Chapter 5 Sustainability and Implicit Contracts

Implicit contracts are ‘invisible handshakes’ that are not legally binding but are grounded in mutual understanding between the parties of what they expect from each other. These contracts are very common both within the firm (e.g., between managers and employees) and in business relationships (e.g., between a firm and its suppliers). Typically, implicit contracts arise in relationships that are in some way open-ended. An extensive literature has showed that implicit contracts allow firms to create value by encouraging relationship-specific investment and motivating effort by stakeholders. This chapter focusses on how sustainability satisfies existing implicit contracts (including a broad social contract with society at large) and facilitates a firm in entering new implicit contracts by improving its trustworthiness. The author 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, and inversely related to the strength of overriding factors that make a firm trustworthy. Based on this reasoning, the author analyses four areas in which rates of sustainability adoption can vary according to the importance of implicit contracts.