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Solving for the Value of HR

by Marguerite Darlington Thursday, February 11, 2016

How the introduction to a special issue of the Academy of Management Journal became one of the most cited academic papers on human resources

In 1996, Barry Gerhart, then an associate professor at Cornell University, and his co-author Brian Becker introduced a revolutionary idea to the academic discipline of human resources—not only is human resources management valuable to a company’s bottom line, but it’s possible to quantify that value.

barry gerhart wisconsin school of business university of wisconsin madison

Barry Gerhart, Bruce R. Ellig Distinguished Chair in Pay & Organizational Effectiveness at the Wisconsin School of Business of the University of Wisconsin–Madison

“When this paper came out, Vanderbilt University contacted me and asked me to interview for a position as an endowed chair in human resources,” remembers Gerhart, now the Bruce R. Ellig Distinguished Chair in Pay & Organizational Effectiveness, professor of management and human resources, and academic director of the Strategic Human Resources MBA Program at the Wisconsin School of Business of the University of Wisconsin–Madison. “My co-author Brian Becker was also asked to come down. I think that part of the reason was that this article was coming out, and it was going to be pretty visible.”

They couldn’t predict exactly how visible. The article, “The Impact of Human Resource Management on Organizational Performance: Progress and Prospects,” was an assessment of where the field had been and where it needed to go, and also was intended to tee up and integrate some of the first empirical Academy of Management Journal research articles intended to help the field advance by studying a key theme: How do HR practices create value for organizations and employees?

“One purpose of this article was to re-orient the field from a micro-level of focus to a macro level—from an individual level to a plant or business level,” says Gerhart. “The idea was to move on from studying how managing individual employees relates to each person’s performance rating to how the design and execution of management practices affect the entire workforce and influence the firm’s bottom line.”

Once this idea was introduced, it signaled a sea change in the industry, introducing a 21st century vision of human resource strategy as critical to successful execution of the firm’s business strategy and profitability of a company.

A special issue that changed everything

The study of human resources focuses on strategies and decisions related to managing people, whether made or executed by line managers or by those in the human resources department. Prior to the mid-1990s, relatively few companies recognized that people, even those at lower levels in the organization, could be a source of competitive advantage and revenue generation, not just a cost to be minimized.

Likewise, in many organizations, the role of human resources departments was primarily transactional—performing administrative functions relating to employees’ needs, including processing payroll, arranging sick leave, and benefits administration; and the academic discipline of HR was focused on how to better predict the success of individuals within an organization. There was often little emphasis on how human resource activities and decisions affected the bottom line.

“A lot of the work that was done before was around predicting applicant characteristics or traits that would predict performance, including personality, cognitive ability, and values,” Gerhart says. “The problem is that these individual characteristics don’t have much to do with the performance of the organization as a whole. For example, you can find organizations that give out all kinds of high performance ratings even though the business is not doing very well.”

Then, in 1996, Gerhart and Becker were asked to co-edit a special issue of The Academy of Management Journal filled with groundbreaking research around a common theme—that how a firm managed its human resources could differentiate it from other firms in a way that created value and, importantly, might be difficult for other firms to imitate. If so, human resources could be an important source of sustained competitive advantage, and an important tactic for outperforming competitors over the course of many years.

“At the time, there hadn’t been much of that work done at all, but Becker and I were two of the people doing it,” Gerhart says. “Becker had mostly studied the effects of labor unions on profitability, and I had studied the effect of different compensation strategies on firm profitability.”

Testing the idea and deepening expertise

Gerhart didn’t plan on being an expert in how compensation or human resource strategies more broadly affect organizational value.

barry gerhart management and human resources wisconsin school of business university of wisconsin madison

Gerhart holds the latest edition of the Compensation textbook.

“In fact, the first paper that I wrote in 1990, I wasn’t convinced that it was possible to isolate the effect of pay strategies on firm performance, but my co-author and mentor, George Milkovich, talked me into it,” says Gerhart. “To my surprise, that article was named the best article published in human resources that year by the Academy of Management. Decades later, I continued to work with George on Compensation, which is now the leading textbook on the subject.”

Later, Gerhart was invited to deepen his expertise in quantifying the value of HR to an organization’s bottom line in a unique context—by working with a leading consulting firm to study whether or not there was actually a financial benefit to having a top-rated workplace culture.

In the Personnel Psychology article, “Are the 100 Best Better? An Empirical Investigation of the Relationship Between Being a Great Place to Work and Firm Performance,” Gerhart and his co-authors discovered that positive employee relations resulted in a competitive advantage that was measurable in the broadest market terms.

“We used Fortune magazine’s list of the 100 Best Companies to Work For, and looked at the average return of about 60 of the Top 100 because we could examine only publicly held companies,” says Gerhart. “We tracked those companies for three years, as well as a couple of comparison sets of companies. We matched some companies based on industry and size, and we also used broad stock market indexes for the other comparisons.”

Applying the theory to a global model

In 2014, Gerhart and his co-authors performed a meta-analysis of 150 studies worldwide to determine whether particular types of management practices are more effective in some countries than in other countries.

“When you find evidence that these types of practices work in the United States, you want to know, does this work elsewhere?” Gerhart says.

The team examined HR practices—including pay for performance, employee participation in decisions, selective hiring, and investment in professional development—designed to provide employees with the motivation, ability, and opportunity to contribute to firm performance. Often referred to as “high performance work practices,” Gerhart and his co-authors assessed the effectiveness of these practices across different countries.

“They didn’t really differ that much,” says Gerhart. “We found that these practices had similar rates of effectiveness regardless of country, national culture, or institutional flexibility. Organizations that use more of the ability-, motivation-, and opportunity-enhancing practices seem to experience higher business performance across countries.”

The authors suggested, in fact, that in a global economy where firms increasingly compete not just with domestic firms, but also with firms from around the world, it is no longer sufficient to be competitive with domestic firms. Rather, performance—and the management practices necessary to achieve it—must meet a global standard of performance.

Gerhart and his co-authors earned international acclaim for this work—the Academy of Management named this article the best in the field of international human resources for 2014.

Changing the way companies operate

As academics continued to examine the idea that effective personnel management offered a quantifiable, strategic value to organizations, the idea gained traction in industry as well—and the way that top companies operationalized the human resource function began to shift.

In 2007, the Society for Human Resource Management conducted a survey of more than 200,000 members in an effort to uncover the state of current HR practices, and they discovered a significant shift from transactional practices to strategic planning, a trend toward measuring outcomes and adjusting strategies. 

“I think there’s been a shift in organizations within the United States and in other countries,” says Gerhart. “To some extent, organizations were doing it before academics. It’s hard to tell. Typically, an organization will say it’s worked for us and then an idea is brought into an academic context to substantiate the practice.”

The workplace has changed significantly since Gerhart and Becker’s article was written. Today, top executives from Fortune 500 companies are employing strategic use of human resource management—from startups to tech giants to consumer goods manufacturers—and reaping the benefits of these performance practices.

Measuring the benefits of motivation

A lot has changed since the 1996 paper was published—Gerhart has served as chair of human resources departments at Wisconsin, Cornell, and Vanderbilt. He has published numerous highly cited articles, as well as several books, and has been inducted as a Fellow of the Academy of Management (AOM) and received the Heneman Career Achievement Award in Human Resources, also from AOM.

Through it all, Gerhart is still committed to improving the rigor of research on the effects of human resource strategy on company performance.

“I believe the evidence shows there is a relationship and that it is economically meaningful, but when it gets into estimating exactly how big the effects are, that’s where we need to control for other factors that might influence financial performance, compare multiple companies in the same industry, think through how we collect the data, and measure human resource and human capital practices and attributes,” Gerhart says. “I do think that there’s very strong evidence that how you manage people makes a major difference. In most industries, firms that are more effective in managing human capital perform better over time.”

Read the full article, “The Impact of Human Resource Management on Organizational Performance: Progress and Prospects."