Richard Hunt and Mat Hayward fom the University of Colorado were interested in employees who asked
their employer for a loan, because they had no money but, for instance, had to
buy a car, pay for their daughter’s wedding, medical bills, buy food and
utilities, or faced home eviction. Therefore, they undertook to survey and
interview small and medium-sized building contractors in Colorado. No fewer than 67 percent of companies lent at
least one of their employees money, with an average of about $1,100. Hunt and
Hayward looked at 83 of them in more depth.
The first thing they found out was that, of the 459 loans
that these 83 companies in combination handed out to one of their employees, no
fewer than 57 percent were completely informal; meaning without any contract or
any other formal enforcement mechanism. Why would firms do this? Even if they
wanted to lend them money, why not give them a contract for the loan? This was
puzzling because making it an informal, instead of formal loan with a contract,
left the employer vulnerable to cheating by the employee. Because the employee
simply could not pay back, or eventually even somehow inform the tax authorities
(since informal loans are illegal). Why would employers voluntarily take that
risk?
Hunt and Hayward theorised that employers granting the loan
sometimes deliberately make themselves vulnerable towards the employee - by
choosing an informal arrangement rather than a contract – to solicit trust and
commitment from the employee. Granting a loan to a valuable employee in his
time of need and do that in a way
which explicitly makes the employer itself vulnerable could create substantial
commitment and reciprocity from the employee, grateful for the loan and
honoured by the trust placed upon him.
In conformity with this theoretical perspective, Hunt and
Hayward found that informal loans were indeed more often extended when the
employee needed the money for something personal and emotional, such as a
wedding, a graduation, or to pay medical bills. When the loan concerned buying
stuff (e.g. a car), paying off a credit card debt or rent, employers more often
resorted to a formal contractual loan.
Moreover, Hunt and Hayward conjectured that employers would
be more likely to make such an informal loan (rather than a formal,
contract-based one) to employees who they were more eager to keep. And indeed
they found that the informal loans were more often extended to better
performing employees; those that were neither very young nor old (but just the
right age to be both experienced and still have many productive years ahead of
them), and at a time when the firm was most dependent on them, because it was
still relatively new and small, and did not yet have a big backlog in terms of
outstanding work assignments.
The question is: Did it work? Does extending an informal
loan – at thus putting yourself at risk of being cheated on – result in
improved (financial) performance? Hunt and Hayward showed that the answer is a
resounding yes: their findings indicated that employers were better able to
retain employees to whom they had extended such a loan. Furthermore, their
calculations showed that it resulted in enhanced employer profit. Hence, making
yourself vulnerable (by not asking for a formal contract) eventually paid off
in financial terms.
Paper presented at the “Sumantra Ghoshal Conference for Managerially Relevant Research” at the London Business School
Our vulnerability is my gain: Linking exchange parties’ vulnerability to informal transactions and firm performance. Richard Hunt & Mathew Hayward (University of Colorado at Boulder)
Paper summary published with permission from the authors.
