The International Journal of Human Resource Management, 2013

Vol. 24, No. 15, 2985–3001, http://dx.doi.org/10.1080/09585192.2013.763845

Strategic integration of HRM and firm performance in a changing

environment in China: the impact of organisational effectiveness
as a mediator
Cherrie Jiuhua Zhua*, Brian K. Cooperb, Stanley Bruce Thomsonc,
Helen De Cierib and Shuming Zhaod
a
Department of Management, Monash University, Clayton, Victoria, Australia; bDepartment of
Management, Monash University, Caulfield East, Victoria, Australia; cDepartment of International
Business, St. Georges University, Grenada, West Indies; dSchool of Business, Nanjing University,
Nanjing, China
In the context of dramatic changes in China, this paper investigates the role of
organisational effectiveness as a mediator in the relationship between the strategic
integration of human resource management (HRM) and firm financial performance.
Our study is based on the survey responses of 618 managers in state-owned and private
(domestic and foreign-invested) enterprises in China. While most studies of the linkage
between HRM practices and firm performance in China have measured firm financial
performance or used an ad hoc combination of financial and non-financial indicators,
we argue for a distinction to be made between non-financial organisational
effectiveness and financial performance. As hypothesised, controlling for sector
(state-owned vs. private), we find positive relationships between perceived changing
business environment and strategic integration of HRM, and between strategic
integration of HRM and organisational effectiveness. Our research adds an important
conceptual link by showing that organisational effectiveness plays an important role as
a mediator in the HRM and firm financial performance relationship and reinforces the
importance of the organisational and environmental context for HRM.
Keywords: business environment; China; firm performance; human resource
management; organisational effectiveness

Introduction
Among emerging markets, China is perhaps the most important and fertile context
for international management scholars to investigate because of the developments in the
Chinese economy and its growing importance in the global economic landscape
(Fetscherin, Voss and Gugler 2010). As Czinkota and Ronkainen (2008) have suggested,
‘[f]or firms who are planning to enter the global market, succeeding in China will be a
crucial indicator of competitiveness’ (p. 259). The human resource management (HRM)
function in firms in China has changed a great deal in recent years, in response to the
challenge of an increasingly competitive environment brought by a series of reforms, such
as those in corporate governance and China’s increasing integration into global business
(Warner 2008; Cooke 2009). Furthermore, many researchers have claimed that western
HRM has been practised in China either with Chinese characteristics, hybridised features
or a possibly increasing degree of convergence, thus reflecting the influence of foreign
multinational corporations that have invested in China (Ding, Ge and Warner 2004; Zhu
2005; Warner 2008). While research on HRM in China has addressed several important

*Corresponding author. Email: cherrie.zhu@monash.edu

q 2013 Taylor & Francis

2986 C.J. Zhu et al.

questions (Zhu, Thomson and De Cieri 2008a), it is widely agreed that further research
is needed. More specifically, reviews of research conducted to date have consistently
identified a need for research to explore strategic integration of HRM in the Chinese
context and its contribution to firm performance (Zhu et al. 2008a; Cooke 2009; Zheng and
Lamond 2009).
This study aims to address such calls for research while China is still in a process of a
series of reforms launched by the central government to encourage further integration with
the global economy. By examining the roles played by the business environment and
organisational effectiveness in the HRM –firm performance linkage in China, the study (1)
tests the application of strategic HRM theory, developed in advanced market economies,
to a transitional economy and (2) develops and tests a model of this linkage, thus drawing
implications for HRM research and practice. In the following section, the theoretical
foundation is outlined and hypotheses are developed. The research method and results of a
survey conducted with managers in China are then presented. Finally, we consider the
implications of the research findings for international management and HRM scholars and
practitioners.

Theoretical background
Strategic integration of HRM
It has been well documented by numerous scholars (e.g. Brewster 1999, 2007; Lengnick-
Hall, Lengnick-Hall, Andrade and Drake 2009) that HRM research has been largely
carried out in advanced market economies, with theoretical perspectives developed within
that context. Furthermore, HRM is widely practised in market economies (e.g. Bowen,
Galang and Pillai 2002; Farndale, Brewster and Poutsma 2008; Lazarova, Morley and
Tyson 2008). The research field of strategic HRM emerged in the 1980s with an emphasis
on an integrative and value-driven approach to HRM (Butler, Ferris and Napier 1991;
Lengnick-Hall and Lengnick-Hall 1988) and has evolved with theoretical support largely
based on resource-based theory (e.g. Wright, Dunford and Snell 2001; Boxall, Purcell and
Wright 2007; Barney, Ketchen and Wright 2011) and empirical evidence (e.g. Lengnick-
Hall et al. 2009; Subramony 2009). A widely adopted definition of strategic HRM is ‘the
pattern of human resource deployments and activities intended to enable an organisation to
achieve its goals’ (Wright and McMahan 1992, p. 298). This definition of strategic HRM
highlights the central concept of strategic integration of the HRM function. It is this
integration that distinguishes strategic HRM from a traditional and narrowly defined view
of HRM that focuses on operational practices.
The integration of strategy and HRM has two important dimensions, i.e. vertically it
links HRM practices with the strategic management process of the firm and horizontally it
allows HRM practices to be integrated and supportive of each other. Vertical integration is
bidirectional: ‘upward’ integration refers to the involvement of HRM in the formulation
and implementation of organisational strategies and the alignment of HRM with the
strategic needs of an organisation (e.g. Budhwar 2000a), whereas ‘downward’ integration
refers to the delegation or devolvement of HRM practices to line managers (Zhu, Cooper,
De Cieri, Thomson and Zhao 2008b).
Researchers argue that, in order to achieve upward integration, which we label as
strategic integration of HRM, HR managers should be involved in strategic decision-
making alongside other senior managers, providing greater opportunity to align HRM
goals, strategies, philosophies and practices with corporate objectives and the
implementation of business strategy (Farndale 2005). Furthermore, increasing complexity
 The International Journal of Human Resource Management 2987

in the global environment creates an imperative for corporate HRM departments to

develop new strategic roles (Farndale et al. 2010). This involvement would include the
membership of HR managers in the senior management team in the organisation (see
Budhwar 2000b), which provides the opportunity for HRM to represent its concerns and
influence business strategy from the outset of decision-making. The involvement of the
senior HR manager in a firm’s senior management team provides an important channel of
information flow, communication and influence. Recently, Sheehan, Cooper, Holland and
De Cieri (2007) have shown that there is a crucial need for the senior HR manager to
manage the views of the CEO and the senior management team to gain their support for
HRM. Despite the importance of strategic integration of HRM, there has been relatively
little research investigating this, particularly with regard to firms engaged in a transitional
environment such as China. Further, there is evidence that vertical integration of HRM
tends to result in enhanced competence, congruence and cost effectiveness (Budhwar
2000a; Teo 2002) and subsequently leads to a positive impact on firm performance.
However, these studies have been conducted in advanced market economies; a gap
remains with regard to understanding in a transitional context. The dynamism of the
Chinese context creates an environment in which organisations must have integrated and
responsive management structures and processes in order to survive (Czinkota and
Ronkainen 2008).

HRM and firm performance

Over the past decade, a substantial research effort has been built around exploration of the
link between HRM practices and organisational performance (Subramony 2009). There is
an increasing recognition of the need to explore beyond this relationship, to investigate the
strategic integration of HRM and the organisational context within which HRM practices
are applied. Researchers have begun to explore the influence of antecedents, such as
market growth, communication (Apospori, Nikandrou, Brewster and Papalexandris 2008),
customer demandingness (Rodwell and Teo 2008), organisational culture (Wei, Liu,
Zhang and Chiu 2008), and political influence (Sheehan et al. 2007) on the relationship
between HRM and firm performance.

Applying a contextualist paradigm of HRM: the changing business environment in

China
There is consensus that a firm’s HRM policy and practices will be influenced by contextual
factors such as political, legal, technological, institutional and social frameworks
(Brewster 2007; Lengnick-Hall et al. 2009), although there will be national differences in
the extent of institutional embeddedness on HRM activities (Farndale et al. 2008). A
contextualist paradigm of HRM recognises that the availability of resources, the dynamic
nature of the environment and the level of complexity will be influential on management
practices and ultimately on firm performance (Morishima 1995). Articulated by Brewster
(1999, 2007), this paradigm emphasises the importance of understanding contextual
differences and the reasons for their influence on HRM. Although the external context or
environment has been considered in the research on HRM, it has been argued that the
existing literature on strategic HRM has largely ignored the implications of external
contexts on HRM – firm performance relationship (Datta, Guthrie and Wright 2005). The
external environment or environment dynamism may refer to the rate of change and
the degree of instability of the environment (Dess and Beard 1984). Given that previous
2988 C.J. Zhu et al.

researchers’ work is mainly related to HRM in advanced market economies, our study,
building on the existing literature, will first focus on the role of China’s changing business
environment in the HRM –performance relationship.
In the context of transition from a command to a market economy and the increasing
globalisation of business, China has experienced and is still undergoing substantial
changes. The two major components of the Chinese command economy, i.e. central
planning and public ownership, were targeted for reforms to introduce a market-driven
economic system and a mixed ownership structure that could stimulate economic growth
(Dong 1992). Increasing participation in the world economy is unprecedented as the
results of China’s inward and outward foreign direct investments (FDIs). The inward FDI
has been accelerated due to China’s Open Door Policy since early 1980s and its accession
to the World Trade Organization (WTO) in 2001. Outward FDI by Chinese-owned firms
has rapidly developed since the central government initiated a ‘going global’ strategy at
the end of last century (Salidjanova 2011). The dynamic environment in China since these
economic reforms is characterised by rapid changes, particularly in competition, business
practices, the role of government and technology.
First, in terms of competition, China has opened up its domestic market, especially its
previously protected and monopolised industries, such as banking, insurance and
telecommunications to foreign competition and ownership since it entered the WTO. This
has forced Chinese enterprises to compete in both domestic and global markets
(Panitchpakdi and Clifford 2002; Chen and Shih 2004). Second, business practices have
become more market-oriented with fewer ‘soft budget constraints’, which provided loss-
making managers in the state sector with unlimited protection from the consequences
of poor performance (see Kornai 1980, 1986; Walder 1986). This has reduced the
government’s protection offered to state-owned enterprises (SOEs) and levelled the ground
for a more equal competition among all enterprises (Cooke 2005, 2009). The change in
business practice is the consequence of a radical restructuring of ownership structure in the
industrial sector and subsequent emergence of a flourishing non-state sector including
foreign-invested and local privately owned firms, which often greatly outperform SOEs
(Fetscherin et al. 2010; Zhu, Cooper, Fan and De Cieri 2012). Furthermore, SOE reform
conducted in late 1990s and rapidly developing non-state sector have brought moves
towards decentralisation, deregulation and cessation of government administration of
enterprises, which has greatly reduced the government’s intervention in enterprises’
operations and offered enterprises discretion to run their businesses (Saich 2003, 2004).
Meanwhile, technological advancement due to the rapid economic development has put
pressure on firms to gain competitive advantage through effective HRM practices (Zhu
et al. 2008a; Law, Song, Wong and Chen 2009). As a result of these changes and the
government’s endeavour to establish a modern enterprise system, enterprises are
experiencing much fewer government constraints and have more autonomy to compete in
the marketplace. The ongoing transition and increasing participation in the world economy
has thus led to significant changes in the context for management practices in China’s
industrial sector and consequently has considerable implications for enterprises
(Hartmann, Feisel and Schober 2010).
Advocates of a contextualist paradigm of HRM propose that firms are ‘institutionally
deeply enrooted and socially embedded into their respective national [institutional]
contexts’ (Matten and Geppert 2004, p. 179). Andreadis (2009) reaffirms that
organisations operate in a dynamic environment and that environment should be taken
into consideration when evaluating organisational effectiveness. Akgün, Keskin and
Byrne (2008) found that environmental dynamism affected not only firm performance but
 The International Journal of Human Resource Management 2989

also the emotional perspective of the firm’s organisational capabilities (such as the
dynamics of encouragement and displaying freedom). Hence, we propose that a firm’s
HRM policy and practice and the way to conduct HRM are reflections of or responses to
the business environment, and can be understood only in relation to the business contexts
in which the firm is embedded. For instance, numerous empirical findings have
demonstrated that HRM policy and practice are to a large extent based on local labour
regulations (Björkman, Fey and Park 2007; Brewster, Wood and Brookes 2008). Given the
dynamism of the business environment, uneven industrialisation development in China
and increasing decentralisation of decision-making power at micro level in China,
demands on organisations to effectively and efficiently manage their workforce are likely
to increase in complexity. In this study, we view the business environment as an
antecedent to strategic HRM. Specifically, we argue that variations in the degree to which
the business environment is perceived as dynamic and uncertain will, at least in part, drive
the execution of strategic HRM in an organisation. Thus, to test the contextualist paradigm
of HRM in a non-western, developing country environment, the following hypothesis is
proposed:
Hypothesis 1: The changing business environment in China will be positively related to
organisations’ strategic integration of HRM

Strategic integration of HRM: impact on firm performance

Much of the research for evidence of the link between HRM practices and firm
performance has focused on intermediary performance indicators such as absenteeism,
commitment, customer satisfaction and innovation (e.g. Bowen et al. 2002; Laursen and
Foss 2003). This type of performance, which we term organisational effectiveness,
examines how well an organisation’s mission is accomplished through managerial
functions such as strategic integration of HRM (Jamrog and Overholt 2004). A second
substantial stream of empirical work has examined the impact of HRM on productivity and
firm financial or market performance (e.g. Huselid 1995; Li 2003). However, there are
ongoing calls for research on the relationship between the strategic integration of HRM
and firm performance (Datta et al. 2005; Wright, Gardner and Moynihan 2005; Sheehan
et al. 2007).
There has been some debate on the definition of organisational effectiveness (Dikmen,
Birgonul and Kiziltas 2005; Kim and Hancer 2010) with some arguing that it entails
achievement of goals as seen through processes (i.e. HRM, organisational communi-
cation), whereas others agree that it is the achievement of goals but these are seen through
financial performance, i.e. results (Andreadis 2009). In keeping with a holistic viewpoint
that a contextualist approach provides, we argue that it is necessary to separate the two
to understand the relationship between the process and the results to truly define
organisational effectiveness.
The proposition that HRM benefits organisational effectiveness has been a research
focus for the last three decades. Early theoretical papers argued that HRM benefited
organisational effectiveness through the personnel and industrial relations areas within
organisations (Jain 1983) or through ‘planning for and managing human resources’
(Schein 1977, p. 1). The process of ‘planning for’ can be translated to the strategic
integration of HRM. In some studies, firm performance is only related to the financial
aspect (e.g. Huselid 1995; Ng and Siu 2004; Wei et al. 2008), whereas a common
occurrence in many empirical studies is combining the two dimensions (i.e. organisational
2990 C.J. Zhu et al.

effectiveness and financial performance) into one measure frequently termed ‘firm
performance’. For example, Vandenberg, Richardson and Eastman (1999) used
organisational turnover rates and return on equity; Stavrou-Costea (2005) used the
Cranet data that measured productivity, profitability and service quality; and Wright,
Gardner and Moynihan (2003) used six indicators including compensation divided by
sales, quality, shrinkage, productivity, operating expenses and profitability. Wright et al.
(2003) argued that increasing organisational effectiveness through the deployment of
HRs is likely to create the conditions for successful firm financial performance. This
proposition is supported by a recent review of the relationship between training and
organisational outcomes that hypothesised ‘organisational performance outcomes’
(consisting of intermediate HRM outcomes or what we call effectiveness here) as a
mediator of the training –financial outcomes relationship (Tharenou, Saks and Moore
2007). These authors also note that although previous studies have found that HRM
practices are related to organisational effectiveness (HRM outcomes) and organisational
effectiveness is related to financial performance, few studies have conducted mediator
tests of these relationships. Koys (2001) found that HRM (measured by employee
satisfaction, turnover and organisational citizenship behaviours) influenced organisational
effectiveness, as measured by customer satisfaction and profit, but organisational
effectiveness did not influence HRM.
Reviewing research in the Chinese context, Zhu et al. (2008a) found that up to 2005,
only seven articles tested the effect of HRM on firm performance in the Chinese context.
Six of these articles examined firm performance in financial terms only, such as enterprise
productivity (Ng and Siu 2004), profitability and productivity (Law, Tse and Zhou 2003),
perceived profitability and overall performance (Björkman and Fan 2002), sales volume,
profit after tax, market share and return on investment (Li 2000), and export performance
in terms of its growth and intensity (Deng, Menguc and Benson 2003).
The literature reviewed here indicates that an area for further research is to examine
how strategic integration of HRM has impacted upon firm performance in China by
separating organisational effectiveness from firm financial or market performance.
Through a contextualist approach, one must understand the influences of context on a
given phenomenon. Thus, we argue that it is necessary to separate out the influence of the
business environment (H1) and the process outcomes or what we term organisational
effectiveness on results – financial performance. The outcomes of HRM (a process) are
therefore used as measurements of organisational effectiveness. Hence, we propose that
the effect of strategic integration of HRM on the bottom line should be mediated by
organisational effectiveness. Thus, to test the effect of strategic integration of HRM and
the relationship between organisational effectiveness, strategic integration of HRM
and financial performance, we present the following hypotheses:
Hypothesis 2: Strategic integration of HRM will be positively related to organisational
effectiveness.
Hypothesis 3: Organisational effectiveness will mediate the relationship between
strategic integration of HRM and financial performance

Conceptual model of business environment, HRM and firm performance

As has been suggested (Zhu et al. 2008a; Cooke 2009), further research investigating HRM in
China is of vital importance to provide empirical testing of the transfer of western concepts
and practices to a transitional economy. Our model of the relationships among the constructs
 The International Journal of Human Resource Management 2991

of changing business environment, strategic integration of HRM, organisational performance

(effectiveness) and firm financial (market) performance is proposed in Figure 1. In summary,
we propose that a perceived changing business environment will be positively related to
strategic integration of HRM (H1). In turn, our model predicts that strategic integration of
HRM will have a positive relationship with organisational effectiveness (H2). Finally, we
predict that organisational effectiveness will mediate the relationship between strategic
integration of HRM and financial performance (H3).

Method
Sample and procedure
Industrial enterprises in the Jiangsu Province of China formed the sample of this study.
Jiangsu is one of the most industrialised provinces in China with a population of over 76
million people and among those coastal opened areas to foreign investment in the early
1980s. This province was the first in China to establish an HRM institution that offers
regular meetings and training programs for HR managers. Before the conduct of survey, a
pilot study was conducted among seven local managers and employees to check for
meanings of terms used in the survey and any possible cultural bias in the questions that
were developed from western researchers’ work. After this exploratory qualitative study,
our survey was conducted during the period from May to October 2005.On the basis of a
distribution list of HR Managers Directory of Jiangsu HRM Institution, 2400
questionnaires were distributed to respondents in 600 enterprises on the directory, with
a self-sealed envelope and an explanation sheet. The criteria for selection of enterprises
included: ownership types (state- and non-state-owned); size (mainly medium to large size
to ensure the existence of HRM systems); and industry (manufacturing). A total of 813
questionnaires were returned, yielding an effective response rate of 33.9%. The focus of
this study was on managerial-level respondents (n ¼ 618). Among them, 26.4% were from
the HRM/personnel department, while the remaining respondents were from other
departments (e.g. production, accounting and finance). The reason for focusing on
managers is because this paper aims to examine the extent of strategic integration of HRM
and how such integration could affect firms’ performance. Among the 618 managerial
respondents who completed the survey, over half of them (56%) described themselves as
middle managers or senior managers (29%), and the remainder (15%) were line managers
(i.e. lowest level managers such as supervisors). The majority (69%) of respondents were
between the ages of 30 and 49 years and 67% were males. The overwhelming majority

Organisational
effectiveness

Perceived H2
changing Strategic
integration of H3
business H1
environment HRM

Perceived
financial
performance

Figure 1. Conceptual model.

2992 C.J. Zhu et al.

(90%) had a bachelor’s degree or higher, which is quite common in well-developed east-
coast Chinese cities for managerial staff. In respect of ownership structure, respondents
who worked in SOEs accounted for 24% of the sample. The others (76%) were working in
the non-state sector, including shareholding firms (30%), private firms (17%) and
foreign/overseas-invested firms (8%). The mean duration of respondents’ work experience
in their current jobs and firms was 8.1 years and 11.4 years, respectively. This level of
tenure and their managerial responsibility implies that respondents had a sufficient
knowledge of the HRM function and business context for their firms.

Measures
To address potential concerns regarding the validity of questionnaires designed in the
West for non-western societies such as China (Cavusgil and Das 1997), the first author,
with bilingual skills and personal experience in China checked the translated questionnaire
and made some alterations in the Chinese version.

Perceived changing business environment in China

The perceived changing business environment was measured by four items adapted from
Geringer, Frayne and Milliman (2002), each rated on a five-point scale ranging from (1)
‘strongly disagree’ to (5) ‘strongly agree’. The items were: (1) since the accession to the
WTO, competition has dramatically increased in both domestic and foreign markets; (2)
business environment is improving for a more equal competition; (3) government
regulations are rapidly changing to accommodate the requirements of the WTO; and (4)
the technology in our product/service is complex. Cronbach’s a coefficient for this
measure was 0.74.

Strategic integration of HRM

Strategic integration of HRM was measured by asking respondents to indicate the degree
to which they agreed that HRM practices were linked to the firm’s business strategy for six
items developed from a review of the literature (Budhwar 2000b; Teo 2002), using a five-
point scale ranging from (1) ‘strongly disagree’ to (5) ‘strongly agree’. The items were: (1)
HR practices help achieve business objectives, e.g. for succession planning, to
reduce/expand the workforce; (2) HR strategy is formulated based on business strategy;
(3) HR is involved in business decision-making, e.g. to allocate resources, to assist in
technology development; (4) the top HR executive is a strategic partner for other senior
managers; (5) the top HR executive offers administrative consultancy to line managers for
them to conduct day-to-day HR activities; and (6) HR practices, such as recruitment and
training, are used to implement business strategies. Cronbach’s a coefficient for this
measure was 0.86.

Organisational effectiveness and financial performance

Perceptual indicators (rated on five-point scales from 1 ¼ ‘very poor’ to 5 ¼ ‘very good’)
were developed from a review of the literature to measure firm performance: one set
measuring financial (market) performance, and the other set measuring overall
organisational effectiveness. Financial performance was measured by three items related
to return on equity and assets and profitability (Cronbach’s a coefficient ¼ 0.85).
Organisational effectiveness was measured by five items related to the company’s
 The International Journal of Human Resource Management 2993

competitiveness by timely adaptation of its products/services, adapting company strategy,

maintaining its quality (Wright et al. 2003; Akgün et al. 2008; Kim and Hancer 2010), and
achieving employee and customer satisfaction (Koys 2001). Cronbach’s a coefficient for
this measure was 0.87.

Method of analysis
Structural equation modelling (SEM) was used to estimate the parameters of our
hypothesised model. We chose SEM as it is the most powerful technique for testing
models involving both direct and indirect effects and is effective in removing the biasing
effects of measurement error (Kline 2011). SEM analyses were performed using a
covariance matrix as input to the AMOS (Analysis of Moment Structure) software
package (Arbuckle and Wothke 1999), using full information maximum likelihood
estimation (FIML) in the presence of missing data. FIML is a superior technique for
handling missing data and generally outperforms conventional methods, such as listwise
deletion, thus yielding parameter estimates with less bias in large samples (Graham 2009).
Prior to estimating our model, we examined the statistical assumptions of SEM. Results of
evaluation of assumptions of normality, linearity, absence of multicollinearity and
homoscedasticity were satisfactory. We included organisational sector (coded 1 ¼ SOE,
0 ¼ otherwise) as a control variable, as ownership type is a variable of some interest in
China (Zhu et al. 2008a).

Results
Table 1 reports means, standard deviations and correlations among the study variables. As
expected, there was a strong correlation between organisational effectiveness and
perceived firm financial performance (r ¼ 0.65, 95% confidence interval: 0.60 –0.69),
with the two measures having about 42% shared variance. However, the magnitude of this
correlation is not large enough to suggest that organisational effectiveness and perceived
firm financial performance are redundant to each other. Table 1 also shows that there was a
positive correlation between strategic integration of HRM and perceived firm financial
performance (r ¼ 0.21, 95% confidence interval: 0.13– 0.28). Previous research has found
positive correlations between HRM and firm performance of similar magnitude in western
countries (see, for example, Subramony 2009; Wright et al. 2005).
Then, we estimated the measurement model for the substantive constructs. In our
measurement model, the scale items were used as indicators for their respective constructs
(i.e. the perceived changing business environment, strategic integration of HRM,
organisational effectiveness and perceived financial performance). A confirmatory factor

Table 1. Means, standard deviations and intercorrelations of study variables.

Mean SD 1 2 3 4
1 State-owned enterprises 0.24 0.43
2 Perceived changing 4.08 0.69 0.06
business environment
3 Strategic integration of HRM 4.23 0.72 0.09* 0.41*
4 Organisational effectiveness 3.80 0.69 0.01 0.32* 0.35*
5 Perceived financial performance 3.68 0.80 2 0.02 0.25* 0.21* 0.65*

*p , 0.05.
2994 C.J. Zhu et al.

analysis (including all the four hypothesised factors) yielded an acceptable fit to the
data x 2 (df ¼ 129) ¼ 603; RMSEA ¼ 0.08, CFI ¼ 0.91. A one-factor measurement
model (where all 18 indicators loaded on to a single factor) resulted in a poor fit, x 2
(df ¼ 135) ¼ 2,504; RMSEA ¼ 0.17, CFI ¼ 0.53. If common method variance is largely
responsible for inflating the relationships among the variables, the one-factor model
should provide a good fit to the data. Hence, the one-factor test provides a partial test for
the presence of common method variance in the data (Podsakoff, MacKenzie, Lee and
Podsakoff 2003).
We then examined the hypothesised relationships among the study variables. Our
hypothesised structural model shown in Figure 1 had an acceptable fit to the data, x 2
(df ¼ 145) ¼ 648, RMSEA ¼ 0.08, CFI ¼ 0.90. Figure 2 presents the standardised path
coefficients for our structural model. In support of Hypothesis 1, there was a positive
relationship between the perceived changing business environment and strategic
integration of HRM (b ¼ 0.45, p , 0.05). The path from strategic integration of HRM
to perceived organisational effectiveness was positive (b ¼ 0.36, p , 0.05), in support of
Hypothesis 2. Note these results control for sector (SOE vs. non-state sector), although it is
worth noting that the coefficients for sector were not statistically significant and for ease of
interpretation are not shown in Figure 2.
Hypothesis 3 predicted that the relationship between strategic integration of HRM and
financial performance will be mediated by organisational effectiveness. Our baseline
model included both direct and indirect effects. We used the joint significance test for
testing Hypothesis 3. MacKinnon, Lockwood, Hoffman, West and Sheets (2002)
compared 14 methods to test mediation via simulations and concluded that the joint
significance test provided the best balance of Type 1 error and statistical power.
For mediation to be present, the joint significance test requires that the path from
the independent variable to the mediator is statistically significant and the path from the
mediator to the dependent from variable, controlling for the independent variable, is also
significant. As shown in Figure 2, we found the paths from strategic integration of HRM
to organisational effectiveness and from organisational effectiveness to financial
performance to be statistically significant. Hence, according to the joint significance
test, Hypothesis 3 was supported. Note that the direct path from strategic integration of
HRM to perceived financial performance was not statistically significant (b ¼ 2 0.02,
p . 0.05), indicating full mediation. Overall, our model explained 50% of the variance in
financial performance. Taken together, we conclude that the relationship between strategic

Organisational
0.36* effectiveness

Perceived
changing Strategic
integration of 0.72*
business 0.45*
environment HRM

–0.02
Perceived
financial
performance

Figure 2. Path diagram of structural equation model. *p , 0.05. Standardized coefficients reported.
 The International Journal of Human Resource Management 2995

integration of HRM and perceived financial performance was fully mediated by

organisational effectiveness. Finally, we also tested a model with a bidirectional
relationship between perceived financial performance and organisational effectiveness.
This model tests if the data are consistent with the proposition that organisational
effectiveness is a consequence rather than cause of financial performance. Results
confirmed the path from organisational effectiveness to perceived financial performance
(b ¼ 0.66, p , 0.05), but not from financial performance to effectiveness (b ¼ 0.09,
p . 0.05).

Discussion
In full support of our three hypotheses, our results show that in the context of industrial
enterprises in China: (1) the changing business environment in China is positively related
to strategic integration of HRM; (2) strategic integration of HRM is positively related to
organisational effectiveness; and (3) the relationship between strategic integration of
HRM and firm performance is mediated by organisational effectiveness. In particular, our
demonstration of the mediating role of organisational effectiveness in the Chinese context
is a key finding that provides significant insights for understanding of the relationship
between HRM and firm performance. Based on the importance of HRM to organisational
effectiveness, we believe it is essential that organisational effectiveness be measured on its
own merit rather than included as a measure of firm performance. Our findings indicate
that it is necessary to separate organisational effectiveness and firm financial performance
to establish a clear picture of the relationship of HRM to firm performance. This is
consistent with emergent research that has begun to take new steps towards investigating
corporate social responsibility and financial performance (Wang and Choi 2010;
McWilliams and Siegel 2011).
In establishing the direction for our research, we noted that Zhu et al. (2008a) had
reported that research conducted in China tended to focus on firm financial performance.
This focus has continued to dominate in this area. For example, two recent papers on
strategic HRM in China measured firm performance from the financial aspects including
net profit, new product development, efficiency and return on assets (ROA) (Wei et al.
2008), and CEO/HRM/finance directors’ perceived corporate performance and ROA (Wei
and Lau 2008). Only Takeuchi, Wakabyashi and Chen (2003) included in their study both
financial performance (the ratio of profit to sales and CEO-perceived corporate
performance) and organisational effectiveness (employee turnover and absenteeism).
A study using a sample from another transitional economy (Vietnam) also found a
strong positive relationship between HRM and organisational effectiveness (Thang and
Quang 2005). Similar to our study, market (financial) performance and organisational
effectiveness were separately measured; however, the authors did not discuss the
relationship between the two measures. Instead, they treated both measures as a single
indicator of performance. However, given the findings of our study, the argument that
organisational effectiveness entails achievement of goals as seen through processes gains
more merit.
Once again, our findings demonstrate that strategic integration of HRM has a positive
relationship with organisational effectiveness. This is consistent with Bowen and Ostroff’s
(2004) proposition that the strength of an HRM system is related to organisational
effectiveness. Bowen and Ostroff (2004) claimed that theory building has lagged behind
the intermediate linkages responsible for the relationship between HRM and firm
performance. We suggest that our findings contribute to theorisation and understanding of
2996 C.J. Zhu et al.

such linkages. These findings, for HRM practitioners in China, should lend credence to the
argument that HRM deserves a seat in the boardroom (Sheehan et al. 2007). It is important
to note that we found that the direct relationship between strategic integration of HRM and
financial performance was not statistically significant. Rather, as predicted, the
relationship between strategic integration of HRM and perceived financial performance
was fully mediated by organisational effectiveness. As previously discussed, by analysing
the relationship between strategic integration of HRM, organisational effectiveness and
firm performance in China, our research contributes additional and important conceptual
links in the HRM – firm performance relationship. We have shown that organisational
effectiveness plays an important role as a mediator in the HRM –firm performance
relationship. What remains to be seen is whether the role of organisational effectiveness as
a mediator is specific to the context of a transitional economy.
Milliman, Von Glinow, and Nathan (1991) utilised congruence of fit theory to
postulate that the fit and flexibility of HRM in multinational companies will lead to greater
organisational effectiveness. One of their suggestions is for future research to focus on the
‘nature of the MNC’s environment’ (Milliman et al. 1991, p. 336). Over the past two
decades, some researchers have taken up this challenge. Organisations do not operate in a
vacuum; the environment in which firms operate affects the manner in which they conduct
business (Brewster 1999, 2007; Farndale et al. 2008, 2010). We have addressed this
challenge, to some degree, with Hypothesis 1. In China, economic reforms have brought
about significant changes in the political, legal, technological and societal environment.
These changes have created a dynamic business environment that has spawned a highly
competitive marketplace for firms operating in China (Hartmann et al. 2010; Zhu et al.
2012), which is supported by the perceptions of the managers surveyed. Our findings
indicate that perceptions of this dynamic, changing business environment are predictive of
the extent to which a firm’s HRM is integrated with organisational strategy. Given the
transition in China from a closed market to an open market, this makes sense. No longer
are the majority of businesses supported by the central government, and SOEs are
expected to show profit like other types of enterprises (Chen and Shih 2004; Cooke 2009).
Organisations are now allowed to operate in the way they deem is best for their business.
Therefore, an organisation must develop capabilities for growth and survival and to do so
it must deploy its resources in a systematic manner to achieve desired goals. In other
words, organisations in China are experiencing increased demands on their HRM function
as the business environment evolves. This echoes the findings of researchers investigating
other dynamic business environments (Greece – Myloni, Harzing and Mirza 2004; India
– Som 2008; Poland – Weinstein and Obloj 2002). We note the emergence of research
exploring the effects of informal institutional constraints, such as a norm of respect for
authority, on HRM (Huang and Gamble 2011); one potential direction for future research
could be to examine the interactions between formal and informal institutional influences
and the implications for HRM and firm performance.
To sum up, we have uncovered two significant aspects of the HRM – organisational
performance relationship. First, and most importantly, there is a need to separate
organisational effectiveness from measures of firm financial performance. As our data
indicate, organisational effectiveness plays a mediating role on the HRM –financial
performance relationship, a proposition not tested in the previous literature. The second
key finding was that the environment in which an organisation operates has an effect on the
strategic integration of HRM in the organisation. In light of these findings, we can also
conclude that strategic HRM theory developed in a western context is applicable in a
transition economy.
 The International Journal of Human Resource Management 2997

Limitations
Several limitations of this research should be acknowledged. Generalisability is somewhat
limited by the location of the sample (from one well-developed province in China) and
possibility of non-response bias. The data are cross sectional, and causal inferences must
be made with caution. A longitudinal or experimental design would help in future research
to strengthen causal inferences. The data were gathered using perceptual measures,
exposing the study to potential common method variance (Podsakoff et al. 2003).
Although the results of the single-factor model in part address the issue of common
method variance, we cannot rule out the possibility of method bias in the data. It should
also be noted that perceptual measures are commonly used in HRM research and have
been found to correlate moderately to strongly with more objective measures of
organisational performance (Delaney and Huselid 1996; Wall et al. 2004). Nevertheless,
future studies could obtain objective indicators of financial performance and use multiple
organisational informants to strengthen validity (Wright et al. 2005).

Conclusion
Three hypotheses were tested in this study, i.e. the positive relationship between China’s
changing business environment and firm’s strategic integration of HRM; the positive
relationship between strategic integration of HRM and organisational effectiveness; and
mediating role of organisational effectiveness and firm’s financial performance. The
results demonstrated support for all three hypotheses. Thus, the study contributes to our
understanding of the complex interrelationships between the variables of changing
business environment in China, strategic integration of HRM, perceived organisational
effectiveness and financial performance. We, in turn, place the constructs of a changing
business environment, strategic integration of HRM and organisational effectiveness as
the links in the HRM –firm performance relationship. Further, we have illustrated that
strategic HRM theory is applicable in a transition economy.
We have shown that it is important to understand the business context within which
strategic HRM operates. How well an organisation performs or is effective in achieving its
goals is based on the appropriate application of its resources. As indicated by our findings,
examination of organisational effectiveness and financial/market performance separately
enables us to show that HRM is associated with organisational effectiveness, which, in
turn, is predictive of the success of an organisation as measured by its financial
performance. This places HRM as an integral part of the organisational system.
By not understanding the effect of the strategic integration of HRM in an organisation
and its relationship with organisational effectiveness, organisations run the risk of ignoring
HR requirements that can be managed by the HRM function that may influence financial
performance. Practitioners need to develop a holistic picture of their organisation, its place
in the environment and the interconnectedness of all the components. Therefore, to create
opportunities for greater success, HRM practitioners in China need to be aware of the
environment, be engaged at strategic levels of their firm and be able to demonstrate how
HRM decisions and practices impact firm financial performance through enhancement of
organisational effectiveness.

Acknowledgement
This research was supported by the National Natural Science Foundation of China for the NSFC
Research Project No: 71172063.
2998 C.J. Zhu et al.

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