Treating Employees Like Contractors Is On the Rise - and Will Likely Backfire

Over the past couple of years, there has been a lot of discussion about the future of work—whether people will continue to work remotely, the trend toward quiet quitting and the rise of the gig economy. But all this fascination has ignored a big and important change already well under way in the U.S. labor force: the widespread use of legal contracts to manage employees.

Companies’ embrace of things such as noncompete and arbitration agreements, as well as policies that spell out exactly what employee behaviors are desired and will be rewarded, can make it easier to manage people. But it also has a pernicious impact on organizations in the long run, because when companies start treating their employees like contractors, those employees are likely to start behaving like contractors.

These days, a majority of U.S. workers are bound by a legal contract of one kind or another. These include noncompete agreements, which prevent employees from taking jobs with competitors; nondisclosure agreements that limit the use elsewhere of confidential information acquired at an employer; and nonsolicitation agreements, which restrict ex-employees from recruiting former clients and/or former colleagues to a new organization. About 62% of employees in the U.S. are covered by at least one of those three types of agreements, according to one estimate. Another estimate suggests that 56% of private-sector workers who aren’t in unions are subject to mandatory arbitration agreements that prohibit them from suing their employer.

Employers also are adopting practices that act like contracts, specifying by formula exactly what behaviors and tasks they want employees to focus on, and then closely monitoring their progress. Incentive pay (do this, get paid that) is one example. A recent development in this area is the use of “tattleware” software to generate a productivity or performance score for office workers that in turn influences their pay. Algorithms make decisions about who works when and who gets promoted. Employers also have pushed this approach into life outside the office with wellness programs, where workers are tracked and rewarded—or punished with higher costs—for certain behaviors and health outcomes.

Employers can make a case for any one of these practices individually. But taken together and in the context of the workplace, they change what it means to be an employee and how employees do their work.

Discretionary effort

Employment is a concept created by common law that rests on a series of broad obligations that employers and employees have to each other. One, known as duty of care, obliges workers to look after the interests of their employer, and employers to look after the welfare of their employees. Most of contemporary management is about getting employees to take more seriously the obligation to look after their employer’s interests, including pitching in and helping when they aren’t being watched—what we think of as discretionary effort.

The way employers get employees to give more discretionary effort, research increasingly shows, is through a kind of social exchange based on reciprocity: We will look after you if you look after us. Good supervisors do this with an exchange of favors—say, by balancing out extra demands on employees with breaks later on, or finding more opportunities for those who go above and beyond.

Managing employees with contracts, however, undermines that reciprocity by giving employees an incentive to behave like contractors. When employers use contracts (or even use language that resembles contracts) to spell out precisely what they want employees to do and what they will reward, they tend to get exactly that output at the expense of everything else that isn’t explicitly specified.

Some employers might think the answer is to draft more rules. But the more rules a company has, the less discretion supervisors have to shape employee behavior and the more difficult it is to build relationships with direct reports in a way that encourages discretionary effort. In fact, when companies start mandating behaviors that are now voluntary and that employees do because it makes them feel good—say, looking after new hires—they may get less of it because mandates kill intrinsic motivation.

Research also shows that people tend to see contract work as lower status, and even working alongside independent contractors can make employees feel worse about their own jobs. They are less likely to identify with their employer or to feel part of the organization. Managing employees like contractors can evoke similar feelings.

An extreme example of how contracting can be detrimental to companies can be seen with CEOs, who often demand complex employment agreements that specify almost everything about their jobs—what they can do outside of work, what they can and can’t be fired for, and the outcomes that will determine their pay. Such details often create problems. There is evidence, for example, that CEOs manage earnings more aggressively and release less negative news when they are coming up for a contract renewal. Studies also show that the shorter a CEO’s contract is, the fewer investments the firm makes such that short-term earnings improve at the expense of longer-term prospects.

Employment is an incredibly flexible arrangement that can tap into the very best ideas and behavior that employees can offer. To get that requires relationships where employees feel an obligation to do so. The effort to pin down employee behavior with contracts and contract-like practices undermines that obligation and ends up treating employees as vendors, an approach that quickly becomes incredibly inflexible and complex. The less of this companies do, the better.

Peter Cappelli, the George W. Taylor Professor of Management at the Wharton School at the University of Pennsylvania and director of Wharton’s Center for Human Resources, is the author of “The Future of the Office: Work from Home, Remote Work, and the Hard Choices We All Face.”

Professor Cappelli co-wrote this article with Liat Eldor, assistant professor at Tel Aviv University for The Wall Street Journal.