LEADERSHIP AND THE CHANGING PSYCHOLOGICAL CONTRACT BETWEEN EMPLOYER AND EMPLOYEE [by] Kenneth P. De Meuse and Walter W. Tornow The 1990s are proving to be a difficult period for American companies and employees alike. Almost daily, headlines announce that a major corporate layoff is underway or that another plant is closing or being relocated overseas. Less dramatic but no less significant, companies are cutting costs by eliminating or limiting employee benefits such as health-care insurance and pensions. Very simply, downsizing and streamlining have become a way of life as U.S. firms seek to transform their operations in order to remain competitive in the world marketplace. To many people it is ironic to find that these same compa- nies are often instituting programs based on nurturing employee commitment: for instance, total quality management, self-managed work teams, and total employee involvement. From the point of view of the employee, the simultaneous efforts at belt tightening and enhancing employee involvement appear contradictory. Certainly, mixed signals are being sent: On the one hand, employees are being told by management that they are a valuable resource: on the other hand, they are seeing this resource being cut or supported less than in the past. The communication literature suggests that when words (in this case, statements about the value of employees as a resource) and actions (in this case, letting employees go and cutting benefits) seem to be in conflict, it is the actions to which people respond (Stewart, Hecker, & Graham, 1987). The credibility of management is thus undermined; and employees, feeling angry, betrayed, and helpless, lose their effectiveness. This erosion of employee confidence may be why downsizing and employee involvement efforts have had decidedly mixed re- sults. Recent research suggests the benefits of corporate down- sizing may be illusory (De Meuse, Vanderheiden, & Bergmann, in press). A 1992 article in The Economist reported that seventy-five percent of those companies downsizing believed financial performance did not increase, and sixty-seven percent found no improvement in productivity. Likewise, a study conducted by McKinsey and Company found that two-thirds of the thirty total quality management programs it examined had stalled or fallen short of yielding meaningful improvements (Fuchsberg, 1992). In a forthcoming book David Noer (in press) notes that often the only thing gained from downsizing organizations is a depressed, anxious, and angry work force. Although many organizations have done a good job with outplacement services and spending money and time to help those laid off, little has been done to address the problems of those who remain--or to address the leadership challenge of revitalizing downsized organizations. We believe that one of the crucial leadership challenges in business today is to create and maintain a more viable relation- ship between employer and employees. A major element of this relationship is something that scholars have termed the psycho- logical contract (Schein, 1980; Schermerhorn, Hunt, & Osborn, 1985; Tornow, 1988). What is the psychological contract, what was it, and what must it become if organizations are to succeed in a contemporary environment that is increasingly ambiguous, complex, and changing? THE UNWRITTEN AGREEMENT The psychological contract is an implicit agreement between employer and employee that each party will treat the other fairly; it is based on presumably shared beliefs (Schein, 1980; Schermerhorn, Hunt, & Osborn, 1985; Tornow, 1988). Because it is unwritten and unofficial, and therefore not legally binding, the motivation for compliance is not, as it is with explicit written contracts, the fear of legal reprisal but, rather, the desire to maintain mutual trust. It, thus, constitutes an essentially emotional bond (which is one reason why when it's broken, people experience deep, long-lasting feelings of betrayal and resent- ment). Such a "contract" is not static. It is affected by changes in society in general and the work environment in particular. During the 1950s and 1960s, when society and business were relatively more stable than they are today, the agreement was (stated from the point of view of the employee), "If I work hard and well and if I'm loyal to the company. I will always have a job and the company will take care of me." There were clear benefits for both parties: The company had an employee who was dependable, worked hard, and was loyal; the employee had job security, a good salary, and fringe benefits. The bond between employer and employee was strong. In the 1970s and 1980s, however, American society underwent a significant transformation. It has become more individualized as our associations--for instance, communities, families--have weakened. People increasingly rely on legal controls and protections--as opposed to social means--to govern their rela- tionships with others. At the same time, American business has been characterized by mergers, takeovers, and other forms of corporate restructuring, causing a kind of drift in corporate identity. And the business environment has gotten much more difficult, with rapidly changing markets and technology and increased foreign competition. Today's psychological contract is therefore very different from the one in the 1950s and 1960s. Both parties--employers and employees--realize that lifetime job security can no longer be guaranteed and employees have to be much more self reliant now. An "I will take care of myself and take responsibility" orienta- tion pervades the relationship. The employee plays a much more active role in monitoring job duties, supervisory practices, variable pay, and career development. The employer uses a more performance-based, context-bound, cost-conscious perspective when managing employees. The employer-employee relationship frequently assumes a short-term posture with immediate results emphasized. In short, the bond between employer and employee has significant- ly changed, if not weakened (De Meuse & Tornow, in press-a, in press-b). We believe the current psychological contract is at the point of becoming unworkable unless we consciously attend to it. If it continues to evolve in the direction it has in the recent past, then employers, pressured by an unpredictable and fast- changing marketplace and the rising costs of doing business, will want an agreement where they will pay salaries for only as long as necessary and will opt out of the burden of providing anything but minimal employee benefits. Employees, with little incentive to do more than what is absolutely necessary to get by, will not be loyal or productive. The bond will have been broken. We think that a new psychological contract must be forged. In order to do this, some of what was once implicit must be made explicit. The agreement must become, in some respects, less emotional. There can still be loyalty, security, and commitment, but these must be achieved in different ways than in the past. The key is that a way must be found to reestablish the mutual benefit that the parties derive from the agreement, Leadership must play an important part in this. THE NEW PSYCHOLOGICAL CONTRACT The new psychological contract must be one of shared vision and mutual benefit rather than one of simply job security and corporate loyalty. Whereas the relationship was once similar to that of a parent and child (with one party having most of the knowledge and making all of the decisions), it now must become one in which the parties recognize their interdependence, with information widely available and decision making more of a joint employer-employee activity. Power and risk are thus shared. Commitment is to what employer and employee must do to keep the relationship mutually beneficial. In order for this to work, leadership must be effective in four areas: culture, structure, employees, and human-resource policies. First, the organization must establish and maintain a quality culture--that is, a culture that promotes ongoing learn- ing, simplification, and innovation (Harold Tragash, personal communication, 1992). Leadership must not only set the direction but also the tone and processes that facilitate rapid communica- tion and feedback among employees, customers, and suppliers; it must also seek to simplify the organization by fostering a continuing dialogue among organizational members that clarifies mission and sets priorities; and it must promote innovation through continuous improvement that assumes "the job is never done" and that there are always better ways of doing things. Second, the organization needs to be structured so that it can respond quickly to changing markets and environments. Leader- ship must establish a closer relationship among employees, customers and suppliers around the relevant products and servic- es. This assumes having more permeable organizational boundaries of who is "inside' and "outside" the organization, and encourag- ing a greater sense of involvement and collaboration among all parties toward a common purpose. Using team approach which brings together employees, customers, and suppliers is one way to help organizations in their planning and problem solving to remain competitive. Third, employees need to have "meta skills" which allow them to rapidly adapt or adjust to changing business requirements. Such skills include learning how to learn and how to exercise judgement in situations of uncertainty. In short, employees must learn "what to do when they don't, and can't, know what to do" (Gillian Stamp, personal communication, 1992). This means that leadership must help employees understand their learning styles, as well as recognize the value for taking responsibility for continuous improvement, self-growth, and development. This would counteract the inevitability of skills obsolescence which comes from the increased shortening of professional/technical "half- lives." Also, managers and executives need to be encouraged to balance the analytic approach ("getting all the facts and infor- mation before making a decision") with a more intuitive decision-making approach which permits "making judgements on the run" when there are not enough time and data in fluid, fast-paced situations. Finally, policies need to be established that link business strategies with human-resource strategies and practices. The latter should empower employees as much as possible to be self-managing in the sense of having an explicit, realistic understanding of the employment relationship and how this relates to their work performance and career. This includes the need for greater flexibility around the nature, place, and time of work; and employees must take greater responsibility for their own performance and career management in partnership with the organi- zation. Development and compensation practices need to link and reinforce each other, as they become tied to the changing context of organizational needs. And we need to reconceptualize our traditional perspective of "jobs" as the basic organizational unit of work, as captured by a job description. Historically jobs have been thought of as bounded and stable--a Frederick Taylor type of "scientific management" proposition that may no longer be as useful within the context of rapidly changing organizational environments. Instead, "assignments" should perhaps be looked at as the more natural unit of work. Assignments recognize more the dynamic and contextual nature of work as defined by the changing needs of the organization. Assignments, or assignment clusters, then might better define the relationship between the individual and the organization at a point in time, and be renegotiated as needs change for the individual and the organization. A new psychological contract, as the basis of the employer-employee relationship, would help eliminate the apparent contradiction in employers' efforts to decrease costs (in order to be more efficient) and increase employee involvement (in order to be more productive). With it in place, the employer and employee together can face the challenges of American business in the 1990s. References De Meuse, K. P., & Tornow, W. W. (in press-a). The tie that binds--has become very, very frayed. In R. A. Levit & C. Gikakis (Eds.), Best practices in HRD for the 21st century . Washington, D.C.: Human Resource Planning Society. De Meuse. K. P.. & Tornow, W. W. (in press- b). The employer-employee attachment continues to erode as companies try to make ends meet. In R. A. Levit and C. Gikakis (Eds.), Best practices in HRD for the 21st century Washington, D.C.: Human Resource Planning Society. De Meuse, K. P.. Vanderheiden. P. A.. & Bergmann. T. J. (in press). Is lean and mean really better than fat and happy? To be presented at the Human Resource Planning Society Research Sympo- sium. Cornell University. Ithaca. NY. Fuchsberg. G. (1992. May 14). Quality programs show shoddy results. The Wall Street Journal. pp. B I, B7. Noer. D. M. (in press). Healing the wounds: Overcoming the trauma of layoffs and revitalized organizations. San Francisco: Jossey-Bass. Pink-slip productivity. (1992). The Economist. 322. 79. Schein, E. H. (1980). Organizational psychology (3rd ed.). Englewood Cliffs, NJ: Prentice Hall. Schermerhorn, J. R., Jr., Hunt. J. G., & Osborn. R. N. (1985). Managing organizational behavior (2nd ed.). New York: John Wiley & Sons. Stewart. D. W.. Hecker, S., & Graham, J. L. (1987). It's more than what you say: Assessing the influence of nonverbal communi- cation in marketing Psychology and Marketing, 4, 303-322. Tornow. W. W. (1988). Contract redesign. Personnel Administrator, 33, 97-101. Kenneth P. De Meuse is an Associate Professor of Management at the University of Wisconsin-Eau Claire. Walter W. Tornow is Vice President, Research and Publication, at the Center [for Creative Leader- ship]. [The article was published in _Issues_&_Observations_, Vol 13, No. 2, 1993, Center for Creative Leadership.]