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STRATEGIC HUMAN CAPITAL MANAGEMENT

IN SMEs: AN EMPIRICAL STUDY OF


ENTREPRENEURIAL PERFORMANCE

James C. Hayton

How can human resource management (HRM) practices promote entrepreneurial performance
in small and medium-sized enterprises (SMEs)? This article discusses the association between
human capital management (HCM) and other contemporary HRM practices and the ability of
SMEs to be entrepreneurial. In a study of 99 SMEs, HRM practices that promote employee dis-
cretionary behavior, knowledge sharing, and organizational learning are found to be positively
associated with entrepreneurial performance. Two contingencies are also identified for this re-
lationship. First, the use of strategic HCM practices enhances the observed positive association.
Second, these relationships are strongest for SMEs operating in high-technology industries.
© 2004 Wiley Periodicals, Inc.

Introduction Of all functional areas within the domain


of HRM, human capital management (HCM)
A firm’s human capital is believed to be an practices have received very little attention
important source of sustained competitive from researchers. One reason for this may be
advantage (e.g., Barney, 1991). This is es- that HCM crosses typical HR functional
pecially so for those firms operating in boundaries, involving the assessment of the
complex and dynamic competitive environ- costs and/or benefits of HRM practices such
ments where the capability to rapidly ac- as selection, compensation, or training. HCM
quire and assimilate new market and tech- typically refers to the measurement and
nological capabilities is the key to analysis of human resource “metrics” such as
enduring advantage over competitors. The cost per hire, turnover costs, the effectiveness
acquisition and transformation of new of training interventions, and indicators of
knowledge in organizations is an inher- overall HRM-system effectiveness such as
ently human process (e.g., Nonaka, 1994), human capital return on investment (e.g.,
making it important to understand the Becker, Huselid, & Ulrich, 2001; Cascio,
contribution that human resource manage- 1999; Fitz-Enz, 2000). HCM practices
ment (HRM) practices make to this aspect may be characterized as either historical and
of firm performance. expense-focused or strategic, future-oriented,

Correspondence to: James C. Hayton, Utah State University, Department of Management & Human Re-
sources, College of Business, 3555 Old Main Hill, Logan, UT 84322-3555, Phone: 435-797-1658, Fax:
435-797-1091, James.Hayton@usu.edu

Human Resource Management, Winter 2003, Vol. 42, No. 4, Pp. 375–391
© 2004 Wiley Periodicals, Inc. Published online in Wiley InterScience (www.interscience.wiley.com).
DOI: 10.1002/hrm.10096
376 • HUMAN RESOURCE MANAGEMENT, Winter 2003

and investment-focused (e.g., Becker et al., have received attention from scholars in the
2001). This aspect of HRM serves as an im- past (Cascio & Ramos, 1986; Cascio & Sib-
portant feedback mechanism for assessing the ley, 1979), little research has examined the
health and effectiveness of the wider HRM association between HCM and firm-level
system (e.g., Kavanagh, Gueutal, & Tannen- outcomes. Second, this study contributes to
Strategic HCM baum, 1990). our understanding of HRM in the context
practices are In this study, I propose that strategic of SMEs, an important population of firms
defined as those HCM represents an important tool for small that have received only limited attention by
focused on the
assessment of
and medium-sized enterprises (SMEs) seek- HR researchers to date. It is important to
effectiveness of ing to leverage their human capital and en- determine the extent to which HRM can
existing HRM hance their entrepreneurial performance. contribute to firm performance for this pop-
practices with Entrepreneurial performance refers to the ulation of firms, as nearly one-half of all
a view to en- ability to innovate, accept risk, and identify HRM professionals are employed by SMEs
hancing fit with
and exploit entrepreneurial opportunities. (Society for Human Resource Manage-
organizational
goals. Strategic HCM practices are defined as ment, 2002a), and these firms are a key
those focused on the assessment of effec- source of innovation and economic growth.
tiveness of existing HRM practices with a Third, I focus on firms’ entrepreneurial per-
view to enhancing fit with organizational formance as an indicator of the effective-
goals. In contrast, nonstrategic or cost-fo- ness of their HRM systems. Entrepreneur-
cused HCM is oriented to financial ac- ial performance reflects the extent to which
counting measures and limited to assessing a firm is able to accept risk and be innova-
direct expenditures associated with HRM tive or competitively aggressive (Lumpkin &
such as compensation and benefits costs. Dess, 1996). This aspect of performance is
There is an absence of research examining very important to firm financial perfor-
the association between a strategic approach mance and survival, particularly for smaller
to HCM and firm performance. firms operating in hypercompetitive high-
A second limitation observed within technology environments (e.g., Zahra &
HRM research is the tendency to focus on Covin, 1995). Entrepreneurial performance
larger, bureaucratic organizations at the ex- involves innovation and risk-taking by the
pense of SMEs (e.g., Heneman, Tansky, & firm. The firm’s HRM system can be ex-
Camp, 2000). Although there have been pected to contribute significantly to such
some exceptions to this tendency (e.g., activity (e.g., Morris, 1998).
Chandler, Keller, & Lyon, 2000; Chandler & I propose that HCM represents a dy-
McEvoy, 2000), HRM research has largely namic capability (Teece, Pisano, & Shuen,
ignored this very significant segment of the 1997), and therefore a strategic resource ac-
national economy. This is unfortunate, as ac- cording to the resource-based view (e.g., Bar-
cording to the U.S. Small Business Associa- ney, 1991), that contributes to firm perfor-
tion, firms with fewer than 500 employees mance and sustainable competitive advantage
account for 99 percent of all employers and for SMEs. I employ a systems-based model
39 percent of the gross national product and invoke the resource-based view of the
(cited in Williamson, Cable, & Aldrich, firm to suggest that a firm’s choice of both
2002). For smaller firms, resource con- HRM practices and HCM practices will in-
straints may mean that HRM activities are fluence its entrepreneurial performance as a
often less formal and may be limited in their result of system flexibility, internal consis-
scope and sophistication (Welbourne & Katz, tency, and environmental fit. I briefly review
2002). However, this does not mean that ef- these two perspectives in the next section. I
fective HRM is any less significant to firm then propose a set of hypotheses concerning
success (e.g., Welbourne & Cyr, 1999). the association among HCM practices,
This study makes three contributions to HRM system characteristics, and entrepre-
the literature. First, I address the impor- neurial performance in SMEs. Following
tance of HCM practices for organizational this, I present the results of an empirical
performance. Although aspects of HCM study designed to test these hypotheses.
Strategic Human Capital Management in SMEs • 377

Theoretical Perspectives—The Systems View are selected from a menu of choices based
of HRM and the Resource-Based View of upon desired employee behaviors. This view
the Firm assumes that it is possible to identify all of
the skills and behaviors needed to support a ... for growing
In research that examines the contributions chosen strategy. However, as soon as the en- firms or those
facing dynamic
made by HRM practices to firm perfor- vironment changes from stable to dynamic, and hostile
mance, a popular theoretical perspective has or as soon as we move from large, established environments,
emerged that characterizes individual HRM organizations to smaller, growing firms, this flexibility is an
practices as a part of a system (e.g., Delery assumption fails. The employee role behav- important
& Doty, 1996; Heneman & Tansky, 2002; iors required to perform in fast-changing en- characteristic
for the HRM
Huselid, 1995). This view suggests that the vironments are difficult to specify ex ante system.
attributes of the HRM system, such as in- and the necessary behaviors are likely to
ternal consistency, external fit, and flexibil- change over time as the firm interacts with
ity are important determinants of organiza- its environment (e.g., Kanter, 1983, 1985).
tional effectiveness. Temporary congruence between practice, be-
Internal consistency of practices is desir- havior, and strategy may be achieved as a re-
able so that they all focus employees on be- sult of careful monitoring, feedback, and
haviors that are functional for the organiza- program adaptation. However, when the or-
tion and none create conflicts or ganization or its environment is changing,
contradictions in terms of the motivation and periods of system equilibrium are likely to be
control of employee behaviors. The benefit temporary. Therefore, for growing firms or
of internal consistency is the achievement of those facing dynamic and hostile environ-
synergistic outcomes, since the power of the ments, flexibility is an important characteris-
practices combined is actually greater than tic for the HRM system. A corollary is that
the sum of the parts. There has been some under conditions in which there is little or no
empirical support for the positive benefits of environmental or organizational change,
internally consistent HRM systems (e.g., HRM system flexibility will represent an un-
Becker & Huselid, 1998). necessary added cost that should be avoided.
External fit refers to the need for HRM Flexibility refers to the capability of a sys-
practices to be congruent with a firm’s busi- tem to adapt in response to changing envi-
ness strategy. For example, firms pursuing a ronmental or organizational demands, which
cost leadership strategy will seek to minimize trigger the need for new HRM practices that
their HRM costs while maintaining conform- promote desired employee behaviors. HRM
ity with product or service standards. In con- system flexibility contributes to overall strate-
trast, firms pursuing an innovation-based gic flexibility—the ability to maintain high
strategy should choose HRM practices that levels of sustained regeneration of products
promote learning, collaboration, experimenta- and processes (e.g., Hitt, Keats, & DeMarie,
tion, and risk-taking. These practices tend to 1998; Sanchez, 1995). Therefore, HR system
be more expensive and are often less efficient, flexibility is expected to be related to entre-
but they contribute to the establishment of a preneurial performance—the ability to enter
flexible, learning organization. While there new markets and create technologies that are
has been some empirical support for the ex- exploited for entrepreneurial profit.
ternal congruence hypothesis (e.g., Jackson, HR flexibility includes both functional
Schuler, & Rivero, 1989), the evidence has flexibility (e.g., Friedrich, Kabst, Weber, &
not been as strong as for the internal consis- Rodehuth, 1998)—the range of jobs that in-
tency hypothesis (Delery & Doty, 1996). dividual employees are capable of performing
Traditional models of strategic HRM (e.g., Cordery, 1989)—and HR system flexi-
tend to ignore the need for system flexibil- bility—the range of contexts to which HR
ity (Wright & Snell, 1998). The behavioral practices can be usefully applied and the
perspective on strategic HRM, which un- speed at which they can be changed (Wright
derlies the internal consistency and external & Snell, 1998). Empirical studies have found
fit hypotheses, suggests that HR practices that HR flexibility is positively associated
378 • HUMAN RESOURCE MANAGEMENT, Winter 2003

with R&D concentration and coordination of personal computers and human resource
and, consequently, a firm’s strategic position information systems (HRISs) has opened
(Zhou & Özsomer, 1999). new avenues for analysis even for very small
An HR system that is internally consis- organizations. Typical criticisms appear to
tent, externally congruent, and flexible is ex- ignore empirical evidence that, when used
Through its pected to contribute to sustained competitive as a part of a larger strategic model, HCM
enhancement of advantage of the firm, as it represents a dy- can contribute to HRM effectiveness by im-
the HRM namic organizational capability (Teece et al., proving the speed and quality of decision
system’s
feedback
1997) that facilitates the acquisition and making (e.g., Rucci, Kirn, & Quinn, 1998).
mechanism, transformation of a key strategic resource: Through its enhancement of the HRM sys-
HCM can human capital. According to the resource- tem’s feedback mechanism, HCM can pro-
promote based view of the firm, it is the extent to mote internal consistency, external congru-
internal which a firm controls strategic resources— ence, and system flexibility. Therefore,
consistency,
those resources that are scarce, valuable, according to the resource-based view of the
external
congruence, inimitable, and nontradable—that deter- firm, HCM holds the potential for con-
and system mines their ability to obtain sustainable com- tributing to competitive advantage.
flexibility petitive advantage (Barney, 1991). There- HCM practices include a broad array of
fore, this study invokes both the systems specific methods that vary in their time orien-
perspective and the resource-based view and tation—that is, the use of leading versus lag-
examines whether HCM contributes to en- ging indicators—and the extent to which they
trepreneurial performance of SMEs. I next focus upon costs versus human resource in-
discuss the nature of HCM and its associa- vestments (Cascio, 1999). For example, calcu-
tion with other HRM practices and the out- lation of compensation and benefits expendi-
come of entrepreneurial performance. tures addresses the cost of HRM but not
outcomes such as employee productivity or
HCM and Entrepreneurial Performance satisfaction. In contrast, assessment of the
yield rate from recruitment sources, the be-
The practice of measuring and valuing HRM havior changes resulting from training, or as-
practices and human capital assets has a sessment of the utility of selection measures
long history, including utility analysis and all address outcomes that result from HRM
human resource accounting (e.g., Boudreau, practices rather than purely their cost. These
1991; Brogden & Taylor, 1950; Flamholtz, types of HCM are strategic in that the assess-
Searfoss, & Coff, 1988; Roslender, 1997). ment of the benefits of HR practices aids se-
More recently, strategic and balanced score- lection from among alternatives by predicting
card accounting techniques have been advo- their effect upon desirable outcomes such as
cated as valid methods for both monitoring employee behavior or attitudes. Recent sur-
human capital inputs and valuing the return veys reveal that such strategically oriented
on human resource investments (Becker et HCM has become increasingly prevalent (e.g.,
al., 2001; Fitz-Enz, 2000; see Cascio, 1999). Gates, 2002; Mercer Human Resource Con-
Some critics have noted the difficulty of sulting, 2003; Society for Human Resource
estimating the value of employee performance Management, 2002b). A well-known example
and the standard deviation of employee per- is the total performance model at Sears (Rucci
formance, both central elements in the cost- et al., 1998) in which the management of
ing process (Scarpello & Theeke, 1989). Oth- Sears is able to quantify the return on invest-
ers have argued against HCM on the grounds ments in employee development and satisfac-
that what gets measured gets managed (Pfef- tion in terms of bottom-line performance.
fer, 1997) and, by focusing HR executives This distinction between historical, cost-
upon costs, HCM can create a disincentive to focused HCM techniques, such as human re-
make long-term investments in HRM pro- source accounting and future-oriented, strate-
grams. Both of these arguments reflect the gic HCM techniques such as the balanced
fact that HCM requires both careful research scorecard approach, parallels that observed
and discipline. However, the increasing power between financial and strategic controls (Hitt,
Strategic Human Capital Management in SMEs • 379

Hoskisson, Johnson, & Moesel, 1996). Finan- success. These “strategic” HCM practices in-
cial controls focus upon goals, targets, and clude some component of outcomes as well as
performance quotas. Managers’ success or inputs. For example, absenteeism costs are an
failure depends upon how well these goals are outcome measure; similarly, yield rates from Since the
achieved. A direct result of this is that finan- recruitment sources involve important out- process of
identifying and
cial controls are observed to promote a short- comes. Another outcome-oriented metric is exploiting
term orientation, risk aversion, and rigidity in change in productivity as a function of train- entrepreneurial
decision making (Zahra, 1996). Such rigidity ing. The use of these strategic, investment-ori- opportunities is
and risk aversion can be expected to inhibit ented HCM practices suggests a reflective ap- inherently
entrepreneurial performance, which is espe- proach to measuring the effectiveness of uncertain and
poorly defined,
cially important for the financial performance specific HR practices. A willingness to monitor entrepreneurial
of smaller enterprises. HR system effectiveness, in turn, implies a firms build in
Strategic controls emphasize broader, willingness to adapt the system to changing slack resources
open-ended goals, and require a greater un- conditions, thus promoting a more flexible, re- and discretion-
derstanding of the tasks, risks, and potential sponsive HRM system. Therefore, I also expect ary time, pro-
mote experi-
trade-offs among the choices managers must that the influence of these strategic HCM
mentation, and
make. For example, a financial goal for HR practices upon entrepreneurial performance in are tolerant of
may be the reduction of total labor costs. In SMEs will be positive, consistent with prior re- failure.
contrast, a strategic goal may be the promo- search on the use of strategic controls. This
tion of employee satisfaction with a view to suggests the following hypotheses:
enhancing customer satisfaction and, ulti-
mately, firm performance. Strategic controls Hypothesis 1: The use of strategic human
are especially important for firms operating capital management practices will be posi-
in uncertain and dynamic markets or tech- tively associated with entrepreneurial per-
nological environments, as the entrepreneur- formance in SMEs.
ial orientation needed to succeed demands
greater environmental responsiveness and Hypothesis 2: The use of financial human
flexibility (Zahra, 1996). Empirical evidence capital management practices will be neg-
supports the proposition that an emphasis atively associated with entrepreneurial per-
upon strategic controls is associated with formance in SMEs.
higher levels of entrepreneurship (Barringer
& Bluedorn, 1999; Zahra, 1996). HCM and Flexibility of the HRM System
I propose that the use of historical, cost-
based HCM methods have a similar negative Scholars of corporate entrepreneurship have
influence upon flexibility and risk taking in noted that HRM practices in entrepreneurial
SMEs to that which is observed with the use firms tend to differ from those in more con-
of financial controls. Cost-focused HCM servative organizations (e.g., Kanter, 1985;
metrics focus exclusively upon the input side Morris, 1998). Entrepreneurial firms tend to
of the equation—for example, “how much use broad and often vague job descriptions,
did we spend last period on salaries, benefits, deliberately allowing duties and responsibili-
or bonuses?” Therefore, I refer to these as ties to overlap and therefore promoting com-
“financial HCM practices.” The incentive munication and learning. HRM practices are
with such cost-based measures will be to also used to promote individual risk taking
demonstrate improved HR performance by and experimentation, employee commitment,
reducing input costs. However, such cost-fo- participation in decision making, and shared
cused management is likely to have adverse ownership (e.g., Block & MacMillan, 1993).
and unintended results, such as cutting in- Since the process of identifying and exploiting
vestments in the development of human cap- entrepreneurial opportunities is inherently
ital (e.g., Pfeffer, 1997). uncertain and poorly defined, entrepreneurial
In contrast, the use of forward-facing, in- firms build in slack resources and discre-
vestment-oriented methods reflects recogni- tionary time, promote experimentation, and
tion of the nature of strategic drivers of firm are tolerant of failure (Fry, 1987).
380 • HUMAN RESOURCE MANAGEMENT, Winter 2003

Traditional approaches to HRM tend to HCM and Internal Consistency of the HR


focus upon identifying the tasks, duties, and System
responsibilities associated with the current
jobs of the organization, and then making im- The internal consistency hypothesis suggests
plicit hypotheses concerning the human cap- that when individual HRM practices con-
Entrepreneurial ital characteristics and behaviors needed to tribute to the achievement of the same overall
performance successfully perform these jobs. These are de- objective, synergy results such that the overall
depends upon rived through formal job analyses, which re- contribution is actually greater than the sum of
behaviors that
are difficult to
sult in clear, formal job descriptions. Employ- the parts. Strategic HCM practices are ex-
specify in ers are then expected to carefully recruit and pected to enhance the value of investments in
advance. select employees for these characteristics, discretionary HRM practices by enhancing the
monitor their performance, and pay them ac- speed and quality of decision making with re-
cording to their ability to effectively perform spect to the selection and management of
their jobs. This approach is very much an ef- these practices. For example, where a firm
ficiency-oriented model, based upon the chooses to focus on maintaining positive em-
premise of matching the abilities of the indi- ployee attitudes through investing in employee
vidual with the needs of the organization. wellness, it will make better, faster decisions if
A second group of HRM practices seeks it is able to monitor the costs of these invest-
to promote the discretionary contributions of ments and their returns in terms of reduced
employees. These include incentive compen- absenteeism and turnover. Therefore, for firms
sation (long- and short-run), employee em- seeking to maximize their entrepreneurial per-
powerment, and participation programs. formance, strategic HCM will contribute to in-
These practices explicitly recognize that it is ternal consistency of the HRM system if that
not possible to specify all of the require- system is also focused upon this goal. This sug-
ments of a job within a formal job descrip- gests the following hypothesis.
tion, nor is it possible to effectively monitor
all of the contributions that employees may Hypothesis 4: The positive relationship be-
make to their organization. Furthermore, tween discretionary HRM practices and
these “discretionary” HRM practices encour- entrepreneurial performance will be
age the transfer of knowledge from the stronger where SMEs also use strategic
minds of individual employees to the rest of HCM practices.
the organization, facilitating the organiza-
tional learning process. Therefore, while HCM and External Congruence
“traditional” HRM tends toward an effi-
ciency orientation, discretionary HRM pro- The third important system characteristic is
motes a learning orientation. the external fit of HRM practices. While
Entrepreneurial performance depends studies of external congruence have most
upon behaviors that are difficult to specify in frequently emphasized a firm’s chosen strat-
advance. Therefore, it is facilitated by the in- egy, the firm’s competitive environment is
herent flexibility of discretionary HRM prac- also expected to be of significance for the
tices, as well as the contribution that these choice of HRM practices. For SMEs oper-
practices make to organizational learning ating in dynamic and hostile competitive
and the acquisition of market and technolog- environments, such as high-technology in-
ical capabilities. In contrast, traditional dustries, HR systems that are more flexible
HRM practices do not contribute to flexibil- and responsive to rapidly changing environ-
ity and may even inhibit organizational learn- mental demands will be of greater benefit to
ing and responsiveness. Therefore, I suggest organizational performance. For firms in
the following hypothesis: these environments, entrepreneurial perfor-
mance has a significant positive influence
Hypothesis 3: The use of discretionary upon financial performance (Zahra &
HRM practices will be positively associated Covin, 1995). Therefore, due to a better fit
with entrepreneurial performance in SMEs. with environmental demands, I expect that
Strategic Human Capital Management in SMEs • 381

SMEs operating in high-technology indus- performance, we can expect relatively low ef-
tries will benefit most by also employing fect sizes—a recent meta-analysis suggests an
strategic HCM and discretionary HRM prac- average correlation of around .13 between
tices. This suggests the following hypotheses. the use of high-performance human resource ... SMEs
management practices and firm performance operating in
high-technology
Hypothesis 5: The association between (Combs, Hall, & Liu, 2003). Therefore, industries will
strategic HCM and entrepreneurial perfor- should statistically significant results be ob- benefit most by
mance will be stronger for SMEs operating served with a representative sample of 99 also employing
in high-technology industries. firms, and consequently relatively low statis- strategic HCM
tical power, we can place some confidence in and discre-
tionary HRM
Hypothesis 6: The association between dis- the inference that the observed relationships practices.
cretionary HRM and entrepreneurial per- do exist in the wider population.
formance will be stronger for SMEs oper- In an open-ended question, survey re-
ating in high-technology industries. spondents represented themselves as direc-
tors of HRM (30%), vice presidents or senior
Methods vice presidents of HRM (22%), or HR man-
agers (22%), and the remaining respondents
Sample reported being either HR generalists or spe-
cialist HR professionals. There were no sig-
In this study, consistent with the definitions is- nificant differences between respondents
sued by the U.S. Small Business Administra- and nonrespondents in terms of number of
tion, SMEs are defined as firms with less than employees, assets, or their current ratio,
500 employees. However, due to the expecta- which indicates the amount of slack re-
tion that formal HRM practices would be lim- sources available to the firm. Therefore, the
ited for firms with less than 100 employees, I sample used in the analysis is representative
eliminated these from the initial sample. A sur- of the population being studied.
vey instrument was designed following a re-
view of prior literature examining HRM and Measures
HCM practices. The initial survey was pilot-
tested with a panel of practicing HR execu- Dependent variable. Entrepreneurial perfor-
tives, and their feedback was obtained through mance is measured using Miller’s (1983) in-
a focus group meeting. The final survey was strument. This scale includes seven items
distributed to 2,200 public and private SMEs with a five-point Likert-like “agreement”
in the United States in 2003. These firms were scale, and including items such as “This com-
identified from a list of all publicly traded firms pany shows a great deal of tolerance for high
in the United States with between 100 and risk projects.” This is probably the most widely
500 employees, generated by Standard & used measure of entrepreneurial perfor-
Poor’s Research Insight database, and a private mance, and there is good evidence of both its
mailing list of a consulting firm specializing in reliability and validity (Miller, 1983). Scores
human resource management issues. on this scale were summed to create an over-
Usable responses were received from 108 all index of entrepreneurial performance.
firms (5%). However, nine of these reported
having more than 500 employees and were Independent variables. HRM practices were
therefore eliminated from the sample. Thus, assessed using items adapted from previous
the size of the sample used in our analyses is studies by Huselid (1995) and Chandler and
99 firms. While the response rate for this sur- colleagues (Chandler et al., 2000; Chandler &
vey was low, even for a mail survey of small McEvoy, 2000). The scale consists of a list of
businesses (Dennis, 2003), this is a suffi- 25 HR practices, with a five-point Likert-like
ciently large sample for a preliminary exami- scale for respondents to rate their agreement.
nation of the issues that are the focus of this Items include such statements as “We have
study. Based upon prior research into the as- formal job descriptions.” HCM practices were
sociation between HRM practices and firm assessed using a list of 27 metrics, reflecting
382 • HUMAN RESOURCE MANAGEMENT, Winter 2003

both cost-focused and investment-focused Specifically, HR practices fall into two dis-
items. Sample items from this list include tinct factors. The first reflects what may be
“labor costs as a percentage of revenue,” “fixed referred to as traditional HR practices, such
compensation costs,” “yield rate from recruit- as job analysis, job descriptions, and struc-
ment sources,” and “revenues per employee.” tured compensation systems. The second
HR practices Respondents rated whether they “always,” factor reflects HR practices that influence
fall into two “occasionally,” or “never” used these metrics. employee discretionary behavior such as
distinct factors. employee empowerment, employee partici-
Control variables. Since a number of firm and pation programs, and incentive pay. I label
industry variables may influence entrepre- this factor discretionary HRM. The results
neurial performance, I included several con- of the factor analysis are reported in Table
trol variables in the analysis. The resources I. Two new variables, “traditional HRM”
available to an organization are expected to be and “discretionary HRM,” were created by
positively associated with innovation and risk- summing the item scores for the items in
taking, therefore I control for both the firms’ each factor.
assets and their slack resources. Assets were The human capital measures also were
included in the form of the log of total current best described by two factors. The first factor
assets. Slack resources were indicated using included items such as cost per hire for se-
the current ratio of the firm. These data were lection tools, validity of selection tools, yield
obtained from Standard & Poor’s Research In- rates from recruitment sources, and cost of
sight database. Since firm size is also expected absenteeism. Since the reason for assessing
to influence entrepreneurial performance, I these metrics is to evaluate the effectiveness
included this variable as a control. Size was of HRM practices and interventions I label
indicated by the number of full-time equiva- this factor strategic HCM practices. The sec-
lent employees in the firm. This variable was ond focused upon compensation and bene-
self-reported by survey respondents and its va- fits expenditures. The assessment of these
lidity assessed against secondary data in Stan- metrics is typically for financial accounting
dard & Poor’s Research Insight database. Fi- reasons, and I label this factor financial
nally, I controlled for whether the firm HCM. The results of this factor analysis are
operated in a high-technology industry, as it is reported in Table II. The items loading on
expected that this will be positively related to each factor were summed to create two new
the rate of innovation and entrepreneurship. variables labeled strategic HCM and finan-
Industry type was self-reported by respon- cial HCM, respectively.
dents and validated against secondary data. The internal consistency estimates of
Examples of high-technology industries in this these four factors were all at acceptable lev-
study include aeronautical engineering, soft- els: traditional HR practices (12 items)
ware, computer hardware, and biotechnology. alpha  0.84; discretionary HR practices (9
Non-high-technology industries in this study items) alpha  0.80; strategic HCM prac-
include banking and finance, insurance ser- tices (9 items) alpha  0.86; financial HCM
vices, utilities, and retail. practices (3 items) alpha  0.80. There was
Preliminary analyses consisted of assess- a significant correlation (r  .65, p  .01)
ing the factor structure of the HR and HCM between the self-reported number of em-
practices with exploratory factor analysis, and ployees and that reported in Standard &
checking the reliability and validity of the mea- Poor’s Research Insight database. While this
sures through internal-consistency estimates correlation appears modest, it should be in-
and correlations with secondary data sources. terpreted in light of the two-year time lag be-
The hypotheses were then tested using a set of tween the date of the secondary data and the
moderated hierarchical regression models. date the survey was completed. During a
two-year period, it is reasonable to expect
Results many SMEs to experience significant
growth in their employee base. As a result,
The preliminary analyses reveal factor this significant correlation offers evidence
structures consistent with expectations. for the validity of the survey data. Table III
Strategic Human Capital Management in SMEs • 383

TABLE I Factor Analysis of HRM Practices

Factor 1 Factor 2
Traditional Discretionary
Item HRM Practices HRM Practices
Formal job descriptions .741
Structured approach to deciding and describing job content .716
Task duties and responsibilities are clearly established .701
Actively try to identify the best recruitment sources .651
Pay levels are set with the help of formal salary surveys .645
Match employee capabilities with job requirements when making
internal transfers .606
Take a structured approach to selecting the best employees .595
Formal performance appraisal process .578
Performance evaluations are used to determine base compensation
and/or incentive compensation .546
Formal orientation program for new employees .535
A structured salary system .531
A policy of hiring from within wherever possible .448
Employee participation in decision making is encouraged and rewarded .786
A clearly defined incentive (variable) pay system .698
Employees are empowered to make decisions that improve product
quality, reduce cost, or enhance customer service .677
We organize socialization activities to enhance the sense of teamwork .660
Incentive pay is based upon the achievement of clearly understood goals .651
We have formal programs in place to encourage employee participation .630
We measure employee attitudes and opinions on a regular basis (e.g., annually) .584
We offer employees stock and/or profit sharing .456
Performance evaluations rely on input from other people in addition to
the immediate supervisor (e.g., coworkers) .408
Eigenvalues 5.865 2.515
% of variance 27.929 11.977

TABLE II Factor Analysis of HCM Practices

Factor 1 Factor 2
Strategic Financial
Item HRM Practices HRM Practices
To what extent does your organization use the following measures?
Base rate of qualified applicants in the total applicant pool .768
Selection rate .679
Absenteeism costs .666
Cost per hire of employee selection tools .663
Employee hours lost to absenteeism for a given period .654
The change in outcomes (e.g., productivity, quality, employee attitudes,
accidents, etc.) as a function of specific HR practices (e.g., training) .649
Validity of employee selection tools .638
Separation costs for the involuntary turnover of personnel .543
Yield rate from recruitment sources .453
Variable compensation costs .856
Fixed compensation costs .849
Benefits costs .569
Eigenvalues 4.424 2.074
% of variance 36.867 17.281
384 • HUMAN RESOURCE MANAGEMENT, Winter 2003

shows the means, standard deviations, and 1 or 2, which predicted that strategic HCM
correlations for the variables in this analysis. would be positively associated and financial
Hypotheses 1 through 4 were tested HCM would be negatively associated with
using hierarchical regression analysis. In the entrepreneurial performance in SMEs.
first model, the control variables were en- In the third model, the interaction term is
tered. In the second model, the four inde- added. This model is also significant overall
pendent variables, traditional HRM, discre- (adjusted R2  .304; p  .05) and the addi-
tionary HRM, strategic HCM, and financial tion of the interaction contributes signifi-
HCM, were added. In the third model the in- cantly to the variance explained in entrepre-
teraction between discretionary HRM and neurial performance of SMEs (change in
strategic HCM was entered. The results of R2  .110; p  .01). In this third model, all
this analysis are summarized in Table IV. of the control variables are significant (p  .1
In Model 1, only organizational slack is or p  .05). Both strategic HCM (p < .05)
significant and then only marginally so and discretionary HRM (p  .001) are posi-
(p  .10). However, this model overall is not tively and significantly associated with entre-
significant with respect to entrepreneurial preneurial performance, giving support to
performance of SMEs. The second model is Hypothesis 1 and Hypothesis 3, respectively.
significant overall (adjusted R2  .190; There is no support for Hypothesis 2, which
p  .05), and the addition of the HRM and predicts that financial HCM practices will be
HCM variables contribute significantly to negatively associated with entrepreneurial
the prediction of entrepreneurial perfor- performance in SMEs. Hypothesis 4 pre-
mance of SMEs (change in R2  .242; p dicted a significant interaction between the
 .05). In this model, only discretionary use of discretionary HRM and strategic HCM
HRM is significant and positively associated practices. This interaction variable is signifi-
with entrepreneurial performance in SMEs, cant in the final model (p  .01). However,
giving support to Hypothesis 3. However, the coefficient is in the reverse direction to
Model 2 provides no support for Hypothesis that suggested in Hypothesis 4.

TABLE III Means, Standard Deviations, and Correlations

Variables Mean SD 1 2 3 4 5 6 7 8 9 10 11
1. Entrepreneurship 23.713 4.801
2. Log assets 4.661 1.470 .055
3. Slack 4.759 5.632 .245 .249
4. Number of
employees (FTE) 208.654 102.230 .132 .315** .072
5. High-technology
industry 0.432 0.498 .017 .217 .371** .197
6. Traditional HRM 46.474 7.384 .222* .257* .136 .096 .079
7. Discretionary HRM 30.042 6.824 .430*** .183 .050 .173 .105 .390***
8. Strategic HCM 13.798 4.112 .133 .018 .135 .017 .154 .331** .124
9. Financial HCM 7.064 1.658 .013 .130 .144 .087 .007 .069 .108 .178
10. Interaction between
discretionary HRM
and strategic HCM 421.829 171.111 .288* .105 .080 .055 .123 .498** .649** .810** .179
11. Interaction between
strategic HCM and
high-technology industry 4.861 6.681 .097 .229 .360** .295** .951** .122 .078 .019 .015 .011
12. Interaction between
discretionary HRM
and high-technology
industry 13.085 15.757 .129 .170 .332* .192 .970** .001 .239* .133 .021 .039 .932**

Note: * = p < .05; ** = p < .01; *** = p <.001


Strategic Human Capital Management in SMEs • 385

Hypotheses 5 and 6 were also tested nificant and positively associated with entre-
using moderated hierarchical regression preneurial performance. Overall however,
analysis. In this analysis, control variables this model was not significant. Model 2 in-
were entered in the first model, independent troduced the two independent variables, dis-
variables were then entered in Model 2, and cretionary HRM and strategic HCM. As in
then the interactions between strategic the previous analysis, discretionary HRM
HCM and high-technology industries, and was positively and significantly associated
between discretionary HRM and high-tech- with entrepreneurial performance (p 
nology industries, were entered in Models 3a .001). This model is significant (adjusted
and 3b, respectively. The results of this R2  .209; p  .001) and contributes signif-
analysis are summarized in Table V. icantly to the variance explained in entre-
Model 1 introduced the control vari- preneurial performance (change in R2 
ables alone, and of these only slack was sig- .200; p  .001).

TABLE IV Hierarchical Regression Analysis of Entrepreneurial Performance on HRM and HCM


Practices and Their Interaction

Variables Model 1 Model 2 Model 3


Log assets 0.070 0.220 0.253†
Slack 0.284† 0.330* 0.354*
Number of employees (FTE) 0.117 0.239 0.267*
High-technology industry 0.080 0.148 0.284†
Traditional HRM 0.031 0.041
Discretionary HRM 0.510** 1.544***
Strategic HCM 0.091 1.423**
Financial HCM 0.014 0.001
Interaction between discretionary
HRM and strategic HCM 1.853**
Adjusted R2 .002 .190 .304
F-Value .975 2.434* 3.382**
Change in R2 .242 .110
F-Value for change in R2 3.662* 7.756**

Note: † = p < .10; * = p < .05; ** = p < .01; *** = p <.001

TABLE V Hierarchical Regression Analysis with Respect to the Contingency of High-Technology Industry

Variables Model 1 Model 2 Model 3a Model 3b


Log assets 0.14 0.120 0.120 0.125
Slack 0.171* 0.179* 0.162* 0.193*
Number of employees (FTE) 0.115 0.209** 0.257** 0.189*
High-technology industry 0.008 0.032 .416* 0.913**
Discretionary HRM 0.449*** 0.473*** 0.320***
Strategic HCM 0.077 0.011 0.080
Interaction between strategic HCM and
high-technology industry 0.435**
Interaction between discretionary
HRM and high-technology industry 0.922**
Adjusted R2 .015 .209 .240 .250
F-Value 1.510 7.016*** 7.175*** 7.514***
Change in R2 .200 .035 .045
F-Value for change in R2 17.287*** 6.396* 8.194**

Note: * = p < .05; ** = p < .01; *** = p <.001


386 • HUMAN RESOURCE MANAGEMENT, Winter 2003

Hypothesis 5 is tested in Model 3a with tics. Therefore, HCM represents an important


the addition of the interaction between dynamic capability that offers a source of sus-
strategic HCM and high-technology industry. tainable competitive advantage for SMEs. This
The model is significant (adjusted R2  .240; capability improves the effectiveness of the
p  .001) and the addition of this interac- HRM system and its products by enhancing
... it is tion variable contributes significantly to the internal consistency among practices, external
important to explanation of variance in entrepreneurial fit with strategy and the organization’s envi-
understand performance of SMEs (change in R2  .035; ronmental demands, and flexibility of the sys-
the extent to
which HRM
p  .05). The coefficient for the interaction tem to respond to organizational and environ-
influences between strategic HCM and high-technology mental dynamism.
performance in industry is positive and significant (p  .01), The results of this study suggest three im-
SMEs, as these indicating support for Hypothesis 5. portant conclusions. First, HRM practices can
firms are a Model 3b introduces the interaction be- be understood in two broad categories, tradi-
significant
tween discretionary HRM and high-technol- tional HR practices and discretionary HRM,
source for
radical inno- ogy industry. This model is significant overall each of which has a different impact upon en-
vation and (adjusted R2  .250; p  .001) and the addi- trepreneurship in SMEs. The traditional
economic tion of this interaction term again contributes model of HRM tends to focus upon clearly
growth. significantly to the variance explained in en- defining jobs in terms of their tasks, duties,
trepreneurial performance (change in and responsibilities; carefully structuring equi-
R2  .045; p  .01). The interaction between table rewards for those jobs; and monitoring
discretionary HRM and high-technology in- individual performance. However, creativity,
dustry is positive and significantly (p  .01) innovation, and risk-taking are at the heart of
associated with entrepreneurial performance entrepreneurial performance. Furthermore,
in SMEs, providing support for Hypothesis 6. the employee skills and behaviors required for
sustained innovation are hard to specify in ad-
Discussion and Conclusions vance. Therefore, traditional HRM practices
may be insufficient to promote entrepreneurial
The purpose of this study was to determine performance. A second category of HRM prac-
the contribution of HCM practices and tices is designed to promote the discretionary
HRM more generally to the entrepreneurial performance of employees by offering incen-
performance of SMEs. Prior HRM research tives and mechanisms for exchanging knowl-
has tended to ignore this population of firms. edge and encouraging organizational learning.
However, it is important to understand the This study provides evidence that these discre-
extent to which HRM influences perfor- tionary HRM practices are positively associ-
mance in SMEs, as these firms are a signifi- ated with entrepreneurial performance in
cant source for radical innovation and eco- SMEs. Therefore, the results of this study sug-
nomic growth. Furthermore, entrepreneurial gest that investments in employee participa-
performance, the extent to which firms pur- tion programs and the creation of incentives
sue innovation and accept risk and uncer- for extra-role behavior are an important suc-
tainty, is an important driver of market and cess factor for SMEs seeking to promote inno-
financial performance (Zahra & Covin, vation and entrepreneurship.
1995). Therefore, this study attempts to fill The second conclusion is that HCM can
three important gaps in current knowledge. also be understood in terms of two dimen-
According to the systems-based perspec- sions—future-oriented, strategic HCM and
tive on HRM, three characteristics of the HR historical, cost-focused, financial HCM.
system have a significant influence on firm Strategic HCM allows a firm to assess the ef-
performance: internal consistency, external fectiveness of its HR investments and this
congruence, and system flexibility. This study contributes to the effectiveness of the HR
examines the contribution that HCM practices system. However, the results do not support
make to firm performance by hypothesizing the proposition that HCM alone is sufficient
that firms that take a strategic approach to to enhance entrepreneurial performance. I
monitoring the effectiveness of HRM practices had hypothesized that HCM would promote
enhance these important system characteris- entrepreneurial performance by improving
Strategic Human Capital Management in SMEs • 387

the flexibility and responsiveness of the HR strategic HCM and discretionary HRM that
system to changing environmental, strategic, promotes entrepreneurial performance in
and competitive demands. Furthermore, the SMEs. Given that industry context was found
results presented here suggest that when to be a significant moderator of the associa-
combined with the use of discretionary HRM tion between HCM practices and firm entre-
practices, HCM is negatively related to entre- preneurial performance, it is possible that the
preneurship in SMEs. The rationale for ex- reversal of the expected association may be
pecting a positive interaction effect is that in associated with this other important moderat-
order to maximize the benefit of investments ing factor, which is considered next.
in discretionary HRM practices it is neces- The third conclusion of this study is that
sary to monitor their effectiveness and make the value of both strategic HCM and discre-
adjustments as necessary. Thus there is ex- tionary HR practices for promoting entrepre-
pected to be an internal consistency between neurial performance varies in relation to the

Figure 1a. Interaction Plot for HCM Practices by Industry Type.

Figure 1b. Interaction Plot for Discretionary HCM Practices by Industry Type.
388 • HUMAN RESOURCE MANAGEMENT, Winter 2003

environment in which these firms operate. the fit and flexibility of their HR systems.
This is illustrated in Figures 1a and 1b. This will enhance the fit between their HRM
For firms operating in high-technology practices and strategy, which, in turn, can be
industries, which are complex, dynamic, and expected to promote sustained competitive
hostile environments, there is a greater need advantage and financial performance. In this
... firms in for flexibility and responsiveness in order to study, those high-technology firms that en-
high-technology maintain entrepreneurial performance. gaged in strategic HCM practices were found
industries Therefore, firms in high-technology indus- to have higher levels of entrepreneurial per-
benefit more
from invest-
tries benefit more from investments in discre- formance. The corollary implication is that
ments in tionary HRM practices, which encourage em- strategic HCM may be of less significance for
discretionary ployee flexibility and innovation. SMEs in non-high-technology firms operating in ma-
HRM high-technology industries also obtain greater ture, stable environments.
practices... benefit from engaging in strategic HCM Third, for SMEs operating in high-tech-
practices, which promote HRM system flexi- nology industries, where the rate of change is
bility and responsiveness. Thus, I find evi- greatest, the flexibility and responsiveness of
dence for external congruence between HR the organization driven by high levels of em-
practices and the firm’s environment with re- ployee discretion will also have the greatest
spect to promoting entrepreneurial perfor- impact upon entrepreneurial performance.
mance in SMEs. As illustrated in Figures 1a Given that entrepreneurial performance is
and 1b, the relationship between both strate- predictive of financial performance in high-
gic HCM practices and discretionary HRM technology industries, we can expect that high
practices and entrepreneurial performance is technology SMEs using discretionary HRM
significantly stronger in high-technology en- practices will outperform their competitors.
vironments than it is for firms operating in
non-high-technology environments. Limitations

Implications for Practice Several limitations to this study must be


noted with respect to our interpretation of
The results of this study highlight several im- these results. First, although I have focused
portant issues for the practice of HRM in on SMEs, our criteria for firm selection elim-
emerging firms. Firms seeking to enhance inated the smallest of these companies. The
their ability to engage in innovation and ven- rationale for not including firms with less
turing activities should consider making in- than 100 employees was that I did not expect
vestments in the use of discretionary HRM these firms to have very well-developed HR
practices such as employee participation and systems. While this may be true, the conclu-
empowerment, incentives, and investments sions of this study should be interpreted with
in socialization and orientation activities. respect to SMEs with between 100 and 500
These activities promote employee discre- employees. A second limitation may arise as
tionary contributions. That is, they encourage a result of the use of a mail survey to gather
the kind of voluntary, helping, and coopera- most of the data for this study. I have at-
tive behavior that supports the development tempted to mitigate the problem of single-
of social capital and thereby encourages source bias by using secondary data to sup-
knowledge creation and exchange. In this plement the primary data.
way, HRM is able to promote organizational The small sample size used in this study
learning and risk-taking, which lie at the should also be acknowledged. While every ef-
heart of an entrepreneurial culture. fort has been made to ensure that the sample
A second important implication of this is representative in terms of the organiza-
research is that SMEs have an opportunity to tional characteristics of respondents versus
further leverage the HRIS technology that is nonrespondents, the results should still be in-
widespread even in these smaller firms. By terpreted in the context of a preliminary in-
engaging in relatively straightforward analysis vestigation. It is possible that the small sam-
of data already held in most HRISs, emerging ple size has resulted in restriction of range in
high-technology firms are able to enhance the variables of interest, limiting the size of
Strategic Human Capital Management in SMEs • 389

the observed regression coefficients. However, tion in decision making, knowledge sharing,
the results of the analyses were statistically and organizational learning. Furthermore,
significant despite the fact that the small firms operating in fast-changing environments
sample size limits the statistical power of the will obtain the greatest benefit from invest-
study. Therefore, this suggests that further ex- ments in discretionary HRM practices and
amination of these issues is warranted. Fur- strategic HCM. Simply focusing upon man-
thermore, although the response rate was lim- agement of HR costs has little influence upon
ited to just 5% of the original sample, our entrepreneurship. Similarly, investments in
analysis of nonrespondents indicates they are traditional HR practices do not promote this
similar to respondents in terms of size and re- aspect of firm performance. This represents a
sources. A final limitation is the rudimentary significant challenge for high-technology
approach to assessing HCM practices. At SMEs, which are frequently competing with
present there does not appear to be a stan- resource constraints. However, this is also an
dardized measure of these practices. However, opportunity in that those firms that succeed in
by employing a panel of expert practitioners to developing effective HCM capabilities are
screen items prior to the distribution of the also developing a potential for sustained com-
survey, I was able to clarify the wording of petitive advantage.
these items, and include those with which
practitioners could be expected to be familiar. Acknowledgment

Conclusion This research was funded in part by financial


support provided by the Management and
This study offers further support for both the Human Resources Department, College of
systems perspective on strategic HRM and the Business, Utah State University and the Merit
resource-based view of the firm. The evidence Resource Group, Dublin, California. I ac-
from this study suggests that HCM practices knowledge with gratitude the helpful com-
play a significant role in the integration of the ments and suggestions made by the editors of
HR system with the objectives of the firm. this special issue and the two anonymous re-
SMEs seeking to promote entrepreneurship viewers. Special thanks also to Brian Gauny
should consider making investments in HR and Anne Hausler for their hard work and
practices that encourage employee participa- support of this project.

James C. Hayton is an assistant professor of management and human resources at Utah


State University. His teaching interests include human resource management, human
capital management, knowledge management, and corporate entrepreneurship. His re-
search focuses upon the links among intellectual capital, human capital, and corporate
entrepreneurship in both domestic and international organizations. He has published in
Research in Management, European Management Journal, and Entrepreneurship Theory
& Practice. He also serves on the review board of Human Resource Management Review.

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