2. HR Practices & Firm Performance: International Evidence

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07/02: HR Practices and Firm Performance: What Matters and Who Does It?

Richard Fabling & Arthur Grimes

[ Last Updated 28 August 2007 ]

Evidence suggests that adoption of new capital equipment and upgrading in human capital are important components of United States productivity behaviour since the mid-1990s (Abowd et al, 2001; Nickell and Nicolitsas, 2000). Black and Lynch (2004, 2001, 1996) find that adoption of individual high performance work practices have also had a material impact on productivity outcomes. To determine these impacts, they estimate a fixed effects model utilising two separate surveys of workplace practices and firm results. Use of firm fixed effects, however, does not cater fully for potential endogeneity of practice choices. Black and Lynch note the difficulty of choosing appropriate instruments (that are both correlated with the choice of workplace practices and are orthogonal to productivity shocks) that would enable instrumental variables estimation of the impact of workplace practices.

The importance of utilising a suite of employee practices, rather than Black and Lynch's focus on individual workplace practices, has been emphasised in a number of studies (Milgrom and Roberts, 1995; Ichniowski et al,1997; Kandel and Lazear, 1992; Kruse et al, 2003). In a variant of these findings, Therrien and Leonard (2003) find, using Canadian data, that establishments with coherent HR systems and establishments with highly dedicated (but more narrowly focused) HR systems have the highest probability of being at the top end of the innovation spectrum. Ichniowski and Shaw (2003) discuss reasons underpinning complementarities between implementation of incentive schemes and more general HR innovations. These include the importance of avoiding free-rider behaviour on the part of some employees (in group incentive schemes) and encouraging individuals to expand their horizons to problem-solving across the firm.¹ In the latter case, employees are expected to "multi-task", so employee management and incentive systems need to be more complex relative to systems in traditionally managed firms (Holmstrom and Milgrom, 1994).

Existing studies also indicate the importance of differentiating the impact of workplace practices on firm productivity from firm profitability. Freeman and Lazear (1995) demonstrate that adoption of certain practices can increase total firm rents through increased productivity (see also Teece et al, 1997; Spanos and Lioukas, 2001). However, the split of these rents between owners and employees is affected by the nature of the practices that are adopted (Lazear, 2000). Another form of rent sharing occurs when both the employee and the firm receive a direct benefit from adoption of a particular practice. Employee training is an example where employees gain greater skills that they can utilise both at the firm and potentially elsewhere, while the firm benefits from increased productivity, particularly in the case of firm-specific training (Becker, 1962; Milgrom and Roberts, 1990 and 1995; Addison and Belfield, 2004; Gerfin, 2004; Munasinghe and O'Flaherty, 2005). Several studies find that provision of employee training contributes to productivity. For instance, Dearden et al (2000) analyse a panel of industries finding that training contributes positively to firm productivity. The estimated effect is much stronger when training is treated as an endogenous variable than when it is treated as exogenous. The latter result indicates that training is likely to be endogenous, with higher productivity contributing negatively to training.²

On the basis of these studies' findings, we test the following hypotheses:³

That adoption of a suite of "high performance" employee practices has beneficial effects on firm performance.
That adoption of performance pay has beneficial effects on firm performance.
That adoption of employee training systems has beneficial impacts on firm performance.

In addition, we test whether other surveyed individual employee practices have beneficial effects on firm performance. We determine the impact of individual practices both in the presence of, and separate from, the adoption of a suite of "high performance" practices.

¹ The experimental economics literature (e.g. Fehr and Gachter, 2000 and 2002) suggests that introduction of performance pay without the introduction of other high performance HR practices (that are viewed as "friendly" by employees) may result in negative outcomes for the firm if the pay scheme’s introduction is interpreted by employees as a reduction in trust between the firm and workers.

² One may conjecture, for instance, that initial low productivity induces some firms to increase training so as to provide a productivity boost.

³ Each hypothesis is stated as the alternative hypothesis (relative to the null of no effect). In each case, the impact is tested after controlling for a range of other firm practices and characteristics. We measure firm performance using measures of relative profitability and relative productivity (in keeping with several cited studies) and by change in market share.

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Printed: 25/11/2009