a huge cost to the organisation.

Organisations are seemingly taking note of dysfunctional turnover. Hannay et. al. (2000) felt that dysfunctional turnover occurs when highly productive and skilled employees leave the organisation while the less productive and low-skilled employee stay on. This not only increases the turnover cost but also adversely affects the productivity. This also becomes a critical factor when these high-skilled employees join competitors.
In the process, what the company may lose is the tacit knowledge that the employees might have developed over the period of association with the organisation. Tacit knowledge is implicit knowledge which differs from explicit knowledge in terms of the inherent difficulties to codify and transfer the knowledge. Explicit knowledge can be accumulated and codified so as to transfer from person to person. But tacit knowledge, by nature cannot be separated from the subject, that is, the knowledgeable person. Tacit knowledge is acquired by practical experience, by ‘doing’ rather than
by reading or other means of transferring knowledge. Polanyi (1962) proposed that a large part of human knowledge is tacit. This is particularly true of operational skills and know-how acquired through practical experience. Explicit knowledge could be codified or ‘written down’, abstracted and transferred across people, time and space independently of the knowing subjects. Tacit knowledge transfer requires close interaction. Examples of this kind of knowledge are abound in the village artisans. The art is passed on by hands-on training for years. Much recent attention has been focused on the importance of ‘tacit knowledge’ for sustaining organisations’ competitiveness. Much of the tacit knowledge that a key employee possess obviously get lost when he/ she leaves the organisation.

Factors Influencing Employee Retention
If one does a survey of the literature on the factors that affect employee retention and turnover, various interesting points could be observed. In his study on employee retention Sunil Ramlall (2003) suggested that lack of challenge and opportunity, lack of career advancement opportunities, lack of recognition, inadequate emphasis on teamwork, not having the opportunity for a flexible work schedule are among the most common reasons for employees’ leaving an organisation. Hannay et. al. (2000) suggested perceived future opportunities from the employer and the degree to which employee expectations have been met by the employer to be most significant variables for employee retention. Again ‘perceived future opportunities’ comprises additional responsibilities, more challenging and interesting responsibilities, more respect, and autonomy among other sub-factors. The organisational equilibrium theory proposed by March and Simon (1958) states that job satisfaction reduces the desirability of moving, thus reducing employee turnover. Porter and Steers (1973) developed the Met-Expectation Model in which they suggested that employees have individual sets of expectations; when those expectations are unmet, the result is dissatisfaction, leading to turnover. Charles R Greer (2001) argued that companies should invest in developing and providing realistic job previews (RJP), ensuring equitable and fair compensation, fair appraisal reviews, exclusion of political factors from decision making, job enrichment, opportunities for personal growth, opportunities for promotion, liberal internal transfer policies, etc. Rhoades et al. (2001) identified organisational rewards (e.g., recognition, opportunity for advancement), procedural justice (e.g., communication, decision making), and supervisor support (e.g., concern for employees’ well-being) led to perceived organisational support (e.g., organisational concern), which led to affective organisational commitment (e.g., sense of belonging, attachment). Lee and Mowday (1987) study findings suggested that job performance, met expectations, job values, organisational characteristics, and organisational experiences explained affective responses.

As suggested by various models and studies, psychological contract is also a major factor for retention. The WRDI™ (workplace relationship development indicator) model of psychological contract suggests that two major predictors for intention to stay are job satisfaction and affective commitment. The model suggests that delivery of employee expectations, trust and fairness lead to affective commitment and job satisfaction. If one examines the content of psychological contract, it would be easy for one to see that the content of psychological contract and the factors leading to employee retention overlap in many cases.

Berman, E.M. and West, J.P (2003) suggested that workload, work schedules, responsibility and authority, quality of work, working relationship with immediate supervisors, interpersonal relations, specific behaviour of employees and managers, individually preferred working styles, job security, rewards, promotion, career development, and loyalty could be part of psychological contract involving employees and employers. P Devidson (2001) suggested employee expectations involve reward for work/effort, safe and comfortable working conditions, opportunities for personal development and career progression, and equitable personnel policies. She also suggested that employer expectations involve productivity for reward, working diligently in pursuing organisational objectives and a few other factors. Though Devidson’s model is simplified, it provides a good insight into psychological contract never-the-less.

Psychological Contract
The concept of Psychological Contract was first used by Argyris (1960) and has been developed further by the works of many researchers like Levinson et al. (1962), Schein (1978; 1980), and most recently by Rousseau (1989; 1995; 2000). Psychological contract is an implicit exchange relationship between the employer and the employees encompassing mutual expectations and obligation of each party towards the other. According to Rousseau (1989), psychological contract is promise based and over time, takes the form of a schema which is relatively stable. A schema is defined as ”a cognitive structure that represents organised knowledge about a given stimulus – a person or situation – as well as rules that direct information processing” (Fiske & Taylor, 1984). Schema refers to an individual’s beliefs, frames of references, perceptions, values and concepts. Schema provides a base that serves as a guide to an individual for information collection, assimilation, interpretation, actions, and expectations, thereby simplifying cognitive processes by which people make sense of events and situation in which they may find themselves (Fiske & Taylor, 1984). Schemas typically influence the perception of incoming information, retrieval of stored information, and inferences based on that.

It is commonly believed by researchers that psychological contract is an individual’s belief about the term and conditions of a reciprocal exchange agreement with an employer – a belief that some form of promises have been made and that the terms are accepted by all involved. By these observations,
psychological contract becomes an unwritten set of expectations between everyone in an organisation and unlike a written contract, is of dynamic in nature. Although the contract is unwritten, it may have significant effect on employee behaviour on the job, employee morale, performance and desire to leave the job.

Rousseau (1995) also suggested that psychological contract depends on the employee’s understanding of the explicit and implicit promises regarding the exchange of employee contributions (such as efforts, loyalty and ability) and organisational inducements (such as pay, promotion, job security). Employer’s perspectives have so far drawn lesser attention from researchers.

But the mutuality aspect of psychological contract has been mentioned by most of the researchers. According to Levinson et. al. “The psychological or unwritten contract is a product of mutual expectations. These have two characteristics: (a) they are largely implicit and unspoken, and (b) they frequently antedate the relationship of person and company” (Levinson et. al 1962). In fact, the model of Levinson et al. (Figure 1) clearly presents that: It is clear from the model that a psychological contract is formed from mutual expectations of the employees and the em­ployer. Each employee brings a set of expec­tations to the organisation regarding how his/her psychological needs are going to be met in the organisational context. These needs include dependence need, need for affection, privacy, control of one’s own life, and expectations that allow for changing self-identity and continuing growth into new occupational roles and responsibilities and all other related needs. The company also has expectations regarding the behav­iour and performance of the employee. An unwritten contract results when the em­ployee and the employer achieve a mutually beneficial working organisation that satis­fies both the parties’ expectations.

In all, it becomes pertinent to conclude a few important features of psychological contract before proceeding further:

  • 1. Psychological contract entails incorpo­ration of beliefs, values, needs, aspira­tions, and expectations of employees and employers, which includes beliefs about implicit and explicit promises and obligations – the extent to which these are perceived to be met or violated.
  • 2. Psychological contract is established when there is mutual satisfaction on the part of both employees and employer vis-à-vis their expectations.
  • 3. Psychological contract is of dynamic nature. It can constantly change based on an individual’s socio-economic situ­ations and career context as well as an organisation’s business situations.
  • 4. Because psychological contract forms the bases of schemas and by definition, schemas have to be necessarily be dif­ferent from individual to individual, there could be a number of psychologi­cal contracts between the employees of an organisation and the organisation in particular.
  • 5. Psychological contract implies mutuality and reciprocity (Levinson et al. 1962). Contract is formed when both employees and employer achieve a stable position vis-à-vis their expectations and obliga­tions from each other.
  • 6. Psychological contract is a central de­terminant of work behaviour which specifies the dynamics of employment relationship.
  • 7. Psychological contract, as it is mostly im­plicit, is entered voluntarily (Rousseau 1994). There is no obligation on part of the employee or the employer to enter into this implicit contract. This means, there are choices for both parties. Even if an organisation offers a job to an indi­vidual, the individual has no obligation to accept the job and vice versa.
  • 8. Psychological contracts have belief an­tecedents, i.e., both parties’ perception of contract would be dependent on past experiences, specially, breach of con­tract. The level of presence of such an­tecedents would depend on the degree of the breach experienced in the past.
  • 9. Psychological contracts may also be categorised based upon context of indi­vidual and group. Rousseau (1995) had identified individual as well as group contexts as depicted in Figure 2.

Types of Psychological Contract
It would be easy to understand that given the dynamics and varying nature of psycho­logical contract, there could be a number of types of psychological contracts exist­ing in the organisational context. Rousseau (1995) identified a simple 2 x 2 model of psychological contract giving rise to four different types of contract (Figure 3)The two dimensions of the 2 x 2 model are time frame and performance requirements. ‘Time frame’ refers to the duration of the employ­ment and ‘performance requirements’ are the expectations of performance (or per­formance benchmarks) as a pre-condition of employment. Many studies concluded that the longer a relationship continues be­tween employer and employee, the greater the exchange between the two parties be­comes one of mutual trust, affection and understanding. The 2 x 2 model creates a framework of four possible types of psy­chological contract – transactional (short term, specified performance), relational (long-term, non-specified performance), transitional (short-term, non-specified performance) and balanced (long-term, specified performance).

Transactional: The transactional con­tract is present when the employment ar­rangement is of a short-term or limited du­ration, primarily focused exchange of work in lieu of money with a specific and definite description of duties and responsibilities and limited involvement in organisation. This is particularly true for employees hired on short-term contracts as well as workers located off-site.

Relational: The relational contract re­sults from long-term employment arrange­ments based upon mutual trust and loyalty. Growth in career and remuneration comes mainly from seniority and other benefits and rewards are only loosely related to work performance. The contract is derived from long term membership and participation in the organisation. This type of contract is very common in family run organisations in India where ‘trusted and loyal’ employees manage most of the senior managerial/su-pervisory work in the organisation.

Transitional: By definition it is not exactly a psychological contract, but a cognitive state which reflects the changes in organisational context and socio-eco-nomic changes and transitions that are in contradiction with a previously established arrangement or psychological contract. This type of cognitive state is apparent during company mergers and acquisition, down sizing as well as related state of uncertain­ties in work life.

Balanced: Balanced psychological con­tract refers to a dynamic and open-ended employment engagement pre-conditioned on business success of the employer or­ganisation and the employee’s opportuni­ties to develop skill sets and opportunities for career advancement based on skills and performance. Both employee and or­ganisation contribute to each other’s de­velopment. Rewards to workers are based upon performance and contributions to the organisation’s business success or competi­tive advantages, particularly in the face of changing business environment. In most of the public owned and professionally managed organisations, balanced type of psychological contract exists.

The transitional contract is usually present when elements of an organisation change, e.g. in a merger, causing uncertain­ty, distrust and instability in the workforce along with the possibility of high turnover. A practical transactional contract is often required to restore even a degree of trust between employees and employer. Con­versely, a balanced contract is the hybrid of the relational and transactional contracts where shared values and commitments are present alongside the need to attain specific business goals. Rousseau (2000) has further analysed the four psychologi­cal contracts in developing a Psychological Contract Inventory (PCI).

This indicates that the employee is obligated to remain in employment with the organisa­tion and do what is required to keep the job going. The employer also fulfills its obliga­tion by providing stable remuneration, long term job security and steady career growth. Employee is obligated to be loyal to the organisation and support the objectives, needs and interests of the organisation. The employee should be a dedicated and a loyal corporate citizen. The employer fulfills its part of obligation by ensuring the well-being of the employee and their families.

This indicates that the employee is obli­gated to constantly develop marketable skills and make himself/herself employable. The employer is obligated to enhance the employee’s long term employability both inside the organisation and outside in the job market. The employee is obligated todevelop skills required by the employer in continuously changing business environ­ment. The employer in turn oblige by pro­viding career development opportunities inside the organisation. The employee is obligated to successfully perform newer and more demanding organisational tasks which are changing in nature. The employee should help the organisation continuously to make the organisation competitive. The employer is in turn committed to promote continuous development and help employ­ees successfully achieve escalating perfor­mance benchmarks.

This indicates that the employee is required to perform only a fixed and defined set of duties and to doonly that much which is asked for by the employer. The employer is obliged to offer adequate compensation to the employee in exchange of his duties. The employer may or may not offer any training and development to the employee. The employee has no obligations to remain with the organisation in the long run and would be committed to work only for a lim­ited period of time. The employer may not guarantee future employment beyond the limited period of time agreed upon.

This is essentially a transition period be­tween two states of psychological contract. Here the employee mistrusts the organisa-tion’s motives and is unsure of job security and career advancements. The organisation may also mistrust the motives of the em­ployee and may withheld important infor­mation from the employee. The employee is uncertain about his future obligations to the organisation. The rganisation may also deny to ensure employment guarantee to the employee. If not managed, in this psychological contract, the employee may continue to receive ambiguous communi­cation from the organisation and become confused as to whether his contributions would elicit adequate compensation from the organisation. The quality of work life of the employee could begin to erode.

Content of Psychological Contract
If one attempts to summarise the various research works (Rousseau 1989, 1995, 2000; Levinson et al. 1062 and other), it would be possible to mark out the content of psychological contract. Although, to have a logical conclusion on the content of psy­chological contract, detailed studies should be undertaken, but still the existing body of knowledge could be used in develop­ing practical implications of psychological contract to business. P Devidson (2001) has depicted eight common content elements: enefits/ reward, job security, challenge in the job, working hours, development oppor­tunities, fair treatment, working conditions, work life and work life balance. Analysing Rousseau’s works (1989, 1995, and 2000) would clearly specify the following as the content of psychological contract: stabil­ity, loyalty, state of well-being, external employability, internal advancements, dy­namic performance, external employability, internal employability, trust, equitable pay, fairness, and all other related contents.

Disruption: This occurs when either or both the employee and the employer are willing to comply with the contract but are unable to do so.

Reneging: This occurs when either or both the employee and the employer are able but unwilling to comply with the con­tract.

Most employees feel that their psycho­logical contracts have been violated in some way by their employer at some time. Viola­tions are most commonly concerned with training and development, pay and benefits, and promotion opportunities. When employ-occur. This may lead to a fall in job satis­faction, performance and motivation as the employee can no longer rely on promised in­ducements. Because psychological contracts are formed on the basis of trust, violation may lead to lower commitment to the or­ganisation and less organisational citizen­ship behaviour (i.e. doing things to benefit the organisation which are not necessarily your responsibility). The subjective nature of psychological contracts makes it easier to feel that a violation has occurred but harder to actually know if it really has.

There are many courses of action an individual or organisation may take in response to a perceived violation. The employee or the employer may voice the breach. Voicing any feelings helps to reduce losses and restore trust. It is an active, constructive effort to change the objectionable features in the situation and compensate for the violation while remaining in the relationship. It is also possible that the employee or the employer, instead of voicing the breach may turn silent. Silence is a form of non-response. It reflects a willingness to endure or accept unfavourable circumstances in the hope that they may improve.

As a passive, constructive response it serves to perpetuate the existing relationship. There could also be a passive negligence or active destructive behaviour in response to the perceived breach of contract. It can involve neglect of one’s duties to the detriment of the interests of the organisation or involve more active examples of counterproductive behaviour. Vandalism, theft and work slowdowns are all examples of this type of response. Lastly, the employee or the employer
may actually exit the contract. Employers can terminate employees whose performance does not meet standards and employees may quit an untrustworthy or unreliable employer.

Considering the available research stud­ies on employee retention and the content and nature of psychological contract, the author tends to conclude that psychologi­cal contract would be one of the major factors influencing employee retention. If one takes a re-look at some of the factors for employee retention/ turnover, factors like lack of challenge and opportunity, lack of career advancement opportunities, lack of recognition, inadequate emphasis on teamwork, not having the opportunity for a flexible work schedule, perceived future opportunities from employer and the de­gree to which employee expectations have been met by the employer, ensuring equi­table and fair compensation, fair appraisal reviews exclusion of political factors from decision making, job enrichment, opportuni­ties for personal growth, opportunities for promotion, liberal internal transfer policies, recognition, opportunity for advancement, concern for employees’ well-being, job per­formance, met expectations, job values, organisational characteristics, and organi­sational experiences significantly influence employee retention/turnover.

In light of the above discussion, it would be pertinent to conclude that a conscious development and management of psycho­logical contract in an organisation would definitely contribute to employee retention and reducing employee turnover.

Prof. Dipankar Sarkar is Dean-Adminis-tration, the Indian Institute of Planning and Management, Ahmedabad.


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