Why Firms Go Sustainable Even With No Financial ReturnNICOLA MISANI HIGHLIGHTS THE CENTRALITY OF IMPLICIT CONTRACTS: INVISIBLE HANDSHAKES THAT ARE NOT LEGALLY BINDING, BUT GROUNDED IN MUTUAL UNDERSTANDING OF WHAT PARTIES EXPECT FROM EACH OTHER
Shareholders are protected in their relationship with a firm by a series of legally binding obligations. Stakeholders are not. Their relationship with firms is governed by a web of implicit contracts, or “invisible handshakes” that are not legally binding but are grounded in mutual understanding between the parties of what they expect from each other. Given that sustainable business practices involve an increase in the role of stakeholders in management decisions, the topic of implicit contracts in relation to sustainability is under researched, said Nicola Misani, Researcher at the Department of Management and Technology.
“Everyone knows we have implicit contracts,” he said. “You find it in all economic textbooks. But no one thought of applying it to sustainability. We should explore the topic more with empirical studies and not just theory.” In “Sustainability and Implicit Contracts” published in 2020 as a chapter in Sustainability (in Business and Society 360 book series, Vol. 4), Misani argues that the adoption of sustainability is directly related to industry- and firm-level variables that make implicit contracts important to a firm’s strategies regarding all types of stakeholder relationships, from employees and suppliers to customers and regulators.
Misani used implicit contacts as a way to explain why companies decide to engage in sustainability even when there is no financial benefit. The implicit contract has a value to a firm because it can make them seem trustworthy. If a firm is seen as sincere, stakeholders are more willing to make investments that are valuable to the company. Sustainability fulfils existing implicit contracts (including a broad social contract with society at large) and helps a firm enter new implicit contracts by improving its trustworthiness. Firms can use these contracts to demonstrate their trustworthiness. “Demonstrating sustainability through implicit contracts makes people think you can keep your word,” he said.
There is another important connection between sustainability and implicit contracts. Firms that invest in sustainability do so with a long-term horizon, investing in R&D, entering new markets at an immature stage, or building resources with no clear short-term worth. “This long-term orientation implies that a sustainable firm will want to honor implicit contracts,” the paper says.
by Jennifer Clark