With unemployment hovering around 10 percent, I am having many conversations with people at all organizational levels who have recently been laid off, terminated, downsized, underemployed, or outplaced (pick a label).

A common theme I am hearing is that most of these folks are genuinely hurt by their situation. I’m not referring to the obvious stress and fear that comes with losing a job and one’s source of income, but to the emotional hurt similar to the mourning that one goes through with the loss of a loved one.

In my experience, most boards of directors and business leaders don’t fully comprehend the huge emotional impact that organizational downsizing has on both the outplaced employees and those who remain within the organization. They don’t realize that they are breaking an invisible psychological contract that grows between an employer and its employees.

Building Trust
During the recruitment process, the employer and the job candidate discuss the “hard elements” of the job, including responsibilities, salary, benefits, training, career pathways, et cetera. When an agreement is reached, a formal written employment contract is signed and the interviewee becomes an employee. Then clarification of all the other “soft elements” starts. The unspoken expectations and the reality of rights and duties emerge and form an unwritten psychological contract between the employee and the employer.

Employees promise to work hard while employers promise to provide pay commensurate with performance. Employees promise to be punctual and to meet attendance requirements; employers promise training and development. Employees promise to work extra hours when required; employers promise opportunities for promotion and recognition. Employees promise to be loyal, flexible, and to learn new skills; employers promise reasonable job security, a career path, and an attractive benefits package. Employees promise to be honest, ethical, and courteous; employers promise to be ethical and provide a pleasant and safe working environment. Employees promise to bring forth new ideas; employers promise recognition for innovation.

The day-to-day expectations slowly become clearer. Employees navigate through what they must do to perform satisfactorily for their managers and peers; employers carefully monitor and measure their employees’ performance. Over time, if these expectations match up, a relationship develops, trust is built, and a mutual commitment is understood. As a result, the psychological contract between the employee and the employer becomes established.

A Weakened Contract
But perhaps the most important implied promise, in my experience, is that of security to the employee from the employer. And this promise was being broken quite often even before the recession, as changes were occurring in the workplace at breakneck speed. More employees are now on part-time and temporary contracts, for instance, while many jobs are being outsourced. “Functional flexibility” is the new name of the game. Markets, technology, and products are constantly changing while customers are becoming more demanding and less loyal.

The effect of these changes, combined with the high rate of business failures and closings, is an environment where the psychological contract between employees and employers, already weakening in recent years, is now in peril of extinction. Generation X and Generation Y employees don’t have the expectation of long-term employment that Baby Boomers once enjoyed. Yet few were prepared for the depth and length of the devastation caused by the Great Recession. Record layoffs and terminations have occurred, and the promise of security has been broken at many companies.

Employees who have been laid off or terminated believe that their employers have failed to deliver on implied promises. Employees’ trust has been broken, and they feel they’ve been let down. Meanwhile, the employees who remain feel a conflicted mixture of relief for not being laid off and guilt for keeping their jobs while their friends join the unemployment lines.

Those who remain are also feeling additional stress from having to do more with fewer people. I recently learned about a company that has mandated that its middle managers make up unmade telemarketing calls in the evenings and on Saturdays. When the managers complained, they were told they were lucky to still have their jobs. Put up and shut up, in other words.

Does this scenario sound familiar? At many companies, a previously motivated workforce, working in a company culture of mutual respect and productivity, has become a fragmented, uncommitted, overworked group of people with broken loyalties, loss of focus, and unproductive workdays. Morale is suffering. And if management’s decisions to downsize are viewed as unjust, unfair, or immoral, the company’s public reputation and brand image have been tarnished.

Trust is an emotion that comes before the emotion of duty. Duty means a sense or emotion that human beings feel to honor or keep promises made to others, including organizations. Without trust in the other person or the organization, duty will not be voluntarily exercised, and tasks will be completed only under some form of coercion.

So the already weakened psychological contract has been broken at many companies. And those fortunate enough to be working for the few strong and healthy companies remaining are probably holding their breath, waiting for the shoe to drop at any moment.

Minimizing the Damage
It’s obviously better to prevent a breach in the psychological contract than to try to repair the damage after it occurs. But in this changing and troubled economy, sometimes organizational downsizing simply cannot be avoided. There are some things business leaders can do to minimize the emotional impact of these unfortunate changes. In a nutshell, they should be as sensitive and caring as they can be toward those being laid off or terminated.

And for those employees remaining, minimizing the emotional damage of downsizing makes good business sense, as well as being the right thing to do. “Human capital” is becoming more and more critical in our knowledge-based economy. Especially as the economy recovers, business leaders need to do whatever they can to retain their employees.

Which is a tough row to hoe. According to the U.S. Bureau of Labor Statistics as of July 2010, in each of the previous three months, more employees quit their jobs than were terminated. Also, a study reported in the May issue of the Harvard Business Review showed that 12 percent of high-potential employees were actively searching for a new job. Losing ambitious, qualified employees is bad news for employers.

Why are so many people leaving their jobs, even with unemployment so high? A recent study by Florida-headquartered consulting firm AchieveGlobal revealed that the top three reasons are a lack of growth opportunities, dissatisfaction with compensation, and a perceived lack of recognition for their contributions. These are all preventable diseases—if employers care enough to diagnose the symptoms.

In today’s world, employees are not replaceable cogs in the wheel of the company’s operations. They are valuable resources that should be managed on a person-to-person level—recognized as individuals with specific goals, needs, and wants. To minimize the damage of the breach of the psychological contract, employers should remind themselves that knowing their employees is more important than knowing their profit margin, market share, return on investment, and the gazillion other metrics they use in their operations.

A very unfortunate result of the recession is the emotional toll of layoffs, terminations, downsizing, and underemployment on so many people. But if more business leaders became aware of the fragile psychological contract between employers and employees and responded with more personal interaction and involvement, perhaps some of the negative impact could be avoided—and over time, the contract would be strengthened once again.