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2. Investing in People and Business Performance

Published onSep 19, 2022
2. Investing in People and Business Performance
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ABSTRACT

How can HRM contribute to the (financial) performance of an organization?

Key Theories
Resource-based theory
Human capital theory
Individual differences theories
Social capital theory
Social exchange theory

Key HR Practices
Selection tools
Strategic human resource development
Work design
Employee incentives

Human resources are the pool of human capital that have a direct employment relationship with the organization and are under the control of this organization (Wright et al., 1994). The words ‘resource’ and ‘capital’ are at the center of this chapter. These emphasize how people can contribute to the success of organizations. By investing in people as a resource for organizational success, they become an asset for organizations, a valuable kind of capital that can make a difference in the competitive advantage of organizations.

The costs for labor as part of the overall operational costs differ per organization. Imagine, for example, a labor-intensive production process like strawberry picking. To date, no machine can replace the complex human dexterity needed to carefully pick the fruit without bruising it. Consequentially, labor costs make up for about 70 percent of the entire production costs of strawberries (Kroon & Paauwe, 2014). When strawberry producers want to increase their profits, they either have to cut down on labor costs by paying lower wages, or they need to increase labor effectiveness, which in return entails that fewer people are necessary to pick the same amount of strawberries. Since strawberry picking jobs require no education, wages tend to be low already. Paying even less than competitors would probably scare employees away and leave the fruits unpicked. Instead, a more efficient way to achieve larger returns on labor costs would be to invest in a more productive workforce. Thus, the questions should be ‘which HR practices lead to a higher productivity of strawberry pickers’ or, ‘which HR practices increase the return on investment (ROI) of labor costs’? With a proportion of around 60 percent, the labor component in the overall production costs is also high in service industries (Batt, 2000), where customers pay for a service rather than for a product. Examples of service jobs range from low-skilled cleaning or waitressing jobs to very-high skilled legal, medical or consultancy jobs. Just as with strawberry picking, working more efficiently will improve the ROI of labor costs in service industries. However, since a service is delivered through the interaction between employees and clients, efficiency alone will not be enough. Service quality also depends on the quality of the interaction. A helpdesk advisor who is very efficient in achieving her/his performance target, but who does not listen well to clients, will negatively impact the client’s satisfaction with the organization and its services. This illustrates that improved productivity not only lies in efficiently meeting quantity requirements, but also in the quality of relationships.

In manufacturing organizations, the labor component of overall costs appears to be, with around 10 percent of the total costs, much lower than in service operations (Batt, 2000). However, also in this sector people can make the difference in gaining competitive advantage. A variety of developments have raised the demand for highly educated and intelligent employees. Products, for example, are becoming more and more high tech and complex, and organizations’ strategies need to respond rapidly to changes in information, technology and finance. In this regard, employees add value to the organization by processing and advancing knowledge. Typically, such so-called knowledge workers do not operate in isolation but in teams and networks of specialists. The added value of these employees is less dependent on efficiency or on relationships with clients, and more on the effectiveness through which they are able to disseminate their knowledge and consequently advance the organization, its strategy, and innovations.

The wide variety of examples from unskilled to high-skilled work illustrates how employees can make a difference for organizations. Employees can contribute to organizational success through processes of efficiency, relationship quality with suppliers, clients, customers, and co-workers as well as through knowledge development, dissemination and innovation. Hence, rather than just as a part of production costs, employees should be viewed as a resource to gain competitive advantage for organizations. No wonder the main question of strategic human resource management concentrates on the alignment between investing in people and business performance.

Two theories dominate the literature on HRM strategy and business performance: the resource-based view and the social exchange theory. Referring to the former theory, since the nineties, a stream of research and theory has emerged advancing the idea that organizations can flourish when they have an outstanding set of resources (Barney, 1991). Those organizations have a unique advantage in outperforming competition. However, resources do not act on their own. In particular, the kinds of resources that are nested in individuals, such as knowledge, skills and abilities, need some leverage to be applied at work. If an employee does not feel the need to use his or her skills and knowledge at work, these resources cannot be used by organizations to gain a competitive advantage. Hence, along with the view that people can make a difference because of their valuable productivity, knowledge and their network of relations, human resource management theory is needed that explains why people are willing to use their talents to benefit the organization. The most-cited theory used to understand why people put in effort at work is the social exchange theory (Cropanzano & Mitchell, 2005).

In the following theory section, we zoom in on resource-based theories and in particular on theories of human and social capital, the two types of resources that are most central in human resource management strategy. In addition, we introduce the most-cited theory used to understand why people are willing to unleash their human and social capital to benefit the organization: social exchange theory.

Theory

All except one of the theories presented in this chapter originate from an economic perspective on human behavior. You will recognize this by the displayed language, where words like ‘costs’ and ‘maximization of returns’ are used to predict the behavior of organizations and individuals. The one exception is the theory on individual differences, which originates from psychology. This theory is included here because it provides further insight into the causes of differences in human capital between people.

Resource-based theories

Strategic management involves making plans about defining and meeting objectives of the organization. Planned strategic management therefore often contains a process in which the characteristics of the organization are listed next to the characteristics of the environment. Positive characteristics of the organization are strengths that the organization can build on, for example an excellent location. Hindering characteristics are weaknesses of the organization (e.g. old-fashioned procedures, slow response times), which need attention to overcome or they will hinder the organization’s success. Scanning the characteristics of the environment will reveal opportunities (e.g. new markets, innovations), but will also provide insights into potential threats (e.g. competition, changes in demands). A good strategy would strike the optimal balance between on the one side profiting from an organization’s strengths and opportunities in the environment, while on the other side simultaneously managing weaknesses and guarding against threats. In such an approach to strategic management, the environment of the organization has a large impact on the strategic direction, even though it also takes organizational aspects into account.

Although the strengths-weaknesses-opportunities-threats (SWOT) analysis still center-stages many strategic management decisions, more recent strategic management literature emphasizes an approach that focuses on the strengths of organizations to achieve a competitive advantage. The key critique on the SWOT approach is that when all organizations follow opportunities in the market, it could lead to many organizations pursuing the same strategy. In practice however, there are many differences between organizations in how they pursue market opportunities. This led practitioners and scholars to look for other ways to understand effective strategic management.

Since the nineties, organizational strategy research and practice have emphasized that boosting the strengths of the organization is the most successful road to competitive advantage. Popular literature at the time was for example Prahalad and Hamel’s ‘Core Competence of the Corporation’ (Prahalad & Hamel, 1990), which pleaded that it is not enough to have a competitive product on the market. To be successful, a firm also needs to be able to keep creating such products. Therefore, not only the product, but also the facilities, machines, people, knowledge, processes and relations contribute to the success of a firm. A well-known example is the ability of 3M, the organization that brought us post-its, to keep inventing new products and manufacture them in an efficient way. Its core competence is the combination of innovation and efficient manufacturing. Hence, the strength of 3M is not primarily to have an innovative product, but having the people and processes which enable the efficient manufacturing of these innovative products. The people and processes are the valuable resources that 3M puts at the core of its management strategies. The idea of the core competence movement was that by looking at those aspects of the organization that contribute to its success, one could see that it is not only a product or service that makes a difference, but that an entire set of resources used to create this product or service is what determines an organization’s strength.

Thus, at the center of organizational strengths are organizational resources. Resources are indispensable features that are available for organizations to create and realize strategies and to increase efficiency and effectiveness. This broad conceptualization of resources covers all assets, buildings, information systems, machines, firm attributes such as reputation and experience, knowledge and relations with clients and suppliers. The list of things that count as resources can easily be extended and basically includes anything an organization can use to its advantage. To ease our understanding, it helps to categorize resources into three broad categories: physical capital, organizational capital, and human capital (Barney, 1991).

First, physical capital contains tangible assets like financial resources, property such as land and buildings, and technological resources. These receive the largest attention by accountants and other financial specialists, who take their value into account to calculate balance sheets. Hence, physical capital concerns all tangible resources which are easy to track and if necessary, can be replaced.

Second, organizational capital represents intangible resources such as policies, procedures, style, values, traditions, and leadership style. Together, these make up a system of routines whereby routines display regular and predictable patterns of activities made up of a system of coordinated actions. Therefore, routines explain to some extent how work is done by employees in an organization. Organizational capital can be even further divided into structural organizational capital, the culture, routines, and processes that have been developed in an organization such as the IT system, the network, management processes and general strategies; and social organizational capital, which refers to all the internal and external relationships an organization has with employees, teams, customers, suppliers, the community and the government.

Finally, human capital concerns the sum of all knowledge, skills, ideas, abilities and health available in the people working within an organization. At the individual level, these characteristics are assets that employees can use to obtain income and wealth. At the aggregated (group) level, human capital equates the human resources, the shared knowledge, education and motivation which is an asset to realize organizational targets.

Neither physical, organizational, nor human resources automatically lead to the desired competitive advantage. Some resources may even cost more than they deliver. To really deliver their return on investment, a resource must be a valuable resource. The following text builds on a set of theories known as resource-based strategy, which describes why resources can contribute to competitive advantage (Barney, 1991)(Grant, 1991). Here is how it works.

If an organization has a set of resources that enable it to reach its business objectives in a cost-efficient, qualitative and innovative way, it will contribute to a good ROI on these resources. However, when competitors have the exact same set of resources, the resources themselves do not contribute to a competitive advantage anymore and therefore lose their value for the company. In other words, in order to be valuable, a resource must contribute to a greater amount of cost-efficiency, a better quality of the service or product, and to more innovation than the resources available to the competition.

An organization that is the first to own new technology has a valuable resource in hand and may outperform competition as long as competitors do not install the new technology as well. For example, when one farmer succeeds in developing an innovative strawberry picking machine that does not bruise the fruits, this would significantly reduce labor costs and provide this farmer with a competitive advantage. However, competitors are likely to follow quickly to buy such a machine. Hence, the competitive advantage of the first farmer will quickly fade as competitors start using similar technology. First-mover advantages are always temporary. Therefore, it is even better when a set of resources becomes really difficult to imitate by competitors. Unique sets of resources that are hard to duplicate by others lead to sustainable competitive advantage (Barney, 1991). Hence, those organizations that strategically create a set of valuable resources which are also difficult to imitate will be able to outperform their competitors in the long run. Following the logic that only resources with certain characteristics contribute to the sustainable competitive advantage leads to a set of requirements to obtain truly valuable resources (Grant, 1991).

First, valuable resources are sustainable, meaning that the organization can rely on their availability over a longer period of time. Second, valuable resources are rare, thus not easy to obtain. For example, an excellent location for a new restaurant in the city center is rare and difficult to obtain and can be a real valuable resource for competitive advantage. Third, transparency matters. The less transparent it is to others how a set of resources leads to competitive advantage, the more difficult it is for competitors to follow that exact same strategy and the more valuable a resource is. Secret recipes for cola are examples of non-transparent and therefore valuable resources. Finally, difficulties of transferability contribute to how valuable a resource is. Some resources are attached to an organization and cannot (easily) be copied from one organization to the next, for example intangible resources like reputation and tradition are very difficult to transfer and therefore highly valuable.

When assessing the value of the three broad categories of resources (physical capital, organizational capital and human capital) against the requirements for valuable resources, it strikes how important organizational and human capital are. Table 2.1 illustrates the potential of each category of resources to become a valuable resource for competitive advantage. It shows that the intangible resources such as reputation, relations, knowledge, skills, and motivation (social organizational capital and human capital) have far larger potential for a valuable contribution to competitive advantage than buildings, machines, policies and systems (physical and structural organizational capital).

Table 1 .
The value of different types of organizational resources

Table 1

Physical capital

Organizational
Capital

Human capital

Structural

Social

Sustainable

Rare

Non-Transparent

-

-

Non-Transferable

-

-

This conclusion of the resource-based perspective holds important lessons for human resource management. Organizations that invest in human and social capital will achieve a workforce that is capable and motivated, which works together in a constructive way, and will therefore positively contribute to organizational success and competitiveness.

Despite the importance of human and social capital to the performance of organizations, it is difficult to express the revenues of human and social capital in the book value of organizations. The yearly financial balance sheet usually shows physical and financial capital (machines, buildings, goods, rents, debts and reserves). Because human and social capital are harder to directly observe and measure, it is more difficult to assign a monetary value to them. It is, however, possible to get an impression of the value of intangible capital, for example by looking at the so-called ‘stock price to book value’. This estimate calculates the ratio between the book value of the organization (from the organization’s yearly financial report) and compares that to the market value of the organization (from the stock market). If the stock market value largely exceeds the book value, this indicates that the organization has a large share of intangible capital. For example, knowledge-intensive information technology organizations tend to have a big difference between book and market value because their physical capital is relatively low compared to organizational and human capital. This indicates the relative importance and value of human and organizational capital to knowledge-intensive organizations.

A few words of warning are necessary before using this estimate for the value of human and social capital. First, a large stock price to book value ratio could also simply imply that an organization is overrated on the stock market, which happened during the dotcom crisis in the 2000s, or more recently in the crisis that started in the overheated banking sector. Second, calculating the stock price to book value is impossible for public service and privately-owned organizations that do not have a stock market value.

Another way to understand the importance of human and social capital to organizational performance is by looking into research evidence, as will be illustrated later in this chapter. In order to understand the research in this area, the next section first zooms in on human and social capital theories.

Human capital theories

The unique aspect about people compared to buildings, machines and systems is that organizations do not own people. Much-valued resources like knowledge and skills are owned by people, who can decide for themselves if they are willing to use their knowledge at work for an organization, and with which effort. This makes human capital a complex type of resource. Human capital theories are grounded in two research disciplines: in economics (Gary Becker, Human capital theory), and in psychology (Spearman, Individual differences and performance theories).

Economic theory: Human capital (Becker)

Human capital theory was ‘invented’ in the 1960s by the economists Schultz and Becker (Becker, 1962). They regarded education as an investment that renders good returns for people because educated people get better jobs and earn more than non-educated people (Becker, 1964). Moreover, the relationship between education and returns is linear: the higher the level of education, the better the prospects for a good job and a nice salary. In the first writings on human capital, it was mostly considered an individual asset (Becker, 1962), but later scholars successfully applied the concept of human capital as an asset of organizations (Andrews, 1965)(Chandler, 1962)(Crook et al., 2011). The common definition of human capital for both individuals and for groups of people often found in literature states that human capital is all the knowledge, skills, and abilities (KSAs) in an organization that are embodied in people (Coff, 2002).

Individuals who invest in their education will increase their human capital, which will help them obtain a better position in society. Continuous investment in education also guarantees that knowledge and skills remain up-to-date and reduces the likelihood that changes in technology or otherwise will lead to useless knowledge. Hence, human capital needs nurturing and investments to stay up to date: ‘lifelong learning’.

Human capital as a group characteristic of the entire workforce of an organization contributes to strategic goal achievement, to an increase of efficiency and effectiveness within an organization, to spotting new opportunities, and to innovation.

The central tenet of human capital theory at the individual and group level is threefold:

  1. Human capital can be rare. Since not all people equally possess the same knowledge, skills and education, human capital is not easily accessible. Organizations need to search for the right employees who hold the necessary human capital. Especially people with high-level professional education and experienced senior managerial staff are much sought after by employers. This nicely fits the requirements laid out in the section on valuable resources; because human capital is owned by individuals, it cannot easily be transferred or copied.

  2. Human capital develops over time by training, education and experience. To be a sustainable resource, it needs nurturing and investments. For example, many typists who were trained in using mechanical typewriters, but who did not invest in learning how to work with text processing software, lost their jobs in the nineties. Today, mainly ongoing technological innovations lead to changes in job requirements that cause knowledge to become quickly outdated. So, in order to be able to work throughout their careers, people have to invest in their continuous development to ensure their employability. The same goes for organizations that do not invest in training and development of their employees. Without investments in employee development, organizations have a workforce unable to deal with changes in the demands and challenges organizations are facing. Those employees and organizations who invest in training and development will benefit from up-to-date knowledge, skills and abilities.

  3. Human capital can be general or firm-specific. General human capital means all knowledge and skills obtained in general education, or by working in an industry. For example, a mechanic can obtain certificates to work with welding equipment that is widely used throughout the industry and thus the mechanic can use this ability in any firm. Firm-specific human capital, in contrast, develops while working and being trained in a specific organization. For example, training in using specific procedures and programs that are only used in one organization, leads to human capital that is more difficult to use in other organizations. Years of work experience in one organization also contributes to firm-specific human capital. Firm-specific human capital helps people to allocate resources such as knowing who does what and where within the organization to do their own work well in the specific organizational context. Hence, firm-specific experience is the oil that greases work processes and the dissemination of knowledge between people within organizations. A meta-analytical study that compared the value of general and firm-specific human capital for organizational performance showed that both types of human capital increase organizational performance, but that firm-specific human capital leads to even larger returns than general human capital (Crook et al., 2011).

To conclude, human capital theory concentrates on knowledge, skills and abilities that workers gain through training and work experience. Organizational investments in training and development contribute to the human capital of the workforce, which is an important organizational resource. The next section concentrates on the type of human capital that exists because people differ from each other, because they are who they are: some are smarter, wiser and more productive than others by nature rather than by training. Where the economic perspective on human capital proposed in this section views human capital as the result of investments in training, the individual differences perspective emphasizes naturally occurring differences in human capital between people. Rather than promoting training as the vehicle to gain human capital, the individual differences approach is mostly visible in employee selection practices.

Psychological theory: Individual differences (Spearman)

The big question in the individual differences approach is which individual characteristics are stable and predict differences in individual performance of employees. For over a century, recruiting organizations have been looking for key abilities of people that determine differences in individual performance. There is an anecdote about Alexander the Great, who made military recruits jump off a cliff and swim across a wild river (Guion, 2011). He selected only those into his army who dared to jump and made it to the other shore. In all its simplicity, this was an effective selection method for brave and physically tough soldiers. This ancient example illustrates how the type of job (in this case, soldiering) requires specific abilities (in this case, strength and courage). It also illustrates that people differ in the required abilities (some were not physically strong enough), and that differences in abilities matter for performance (the strongest and most courageous arriving first).

Nowadays, the selection and hiring process is an expensive procedure for organizations if you for instance only think about the recruitment costs for posting job advertisements or being present at job fairs. Furthermore, the firm has to make interview costs and so-called adaptation costs since a new hire is less productive in the beginning than an experienced employee and may need additional training. Mistakes in the hiring process that lead to a mismatch between the KSAs of the selected person and the KSAs needed for a vacancy can therefore have detrimental financial consequences. Furthermore, applying valid recruitment instruments to select the right applicant has an impact on future organizational performance. For example, a utility analysis that compared different selection methods for sales representatives found that using valid selection methods would lead to a 34% increase in productivity. In monetary value, this means that if an average sales representative’s productivity is 126,000 dollar per year, using a better selection procedure could increase this productivity with 43,000 dollar annually (Farrell & Hakstian, 2001). Hence, selecting the right people for the right positions brings substantially larger revenues to organizations, and it will come as no surprise that researchers and practitioners are highly interested in the domain of individual differences and their impact on performance.

There is a wide array of abilities on which people differ that may relate to differences in performance, for example physical strength, intelligence, personality, preferences, motivation, and behavior. For selection purposes, it makes sense to focus on those abilities that are measurable, stable and that cause real differences in performance. Serious research into individual differences related to performance took off in the early 20th century with the work by Spearman (Spearman, 1904). He supposed that there is a latent underlying ability, which he called ‘g’, or ‘general mental ability’, that accounts for differences in performance between people over a variety of tasks. This was a brilliant insight, because selection would be much easier if indeed one ability could explain performance in various domains. It took a few more decades before researchers agreed on the existence and nature of ‘g’, but today the amount of evidence for a few key abilities that matter for performance is impressive. Comparing all kinds of performance domains, the following three abilities stand out: intelligence, conscientiousness and, to a lesser extent, emotional stability.

  1. Intelligence is a latent ability that appears when people perform tasks in which active information processing is involved like solving puzzles, learning a new language, calculating, and making associations. It is the speed with which people process, retrieve and combine information. The general level of intelligence predicts how well people perform all kinds of different tasks. The reason why more intelligent people are better performers at work is because they are able to obtain more knowledge about their jobs and the organization in a shorter amount of time. The better people know their jobs, the better they perform (Schmidt & Hunter, 2004). Because intelligence can be measured by reliable tests, it is an excellent selection criterion that reduces the chance of a wrong hire by 50%. Of all selection instruments, intelligence tests have the highest reliabilities. Moreover, people achieve stable scores on intelligence tests, even over very long periods of time (> 20 years), indicating that intelligence is a characteristic that does not develop after adulthood. And even within groups of a similar educational level, differences in intelligence predict differences in performance. This makes intelligence the most important individual difference characteristic to date (Kuncel et al., 2010).

  2. Personality is the second domain of characteristics that qualifies for finding meaningful differences between people that matter for performance. Personality encompass a relatively consistent style that people show in the way they think, act and feel as they respond to their environment. Definitions of personality mostly relate to personality traits (Hofstee, 1994) which are distinguished entities that can be compared for individuals (Cattell, 1943). This displays that personalities are able to vary across a number of dimensions. Most researchers agree on a model that distinguishes five personality traits, called the Big Five or the Five Factor Model of personality (McCrae & Costa, 1987). The acronym OCEAN summarizes these dimensions: Openness to new experiences (versus conventional), Conscientiousness (versus un-directedness), Extroversion (versus introversion), Agreeableness (versus antagonism), and Neuroticism (versus emotional stability). In an impressive number of studies, each of these dimensions has been related to overall performance (Barrick et al., 2001). However, most effects are quite small and tend to diminish when controlling for overall intelligence. One of the problems concerns the measurability of personality. Other than intelligence tests, personality measures are self-reported questionnaires that ask for people’s self-evaluation of a trait. This requires some level of self-reflection and a lot of honesty. So, compared to intelligence tests, personality measures are somewhat less reliable. This reduces their predictive power. The only two personality dimensions that have a separate and somewhat more substantial contribution to overall performance over and above intelligence are conscientiousness and emotional stability.

  3. Conscientiousness is the preference to work hard, to work neatly and to complete all tasks. This trait does not correlate with intelligence and it correlates positively with performance. This indicates that selection of people based on intelligence in combination with conscientiousness leads to the best prediction of performance. While smart people quickly learn to perform well, conscientiousness will help people to stick to promises and to put effort into bringing their work to a good end.

  4. Emotional stability is the tendency to not experience anxiety or hostility. It also holds no correlation with intelligence, but its relationship with overall performance is weaker than that of conscientiousness. People with stronger nerves are better able to cope with stressors at work, which makes them better able to focus on the task rather than worrying about other things.

The remaining personality traits have no relationship with overall job performance, but they do in some cases matter for particular types of performance. For example, extraversion is a trait that benefits managerial performance, and openness to experience is beneficial for tasks that involve learning and change (Barrick et al., 2001). A thorough job analysis will show which behaviors really matter for a specific position to achieve a great job performance, and for these specific behaviors specific personality profiles can be proposed.

Although several new abilities have been suggested that could additionally qualify as individual difference predictors of performance (e.g. emotional intelligence), none of these have the same research evidence as the three abilities mentioned in this section (intelligence, and the two personality traits conscientiousness and emotional stability).

The reason why these individual differences matter for performance is because people who think fast (intelligence), who are determined to succeed (conscientious) and do not get stressed too easily (emotional stability) are most capable of learning the job and getting results. It is reasoned that this combination of individual capabilities enables people to succeed in education and in learning at the job, which in turn contributes to their achievements at work (performance) and in life (career, health) (Kuncel et al., 2010) (see Figure 2.1).

A diagram showing boxes with arrow drawn between them. The following arrows and boxes have bold outlines. "Intelligence" points to "Learning" and "Job Performance". "Learning" points to "Job knowledge", and "Job knowledge" points to "Job Performance". The boxes "Conscientiousness" and "Goal Orientation" have medium outlines and medium arrows. "Conscientiousness" points to "Learning" and "Goal Orientation". "Goal Orientation" points to "Job knowledge" and "Job Performance". The final box, "Emotional Stability", has a dashed outline and points to "Goal Orientation" and "Job Performance" with dashed arrow.
Figure 1

Individual differences and job performance

Other than the human capital theory laid out by Becker, the individual differences approach was not intended to predict unit-level outcomes such as turnover or organizational performance, but individual performance. However, the individual differences approach does help to detail the essence of human capital before aggregation. Human capital theory and individual differences theories on intelligence and personality are complementary in their conceptualization of human capital. Human capital theory predicts that organization-specific human capital, that is the ultimate source for competitive advantage, develops by learning organization-specific knowledge and skills on the job. According to individual differences theories, more intelligent and more conscientious people are best capable of acquiring job-specific knowledge and skills. The theories therefore underline the importance of selecting those with outstanding abilities and to keep investing in training and development after hiring.

Social capital theory

Human capital theories concentrate on knowledge and abilities that nest in people and that together aggregate to a group of smart and wise employees. Social capital focuses on the interactions between people. It can be broadly defined as the potential that is generated by the network of social relations in an organization and that can be used to enable actions (Adler & Kwon, 2002). For individuals, social capital (knowing who) is as important as human capital (education, knowing what) for career advancement. For organizations, social capital means synergy between employees, which facilitates cooperation and is positively associated with sharing knowledge and creating opportunities to learn and innovate. Social capital is also defined as the goodwill that is available to people or groups: are connected people or groups willing to help and inform each other? Hence, the value of social capital follows from the information, influence and solidarity that are available to people (Adler & Kwon, 2002).

The origins of social capital theory are rooted in thinking about the prosperity of communities. In order to survive and develop, communities have always needed to cooperate not only within the community itself by connecting the talents of people to achieve community goals, but also by relating the community to other groups in order to obtain the resources they need (Jacobs, 1965). In addition, Loury (1977) theorized that networks are important for individual success as well. Both authors emphasized that with whom one has ties in the network and the quality of those ties between actors are an important resource for groups and individuals alike.

Three dimensions of social capital are discerned, namely structural, relational and cognitive social capital.

  1. Structural social capital: The number and pattern of connections that individuals or groups have with others (Granovetter, 1973), also referred to as ‘bridging’. The structure of a network determines who you can connect with to reach a goal for which you need someone else. Connections in a network of relations allow people to build bridges to people they do not connect directly with, but who can provide the resources they need.

  2. Relational social capital: The quality of relations within a network, also referred to as ‘bonding’. Interactions between people are facilitated if people know each other and trust each other. Relational ties are stronger in friendship relations than in business relations. In friendship relations, people are willing to go the extra mile for each other, while business relations are more focused on economic transactions. However, friendship-like relations in business provide a lot of goodwill and are very beneficial to the people involved. Good-quality ties bring cordiality, approval and prestige. For example, employees who hold a good-quality relationship with their superiors will find it easier to get access to information and resources to advance their careers.

  3. Cognitive social capital: The overall climate in an organization regarding the goodwill to share information and trust each other. Some organizations have put facilities and communication in place that facilitates cooperation and teamwork. For instance, implementing team rewards most likely lead to a higher willingness to share knowledge within a team to achieve a greater group performance. The implicit message by organizing work to intensify the amount and quality of relations in the organization is that relating to others throughout the organization is valued behavior, making people more prone to participate in connecting to others.

Social capital is mostly complementary to human capital. By bridging people, ideas and knowledge (human capital) are exchanged, which contributes again to the development of human capital. Moreover, in close and bonded relationships, people are willing to put in effort and share resources, thereby facilitating the flow and use of resources in the organization.

Like human capital, social capital needs maintenance. Without actively reinforcing existing relationships, the quality of those relationships will deteriorate and the connection will diminish. Socializing, communication and cooperation are important behaviors to reinforce and develop relationships and to build social capital. Organizations can stimulate the development of social capital by creating opportunities (structural lay-out of the network should enable cooperation), by motivating to contribute to social capital (promoting trust, interpersonal liking and creating bonds) and by providing the resources that facilitate bridging and bonding (such as communication systems, time) (Adler & Kwon, 2002).

Unleashing human and social capital: Social exchange theory

Human and social capital are ‘stored’ within people who can decide for themselves to put their capital to work for the organization. So, it is not enough to have a set of talented people with excellent social relationships. In the end it comes to their willingness to apply their knowledge, skills and social connections at work to contribute to the goals of the organization. What is missing in the resource-based theories of human and social capital, is the explanation why people would use their human capital at work and why they would generate social capital. Practical observations of performance differences between teams and organizations of equal levels of human and social capital help to understand the need for such a theory. Apparently, in some teams and organizations people are more willing to commit their resources to work than in others.

The most cited theory to explain why people put in effort at work is the social exchange theory (sometimes abbreviated as SET). Social exchange theory is a broad theory about human behavior in relations. It states that relations develop as the result of some universal implicit rules about how to behave in lasting relationships. In SET, relationships are viewed as exchange relationships where people bring something and receive things they want in return. The exact nature of what people want in relations and what they are willing to bring in order to sustain a relationship was outlined by a number of authors in the fifties and sixties. There has been no author who is solely responsible for the development of social exchange theory. The key ideas of the theory are explained by following the contributions of each founding father of SET: Homans (1958) who defined relationships in terms of costs, benefits and exchange, Gouldner (1960) who introduced the norm of reciprocity, and Blau (1964) who extended the ideas of exchange and reciprocity to the organizational context. The three ingredients that capture the essence of social exchange theory are described below.

  1. Relationships as exchange mechanisms. Homans (1958) was a sociologist writing about relations between people. He said that people are essentially hedonistic, looking for fun and pleasure in their lives. Therefore, people behave like “Homo Economicus” looking for relationships which provide them with the most pleasure in exchange for the lowest effort. In order to secure a pleasant relationship, people are willing to invest in that relationship. Efforts invested in a relationship can be both economic and social. Examples of economic efforts devoted to a relationship are time and money. For example, employees invest time in their jobs at the cost of time they could otherwise spend at home, because they get money for it that enables them to have more fun in their leisure time. Social efforts in relationships concern non-tangible input and benefits, such as friendship, attention, love and trust. Social exchange relationships reap much more pleasure than economic exchange relationships. People are therefore more willing to invest in social exchange relationships than in economic exchange relationships. Economic exchange relationships are based on a contract: so much effort for so much returns. Social exchange relationships are more open ended. As long as there is a balanced exchange of love, trust, attention and the like, the relationship will continue to exist. The relationship will end when the benefits (love, friendship, fulfilment of sexual desires) no longer outweigh the costs (conflicts, compromises).

  2. The norm of reciprocity. Gouldner (1960) was a psychologist who wondered why people are even willing to persist in a relationship if there is an apparent unbalance between their perceived input and what they get in return. For example, why do abused women stay with their violent partner? To understand such behavior, Gouldner introduced the norm of reciprocity. Reciprocity is the unwritten rule that one should equally reply to the input of the other in a relationship. This unwritten rule feels like an obligation. If someone smiles at you, you feel the implicit obligation to smile back. If you are asked a question, you automatically sense that you need to reciprocate with an answer. The larger the gesture, the more pressing this sense of reciprocity. This urge to reciprocate the input of others in relationships is an inborn habit of people. Reciprocity expectations are important to people. If you are nice, you expect the other to be nice as well. And if the relationship is valuable to you, you are even willing to go the extra mile by being very nice to the other person because you expect that the other will eventually reciprocate by being nice to you in return. People are even willing to wait for the other to reciprocate over a longer period of time, especially when one has already put a lot of effort into a relationship or if one perceives that the alternatives to this relationship are even worse. In this case, it becomes really difficult to let go of that relationship. This explains why apparently unbalanced relationships do not break up. Although outsiders see the unbalance, the deprived party in the unbalanced relationship still hopes that all their love, attention and efforts will be repaid in the end. After all, having a bad relationship is better than having no relationship at all…

  3. The organization as exchange party in employment relationships. (Blau, 1964) was a sociologist who examined work relationships within organizations. He defined the employment relationship as an exchange relationship between employers and employees. While Homans and Gouldner focused on dyadic relationships between people, Blau theorized that people can also develop relationships with more abstract things such as ‘the organization’. Of course, organizations are not persons. However, employees assign people-like characteristics to organizations. They describe their employer as being good and caring, or as being demanding, discriminating or generally not fair. An organization that is perceived as good and caring will reap social exchange relationships. In organizations that are less nice and where people come to earn an income and nothing else more economic exchange relationships will develop. Because people find social exchange relations more pleasant than economic exchange relations, they are willing to put more effort into employment relationships that offer them things they like from social exchange (attention, growth, trust), than in employment relations that are based on the economic exchange (just wage for the hours worked and nothing else). The norm of reciprocity dictates that if the organization exceeds the expectations that employees have about what the organization should do, employees feel the implicit obligation to return the organization’s good care with extra effort. So when an organization offers an excellent package of benefits, employees will be motivated to work very hard and as such compensate for their employer’s kindness.

Today you see that these essential ideas laid out in social exchange theory have inspired many theories about people at work, for example to what extent the relation between leaders and subordinates influences the follower to put in extra effort (Graen & Uhl-Bien, 1995), or how the frustration of expectations that employees have about their employer leads to compensating behavior (Rousseau, 1995) and how employees perceive the behavior of managers representing the intentions of the ‘person’ of the organization (Rhoades & Eisenberger, 2002). Moreover, social exchange theory inspired work on justice and trust in the context of the employment relationship (Colquitt et al., 2001).

The important lesson from social exchange theory is that while investing in the development of human and social capital, organizations have to think about the employment relationship in which employee-owned human and social capital are exchanged for salary and other inducements favored by employees. Although employment relationships start as business relationships defined by a contract in which people agree to spend their time, knowledge and effort on behalf of the organization in return for income, it has the potential to grow into an open-ended social exchange relationship with a willingness to put in more effort than contractually agreed on.

Social exchange is especially used to explain employee behaviors that go beyond contracts, such as organizational citizenship behavior and organizational commitment. Organizational citizenship behavior (OCB) is behavior that is not formally required by the employer in a job description, but which contributes to the overall functioning of the organization (Organ, 1997). An example of organizational citizenship behaviors is talking positively about the employer to people outside of the organization, or working extra hours to get the work done, or helping new team members find their way in the organization. Organizational commitment expresses that people choose to stay with their employer instead of looking for a better job (Allen & Meyer, 1990). High employee turnover, the opposite of commitment, causes destruction of human and social capital and leads to high hiring and training costs for the organization. By investing in employment relationships, employees will perceive these as a social exchange relationship and organizations will benefit most from the potential of acquired human and social capital.

The next section shows some of the overwhelming research evidence for each theoretical contribution presented in this section.

Key research

There is a tremendous amount of literature about the relationship between HRM and performance, and many of those build on the theories explained in this chapter. The selected research that is presented below explicitly focuses on human and social capital in relation with organizational performance, showing the ‘evidence’ that the proposed mechanisms matter for businesses.

  1. Human capital generated through education and experience. A meta-analytic study by Crook et al. (2011) took all studies between 1991 and 2011 into account that took a measure of human capital and related it to some indicator of organizational performance (N=66 studies, n > 12,000 observations). Human capital measures encompassed for example investments in training or the aggregated amount of experience of the board of directors. Performance indicators were for example the financial performance of organizations, or the average employee productivity. On average, they found an overall effect of r = .21 between human capital and organizational performance. To give an example, a one standard deviation increases in human capital (i.e. the aggregated amount of experience of the board of managers) from 35.2 to 59.4 years, on average, translates to an increase in ROA (return on assets) from .05 to .09, an 80% improvement. Hence, human capital pays off. The study further shows that company-specific human capital yields even greater returns on investment than general human capital. This difference was rather large. It implies, for instance, that a management team with a lot of specific organizational experience, as expressed in the number of years they have worked together in the organization, would be more productive than a management team with very bright MBA graduates who have a shorter aggregated tenure in the organization.

  2. Human capital generated through individual differences. The key assumption that individual differences in intelligence and personality relate to individual performance differences has been very well researched (Barrick et al., 2001)(Kuncel et al., 2010). As well-examined in a number of studies is the assumption that a workforce with higher average intelligence, conscientiousness and emotional stability also yields better performance at the team- and organizational level. Despite difficulties that derive from aggregating individual characteristics to some group level characteristic (for example: Should everybody be smart? Or is it better to have a mixture? Or do different personality traits matter at the group level but not at the individual level?), existing meta-analyses support the straightforward idea that higher average intelligent groups perform better as can be found in the meta-analysis by (Devine & Philips, 2001). Similarly, a higher average conscientiousness relates to better team performance (Peeters et al., 2006). However, at the team level, the trait ‘agreeableness’ is more important than emotional stability for performance. Being nice and accepting towards others is a trait that is more beneficial to team processes than emotional stability, which is most important for individual level performance.

  3. Social capital. Westlund and Adam (2010) examined the value of social capital impacting various outcomes for individuals, organizations and societies. For organizations, the results were unambiguous: there is strong evidence of the impact of social capital on organizational performance (Westlund & Adam, 2010). Furthermore, there is abundant evidence for the importance of all social capital dimensions for knowledge creation (Van Wijk et al., 2008), team performance (Balkundi & Harrison, 2006) and employee retention (Moynihan, 2017).

  4. Inducing social exchange by investing in people. A study by Tsui et al. (1997) compared organizations with respect to the type of employment relationships they hold with their employees. They distinguished among others a type where organizations hold purely economic exchange relationships with employees (short-duration contracts, no further incentives) and compared that with organizations that aimed for social exchange relationships with their employees (open-ended contracts, a lot of extra inducements). In line with the predictions of social exchange theory, they found that the level of job performance, organizational citizenship behavior and employee commitment was much higher in organizations that really invested in their employees beyond the employees’ expectations compared to those holding economic exchange relationships with their employees (Tsui et al., 1997). Other longitudinal and meta-analytical evidence underlines that the behaviors induced by social exchange (OCB, commitment, satisfaction) result in better organizational performance (Koys, 2001).

  5. ‘Human resource’ capital and competitive advantage. Much of the research on the effectiveness of HRM in relation to organizational performance builds on the human and social capital theory in combination with social exchange theory presented in this chapter. The key finding of meta-analyses is that investing in people by creating a system of HR practices that improves human capital, social capital and employee reciprocity behavior matters for organizational performance. As a reference, see for example Combs et al. (2006), Jiang et al. (2012) and Subramony (2009). The following section will highlight HR practices organizations can implement to achieve a great performance because these develop and foster human and social capital as well as facilitate social exchange.

HR Practice

Many HR practices aim to contribute to the development of human and social capital, and to the motivation of people to utilize their human and social capital to benefit organizational goals.

HR practices for human capital

The most obvious HR practices that contribute to human capital are selection and employee training and development.

Selection happens before people enter the organization and is about applying techniques that reduce the uncertainty about the performance potential of new recruits. Given the rather straightforward findings of individual differences literature, one would assume that selecting by intelligence is a no-brainer. In practice, however, the uptake of selection techniques that really make a valid judgment about intelligence and conscientiousness is surprisingly low (Rynes et al., 2002). The most-used selection technique by managers is a simple non-structured interview in which hiring managers ask any question that pops into their heads. In such interviews, so-called rater mistakes easily interfere with sound judgment. Been to the same university? Great! Got a scholarship? Must be excellent at any other non-related skill. The power to make the right prediction based on such non-structured interviews is very low. The reason why its value is not completely zero, is because more intelligent people better know how to ‘play’ their interviewers, and get selected more quickly (Ng et al., 2005; Ployhart, 2006; Schmidt & Hunter, 1998). There are, however, more reliable ways to predict a candidate’s performance. Here is an overview of the most valid selection techniques:

  • Tests for intelligence and personality. There exist many short, reliable tests for intelligence and personality. Intelligence tests involve doing tasks that require cognitive processing of information, for example solving puzzles, analyzing texts or figures and making logical connections. Most tests for intelligence used in selection are speed tests in which applicants have to solve a series of tasks within a limited amount of time. The number of correct answers of a candidate is compared to the distribution of results of a norm group. Those who score more than one standard deviation above average people with the same background characteristics in the norm group (the same educational level) have a higher-than-average intelligence. Personality tests measure people’s preferences for behavioral styles. Other than intelligence tests, these have no ‘right or wrong’ answer format. Personality tests are therefore slightly more subject to socially desirable answering by candidates. This means that knowing the job requirements can lead candidates to give answers they think the organization wants to hear rather than their real preferences. A good personality test is constructed in such a way that socially desirable answering is difficult. The interpretation of personality test results is comparable to that of intelligence tests. A candidate’s preferences are compared to the average preferences of a relevant norm group. Those who score higher on a desired personality trait (for example conscientiousness) are likely to be better performers at work. The costs for using a test in a selection procedure are relatively small, given the return that selecting the best candidate will bring to the organization. Advice about the appropriateness of a test should always be considered when purchasing a test to ensure that a valid instrument is used.

  • Structured interviews. Interviews are the most widely used selection method. However, not all interviews are useful in making good selection decisions. Most selection interviews are unstructured interviews. The disadvantages of these types of interviews are that they are ill-prepared, different for each candidate and subject to all kinds of rating mistakes. Good selection interviews are structured. This means that interview questions are based on an analysis of job requirements, that there is a scoring form to rate the candidates’ answers to the questions, and that all candidates are asked the same questions so that they can be compared. Structured interview questions can serve to test job knowledge, to see if candidates are capable of performing relevant job behavior and even to measure personality. Structured interviews are not difficult or expensive; they just require a little more preparation than a traditional unstructured interview.

  • Work samples. Work samples are exercises that take a part of the job and require people to perform that part of the job as well as they can. Work samples can involve showing a skill (a stonemason’s work sample can consist of laying bricks), having a conversation (a managerial work sample typically involves some conversation with a subordinate), doing a presentation or analyzing documents. Work samples mimic the behavior that is required in the actual job. They are based on the idea that if people are able to perform the behavior now, they will probably be able to show the same behavior in the future on the job. Work samples have high predictive validities, meaning that they are good instruments to use in selection. There is, however, some debate about work samples as compared to structured interviews and tests, because of their high development costs and the changing nature of jobs. Work samples that mimic the actual job the closest tend to have better predictive validity than those that are more generic situations. But developing a specific work sample for every job is quite expensive. Moreover, jobs tend to change and this could result in outdated work samples. Some researchers therefore argue that it is better to select on stable characteristics like intelligence and personality, because smart and hard-working people will be able to learn changing job requirements. Put more technically, the predictive validity of work samples reduces over time, while the predictive validities of intelligence and personality are stable predictors of future performance over a longer period of time.

Training and development most likely take place after organization entry and consider all activities aimed at increasing knowledge, skills and abilities of people. The chapter on learning organizations will further elaborate on theories and evidence about learning and development. In this chapter on Investing in People, the focus is on the question how to invest, in order to improve the human and social capital. Here are some examples:

  • Strategic human resource development plans. Given the expenses incurred by training and development activities, a strategic investment in creating training budgets will yield the largest return on investment. This may involve understanding the most critical functions in the organization, investigating knowledge gaps and weaknesses and drafting a training and development plan for those positions.

  • Training budget. Simply allowing all employees to work on their own development by offering and financing training and learning activities will stimulate the workforce to keep their human capital up to date.

HR practices for social capital

To improve social capital, we need to turn away from individual characteristics and focus on interactions between people in organizations. HR practices that stimulate cooperation are work design interventions in which people have to work together, meet and interact.

  • Self-managed teams. Delayering organizations and transferring decision authority to teams stimulates the necessity to work together within teams and to build bridges to other individuals and teams in organizations. This will increase the number and the quality of social ties in the organization.

  • Cross-functional collaboration projects. Deliberately form teams of people from different departments to solve complex organizational challenges.

  • Office lay-out. Simply thinking about the design of offices can stimulate social ties. Many bright ideas develop from meetings at the coffee machine.

  • Socializing events. Create opportunities and communicate the importance of socializing at work.

  • Employee involvement. Ask employees for their input concerning their work, their team and the operation and strategy of the organization. This improves horizontal ties between co-workers, but also improves the hierarchical ties from merely sending to really sharing in top-down relationships.

HR practices for social exchange

Finally, to improve social exchange in the employee-organization relationship, organizations can design HR practices that make employees feel they are appreciated. Examples of HR practices to stimulate a social exchange relation of employees with their employer include:

  • Excellent packages of pay and benefits. In particular, systems of benefits that are valued by individual employees. The more employees feel their remuneration package fits their needs, the more they will appreciate their employers. Organizations can offer pensions, insurances, flexible working arrangements and reimbursement of travel expenses.

  • Career development opportunities. Offering career paths is highly appreciated by employees. People feel valued when they see positive prospects to increase their own human capital.

  • Performance feedback and appraisal. Managers who take the time to communicate, give feedback and praise each individual employee will stimulate the relationship quality with subordinates and motivate social exchange induced behaviors. Verbal appreciation by superiors is even more important to generate social exchange than impersonal systems of bonuses.

The above list of HR practices is far from complete. There are many creative ways in which organizations work on improving human and social capital and social exchange. Evidence-based practitioners can build on many examples of specific HR interventions in the literature. Also, the insights from the theories presented in this chapter will contribute to drafting new types of interventions.

This chapter showed the key theoretical contributions to understand the importance of strategic people management in organizations. First, resource-based theories point out the potential that organizations can build a strategic advantage by having a unique quality of resources. Human resources, the set of people and their skills, knowledge and abilities contributing to achieving organizational goals, are an important source for achieving such unique competitive advantage. Human capital develops through education and training, and by cleverly selecting the best people from the pool of naturally occurring differences in intelligence and personality. In addition, strategic investments in the layout of collaboration in organizations stimulates the development of social capital, which facilitates the application of human capital to benefit the organization. Finally, social exchange theory illustrates that in order to fully benefit from human and social capital, conditions should be created that motivate people to exchange their goodwill and resources in relation with each other and the organization.

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