A psychological contract most often refers to the unspoken agreements made between an employer and an employee that communicates each's expectations of the relationship. The terms of the contract exist in a mostly implied, intangible form. The employee does not sign any papers and the employer makes no formal promises, yet each party comprehends what the other is suggesting in terms of input and outcome. Psychological contracts serve an important purpose when honoured by both parties.
When both parties honour the psychological contract, a bond of loyalty is formed between the two. When the employee shows that he is willing to put in as much work as he implied and the boss' expectations prove fair, both parties will go out of their way to maintain this positive relationship. The boss may offer the employee a raise after the next annual review while the employee may pass up a higher-paying job because he knows he will be treated well at his current job.
In this kind of working relationship, the ability to perceive one another as human beings can make a big difference. A productive psychological contract depends on the employer's ability to occasionally let an employee's shortcomings slide, which will then result in the employee returning the favour. For example, a boss may allow a good employee to miss a couple of extra days of work due to a family emergency, even though this is against company policy. The employee might return the favour by speeding up when his stressed-out boss is under a tight deadline instead of becoming uncooperative.
When trust has been established through the psychological contract, it makes it easier for both parties to exhibit openness and honesty. When neither the employee nor the boss fear the possibility of betrayal, it is easier for each to open up about personal needs, frustrations or experiences. This allows each to respond in a healthy, productive manner. For example, if an employee finds himself frustrated that his boss only gives him a two-hour notice before a report is due, he may request a half-day's notice if he trusts the boss. This open communication can prevent building animosity, which could deteriorate the psychological contract.
When the terms of the psychological contract are honoured, all aspects of the working relationship should run more smoothly. This greater degree of trust, respect and understanding can lead to a positive, healthy relationship, a workplace that is run in a more efficient manner and a greater degree of job satisfaction by both parties. Greater enthusiasm for the job and higher morale go hand in hand, and may feed positively into all other areas of the job.