Exploring human resource (HR) practices in small medium-sized enterprises (SMEs) and firm performance

Transcription

1 Exploring human resource (HR) practices in small medium-sized enterprises (SMEs) and firm performance Abstract: There have been many researches on the practices of human resource management (HRM), especially in regard to the degree of formality of HRM and, particularly, in the context of large organizations. For small and medium-sized enterprises (SMEs), the degree to which human resource management has been formalized is still relatively unknown, as well as how this formalization relates to firm performance. Hence, this study looks at the degree of formality of human resource practices in SMEs and how these impact firm performance. This study develops and tests a conceptual framework, linking human resource management (HRM) to firm performance, with a moderating effect of firm size. In order to test the hypotheses, primary data is collected through the distribution of a survey among 137 SMEs worldwide. Employee Staffing Formality is found to be of particular relevance to SMEs, showing a positive relationship with firm performance across the board of companies included in this study. On the other hand, the data used in this study shows that Employee Training Formality shows a negative relationship with firm performance. The findings of this study contribute to existing research by further clarifying the relationship between formal HRM and firm performance. A number of the findings in existing research are confirmed by this study, whereas the findings of this study also raise questions that are interesting for future research. Suraya Shaharin ( ) June 29th, 2012 University of Amsterdam Department of Business Studies (Faculty of Economics and Business) Paper for Master s Thesis Business Studies (6314M0180) Supervisor: Dr. Stefan Mol

2 Table of Contents 1. Introduction.3 2. Literature Review 5 Independent Variables 2.1) Employee Training Formality (ETF) ) Employee Staffing Formality (ESF) 6 2.3) Employee Compensation Formality (ECF).7 2.4) Management Structure Formality (MSF) 8 Dependent Variable 2.5) Firm Performance.9 3. Methodology Results 4.1) Demographic factors ) Reliability and Correlations ) Regression Analysis Discussion ) Limitations and Future Research Suggestions Conclusion.24 References.25 Appendixes 28 2

3 1. Introduction For the past decade, large companies around the world have been in increasing competition with small and medium sized enterprises (SMEs), both globally and locally (Knight, 2000; Nankervis, Compton and Savery, 2002; Georgiadis and Pitelis, 2012). The flexibility and adaptability of SMEs can provide them competitive advantage over more inert larger companies (Brand and Bax, 2002). However, compared to larger firms SMEs still lack capabilities of applying resources (Knight, 2000; Chi, Wu and Lin, 2008). Next to productspecific resources, amounts of capital or other types of tangible resources, human resource management plays an important part in influencing firm performance (Katz, Aldrich, Welbourne and Williams, 2000; Georgiadis and Pitelis, 2012). Human resource management (HRM) is defined as a set of distinct but interrelated activities, functions, and processes that are directed at attracting, developing, and maintaining (or disposing of) a firm s human resources (Tocher and Rutherford, 2009). A move towards more structured, formal HRM can be seen when a firm starts forming a hierarchy structure, with an approach toward labor division and increased administrative processes (Kotey and Slade, 2005). The HRM of SMEs is known to be less structured and planned, in contrast to the formal human resource practices of large firms (Wright, 1992; Kotey and Slade, 2005). Hence, in the light of increasing competition between large firms and SMEs, the degree of formality of HRM and its relation to firm performance is of particular interest to scholars (Tocher and Rutherford, 2009). Several scholars (Chandler and McEvoy, 2000; Georgiadis and Pitelis, 2012) point to a lack of research on the recognition and identification of human resource practices in small firms. Research by Kotey and Slade (2005) has shown that smaller firms are increasingly adopting more formal HRM practices. There is also evidence that SMEs that engage in formal HRM perform better than SMEs that do not formalize HRM (Gibbons and O Connor 2005). On the other hand, there have been studies highlighting the difficulties of HRM in SMEs, stating that effective recruiting, training and rewarding of employees are actually important problems encountered by small and medium-sized enterprises (Chandler and McEvoy, 2000; Kotey and Folker, 2007). Still, the amount of research on HRM in SMEs is small in relation to the amount of research that focused on large companies (Ram et al 2001; Barrett and Rainnie, 2002; Georgiadis and Pitelis, 2012). The vast majority of studies has focused on the HR practices in large firms (Wilkinson, 1999; Bacon and Hoque, 2005). 3

4 Since large firms are generally different from SMEs, for example in terms of flexibility, innovativeness or organizational structure (Brand and Bax, 2002), the management of human resources is different between SMEs and large firms as well. For example, prior research shows that HRM practices applied in large firms are not always suitable for SMEs (Tocher and Rutherford, 2009). Because SMEs do not commonly have an HRM department and do not use HRM practices to the same extent as large firms, SMEs still usually depend on an unstructured mix of training, compensation, recruiting, and selection of employees (Kotey and Folker, 2007). Whereas formal HRM practices have been shown to positively relate to firm performance (Tocher and Rutherford, 2009; Subramony, 2009), SMEs frequently face human resource issues that affect their firm performance (Tocher and Rutherford, 2009). Hence, this paper will investigate the HRM practices applied in SMEs, and try to establish the relationship of HRM with the financial performance of SMEs. Given that the formality degree of the HRM practices of SMEs is a relatively uncovered part of HRM research, the central question of this study is: What is the influence of the degree of HR formality on firm performance in SMEs? This study will try to answer the main research question by constructing a conceptual model, formulating hypotheses and collecting primary data to test these hypotheses. In order to collect the data, a standardized questionnaire will be sent out to the owners and managers of 137 SMEs around the globe. In SMEs, due to the general lack of an HR department, the HR issues such as hiring, compensation and training are typically the task of managing directors (Collins and Clark, 2003). These SMEs are all partners in the International Student Identity Card (ISIC) sales network, which means that these companies sell the ISIC cards from their outlets. The ISIC Association is a not for profit organization managed by ISIC Global Office BV (IGO), a private limited company based in Amsterdam, The Netherlands. The ISIC student card is sold each year to approximately 4.5 million students in 120 countries, and gives access to a portfolio of tens of thousands student services and discounts worldwide. These services and discounts range in category from hotels to entertainment, shopping to museums, and travel to restaurants. The ISIC is distributed through a network of licensed retailers. These retailers, usually the leading student travel organizations or the national student union, hold the exclusive responsibility for ISIC sales, distribution and marketing, as well as for building and managing the portfolio of benefits in a specific territory. Retailers issue the card through their own branches and through partnerships, such as with universities and banks. For each market there is a fixed ISIC retail price, which depending on the country usually varies between 4.00 and USD. 4

5 In the next section the relevant literature on HRM in SMEs will be reviewed. The literature review will result in definitions of the variables that will make up the conceptual model. 2. Literature review As mentioned before, Human Resource Management has been the topic of many studies over the years. The success of HRM has been related to many factors, of which firm size and HRM formality are the most relevant to this study. According to Dunn, Short and Liang (2008), high performing SMEs with successful HRM practices focus on employee training, employee compensation and employee staffing. These three variables have also been pointed out by Cardon and Stevens (2004), stating that it are these variables that contribute most to the success of HRM in small firms. Hence, each of these variables will be further reviewed in this section. 2.1) Employee Training Formality (ETF) According to Chandler and McEvoy (2000), regular employee training has a positive effect on an individual worker's productivity. Logically, improvements in individual productivity will result in increased organizational performance (Wright, Gardner, Maynihan and Allen, 2005). Chandler and McEvoy (2000) mentioned that training provides both the socialization and skills needed for a worker to increase productivity and quality. Looking from an HRM perspective, examples of formal training by large firms are generally provided to employees on a yearly basis and contain personal development opportunities (Wright et al., 2005). On the other hand, providing formal training to employees is a problem for small firms since it is highly costly (Mayson and Barrett, 2006). Cassell, Nadin, Gray and Clegg (2002) mentioned that teams of employees in small firms are less likely to receive a proper, structured training compared to teams in larger firms. Moreover, SMEs have regularly experienced difficulty in terms of recognizing the needs to train employees (Chi et al., 2008). Perhaps this lack of need recognition is due to the organizational structure of SMEs, as pointed out by Sun, Aryee, and Law (2007), stating that SMEs provide less internal promotion opportunities in comparison to large organizations. The possibility to gain an internal promotion leads to employees motivation to enhance their skills and to managers opportunity to train their employees (Sun, Aryee, and Law, 2007). 5

6 Kotey and Folker (2007) highlighted the informality of employee training in SMEs, how it is unplanned, has minimal provision and is short term oriented. These authors also stated there is a linear relationship between the size of a firm and the number of structured trainings on offer. Hence, two hypotheses in regard to employee training are formulated: Hypothesis (H1a): There is a positive relationship between employee training formality and firm performance. Hypothesis (H1b): The relationship between employee training formality and firm performance is stronger in larger firms. 2.2) Employee Staffing Formality (ESF) Employee staffing is an often studied HR component in the context of SMEs. Although SMEs could lack legitimacy as an employer, staffing is a low cost means to improve the quality of employees, in comparison to training for example (Cardon and Stevens, 2004). Formal staffing as defined by Wright et al. (2005), is conducting structured interviews and formal tests of applicants during the hiring process. Generally, applicants that are selected by large firms have to undergo interviews with professional recruiters, meaning that large firms generally have a more formal hiring process (Dyer and Reda, 2010). Additionally, larger firms have more resources at their disposal and can make use of a wider range of hiring channels (Wilkinson, 1999). SMEs use recruitment and selection procedures more than any other HR practice (Cassell et al., 2002). Despite that, staffing has been identified as SMEs weakest HRM practice (Barrett and Mayson, 2007). The literature on staffing of SMEs is ambiguous, as other scholars found that staffing is the most manageable and productive HR component for SMEs (Cardon and Stevens, 2004; Tocher and Rutherford, 2009). Furthermore, SMEs have endured problems recruiting capable employees, because they apply less appealing hiring channels, such as newspaper advertisements and walk-ins, in contrast to online advertisements and external recruitment agencies used by large firms (Bacon and Hoque, 2005). In fact, it has been stated that the most frequent staffing method by SMEs is word of mouth, as it is a low-cost option of attracting candidates (Barrett and Mayson, 2007). However, it has been stated that costeffective staffing for SMEs requires at least a clear job description (Sun, Aryee and Law, 2007). 6

7 Furthermore, Tocher and Rutherford (2009) mentioned that SMEs generally take a traditional approach to the recruitment process. The 'traditional' staffing method prioritizes job descriptions, setting tasks, duties and responsibilities for the employee. In summary, the traditional method starts with the recruitment process, making a selection, training employees, followed by a performance appraisal (Tocher and Rutherford, 2009). This study will examine the statement that a more formalized staffing approach will be more likely to improve firm performance. As larger firms have more resources to recruit capable employees, it is stated that formal staffing is more likely to improve firm performance in larger firms. H2a: There is a positive relationship between employee staffing formality and firm performance. H2b: The relationship between employee staffing formality and firm performance is stronger in larger firms. 2.3) Employee Compensation Formality Employee compensation is another part of HRM that is important in contributing to a firm s success (Collins and Smith, 2006; Dunn, Short, and Liang, 2008). Regardless if it is a group or individual reward, compensation can drive the determination of employees to act in their firm s best interest. A formal performance appraisal that results in compensation is likely to boost a firm s performance (Chandler and McEvoy, 2000; Sun, Aryee and Law, 2007). Large firms have standard and centralized HRM procedures to compensate employees (Dyer and Reda, 2010). In general, employees get a yearly formal evaluation of their performance and have the opportunity to earn bonuses based on individual performance (Wright et al., 2005). Otherwise, a monthly feedback system is another example of a formal HR practice (Hudson, Smart and Bourne, 2001). This formal appraisal process can lift employees motivation (Subramony, 2009). On the other hand, informal and uncoordinated compensation routines are applied by SMEs to reward their employees (Mayson and Barrett, 2006). Compensation is different in SMEs, in the sense that SMEs have a greater focus on non-financial rewards, such as educational benefits and recreational facilities (Cardon and Stevens, 2004). By doing so, performance remuneration and incentives for workers become more complicated. Additionally, compensation incurs more costs for SMEs, which is why it is applied on an infrequent basis (Wright et al., 2005). It is therefore proposed that: 7

8 H3a: There is a positive relationship between employee compensation formality and firm performance. H3b: The relationship between employee compensation formality and firm performance is stronger in larger firms. 2.4) Management Structure Formality The management structure of a firm relates to the other HRM components through organizational and job structures. Large firms, due to separate divisions and job levels, have a different approach to HRM than small firms (Chou, 2008).According to Cosh, Fu and Hughes (2010), an organizational structure can be divided into two types: organizations with a tall hierarchy and a flat hierarchy. The first type, the tall hierarchy, is also known as a formal management structure (Cosh et al, 2010). Tall hierarchies are bureaucratic and deal with slow responses to organizational changes (Idrus et al, 2011). Furthermore, tall hierarchies are usually the structure adapted by large companies (Idrus et al. 2011). On the other hand, the flat hierarchy structure can be associated strongly with SMEs (Supyuenyong and Islam, 2009). Flat hierarchy organizations rely on teams and networks to innovate and complete tasks (Chen, Hsu, Wang and Lin, 2011). In other words, a flatter organization points to a higher flexibility in work and lower degree of job specialization (Supyuenyong and Islam, 2009). Besides the hierarchy structure, firms can differentiate in the level of employee participation in decision making (Sun, Aryee and Law, 2007). It needs to be noted that firms can grow from a flat hierarchy, which is usually associated with SMEs, into an organization with a tall hierarchy, which is usually associated with large firms (Covin and Slevin, 1989; Chou 2008). Such a transition includes an increase in the degree of HR formality of SMEs (Chou, 2008). This process can be identified with divisionalization, where business segments are grouped into divisions and division managers are given the authority to take over the decision making process (Chou, 2008). Thus, to find the relation between SMEs organization structure and firm performance, the hypothesis below is proposed: H4a: There is a positive relationship between formal management structure and firm performance. H3b: The relationship between management structure formality and firm performance is stronger in larger firms. 8

9 2.5) Firm Performance Several authors have suggested the need to have a clearer understanding on how HRM practices are related to firm performance (Hutchison et al, 2002; Wright, Gardner and Moynihan, 2003). According to Wright et al. (2005), there are two ways of measuring firm performance. The first way is the organizational outcome where operation measures such as productivity and quality are used to calculate performance. Secondly is the financial or accounting outcome, which is a measurement of real financial performance. Measures for financial outcomes are expenses, revenues and profitability (Wright et al., 2005). For this study, the performance measure would be taken from the latter, since it has been shown that financial indicators are the commonly chosen output measures of SME performance (McKiernan and Morris, 1994, Simpson, Padmore and Newman, 2012), making this study more comparable with existing literature. The review of the literature resulted in four HRM variables that relate to firm performance, with the inclusion of firm size as a moderating effect. The conceptual model, which has been derived from the analysis of the literature, is displayed below. Conceptual Model HRM Formality Employee Training Formality Firm Size Employee Staffing Formality Employee Compensation Formality Firm Performance Management Structure Formality Model 1: The four independent variables of Human Resource Management (HRM) Formality relate to Firm Performance. As this relationship seems to be stronger in large firms, Firm Size is included as a moderator. 9

10 This section identified the relevant concepts for this study, which have been integrated into a conceptual model. In the next section the methodology of the study will be described, including the research design, the variables, collection of the data and the method of data analysis. 3) Methodology This study will conduct an empirical analysis of primary data obtained from SMEs. The factors of the conceptual model were divided into separate scales, which in turn were compiled into a survey. The survey was spread among 137 firms, from early May until June The targeted respondents were managers, directors or owners, who were also asked about their knowledge of human resource management, their education level, work experience, age and gender. This study used the method of contacting the firms, mailing the questionnaires and following up on the respondents. Out of 137 SMEs contacted, 66 completed the questionnaire (48.2%), which is a relatively high response rate (Dillman, 1999). The survey was kept as short as possible, to maintain the focus and interest of the respondent. As stated previously, the questionnaires included questions on each of the variables. The performance measure for this study is conducted by survey questions about each organization s Return on Assets (ROA), Return on Sales (ROS), total sales growth and the creation of new products or services, all four in regard to their competitors. To answer these questions, a Likert scale was included for every indicator, ranging from 1 to 5, where each point of these scales represents 20%. For example, a manager could answer that his firm is in the highest 20% of ROA, compared to its competitors. In an international context where many factors could influence the sales performance, it is chosen to measure the sales of one homogenous product: the sales of ISIC cards. The sales are measured by asking for the percentage of sales accounted for by the sales of ISIC cards. These percentages are classified in five segments of 20% (0-20%, 21-40%; 41-60%; 61-80%; and %), aligning the scores with the Likert-scales of the other firm performance indicators. The four independent variables were measured in similar fashion: 5-point Likert scales for each variable (1 = strongly disagree, 2 = disagree, 3 = neither agree nor disagree, 4 = agree, 5 strongly agree), with several questions to measure each variable. The following table shows the questions that measure the four independent variables. 10

11 Table 1 Scale items for the independent variables and firm performance Construct Selective Staffing Items Great effort is taken to select the right person Long term employee potential is emphasized Considerable importance is placed on the staffing process Very extensive efforts are made in selection Applicants undergo structured interviews ( job related questions, same questions asked of all applicants, rating scales) before being hired Qualified employees have the opportunity to be promoted to positions of greater pay and/or responsibility within the company During the staffing process, applicants take formal tests (paper and pencil or work sample) before being selected for hiring Once hired by this company, employees can generally expect to stay in the organization for as long as they wish. Except for entry-level positions, job vacancies in this company are generally filled from within. Extensive Training Results Oriented Appraisal Incentive Reward Management Structure There is advance planning as to which of this company s current employees will be transferred or promoted when there is a job vacancy. Employees are expected to do a wide variety of different tasks as needs arise. Does your firm offer training programs to employees? If the question above is a Yes, please answer the questions below : Training is provided to employees on a recurring basis Extensive training programs are provided for employees in customer contact or front-line jobs Employees in customer contact jobs will normally go through training programs every few years There are formal training programs to teach new hires the skills they need to perform their job Formal training programs are offered to employees in order to increase their promotability in this organization The company devotes considerable resource to employee training and development. The company offers training to improve the interpersonal skills of employees. Employees undergo extensive orientation training in order to learn the values and culture of this company. Many of this company s employees are moved through a series of different job assignments in order to prepare them for future assignments. Performance appraisals are based on individual's objective quantifiable results Employee appraisals emphasize long term and group based achievement Employees in this organization regularly ( at least once a year) receive a formal evaluation of their performance Pay raises for employees in this organization are based on job performance Employees have the opportunity to earn individual bonuses (or commissions) for productivity and performance Employees receive bonuses based on the profit of the organization Employees receive bonuses based on individual/group performance Highly structured channels of communication and a highly restricted access to important financial and operating information A strong insistence and demand on a uniform managerial style throughout the firm A strong emphasis on giving the most to say in decision-making to formal line managers A strong emphasis on always getting personnel to follow the formally laid down procedures Tight formal control of most operations by means of sophisticated control and information systems A strong emphasis on getting line and staff personnel to adhere closely to formal job descriptions The organization s management structure is based on functions, products or markets Firm performance ( Returns) Return on total assets (ROA) compared to competitors Return on totals sales (ROS) compared to competitors Total sales growth compared to competitors Creation of new products or services compared to competitors The organization performs other business/commercial activities that bring in additional income, besides ISIC sales. Please indicate the approximate percentage of your firm's ISIC Card sales revenue as a percentage of your firm's total revenue Lastly, firm size was measured by asking for the number of people employed by each firm. This follows the majority of literature on SMEs, in which it is often stated that SMEs are defined by the maximum amount of 100 employees. The maximum possible firm size in this study fits within the range of 250 to 500 employees. The data is analyzed by descriptive statistical output, such as means and standard deviations, the correlations are computed and the scales are controlled for reliability. The hypotheses are tested by using multiple regressions. For each of the four independent variables that make up HRM Formality, the relationship with firm performance is computed, with firm size as a moderating variable. In the next section, the results of the collected data will be presented and subsequently analyzed. 11

12 4) Results Of the 137 people that were invited to fill out the questionnaire, 66 responses were obtained. The first part of the results presents the demographic characteristics of the respondents. Second, the correlation matrix is presented, showing the individual relationships among the different variables. Third, the relationships between the independent variables, the dependent variable and the moderating variable are displayed. The strengths of these relationships are computed with use of the regression analysis tool Process, which allows the incorporation of a moderating variable. 4.1) Demographic factors The demographic variables were a non-compulsory part of the survey, resulting in not every respondent answering these questions. The average age of respondents to the survey is 41 years old, with a standard deviation of 9.87 (n=55). A few of the respondents (10 out of 66) did not state their gender, but the respondents who did, showed a balanced division with slightly more male respondents (30 men and 26 women). Most respondents indicated having a moderate level of HR knowledge (mean = 2.95; SD =.74). Furthermore, most respondents have high educational qualifications, in the sense that they hold a Master s degree (mean = 3.49; SD =.71). Experience wise, the majority of the respondents has been working for their current organization for at least five years (mean = 3.40; SD = 1.50), as well as in their current position (mean = 3.02; SD = 1.56). The firms differentiated heavily in size, industry and country of origin. This led to a heterogeneous sample of companies, ranging from having 0 to 500 employees, with an average of 40 employees (mean = 1.65; SD =.98). However, more than half (56.1 %) of the companies included in this study had less than 25 employees, while more than a quarter (27.2%) had less than 50 employees. The responding companies (n=66) operate in the travel industry (26), education sector (18), non-profit sector (8), logistics industry (3), government services (4), IT industry (2), media industry (2), legal sector (1), consulting services (1) and the industrial sector (1). 12

13 4.2) Reliability and Correlations Before computing the correlations, each scale of the four independent and the dependent variable were tested for reliability. The reliability of a scale is indicated by Cronbach s Alpha (α). The measurements of the four independent variables (making up human resource formality) have a sufficient to relatively high reliability (α >.70). Therefore, the internal consistency of the independent variables is acceptable( Bryman and Bell, 2003). The reliability test for the dependent variable, firm performance, showed that the two questions regarding ISIC card sales actually decreased scale reliability. With those two items removed, the scale consisted the four questions about the general financial performance of the firms (see table 1). These four remaining items did show a significant reliability, with α =.854. The correlation matrix pointed out mostly significant relationships among variables, with medium (r >.30) to relatively large effect sizes (r >.50). The relationships between Employee Training Formality and Employee Staffing Formality has a large effect size (r =.64; p =.00), as well as the relationship between Employee Training Formality and Employee Compensation Formality (r =.59; p =.00). Moreover, the remaining relationships between the HR practices all show a positive correlation coefficient with a medium effect size (r >.30; p <.01). As these conceptualized HR Practices measure HR Formality, positive and significant correlations show a valid measurement of HR Formality. Employee Staffing Formality shows the strongest correlation with firm performance (r =.41; p =.001), followed by compensation (r=.38; p =.002). Management Structure Formality and Firm Performance also correlate positively, but the statistical significance is less strong (r =.29; p =.017). There is no statistically significant evidence that Firm Performance correlates with Employee Training Formality, based on this dataset. Hence, Firm Performance positively correlates with three out of the four concepts: only Employee Training Formality is not significantly correlated with firm performance. Firm size is not significantly correlated with any of the HR concepts, and this indicates that there is not a strong relationship between the independent variables and the moderator. To further investigate the moderating effect of firm size, the next step is to conduct a regression analysis. 13

14 4.3) Regression Analysis The regression analyses were conducted with the use of the Process procedure for SPSS, written by Andrew Hayes (2012). This method calculates the p-value of the model as a whole, as well as the p-values of the separate variables. Moreover, the moderating effect of firm size can be calculated. Testing the model as a whole In order to test the entire model, meaning the relationship between HR Formality and Firm Performance, moderated by Firm Size, a few steps had to be taken. The four independent variables, which as previously mentioned show reliability and construct validity, were combined to compute a single independent variable: HR Formality. This variable was included in a regression analysis using the Process tool. The output of this model shows that the p-value is.0005 making it statistically highly significant (p <.01). The overall test of predictors, which includes HR Formality, Firm Size and the interaction effect (HR Formality x Firm Size), explains 24,66% percent of the variance in firm performance. When taking a closer look at the predictors, the analysis shows that both HR Formality and the interaction term are significant (respectively p=.0011; p =.0224), and that the coefficients are positive (respectively β =.4715; β =.3032). Additionally, the R-square of the interaction effect shows that it accounts for 6.67% of the variance in Firm Performance. This means that Firm Size strengthens the positive relationship between HR Formality and Firm Performance. For relatively smaller firms, the relationship between HR Formality and Firm Performance is insignificant. However, as firms grow in size, the relationship of HR Formality and Firm Performance increases and becomes increasingly significant (see Table 2). Table 2: Regression Estimating the Relationship between HRM Formality and Firm Performance and Their Interaction coeff se t p constant Firm Size (M) HR_Formality (F) F x M Note: R =.50, R-sq =.25, F = 6.76 and p =.0005 To further investigate how the four independent variables relate to Firm Performance, regression analyses were conducted for each of the independent variables. The Process tool allows the inclusion of one independent variable for conducting the regression with one moderator. Hence, for each relationship between one independent variable and Firm Performance, the other three independent variables were included as covariates. 14

15 Employee Training Formality (ETF) When testing the relationship between ETF and Firm Performance, it appeared there was a statistically insignificant negative relationship. Furthermore, for relatively small firms, the negative relationship between ETF and Firm Performance becomes significant (β = , p =.0077). The interaction effect is not statistically significant, but there seems to be a direct relation to firm size. This can be derived from the conditional effect of Employee Training Formality on Firm Performance at values of Firm Size : as firms grow larger in size, the negative effect of ETF decreases. These results are included in the Appendix. Table 3: Regression Estimating the Relationship between Employee Training Formality and Firm Performance and Their Interaction, With Various Statistical Controls coeff se t p constant Firm Size (M) ETF (F) F x M ESF (W1) ECF (W2) MSF (W3) Note: R =.59, R-sq =.32, F = 4.68 and p =.0006 Employee Staffing Formality (ESF) The relationship between ESF and Firm Performance is positive (β =.3045) and significant (p =.0415). The interaction effect is also significant (p =.0355) and positive (β =.2208). This means that the relationship between ESF and FP is strengthened by Firm Size: in the relatively medium and larger sized firms of this sample, the effects of ESF on Firm Performance become stronger. Table 4: Regression Estimating the Relationship between Employee Staffing Formality and Firm Performance and Their Interaction, With Various Statistical Controls coeff se T p constant Firm Size (M) ESF (F) F x M ECF (W1) MSF (W2) ETF (W3) Note: R =.58, R-sq =.34, F = 5 and p =

16 Employee Compensation Formality (ECF) The direct relationship between ECF and FP is marginally significant (p =.0733) and positive (β =.2326), but the interaction effect is not significant. However, as firm size increases, the effect of ECF on firm performance becomes significant. Similarly to ETF, these results are included in the Appendix. Table 5: Regression Estimating the Relationship between Employee Compensation Formality and Firm Performance and Their Interaction, With Various Statistical Controls coeff se t p constant Firm Size (M) ECF (F) F x M MSF (W1) ETF (W2) ESF (W3) Note: R =.56, R-sq =.31, F = 4.49 and p =.0008 Management Structure Formality (MSF) The relationship between MSF and Firm Performance does not show any sign of statistical significance, not even if firm size increases, as was the case with ESF and ECF. However, as Firm Size grows the p-value of the relationship between Management Structure Formality and Firm Performance also grows. Table 6: Regression Estimating the Relationship between Management Structure Formality and Firm Performance and Their Interaction, With Various Statistical Controls coeff se t p constant Firm Size (M) MSF (F) F x M ETF (W1) ESF (W2) ECF (W3) Note: 1 R =.54, R-sq =.29, F = 4.07 and p =

17 5) Discussion This section summarizes the results and discusses their implications for theory and practice. Based on the statistical findings that were described in the previous section, formal conclusions about the hypotheses will be drawn. Lastly, the limitations of this study and suggestions for future research will be stated. This study attempted to shed light on the relationship between formal human resource practices and firm performance. The majority of earlier research focused on larger companies, which indicated a research gap on how formal human resource practices affect the performance of small- and medium-sized enterprises (SMEs). Hence, to narrow down and specify the context, firm size was integrated as a moderating effect on the relationship between formal human resource practices and firm performance. Deducting from existing literature, formal human resource practices consist of four main components: the degree of formality of employee training, employee staffing, employee compensation and the management structure of an organization. The measurements of these four variables were also integrated into one single variable, HR Formality, in order to test the model as a whole. The results show that the latter model is highly statistically significant and has a substantial R-square, (p =.0005; R-square =.2466). The predictor HR Formality, which consists of the means of the four independent variables, shows a positive and significant beta (β =.4715; =.0011). Hence, it can be stated that HR Formality has a positive relationship with Firm Performance, thus that a more formal approach to human resources is likely to go along with higher financial performance. The interaction between HR Formality and Firm Size has a positive beta of.3032 (p =.0224), which means that Firm Size has a strengthening effect on the relationship between HR Formality and Firm Performance. The effects of a predictor can be positive or negative. A moderation variable can strengthen or weaken that effect. The effect of HR formality on Firm Performance becomes larger when firms are larger in size. For small firms, the p-value is insignificant, which makes it seem that HR Formality does not influence firm performance that much in smaller firms. On the contrary, if firms become larger, the firms with formal HR practices outperform firms without formal HR practices. This study attempted to further investigate the relationship between HR formality and firm performance, by looking more closely at four types of human resource practices. 17

18 Firstly, Employee Training Formality (ETF) shows a negative relationship with firm performance. Thus, the hypothesis that employee training is positively related to firm performance (H1a) is not supported. Although the majority of research finds a positive relationship (Tocher, 2009), this finding is in line with the research by Cardon and Stevens (2004) and Kotey and Slade (2005). These authors stated that SMEs face high costs and substantial time consumption for their employees to attend formal training. Thus, formal training is often perceived as an unaffordable luxury (Kotey and Slade, 2005). Instead of investing in such training practices, in-house and casual trainings are common in SMEs (Cardon and Stevens, 2004). Besides costs and time, formal training of employees in smaller firms seems to involve an unforeseeable risk that employees might leave the company, whereas larger companies can offer employees more growth opportunities (Beaver and Hutchings, 2005). Furthermore, as firms grow larger, the negative relationship between ETF and FP seems to become less pronounced. However, the data used in this study does not provide enough evidence to state there is a statistically significant relationship between ETF and FP. The hypothesis that the relationship between ETF and Firm Performance grows stronger as firms grow in size (H1b) is thus not supported. Employee Staffing Formality (ESF) is the second independent variable. The first hypothesis regarding this factor (H2a), states that there is a positive relationship between ESF and Firm Performance. This is indeed the case, which leads to the acceptance of H2a. The second hypothesis regarding this factor (H2b), states that this relationship is strengthened by the effect of firm size. Indeed, in this study, it was found that the larger firms had stronger relationships between ESF and firm performance. Tocher and Rutherford (2009) state that smaller firms, and especially start-ups, are more concerned with staffing than with any other form of HR. Kotey and Slade (2005) state that this is because smaller firms do not tend to have a hierarchical structure, which is generally a requirement for most HR practices, except for staffing. This is in line with this study s findings that ESF is the only HR component that shows a positive and significant relationship with firm performance for the relatively smaller firms. Furthermore, as smaller firms are less able to provide internal promotion, they rely more on the external labor market. As firms grow in size, internal growth opportunities arise, making the firms less dependent on external recruitment. This in turn allows firms to be more selective in recruiting (Bayo and Ortin, 2006). This is in line with this study s finding that formal staffing is relevant to the relatively smaller firms and becomes more relevant as firms grow in size. 18

19 Thirdly, Employee Compensation Formality (ECF) shows a marginally significant positive relationship with Firm Performance, which is why Hypothesis 3a is marginally supported. The relating hypothesis (H3b), testing the strengthening effect of firm size on the relationship between ECF and FP, is also supported. For relatively smaller SMEs, the relationship between ECF and FP is insignificant, but this relationship grows to significance for relatively mediumand large-sized SMEs. This is in line with the statement by Yanadori and Kang (2011) highlighting that larger firms tend to have the financial leverage to formally compensate employees. Instead, SMEs often provide educational benefits and recreational facilities as rewards (Cardon and Stevens, 2004). On the other hand, start-up firms that are gradually growing in size seem to perform better when a formal compensation practice is applied in the firm (Messersmith and Wales, 2011). However, compensation seems to be related to the job type. For example, sales employees generally work with targets and are financially rewarded for reaching those targets, whereas the job nature of an office manager requires a different reward approach. In this study, the fourth variable discussed is Management Structure Formality, tested by the hypotheses stating that it has a positive relationship (H4a) with Firm Performance and that this relationship is strengthened by Firm Size (H4b). There was no statistically significant evidence for a positive relationship. Hence, H4a is not supported. Secondly, there is no evidence of moderation by firm size. Hence, H4b is also not supported. However, the relationship between MSF and FP seemed to grow stronger as firm size increased, but this relationship never reached significance with the data used in this study. The correlations show that a more formal management structure goes along with higher formality of the other variables, and higher firm performance. It is a tentative reasoning that larger firms, larger than the ones included in this study, start to show a positive and significant relationship between MSF and FP. This reasoning is in line with the findings by Cosh, Fu and Hughes (2010), stating that larger firms have a tall hierarchy (or formal management) structure, whereas SMEs generally do not grow beyond a flat hierarchy (or informal management) structure. That is, firms growing into a formal management structure are generally too large in size to still be considered an SME (Cosh, Fu and Hughes, 2010). A tall hierarchy structure is characterized by several job levels and divisions (Chou, 2008), which seems to provide more growth opportunities, which in turn paves the way for formal training and selective staffing. 19

20 As mentioned previously, more than half (56.1 %) of the companies included in this study had less than 25 employees, while more than a quarter (27.2%) had less than 50 employees. The relatively larger firms (more than 150 employees) accounted for 6% of the firms included in this study. In this sense, it is not surprising this study did not find any significant relationship between a formal management structure and SME performance. Although the strength of this relationship does not reach significance with the data used in this sample, it possibly indicates a benefit of formal management structure for firms larger than included in this sample. This study has a number of practical implications. First of all, this study suggests that SMEs can benefit from formal HR, although there are several conditions and nuances. First of all, the findings of this study suggest that formal training could be of limited relevance to (relatively smaller) SMEs. Next to the relatively high cost of formal training, a firm seems to need to provide internal growth opportunities for its employees. In that situation, formal training provides employees with an incentive to improve their skills and stay with the company. Hence, it seems that with more internal growth opportunities, it becomes more attractive for firms to offer formalized training to employees. With regard to staffing, smaller firms are mostly dependent on the external labor market, as internal mobility is limited. That is why smaller firms seem to benefit from a formal, structured staffing procedure. However, as firms grow larger and internal growth opportunities arise, firms obtain the option to recruit internally. Better performing firms arguably have a larger budget available for recruitment, meaning that these companies can be more selective (Cardon and Steven, 2004). According to the findings of this study, formal compensation is also more effective in relatively larger SMEs. Smaller SMEs not only have fewer resources, but the future of these firms is also less certain. Moreover, Cardon and Stevens (2004) state that creativity, innovation, willingness to take risks and cooperation are important behaviors in smaller firms, but may not be as important in larger firms. Hence smaller firms do not have to copy the reward structure of larger firms. Informal compensation such as educational benefits or recreational facilities can be effective in smaller firms. Formal HR seems to be the most beneficial to companies with a tall hierarchy or formal management structure, whereas SMEs generally have a flat hierarchy or informal management structure. Hence, it seems that small organizations should not be managed in the same way as larger organizations. As stated by Cassell et al. (2002), SMEs deal with unique, distinctive processes and practices, which match with an informal approach to HRM. In short, formal HR seems to be more successful in larger, more structured firms, whilst for SMEs it seems to depend more on the context and characteristics of the firm. 20

21 Firm performance was measured using financial indicators. However, next to Return on Assets, Return on Sales and total sales growth, the creation of new products or services was included as a predictor of firm performance. These four indicators are all in comparison to competitors. The asset structure of firms is related to firm size, as capital resources are a major distinction between SMEs and large firms (Bretherton and Chaston, 2005). Although the majority of firms used in this sample have less than 50 employees, the difference in asset structure is not taken into consideration in this study. Return on Sales obviously depends on more than HRM formality, such as competition and business strategy. Taking these many other factors into account would have made this study too complex. However, although it is obvious, it needs to be stated that there are many other determinants of firm performance, besides the financial indicators. Total sales growth as an indicator of firm performance is also limited. Not all well performing firms show sales growth. The same limitation applies to the indicator that new products and services show better firm performance: a firm could still outperform its competitors, even if no new products are services are developed. Besides including companies from several industries, the global sample of this study take the findings out of a specific national context. The sample included SMEs only, covering all continents of the world, with companies from both developed and developing economies. The broad context increases the external validity of the findings. 5.1) Limitations and Suggestions for Future Research A number of limitations need to be taken into account before concluding this study. One limitation of is that the coverage of variables discussed consists of only four practices of HRM. This study focused on the HRM components that are the most firmly rooted in existing literature. Other human resource management practices that could be topic of investigation are internal mobility opportunities of employees and the participation of employees in decisionmaking (Sun, Aryee and Law, 2007). The presence of internal mobility opportunities is arguably a major difference between SMEs and large firms, which makes it a relevant topic for future research. Decision making participation, but also employee recognition, employee empowerment and leader development, are aspects of organizational culture which in turn, in a globalizing business environment, is of increasing relevance to HRM (Enz and Siguaw, 2000; Sun, Aryee and Law, 2007). Data-wise, although most results were statistically significant, the sample size of 66 is considered to be rather small. Another shortcoming of this study is that the questionnaires were filled out by single representatives of the SMEs, and the self-reported answers could be lacking in reliability. 21

22 Furthermore, it needs to be accentuated that this study does not provide evidence that the relationship between HRM formality and Firm performance is causal: it does not show that a more formal approach to human resources causes higher firm performance, or vice versa. Wright et al. (2005) state that research on HR practices on firm performance has assumed that HR is the causal variable, but that this causality is in lack of evidence. This is because the measuring the causal relationship between HR and firm performance is rather difficult. First of all because it is not clear whether it concerns straightforward causation or reverse causation: more formal HR results in better performance, or whether better performance results in more formal HR. Even if HR causes firms to perform better, the wider organizational context should be taken into account, including aspects of firms such as product or service quality, the particular industry, and organizational culture, for example (Wright et al. 2005). It seems logical, that in a complex combination of factors that determine firm performance, single causal relationships are not likely to be very strong. Contrary to a causal, positive relationship, Cardon and Stevens (2004) state that formalization of HR might not be the desirable path to growth for SMEs, as formalization may stifle creativity, flexibility and innovativeness. On the other hand, larger firms do not necessarily formalize their HR practices because it provides a chance to increase their performance. Larger firms have more employees, making it harder for managers to provide constant personal feedback or to monitor job performance. Hence, it is inevitable for large firms to formalize HR. As shown by Guest (2011), the causal relationship between HR and firm performance is still relatively uncovered and requires more comprehensive and longitudinal research. Due to the explorative nature of this study, a number of future research possibilities were uncovered. First of all, the negative effect of formal training on firm performance was an unexpected result of this study, but not unique in regard to former studies. Future research could further explore the relationship between formal training practices and firm performance of small companies, in particular. Another interesting future research possibility is to investigate at which point, or which firm size, formal training becomes beneficial to SMEs. Perhaps those future studies should include firms (slightly) larger than the ones included in this study. 22

23 Moreover, future research can focus on the relative importance of extrinsic and intrinsic rewards, and how they change over the life cycle of the firm. The life cycle of the firm is another specific interesting research perspective in regard to HR practices. Firms that still desire to grow could have significantly different approach to HR than similarly-sized firms at a later stage of their life-cycle. Another interesting perspective is to build on the research by Enz and Siguaw (2000), and to incorporate employee empowerment, leader development, and employee recognition in a global context of SME human resource management. Researchers that are interested to include moderating variables in their study can go more in-depth, looking into indicators such as the presence of HRM departments, firm age, or focus on specific industries. Performance measures can also be calculated by adapting a more precise approach of the price-cost margin (PCM) formula or at the broader view of firms market share growth (Georgiadis and Pitelis, 2012). Overall, quantitative and qualitative studies can be designed to measure firm performance, not only in terms of financial performance, but also in terms of overall performance of firms, such as fulfillment of its goals and objectives. Lastly, future research could further investigate the specific strengths and weaknesses of individual SMEs, and how they relate to HR formality and firm performance. An in-depth qualitative case study could provide more insights than a quantitative study like this. 23

24 6. Conclusion The main objective of this study was to explore the Human Resource Management (HRM) practices in SMEs and how they relate to firm performance. Following this objective, the literature review led to the inclusion of four HRM practices: Employee Training Formality (ETF), Employee Staffing Formality (ESF), Employee Compensation Formality (ECF) and Management Structure Formality (MSF). In accordance with these HRM variables, a conceptual model was designed and eight hypotheses were formulated and tested. The conceptual model showed all four HRM components as independent variables and firm performance as a dependent variable, whereas the relationships were moderated by firm size. In order to investigate the research question, questionnaires were distributed to gain data collection from 66 SMEs worldwide, all part of the sales network of the International Student Identity Card (ISIC) Association. With a small sample size of 66, the results of this study were surprisingly strong. Following the data collection, three out of eight hypotheses were supported, with Employee Staffing Formality being the most predominant HRM practice in relation to firm performance. The findings of this study are both contradicting and in accordance with existing literature. This is because the literature on SMEs is characterized by ambiguity. This ambiguity can be mostly attributed to the distinctive and hardly comparable nature of SMEs. Hence, consistency of human resource management can be found among large firms, but it is limitedly applicable in the case of SMEs. Small firms seem to focus on their unique strengths and maintaining their flexibility, or simply have insufficient funds for formal HRM, which leads to a more selective and informal approach. Thus, although the homogenization and clustering of SMEs provided significant results in this study, every SME seems to develop its own mix of HRM practices and corresponding formality. However, SME owners or managers should be more willing to imply further formality in their firms HR practices, as this study shows that the adequate level of formality does positively relate with firm performance. 24

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28 Appendix: Tables and Output Table 3: Firm Location by Country -Firm Location by Country Frequency Percent Valid Percent Cumulative Percent Valid Argentina Australia Austria Azerbajjan Belgium Bolivia Chile China Cyprus Denmark Dominican Rep Ecuador Egypt Estonia Finland Georgia Germany Greece Guatemala Hungary Ireland Kenya Latvia Lebanon Lithuania Luxemburg Netherlands New Zealand Poland Romania Russia Serbia Singapore South Africa South Korea Sri Lanka Sweden Switzerland Thailand Ukraine USA Venezuela Total Missing System Total

29 1. Correlation Matrix, Descriptive Statistics and Scale Reliability Mean Std. Deviation Employee Staffing Formality **.482 **.421 **.405 ** 2 Employee Training Formality **.432 ** Employee Compensation Formality **.382 ** 4 Management Structure Formality * 5 Firm Performance N = 66, Cronbach's α for each of the variables is listed on the diagonal. ** p <.01; * p <.05 29

30 Process Output Tables Firm Performance Process Output Model Summary R R-sq F df1 df2 p Model coeff se t p constant Firm_Siz HR_Forma int_ Interactions: int_1 HR_Forma X Firm_Siz R-square increase due to interaction(s): R2-chng F df1 df2 p int_ Conditional effect of X on Y at values of the moderator(s) Firm_Siz Effect se t p Values for quantitative moderators are the mean and plus/minus one SD from mean 30

31 Employee Training Formality Process Output Run MATRIX procedure: Model Summary R R-sq F df1 df2 p Model coeff se t p constant Firm_Siz Training int_ Staffing Compensa Mgmt_Str Interactions: int_1 Training X Firm_Siz R-square increase due to interaction(s): R2-chng F df1 df2 p int_ ************************************************************************* Conditional effect of X on Y at values of the moderator(s) Firm_Siz Effect se t p Values for quantitative moderators are the mean and plus/minus one SD from mean 31

32 Employee Staffing Formality Process Output Model Summary R R-sq F df1 df2 p Model coeff se t p constant Firm_Siz Staffing int_ Compensa Mgmt_Str Training Interactions: int_1 Staffing X Firm_Siz R-square increase due to interaction(s): R2-chng F df1 df2 p int_ Conditional effect of X on Y at values of the moderator(s) Firm_Siz Effect se t p Values for quantitative moderators are the mean and plus/minus one SD from mean 32

33 Employee Compensation Formality Process Output Model Summary R R-sq F df1 df2 p Model coeff se t p constant Firm_Siz Compensa int_ Mgmt_Str Training Staffing Interactions: int_1 Compensa X Firm_Siz R-square increase due to interaction(s): R2-chng F df1 df2 p int_ Conditional effect of X on Y at values of the moderator(s) Firm_Siz Effect se t p Values for quantitative moderators are the mean and plus/minus one SD from mean 33

34 Management Structure Formality Process Output Model Summary R R-sq F df1 df2 p Model coeff se t p constant Firm_Siz Mgmt_Str int_ Training Staffing Compensa Interactions: int_1 Mgmt_Str X Firm_Siz R-square increase due to interaction(s): R2-chng F df1 df2 p int_ Conditional effect of X on Y at values of the moderator(s) Firm_Siz Effect se t p Values for quantitative moderators are the mean and plus/minus one SD from mean 34