HR OUTSOURCING AND ITS IMPACT THE ROLE OF TRANSACTION COSTS

Transcription

1 PERSONNEL PSYCHOLOGY HR OUTSOURCING AND ITS IMPACT THE ROLE OF TRANSACTION COSTS BRIAN S. KLAAS The Darla Moore School of Business Administration University of South Carolina JOHN MC CLENDON School of Business and Management Rmple University THOMAS W. GAINEY The Darla Moore School of Business Administration University of South Carolina Although HR activities have traditionally been performed in-house, organizations are increasingly relying on outside contractors to perform these activities. Using a Transaction Cost Economics perspective, this study examined whether organizational-level factors moderated the relationship between the degree of reliance on HR outsourcing and the perceived benefits produced by outsourcing. Moderated regression was performed using data provided by over 300 HR executives on outsourcing levels, organizational characteristics, and the perceived impact of outsourcing. Support was found for a number of the transaction cost hypotheses regarding the impact of organizational characteristics. Specifically, the relationship between the degree of outsourcing and the perceived benefits generated was moderated by reliance on idiosyncratic HR practices, uncertainty, firm size, and cost pressures. No support was found for hypotheses regarding the moderating effect associated with pay level, overall outsourcing emphasis, or strategic involvement by HR. Although research has shown the importance of HR activities to organizational performance (Becker & Gerhart, 1996; Huselid, 1995; Wright, Smart, & McMahan, 1995), there is much controversy about who should perform these activities (Lepak & Snell, in press; Mohrman, Lawler, & McMahan, 1996; Wright, Gerhart, Snell, & McMahan, 1997). Traditionally, HR activities have been performed in-house. Increasingly, however, HR activities are being outsourced (Jamrog, Groe, & Pyle, 1997; Stewart, 1996). In some instances, HR outsourcing has been shown to reduce costs by providing economies of scale, increasing incentives and accountability, and increasing access to specialized expertise Correspondence and requests for reprints should be addressed to Brian S. Klaas, The Darla Moore School of Business Administration, University of South Carolina, Columbia, SC COPYRIGHT PERSONNEL PSYCHOLOGY, INC 113

2 114 PERSONNEL PSYCHOLOGY (Csoko, 1995). In other instances, outsourcing has been found to limit the development of distinctive competencies and to create inefficiencies because contractors lacked firm-specific knowledge and engaged in opportunistic behavior (Ulrich, 1996). Clearly, much variation exists in the effects associated with HR outsourcing. Although little is known about the source of this variation, Transaction Cost Economics (TCE; Hart, 1988; Klein, Crawford, & Alchian, 1978; Williamson, 1996) offers a useful framework for understanding the conditions under which HR outsourcing is likely to benefit organizations. TCE argues that in acquiring inputs, firms must choose between alternative governance structures. When firms rely on outside suppliers, they are relying on market contracting as a form of governance. When they rely on internal employees, they are relying on organizational hierarchy as a form of governance (Milgram & Roberts, 1990; Williamson, 1985). TCE further argues that firms will attempt to choose governance structures that minimize the total transaction costs associated with obtaining inputs of a desired level of quality. These transaction costs include the unit price, the expected costs associated with forming and maintaining contractual and employment relationships, and the costs associated with monitoring performance and quality (Williamson, 1975). Pansaction costs also include the costs generated by opportunistic behavior by service providers upon whom the organization has grown dependent. Examples of opportunistic behavior include introducing excessive price increases at contract renewal, charging excessively for adjustments or add-ons during the contract period, and cutting costs by reducing service quality in areas where outcomes are not thoroughly specified. According to TCE theorists, the process by which transaction costs are generated differs across alternative governance structures. For instance, whereas market contracting is more likely to produce costs associated with opportunistic behavior by suppliers, organizational hierarchy is more likely to produce costs associated with bureaucratic inefficiency (Mulherin, 1986; Williamson, 1993). TCE also suggests that characteristics of an organization will affect vulnerability to different types of transaction costs as well as the capacity to benefit from different sources of cost reduction (Williamson, 1991). Traditionally, TCE has been used as a descriptive theory in order to predict choices made by organizations about governance structure. Because firms are seen as attempting to minimize transaction costs, TCE predicts that firms will adapt marketbased governance when organizational conditions make them less vulnerable to the costs typically associated with this form of governance. However, because firms often do not behave in accordance with what would be predicted by TCE, this theoretical perspective can also be used

3 BRIAN S. KLAAS ET AL. 115 as a normative theory. When used normatively, TCE predicts that firms relying on market governance even when they are vulnerable to the costs typically associated with this mode of governance will experience fewer benefits. In this paper, we use TCE to identify organizational-level factors likely to affect vulnerability to the costs associated with alternative governance structures for the HR function as well as the capacity to benefit from how costs are reduced by these alternative governance structures. In accordance with TCE, we examine whether these organizational-level factors moderate the relationship between the degree of reliance on HR outsourcing and the perceived benefits from outsourcing. Theoy and Hypotheses According to Williamson (1996), market-based governance differs from organizational governance in how transaction costs are generated. Because the returns from efficiency are not diluted by the need to share such returns across a diversified organization, market-based governance is thought to offer stronger incentives for high performance (Masten, 1984). Combined with the discipline of market competition, stronger incentives have the potential to ensure efficient completion of contractual obligations as well as efficient adaptation to supply and demand shifts (Shelanski & Klein, 1995). Further, greater economies of scale are possible if similar services are required by multiple clients, allowing for efficient access to expertise (Grossman & Hart, 1982). Organizational hierarchy can be distinguished from market contracting by its reliance on the employment relationship. The employment relationship is based heavily on authority within the hierarchy and, as such, creates a zone of acceptance -a willingness among employees to accept direction and redirection across a wide range of issues (Williamson, 1985). This zone of acceptance avoids the costs associated with forming complex and long-term contracts. Moreover, complex and long-term contracts are often incomplete in that they fail to anticipate contingencies likely to arise during the course of the contract or to fully specify service requirements. Such incomplete contracting introduces costly conflict, contracting costs, and the possibility of opportunistic behavior by service providers upon whom the organization has become dependent (Masten & Crocker, 1985). In addition, because all parties involved share membership in the hierarchy and the potential to benefit over the long-term from cooperation, coordinating adjustments across multiple parties is more easily accomplished (Dow, 1987). However, organizational hierarchy offers weaker incentives (largely because the benefits of efficiency are diluted across a diversified organi-

4 116 PERSONNEL PSYCHOLOGY zation). It is less responsive to supply and demand shifts (because of insulation provided by a diversified organizational structure) and requires higher levels of monitoring. It is also subject to bureaucratic distortions caused by the pursuit of subunit goals at the expense of organizational goals (Simon, 1991; Williamson, 1996). These differences suggest that the transaction costs experienced when obtaining HR services via outsourcing are likely to stem from different sources than the costs experienced when relying on in-house task performance. Organizations are likely to vary in their vulnerability to alternative sources of transaction costs and in their capacity to benefit from alternative methods for controlling these costs. Reliance on HR outsourcing is most likely to yield the desired results when organizational characteristics make the firm less vulnerable to the types of transaction costs generated by market-based governance and more receptive to cost reductions offered by market-based governance. These organizational characteristics, then, are likely to moderate the relationship between the amount of HR outsourcing and the perceived benefits from outsourcing. In the remainder of this section, we draw on TCE to develop hypotheses about organizational-level factors that are likely to affect whether reliance on HR outsourcing will produce benefits for the organization. Idiosyncratic HR Practices Combined with bounded rationality, complex interfirm relations make it likely that contracts will be incomplete and that there will be substantial need for modification of contract provisions during the term of the contract. This need for frequent modification of contract provisions means that market-based governance mechanisms expose each party to the risk of opportunistic behavior by the other (Riordan & Williamson, 1985). The need for asset-specific investments (i.e., investments in assets that cannot be easily redeployed) further increases this risk, making the investor dependent on the other party and more vulnerable to opportunistic behavior (Joskow, 1988; Masten, 1984). For instance, many payroll systems are standard across organizations and industries. Thus buyers and sellers or these services incur few up-front costs and have minimal relative dependence on one another. In contrast, certain training programs must be tailored to meet the unique requirements of organizations. These programs require greater up-front investments and increase the levels of relative dependence and risk of opportunistic behavior by the party who did not pay for this investment. Following this logic, where organizations utilize a distinctive approach to managing their workforce (Barney, 1991), HR outsourcing is likely to require up-front investment in understanding the particular

5 BRIAN S. KLAAS ET AL. 117 needs of the organization. This up-front investment is likely to be substantial in that HR processes cannot always be codified and often are based on tacit knowledge (Barney, 1991; Conner & Prahalad, 1996). If the employer pays for this up-front investment, the firm is at risk of opportunistic behavior by the contractor, thus increasing expected transaction costs (Hart, 1988). If the contractor incurs the cost of the up-front investment, they are at risk of opportunistic behavior by the employer. And the risk assumed by the contractor is likely to be reflected in the price charged for the services provided (Williamson, 1996). Beyond this, market contracting is argued to result in greater economies of scale due to the availability of multiple clients with similar needs (Abraham & Taylor, 1996; Walker & Weber, 1984). However, economies of scale will decline where idiosyncratic practices require asset specific investments, thus reducing the cost advantage of outsourcing. Because HR idiosyncrasy is likely to affect the generation of transaction costs associated with market governance, it is likely to affect whether reliance on HR outsourcing will generate benefits for the firm. Hypothesis 1: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by the degree to which HR practices are idiosyncratic. Uncertainty The level of uncertainty facing a firm also has the potential to affect the transaction costs associated with alternative governance structures (Milgram & Roberts, 1990; Williamson, 1996) and this uncertainty is likely to vary depending upon the environment in which an organization operates. For example, in our study we found that most firms who classified themselves as manufacturers reported that they operated in relatively stable environments and faced little uncertainty. By contrast, those who identified themselves as operating in the information systems industry reported facing much more instability and uncertainty. According to TCE, when uncertainty exists about a firm s prospects and, therefore, its demand for labor, it is more costly to establish the longer-term commitments typically associated with organizational forms of governance. Firms facing substantial uncertainty are likely to make frequent adjustments in staffing levels and the allocation of work. With organizational governance, staffing increases require substantial investments in the hiring and training of new employees (Abraham & Taylor, 1996). Staffing decreases require that the organization forgo investment in hiring and training and also incur direct and indirect costs associated with terminating permanent employees (Abraham, 1990).

6 118 PERSONNEL PSYCHOLOGY By contrast, relying on outside contractors allows staffing levels to be adjusted without significant costs. Contractors can more readily reallocate work across its client base when there is a shift in demand from any particular client (Abraham & Taylor, 1996). Because uncertainty is likely to be associated with greater fluctuations in staffing levels, it is likely to increase the transaction costs associated with organizational governance. As such, increased HR outsourcing is likely to be seen as generating more substantial benefits for firms facing substantial uncertainty than for more stable organizations. Hypothesis 2: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcingwill be moderated by the level of uncertainty facing a firm. Pay Level Within TCE, emphasis is given to how nonprice attributes determine governance structures because it is these attributes which vary most across organizations (Williamson, 1996). However, due to the importance of pay level policies and wage contours (Gerhart & Milkovich, 1990; Martocchio, 1998), the price charged for HR services provided in-house also varies across organizations and is likely to affect the transaction costs associated with organizational governance. For example, pay level in some industries is significantly higher, even for positions that are not industry specific (Milkovich & Newman, 1996). For these organizations, obtaining HR services in-house is likely to be more costly. Similarly, in some organizations pay level is set to lead the market in order to attract higher quality employees (Rynes & Barber, 1990). Frequently, this pay level policy is established for the entire organization (Gerhart & Milkovich, 1990). As such, managers must lead the market even for routine, administrative positions unlikely to significantly contribute to obtaining competitive advantage. For such positions, the gap between the cost of providing services in-house and the costs associated with HR outsourcing may be substantial. Because the potential for cost savings is likely to be greater in firms that lead the market in terms of pay level, increased outsourcing is likely to be seen as producing more benefits in firms that offer market-leading levels of pay. Hypothesis 3: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by whether a firm leads the market in terms of pay level.

7 BRIAN S. KLAAS ET AL. 119 Firm Size Firm size is likely to affect the transaction costs associated with alternative governance mechanisms because of its impact on economies of scale (Abraham & Taylor, 1996). Many HR services require specialized expertise and, therefore, substantial training (Ulrich, 1996). However, a given employee or manager is only occasionally likely to need such services. As a result, in small firms many specialized HR activities will be infrequently performed. And because of the high costs associated with acquiring the expertise to perform these activities, the per unit cost associated with providing such HR services in-house will be relatively high. By contrast, in larger firms the per unit cost will be substantially lower due to greater economies of scale. Because of the larger employee group, even specialized activities will be performed more frequently, thus spreading the cost of acquiring expertise across a larger number of HR transactions. Due to differences in economies of scale, the transaction costs associated with organizational governance are likely to be greater for smaller firms than for larger firms (Abraham & 'Bylor, 1996; Williamson, 1996). As such, smaller firms that move away from organizational governance via increased outsourcing of HR will likely experience greater benefits than will larger firms. Hypothesis 4: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by firm size. Overall Outsourcing Emphasis In order to minimize the risks associated with outsourcing, firms must develop contracts that fully specify the outputs required and that anticipate possible contingencies (Masten & Crocker, 1985; Mulherin, 1986). Firms must also find ways to efficiently monitor work that is outsourced and to integrate such work with activities that are performed in-house (Barzell, 1982; Milgram & Roberts, 1990). Finally, risk minimization also requires the development of partnership-type relationships with the outsourcing firms (Gulati, 1995). Firms are likely to differ in their ability to perform these tasks in that the required competencies depend on tacit knowledge acquired largely through experience. Therefore, firms that emphasize outsourcing across many different functional areas of their business (e.g., information systems, marketing, and R&D) are more likely to have acquired these outsourcing competencies. When such firms then begin to outsource HR activities, they are more likely to take steps to minimize opportunistic behavior by contractors, thus reducing the transaction costs associated with market-based governance.

8 120 PERSONNEL PSYCHOLOGY As a result, increased reliance on HR outsourcing is likely to be seen as producing more benefits in firms that emphasize outsourcing across many different functional areas than in firms that make little use of outsourcing outside of HR. Hypothesis 5: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by the overall level of outsourcing across all functional areas. Cost Pressures HR outsourcing is often argued to offer immediate cost savings because of efficiencies created by economies of scale and market competition (Goldfarb & Naasz, 1995). However, because firms face different cost pressures, there is likely to be variation in the degree to which such cost savings will be valued by managers in a firm (Williamson, 1996). In organizations where cost pressures are severe, the value assigned to reducing short-term costs may be sufficient to offset any concerns about the risk of opportunistic behavior by contractors over the long term. Because of their likely effect on how firms value immediate cost savings, cost pressures are likely to affect the strength of the relationship between reliance on HR outsourcing and the perceived benefits from outsourcing. Increased HR outsourcing is likely to be seen as generating more benefits among firms facing severe cost pressures than among firms fating a more munificent environment. Hypothesh 6: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by the cost pressures faced by the firm. HR Strategic Involvement Repeated calls have been made regarding the need for linkages between HR activities and the strategic objectives of the firm (Martell & Carroll, 1995). Where HR services are provided by outside contractors, such linkages are likely to require substantial asset-specific investment (i.e., investment in assets that cannot be easily redeployed) in order for service providers to understand strategic issues facing the firm (Ulrich, 1996). Where the firm pays for this investment, they are likely to be at risk of opportunistic behavior by the contractor. Where the contractor pays for this investment, it risks opportunistic behavior by the firm and is likely to adjust its fees accordingly. Given that strategic objectives are likely to regularly change, where linkages to HR practice exist, frequent adjustments in HR services will

9 BRIAN S. KLAAS ET AL. 121 be needed. Such adjustments may be more difficult to accomplish with market-based governance because contracts specify in advance the services to be provided (Conner & Prahalad, 1996). However, such adjustments are less difficult in organizational governance because employees have a greater obligation to accept direction and redirection (Williamson, 1996). For these reasons, increased HR outsourcing is likely to be seen as generating fewer benefits in firms that emphasize strategic involvement by HR. Hypothesis 7: The relationship between the amount of HR outsourcing and the perceived benefits from outsourcing will be moderated by the degree to which the firm emphasizes strategic involvement by HR. Sample and Procedure Method The sample for this study consisted of 2,000 members of the Society of Human Resource Management (SHRM) who had the job title of Vice President or Director of Human Resources. Selection was random except for the stipulation relating to job title and a stipulation that there be only one executive from a given organization. Each of the SHRM members solicited to participate was asked to complete a questionnaire and mail the completed questionnaire directly to the researchers. Of the surveys mailed, 98 were returned because of incorrect addresses. Of the 1,902 SHRM members who received a questionnaire, 432 returned a completed survey to the researchers. This resulted in a response rate of 22.7%, comparable to other firm-level surveys (Rynes, Orlizky, & Bretz, 1997; Terpstra & Rozell, 1993). The distribution of respondents across industries was as follows: manufacturing (26%), healthcare (22%), financial services (13%), professional services (7%), other services (6%), trade (6%), information systems (4%), utilities (3%), government (3%), communications (3%), hospitality (3%), transportation (2%), petrochemicals (l%), and construction (1%). Because this study examines the impact of outsourcing, we excluded from our final sample the 116 respondents who indicated that their firm did not make any use of outsourcing or that they were not involved in decisions relating to outsourcing.

10 TABLE 1 Factor Analysis of HR Outsourcing Activities Item 1. HR planning: design 2. Employee relations: design 3. EEO/diversity: design 4. Organizational development: design 5. Safety & health: design 6. Performance appraisal: design 7. HR planning: delivery 8. Employee relations: delivery 9. EEO/diversity: delivery 10. Organizational development: delivery 11. Safety & health: delivery 12. Performance appraisal: delivery 13. HRIS: design 14. Payroll: design 15. Exempt compensation: delivery 16. Non-exempt compensation: delivery 17. HRIS: delivery Factor loadings HR generalists ltansactional Human capital Recruiting & activities activities activities selection lo lo

11 E!i Y F TABLE 1 (continued) Factor loadings m HR generalists 'Ransactional Human capital Recruiting & Item activities activities activities selection 18. Payroll: delivery oo 19. Benefits: delivery ltaining exempt employees: design.oo M -.lo 21. Tfaining non-exempt employees: design Employee assistance programs: design 'Raining exempt employees: delivery 'Raining non-exempt employees: delivery Employee assistance programs: delivery.11.m Recruiting exempt employees: design M Recruiting non-exempt employees: design Selecting exempt employees: design -.M Selecting non-exempt employees: design Recruiting exempt employees: delivery Recruiting non-exempt employees: delivery Selecting exempt employees: delivery Selecting non-exempt employees: delivery Note: Highest loadings are underscored.

12 124 PERSONNEL PSYCHOLOGY Vhriables Perceived benefits. The dependent measure for this study consists of seven Likert-type items asking about the degree to which HR outsourcing produced a positive effect for the organization (alpha = 39). Items asked about the degree to which HR outsourcing reduced costs and increased accountability, flexibility, quality, access to expertise, and the ability to focus on core activities. Actual scale items can be seen in the Appendix. Because of the wording of the items, responses could be influenced both by the success of outsourcing arrangements and the degree to which outsourcing is actually used (because outsourcing is unlikely to generate significant benefits if it used relatively little). Only one factor emerged when performing factor analysis on the items for this scale. Amount of outsourcing. Using a 7-point scale with percentages as anchors, participants rated the degree of outsourcing in different areas of HR for: (a) the design of programs and policies; and (b) the administration of programs and policies. Responses to the items were factor analyzed using principle component analysis with promax rotation. Skree plot analysis as well as an examination of eigenvalues suggested a 4-factor solution. Factor loadings are displayed in Table 1. As can be seen, factor one (HR generalist activities; alpha = 37) consists of items related to tasks typically performed by HR generalists (e.g., performance appraisal, planning, & EEO/diversity). Factor two (transactional activities; alpha = 30) consists of items relating largely to more routine, transactional activities (e.g., payroll, benefits, & HRIS). Factor three (human capital activities; alpha =.73) consists largely of items relating to the building and maintenance of human capital (e.g., training & development as well as employee assistance). Factor four (recruiting & selection; alpha =.72) consists of items relating to staffing activities. Idiosyncratic HR practices. The extent to which the HR practices in a firm are seen as idiosyncratic or unique was measured by a 4-item scale (alpha =.92). Please note that factor analysis was conducted using all Likert-type items related to organizational characteristics likely to moderate HR outsourcing s impact. The scale created for this and other moderator variables is supported by the factor analysis results. Uncertainly. The level of uncertainty facing a firm was measured using a 5-item scale (alpha = 30). Items captured predictability of firm performance, product demand, and demand for labor. Pay level. Pay level was measured by a single item regarding whether the firm led the market in terms of pay for its HR staff. Pay level was coded as one when the firm led the market and zero otherwise. Firm size. Respondents were asked to indicate the number of fulltime equivalent employees working in their firm or in the division of

13 BRIAN S. KLMS ET AL. 125 their firm for which they had responsibility as an HR professional. The logarithmic transformation of size was used in the models estimated here. Overall outsourcing emphasis. The level of outsourcing across functional areas was measured by a 3-item scale (alpha =.90). Items related to top management sentiment regarding outsourcing more generally and to its utilization across segments of the organization. Cost pressures. The degree to which a firm faces pressure to reduce costs was measured by a 9-item scale (alpha =.93). HR strategic involvement. The degree to which the HR function in a firm is seen as being strategically involved in overall business issues was measured by a scale containing two items (alpha =.92). Interrater Reliabilities Of the 2,000 HR executives who were sent surveys, 500 also received a second questionnaire that they were asked to distribute to another HR professional in their organization. The additional participant was instructed to complete the survey and mail it to the researchers. Coding of the surveys allowed the questionnaires to be matched upon return. Of the 500 organizations receiving two surveys, 39 complete sets were received. The interrater reliabilities computed from the subsample were as follows:.53 for perceived benefits,.79 for amount of outsourcing,.70 for idiosyncratic HR practices,.74 for uncertainty,.89 for pay level,.94 for firm size,.58 for overall outsourcing emphasis,.61 for cost pressures, and.65 for HR strategic involvement. Analysis Moderated regression (Stone & Hollenbeck, 1984) was performed to examine whether the relationship between the amount of HR outsourcing and the perceived benefits from outsourcing was moderated by the organizational characteristics identified earlier. In the initial step, the four factors relating to the amount of HR outsourcing (HR generalist activities, transactional activities, human capital activities, and recruitment and selection) were regressed on the perceived benefits from outsourcing. Then, Steps 2 and 3 were performed for each variable hypothesized to moderate the relationship between factors for the amount of outsourcing and the perceived benefits. In Step 2, the main effect for a given moderator variable was estimated along with the main effects for the four factors capturing the amount of outsourcing. In Step 3, the interaction between a given moderator variable and the factors capturing the amount of outsourcing was estimated along with the main

14 126 PERSONNEL PSYCHOLOGY effects for both the amount of outsourcing and the moderator variable. The moderator effect was then assessed by using the F-test to examine the incremental R2. This analytical approach is useful in this instance in that moderator effects are less susceptible than main effects to common method bias. Results Table 2 displays the means and standard deviations as well as the intercorrelation matrix. Table 3 displays the moderated regression results. In the first step (which remains the same across the seven models examined here), the four factors relating to the amount of HR outsourcing were entered. As can be seen, the factors for HR generalist activities, transactional activities, and human capital activities were all significantly and positively related to the perceived benefits associated with HR outsourcing. The factor recruiting and selection, by contrast, was significantly and negatively related to perceived benefits. In total, the model estimated at Step 1 explained 15% of the variance (p <.01). At Step 2 of the model for Hypothesis 1, idiosyncratic HR practices was added and the AR2 was 1% (ns.). At Step 3, consistent with Hypothesis 1, the interaction between the factors relating to the amount of outsourcing and idiosyncratic HR practices resulted in a significant increase in the variance explained. The AR2 for Step 3 was 5% (p <.01). The coefficients for the interaction between idiosyncratic HR practices and both human capital activities and recruitment and selection were in the direction hypothesized and statistically significant at either p <.01 or p <.05. In the model for Hypothesis 2, uncertainty was added at Step 2. The An2 at Step 2 was 5% (p <.01). At Step 3, consistent with Hypothesis 2, the AR2 was 4%, which is statistically significant at p <.01. The coefficients for the interaction between uncertainty and transactional activities, human capital activities, and recruitment and selection were in the direction hypothesized and significant at either p <.01 or p <.05. The coefficient for the interaction between HR generalist activities and uncertainty was significant (1.1 <.05) but not in the hypothesized direction. In the model for Hypothesis 3, pay level was added at Step 2. The addition of this variable resulted in a An2 of less than 1% (n.s.). In Step 3, contrary to Hypothesis 3, the AR2 was 1% (n.s.). Thus, no evidence was found to suggest that pay level moderated the relationship between the amount of outsourcing and the perceived benefits. In the model for Hypothesis 4, the log of firm size was added in Step 2. The An2 was less than 1% (n.s.). In Step 3, consistent with

15 TABLE 2 Descriptive Statistics and Correlations M 3 F.38** SD Perceived benefits HR generalists activities ** 3. Tfansactional activities 4. Human capital activities **.29**.29**.32**.20** vl! 5. Recruiting and selection **.18** 6. Idiosyncratic HR practices lo * 7. Uncertainty **.16**.26**.11* * 8. Pay level ** -.14** 9. Firm size *.23** Overall outsourcing emphasis **.20**.34**.29**.24** **.12*.15**.15** 11. Cost pressures **.28**.08.23**.09 -.lo.a** HR strategic involvement * ** ** -.16**.25** Note: N ranges from 320 to 325 * Significant at.05 ** Significant at.01

16 TABLE 3 Hierarchical Regression Estimates Idiosyncratic HR Pay Firm Overall Cost HR strategic practices Uncertainty level size outsourcing pressures involvement Moderator variables (HI) (H2) (H3) (H4) emphasis (H5) (H6) (H7) Step 1 HR generalists activities.39**.39**.39**.39**.39**.39**.39** Ttansactional activities.09*.w*.09*.09*.w*.09*.09* Human capital activities.20**.20**.20**.20**.20**.20**.20** Recruiting - and selection -.33** -.33** -.33** -.33** -.33** -.33** -.33** A F 13.83** 13.83** 13.83' " 13.83** 13.83' ** Step 2 Moderator variable **.W.02.36**.31** -.lo R~A.O1.05.MI.oo F ** ** 14.04** 2.59 Step 3 Moderator* HR generalists activities *.73* Moderator* transactional activities ** *.16* -.06 Moderator' human capital activities -.21**.13* *.08 Moderator* recruiting and selection -.37*.26* ** R~ A F 4.17* * 4.32'" ** * 1.19 Overall R~ N Nore: Unstandardized regression weights are reported. Firm size is a logarithm. Dependent variable = perceived benefits. * Significant at.05 ** Significant at.01

17 BRIAN S. KLAAS ET AL. 129 Hypothesis 4, the AR2 was 3% (p <.01). However, only the coefficient for the interaction between recruitment and selection and the log of firm size was statistically significant (p <.01) and in the direction expected. In the model for Hypothesis 5, overall outsourcing emphasis was added in Step 2. The AR2 at Step 2 was 5% (p <.01). In Step 3, contrary to Hypothesis 5, the AR2 was 2% (n.s.). Thus, no evidence was found to suggest that overall outsourcing emphasis moderated the relationship between the amount of outsourcing and the perceived benefits. In the model for Hypothesis 6, cost pressures was added at Step 2. The AR2 at Step 2 was 4% (p <.01). At Step 3, consistent with Hypothesis 6, the AR2 was 3% (p <.05), suggesting that the interaction between the factors for the amount of outsourcing and cost pressures significantly added to the predictive power of the model. The coefficients for the interaction between cost pressures and both transactional activities and human capital activities were significant (p <.05) and in the direction expected. Finally, in the model for Hypothesis 7, HR strategic involvement was added at Step 2. The AR2 was 1% (n.s.). At Step 3, contrary to Hypothesis 7, the AR2 was only 1% (n.s.). Note that an overall moderated regression model was estimated where Step 2 contained all possible main effects and step three contained the main effects plus all possible interaction effects. The AR2 from Step 2 to Step 3 was statistically significant at p <.01. This suggests that-in total-the moderating effect of the seven transaction cost variables explains a significant amount of the variance in the perceived benefits of outsourcing. Discussion TCE argues that the major sources of transaction costs will vary across governance mechanisms. It further argues that firms will differ in how vulnerable they are to these different sources and in their capacity to benefit from how governance mechanisms reduce transaction costs. This paper identified organizational characteristics likely to influence vulnerability to different sources of transaction costs and/or the capacity to benefit from how governance mechanisms reduce transaction costs. Consistent with TCE, it then examined whether these organizational characteristics affect the relationship between the level of HR outsourcing and the perceived benefits from outsourcing. This transaction cost-based view received support in that idiosyncratic HR practices, uncertainty, firm size, and cost pressures all moderated the relationship between the amount of outsourcing and the perceived benefits.

18 130 PERSONNEL PSYCHOLOGY Consistent with Hypothesis 1, the results suggest that firms relying on idiosyncratic HR practices perceived fewer benefits resulting from increased outsourcing. In particular, idiosyncrasy moderated the impact associated with increased outsourcing of human capital development and maintenance activities and recruitment and selection activities. Where idiosyncratic practices are emphasized, obtaining quality results will require substantial investment in assets that cannot easily be redeployed. Asset specific investments are likely to result in either higher costs or greater exposure to opportunistic behavior by service providers. Further, idiosyncrasy limits the advantages offered by economies of scale, making it less likely that outsourcing will generate cost advantages. Support was also found for Hypothesis 2. Increased outsourcing resulted in bigger increases in the perceived benefits among firms facing more uncertainty. In particular, uncertainty moderated the impact associated with the outsourcing of transactional activities, activities related to the development and maintenance of human capital, and recruitment and development activities. Because uncertainty increases the need for staffing adjustments and the reallocation of tasks, uncertainty is likely to increase the transaction costs associated with organizational governance. Organizational governance relies on longer term commitments and investments in employees, both of which are likely to be more costly in an environment that demands staffing adjustments. By contracting with a HR outsourcing firm, an organization is able to reduce the transaction costs associated with staffing adjustments. Because the outsourcing firm can readily reallocate work across multiple clients, staffing adjustments required by any one client are unlikely to introduce significant transaction costs. Consistent with Hypothesis 4, the relationship between the amount of HR outsourcing and the perceived benefits from outsourcing was moderated by firm size. In particular, increases in the outsourcing of recruiting and selection activities were seen as generating more benefits in smaller firms. This finding is consistent with the argument that organizational governance is more costly for smaller firms because they are not able to spread the costs of acquiring HR expertise across a large number of employees. For such firms, HR outsourcing provides a mechanism by which to share with other employers the costs associated with obtaining HR expertise. Finally, support was found for Hypothesis 6 in that cost pressures were found to moderate the relationship between the amount of outsourcing and the perceived benefits from outsourcing. In particular, increases in the outsourcing of transactional activities and activities relating to the development and maintenance of human capital were seen as

19 BRIAN S. KLAAS ET AL. 131 generating more benefits in firms reporting greater cost pressures. As cost pressures increase, firms are likely to value immediate cost savings more while giving less consideration to the possibility that, over time, contractors will engage in opportunistic behavior. And because outsourcing arrangements often generate immediate savings (albeit with some long-term risk of opportunistic behavior by contractors), cost pressures are likely to increase the degree to which firms will see HR outsourcing as generating benefits. Support was not found for three of the hypotheses examined here. No evidence was found to suggest that pay level (Hypothesis 3), overall outsourcing emphasis (Hypothesis 5), or strategic involvement by HR (Hypothesis 7) moderated the impact associated with increased HR outsourcing. Each of these hypotheses was based on the assumption that the variable in question affects the transaction costs associated with obtaining HR services through either HR outsourcing or organizational governance. This assumption may not be valid. For example, overall emphasis on outsourcing across functional areas within the organization was treated as a proxy for competence in managing outsourcing relationships and, thus, was assumed to affect transaction costs. However, it may be that more direct measures of competencies relating to the outsourcing of HR are needed if we are to effectively assess the role such competencies play in determining HR outsourcing s impact. In addition, strategic involvement by HR might often be accomplished by a few key executives and it is unclear whether their involvement will affect the need for asset-specific investment by contractors (and, therefore, transaction costs) when providing a wide range of more routine HR services. On the whole, the results seem to suggest that the perceived benefits from HR outsourcing will vary with a number of organizational characteristics. Further, the results suggest that transaction cost economics may offer a useful framework for understanding the profile of firms likely to benefit the most from market-based versus organizational governance. Such a conclusion argues for further research to more fully investigate how organizational characteristics affect HR outsourcing s impact. Note, however, that our results do not address whether proper management of the outsourcing relationship will allow for outsourcing to generate benefits even when a firm s profile suggests they are less likely to benefit from HR outsourcing. Developing trust through repeated interaction and building partnership relationships, forming fully specified contracts, and selecting the best-in-class outsourcing firms may allow firms to benefit even if they possess characteristics which are inhospitable to outsourcing (Ghoshal & Moran, 1996; Helper & Levine, 1992; Moran & Ghoshal, 1996). It is also unknown whether the results obtained here are a function of inefficient markets for HR outsourcing

20 132 PERSONNEL PSYCHOLOGY services. As a consequence, the results obtained here may well be timedependent. TCE was used in this study in a normative sense to examine the relationship between organizational characteristics and the perceived benefits from outsourcing. It should be noted, however, that TCE is often used as a descriptive theory to predict choices made by firms in determining the governance structure. Used as a descriptive theory, TCE would predict that the firms that make little or no use of outsourcing would be more likely to have organizational characteristics which make it costly to rely on market-based governance and inexpensive to rely on organizational governance. To assess whether TCE has value as a descriptive theory, we examined the correlation between organizational characteristics used as moderator variables in the previously discussed regression models and the total amount of HR outsourcing. The sample included all responding firms, including those who did not currently utilize outsourcing. The correlations between the total amount of outsourcing and organizational characteristics are as follows:.07 (Idiosyncratic HR practices),.21 (Uncertainty),.ll (Pay level),.15 (Firm size),.45 (Overall outsourcing emphasis),.15 (Cost pressures), and.06 (HR strategic involvement). Of these correlations, four (Uncertainty, Pay level, Overall outsourcing emphasis, and Cost pressures) are statistically significant (p <.05) and in the direction expected. This suggests that TCE hasvalue in this context as a descriptive theory as well as a normative theory. It is important to consider our findings in light of the limitations associated with this study. First, the dependent and independent variables were measured using a single respondent from each of the organizations surveyed. This raises questions about the impact of common method variance and about the accuracy of judgments regarding levels of HR outsourcing and relevant organizational factors. Although these questions should not be minimized, we took steps to reduce the threat posed by this issue. To begin with, for a subset of the sample, we were able to obtain two respondents per organization. Estimates of interrater reliability are reasonably supportive of our usage of the dependent and independent measures. In addition, this study focused on moderator effects that are less susceptible to percept-percept bias. Finally, consistent with the key informant literature (Chen, Fahr, & Macmillan, 1993; Kumar, Stern, & Anderson, 1993), we used responses only from respondents who indicated they were involved with the outsourcing process. Second, although the response rate obtained here is consistent with that typically obtained in firm-level studies (Rynes et al., 1997), it is still modest. Thus, questions can legitimately be raised about sample representativeness.

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