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Human resource involvement indeveloping intellectual capitalStephen T.T. Teoa, Kira Kristal Reedb & Karen Lyc

a AUT Business School, New Zealand Work Research Institute, AUTUniversity, Auckland, New Zealandb Martin J. Whitman School of Management, Syracuse University,721 University Avenue, Office 514, Syracuse, NY 13244–2450, USAc IBM Australia, Sydney, AustraliaPublished online: 04 Aug 2014.

To cite this article: Stephen T.T. Teo, Kira Kristal Reed & Karen Ly (2014): Human resourceinvolvement in developing intellectual capital, The Service Industries Journal, DOI:10.1080/02642069.2014.942651

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Human resource involvement in developing intellectual capital

Stephen T.T. Teoa∗, Kira Kristal Reedb and Karen Lyc

aAUT Business School, New Zealand Work Research Institute, AUT University, Auckland,New Zealand; bMartin J. Whitman School of Management, Syracuse University, 721 University

Avenue, Office 514, Syracuse, NY 13244–2450, USA; cIBM Australia, Sydney, Australia

(Received 21 December 2012; accepted 26 January 2014)

This study examined the extent of a strategic approach to human resource (HR)management in small and medium professional service firms, and if it is used todevelop intellectual capital (IC). Data were collected from 165 Australianprofessional service firms. Path analysis showed that HR involvement and theadoption of a collective set of strategic HR practices contributed positively to IClevels (particularly human, social and organizational capital). IC acts as a mediatorbetween HR practices and firm performance. HR practices alone did not increase theperformance of the firms studied. The findings are unique in the context of studieson small- and medium-sized professional service firms in that a holistic approach toassessing both HR practices and all IC components was taken rather than examiningthe individual construct relationships. In the context studied, HR influence is criticalto increasing IC.

Keywords: intellectual capital; human resources; performance; professional service

In recent years, there has been an increasing interest in the strategic management literature

in the ways in which knowledge-intensive firms are special. A knowledge-intensive firm

has been referred to as ‘a company where most work can be said to be of an intellectual

nature and where well qualified employees form the major part of the workforce’ (Alves-

son, 2000, p. 1101). Professional service firms are an example, or a subset, of knowledge-

intensive firms as they employ highly skilled individuals, produce, distribute, and use

knowledge and information as their source of competitive advantage. The significance

of intangible assets in knowledge-intensive firms has led to them being considered an

important source of competitive advantage (Teece, 1998). Therefore, knowledge

workers, who form the knowledge base of these firms, are critical to their success; yet

little is known about the human resource (HR) management of these workers.

In the HR management literature, there is a continuing interest in how HR management

is being used as a value-adding function in firms’ creation and maintenance of competitive

advantage, as signified by the study of the impact of HR practices on knowledge transfer

(see Minbaeva, 2005). However, a relationship which has not received much research is

between a strategic approach to HR management and the survival of small- and

medium-sized firms. Thus far, the findings are inconclusive. For instance, some studies

# 2014 Taylor & Francis

∗Corresponding author. Email: stephen.teo@aut.ac.nz

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such as Duberley and Walley (1995) conclude that small firms do not adopt HR practices

because they lack HR management expertise and resources. Others, such as Sels et al.

(2006), reported the presence of a strategic approach to HR management by small- and

medium-sized firms in Belgium but it was unclear how generalizable these findings

might be. Therefore, the first aim of this study is to examine the extent to which small-

and medium-sized professional service firms adopt a strategic approach to HR

management.

Another topic that has received attention in the last few years is intellectual capital

(IC). While there is a significant amount of literature supporting the importance of lever-

aging knowledge to create core capabilities in achieving a competitive advantage (for

example, Jackson, Hitt, & DeNisi, 2003), few empirical studies exist to show the relation-

ships between strategic HR management and IC levels, particularly in knowledge-inten-

sive firms as most prior studies utilize cross-sectional samples. Additionally, the

theoretical portion of prior IC studies emphasized the impact strategic HR management

has on the human capital component of IC rather than the collective level of IC. A com-

prehensive talent and resource management objective exists for managers or owners of

small- to medium-sized service firms because the human capital of these firms is, in

essence, the product they are selling. Thus, the employees are the embodiment of all

three components of IC (human, social and organizational capital) in the eyes of the cus-

tomer, making them an interesting sample to study. Therefore, the second aim of the study

is to assess how professional service firms’ collective IC affects performance.

Strategic HR management in small- and medium-sized firms

As noted earlier, there are inconclusive findings on the adoption of strategic HR manage-

ment practices in the literature utilizing small- and medium-sized firms as a sample. De

Kok and his colleagues concluded that smaller firms generally make less use of HR prac-

tices (de Kok, Loraine, Uhlaner, & Roy, 2002) and that HR practices tend to be ad hoc and

informal (de Kok & Uhlaner, 2001). It is suspected that the reasons for the lack of soph-

isticated HR practices is in part due to the lack of time and financial resources and the

absence of HR experts (Klaas, McClendon, & Gainey, 2000; de Kok & Uhlaner, 2001).

On the other hand, others such as Bacon, Ackers, Storey, and Coates (1996) and Golhar

and Deshpande (1997) indicate that HR practices in smaller firms may be more sophisti-

cated than previously expected. Bacon et al. (1996) suggest that small business managers

are increasingly aware of new management approaches such as teamwork, devolved man-

agement, and performance appraisals. Additionally, Golhar and Deshpande (1997) find

that many HR practices do not differ significantly between large and small firms.

The level of sophistication of HR practices adopted by small- to medium-sized firms

may be a function of the expertise and relative status of its HR department. Glass (1988), in

his study of 13 large corporations, finds that higher performing firms make greater efforts

to involve HR executives in the planning and decision making process. Golden and Rama-

nujam (1985) argued that, as the HR management function becomes more influential in an

organization’s strategic decision making process (for example, formulation and

implementation of strategies), it will be perceived by senior and line management to be

more effective when evaluated against their performance outcomes. This is supported

by Barney and Wright (1998) as they urged HR management functions to be strategic

and add value during business challenges. Wright, McMahan, McCormick, and

Sherman (1998) found a strong relationship between the HR department’s involvement

in the strategic decision making process and the achievement of organizational goals.

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They argued that the higher the perceived status of the HR management area, the higher is

the perceived contribution of that area. Research has shown that a strategic approach to HR

management can be demonstrated by the coherent set of HR practices which are formu-

lated to achieve organizational outcomes (Barney & Wright, 1998). Various studies

have noted that a coherent set of HR practices are strategic HR management practices

were they are formulated to consider the alignment between organizational and HR man-

agement strategies (e.g. Snell & Dean, 1992; Teo, Le Clerc, & Galang, 2011). Therefore,

HR departments’ influence facilitates the implementation of the necessary set of HR prac-

tices for developing core competencies in professional service firms. Hence, it is hypoth-

esized that:

H1. There is a positive relationship between HRs’ involvement in strategic decision makingand the implementation of a coherent set of HR practices.

HR practices and firm performance

There are several approaches to the operationalization of ‘strategic HR management’.

Scholars such as Teo et al. (2011) have used Snell and Dean’s (1992) determination of

HR practices that are human capital enhancing in that they emphasize human capital

accumulation and can have a direct influence on firm productivity. Human capital is a

vital aspect of professional service firms, as shown by Hitt, Bierman, Shimizu, and

Kochhar (2001), Chang and Chen (2011), and Rodwell and Teo (2004). HR practices

(such as staffing and training) were used by health service organizations to create the

necessary human capital required for enhancing organizational performance. These prac-

tices attempt to successfully harness an organization’s human capital, particularly employ-

ees’ collective knowledge skills and abilities (Rodwell & Teo, 2004). These practices were

also found in small- and medium-sized manufacturing firms in Australia as HR practices

(such as staffing, training, performance appraisal and compensation) were used to posi-

tively impact manufacturing performance outcomes (Teo et al., 2011). The theoretical

foundation of these studies is the concept that the human capital firms possess (including

skills, experience, and knowledge) has economic value to firms (see Snell & Dean, 1992,

p. 468). This perspective is relevant for professional service firms, as shown by Chang and

Chen (2011) and Georgiadis and Pitelis (2012). These studies have shown that human

capital is a key source of competitive advantage in the service industry. More recently,

a meta-analysis by Crook, Todd, Combs, Woehr, and Ketchen (2011) showed that

human capital could lead to better firm performance. Hence, human capital is the lens

in operationalizing strategic HR management in the current study. Therefore, it is expected

that:

H2. There is a positive relationship between an HR management system designed to enhancehuman capital and perceived firm performance.

Intellectual capital and strategic HR management

Professional service firms are knowledge-intensive firms. A theoretical frame used to

examine professional service firms is that of the resource-based view perspective. In

order for knowledge-intensive firms to perform better than their competitors, they have

to integrate and apply their specialized knowledge than their competitors (Grant, 1996).

They rely on knowledge as a source of competitive advantage. The resource-based view

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emphasizes internal firm resources as sources of competitive advantage (Barney & Wright,

1998; Wright, Dunford, & Snell, 2001). Hitt et al. (2001) applied the perspective to

examine the performance effects of human capital in a sample of law firms. Consistent

with Barney and Wright (1998), Hitt et al.’s study provided empirical support for utilizing

internal firm resources (such as human capital) as a basis for the implementation of com-

petitive strategies.

Another example of internal resources is IC. Reed, Lubatkin, and Srinivasan (2006)

showed that IC is a scarce resource and can be explained using the resource-based

view. Previous research (Reed et al., 2006; Subramaniam & Youndt, 2005; Youndt &

Snell, 2004) operationalized IC with three components. IC is conceptualized as the sum

of all knowledge and knowing capabilities that can be utilized for gaining a competitive

advantage (Youndt, Subramaniam, & Snell, 2004). IC is the sum of internal and external

sources of knowledge-intensive firms have in their arsenal to gain competitive advantage

(Youndt et al., 2004). Following Youndt et al. (2004) and Reed et al. (2006), the current

study adopted the same operationalization of IC, which comprised three sub-components:

human, social, and organizational capital.

To sustain firm performance, firms need to build upon their core competencies to

create knowledge as a resource. It is important for senior management to ensure that

knowledge workers interact substantially with clients and colleagues, have up-to-date

information and technological systems, and are adept at accumulating and retaining the

three different IC components to be competitive. This has brought legitimacy to the HR

management area and the assertion that people are strategically important to firm

success (Barney & Wright, 1998; Wright et al., 2001).

Specific HR practices can be used by firms to enhance the internal labour market by

developing the knowledge and skills of these employees (Youndt, Snell, Dean, &

Lepak, 1996). Collins and Smith (2006) show that HR practices, if designed appropriately,

can also positively affect the social climate conditions (for example, trust, cooperation,

and shared codes and language), which improves the level of social capital. This is essen-

tial in knowledge-intensive firms, which require a great deal of knowledge exchange and

integration, and positively impacts firm performance.

Essentially, organizational capital plays a significant role in the storing and filing of

information in knowledge-intensive firms. More importantly, organizational capital

encompasses structures and the organizational culture of firms. It dictates ‘how things

are done’. It is these structures and the culture of the business that influence how social

norms and networks are developed. Without social capital, organizational capital will

be a set of lifeless, rigid systems that cannot be utilized. In essence the component of

social capital is an important aspect of organizational capital, in terms of networks and

relationships between employees that allow these systems and networks to be utilized

towards the contribution of firms’ performance. Although organizational capital provides

the basis of an organization’s system, it is the social capital of individuals that allows for

these systems to be put into use.

It is further asserted that firms’ ability to acquire, integrate, store, share, and apply their

knowledge first requires employees who possess the appropriate knowledge, skills, and

abilities. These will form the capabilities required for building and sustaining a competi-

tive advantage. Tan, Plowman, and Hancock (2007) find IC to be positively related to firm

performance. Reed et al. (2006) found that the three-way interaction in which each of the

IC components were combined was a more comprehensive and significant predictor of

financial performance. Hence the following is expected:

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H3. There is a positive relationship between HR management systems designed to enhancehuman capital and IC.

H4. There is a positive relationship between IC and firm performance.

H5. The relationship between HR management systems designed to enhance human capitaland firm performance is fully mediated by IC.

Based on the above literature review, the following research model (Figure 1) was devel-

oped. It adopts a strategic HR management theoretical framework to examine how HR’s

influence effects both the adoption of a human capital-enhancing HR management system

and the overall level of IC. It is then expected that higher IC leads to professional service

firms’ performance outcomes.

Methodology

The study targeted a sample of small- and medium-sized professional service firms drawn

from the Dun and Bradstreet Business Who’s Who of Australia database. The database lists

companies according to Standard Industrial Classification codes. As the literature shows,

the HR function typically exists informally in smaller firms, under the direct control of

owner–managers (Marlow & Patton, 1993). These individuals were targeted by sending

them the questionnaire together with a cover letter to explain the purpose of the study.

A self-addressed, postage-paid reply envelope was also enclosed. A follow-up occurred

approximately four weeks later; 1072 questionnaires were mailed to senior executives

of professional service firms within industries such as legal services (129 firms), account-

ing services (446 firms), management consulting services (383 firms), commercial econ-

omic, sociology, and education research (129 firms), and non-commercial research

organizations (50 firms).

The study received a response rate of 15.4% (N ¼ 165) after deleting returned mail

due to change of address and/or a person having left the organization. This is double

the response rate normally expected using a ‘cold’ direct mail approach where respondents

were not contacted prior to receiving the questionnaire and letter of introduction (Reed,

1998).

More than half of the professional service firms (55.8%) employed fewer than 50

employees. Fewer than half of the respondents (40.8%) held positions such as managing

director, CEO, or managing partners. These respondents reported that they were the person

authorized to co-ordinate and finalize their organization’s HR strategies. The other group

of respondents (49.4%) comprised HR managers who reported one hierarchical level

between themselves and the most senior executive of the professional service firms.

Figure 1. Theoretical model.

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The path model developed for this study was analysed using partial least-squares

(PLS) latent path model (see Hair, Hult, Ringle, & Sarstedt, 2013). PLS can accept

smaller sample sizes because ‘each causal subsystem sequences of paths is estimated sep-

arately . . . and is particularly suitable for studies in the early stages of theory development

and testing . . . ’ (Johansson & Yip, 1994, p. 587). PLS also allows the incorporation of for-

mative constructs, which other structural equation modelling software are not able to do

(Chin, 1998). The sample size of 165 cases was more than sufficient to achieve a

medium effect size of 0.80 for a path model with four constructs (Green, 1991, p. 503).

The significance of PLS parameter estimates was assessed by using the bootstrap

option incorporated within the SmartPLS v.2 software (Ringle, Wende, & Will, 2005).

The bootstrapping procedure is carried out to provide extra confidence that the results

are not sample-specific by using repeated random samples drawn from the data. In this

instance, the bootstrap procedure was repeated until it reached 500 bootstrap samples.

Measurement variables

Strategic involvement of HR management area (reflective scale). Strategic involvement of

the HR management area was operationalized by adopting the seven items from Wright

et al. (1998). These items reflect the literature on the status and influence of the HR man-

agement area (Galang & Ferris, 1997; Teo et al., 2011; Wright et al., 1998). Respondents

were asked to indicate their response on a seven-point scale, ranging from ‘1 ¼ not at all’

to ‘7 ¼ to a great extent’. Sample items include: ‘Provide input into the organization’s

long-range strategic planning’ and ‘Meet with the organization’s manager to discuss

HR issues’. This scale has a composite reliability coefficient of .95.

Human capital-enhancing HR management system (formative scale). A human capital-

enhancing HR management system comprised 31 HR practices that can be used to

attract, train, motivate, and compensate HR. They were adopted from Snell and Dean

(1992) and Zhu, Chew, and Spangler (2005). These items were previously tested in the

Australian context (see Rodwell & Teo, 2008; Teo et al., 2011). Respondents were

asked to answer questions referring to the HR management systems used for the core

workforce in their organization. Five reflective sub-scales that emphasize an HR manage-

ment approach were formed. These were: selective staffing (Cronbach’s a ¼ .75), devel-

opmental performance appraisal (Cronbach’s a ¼ .79), training (Cronbach’s a ¼ .64),

and compensation (Cronbach’s a ¼ .64). These sub-scales were then used to form a

second-order reflective latent variable in the path model (composite reliability ¼ .85).

IC (reflective scale). The 14 items developed by Youndt et al. (2004) to measure human,

social, and organizational capital were adopted. Respondents were asked the extent to

which they agreed with the statements describing the IC within their organization. The

three sub-scales were then used to create a second-order reflective latent variable, that

is, ‘IC’ (composite reliability ¼ .84).

Perceived firm performance (formative scale). When examining performance issues in

professional service firms, where the skills and knowledge of employees are a key input

of the process, and customer satisfaction of the service performed is regarded as an impor-

tant indicator of firm performance, profitability predictably is not seen as a key indicator.

Therefore, it is often necessary to assess performance using subjective means (Becker &

Gerhart, 1996), especially when the output performed is intangible. Perceptual measures

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of performance are used in this study as the sample population contains both publicly and

non-publicly listed small- and medium-sized professional service firms.

The dependent variable consisted of 12 items, with 11 items adopted from Delaney and

Huselid (1996), and one item adopted from Lau and Ngo (2004). Respondents were asked

how they would compare their organization’s performance over the last three years com-

pared to other organizations that do the same kind of work. This was operationalized as a

formative scale as it is argued professional service firms’ performance required all 12

items for measurement.

Validity and reliability issues

Prior to sending the questionnaires to the owners–managers/senior executives of firms, the

survey was pilot tested and emailed to four HR managers and three HR management aca-

demicians for validation. The survey was subsequently revised after considering feedback

and comments provided by the expert panel. Changes were made to the format, structure,

and wording of the questionnaire items. A list of items used in the measurement model is

reported in the appendix.

Two different tests were used to examine the effect of common method bias since the

data were collected from a single source. First, Harman’s ex post one-factor test was used

to ensure that the current study did not suffer from common method variance (Podsakoff &

Organ, 1986). All the variables used in the study were entered into an unrotated factor

analysis to determine the number of factors. The analysis showed that there were 17

factors (with eigenvalues greater than 1.0) and the largest factor explained 21.4% of the

variance. This result provided some support that common method variance was not an

issue in the current study.

The next test of common method bias was undertaken using a method factor (see the

discussion in Podsakoff, MacKenzie, Lee, & Podsakoff, 2003). A three-item method factor

comprising absenteeism, involuntary turnover, and voluntary turnover into the path model

(see model 3 in Table 2) was incorporated. Results showed that none of the paths from this

method factor to any of the constructs in the model was statistically significant. This

finding provided us with additional confidence that common method bias variance was

not a concern when interpreting the findings.

Validity and reliability of formative scales were checked by following the procedures

described in Petter, Straub, and Rai (2007). For instance, face and content validity of the

formative construct is derived from theory. The construct under investigation is considered

abstract and complex. Hence, the decision to retain or exclude an item underlying the for-

mative construct is based on the theoretical meaning of the construct. Following Cenfetelli

and Bassellier (2009), variance inflation factors (VIFs) of the items in the formative con-

struct to test for multicollinearity were calculated. Results of the analyses for the formative

construct showed that multicollinearity is not an issue as the VIFs were all less than 3.33

(Cenfetelli & Bassellier, 2009).

The quality of the proposed structural model using R2 of the dependent variables and

the Stone–Geisser Q2 test for predictive relevance (Chin, 2010) was evaluated. Since the

values were stable for both omission distances and the majority of the Q2 were greater than

zero, the model was stable and satisfied the predictive relevance requirement.

As reported previously, the study yielded a response rate of 15.4%, comprising 109

surveys returned prior to the first follow-up and 56 additional responses post follow-up.

The majority of the respondents were male (n ¼ 117), with a tertiary degree. Most of

them were between 41 and 60 years of age. Most of the responding professional service

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firms employed fewer than 99 full-time employees (75.2%). One-way ANOVA was under-

taken to examine whether there was any significant difference between prior and post

follow-up surveys. No significant difference was found, hence, both samples were com-

bined into a single data set for further analysis.

Before conducting the path analysis, several tests were done to check for the impact of

implicit theory on HR management variables (Gardner & Wright, 2009). These were com-

posed of ANOVA analyses to test for differences in all of the variables in the model, and

Table 2. Results of measurement model.

Paths Coeff.t-

Statistic Sig. level R2Model

fit

Model 1: Without intellectual capitalHR Involvement � HR Management Systems .40 4.83 ∗∗∗ .27 .249HR Management Systems � Professional

Service Firms Performance.52 8.39 ∗∗∗

Model 2: Without intellectual capitalHR Involvement � HR Management Systems .40 4.86 ∗∗∗ .39 .313HR Management Systems � IC .38 5.57 ∗∗∗

HR Management Systems � ProfessionalService Firms Performance

.25 1.66 n.s.

IC � Professional Service Firms Performance .49 4.14 ∗∗∗

HR Management Systems � IC � ProfessionalService Firms Performance(Mediation Hypothesis)

Sobel ¼ 3.3202 ∗∗∗

Model 3: With method factor .43 .323Method Factor � HR Involvement .06 0.40 n.s.Method Factor � HR Management Systems 2.09 0.76 n.s.Method Factor � IC .014 0.18 n.s.Method Factor � IC 2.26 1.27 n.s.HR Involvement � HR Management Systems .41 4.57 ∗∗∗

HR Management Systems � IC .38 5.65 ∗∗∗

HR Management Systems � ProfessionalService Firms Performance

.23 1.60 n.s.

IC �Professional Service Firms Performance .47 3.85 ∗∗

Notes: n.s. not significant. Method factor comprised three items: absenteeism, involuntary turnover, andvoluntary turnover in % over the last 12 months.∗∗p , .01.∗∗∗p , .001.

Table 1. Descriptive statistics, AVEs, and correlations.

Mean SDCompositereliability AVE 1 2 3 4

1. HR Involvement 5.11 1.24 .95 .72 .852. HR Management Systems 4.39 0.79 .85 .59 .37∗∗∗ .773. IC 15.12 2.33 .84 .64 .36∗∗∗ .36∗∗∗ .804. Perceived Firm Performance

(formative scale)60.20 9.50 – – .23∗∗∗ .32∗∗∗ .44∗∗∗ –

Notes: n ¼ 165. Discriminant analysis for reflective scales is shown in diagonal as underlined.∗∗∗p , .001.

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they included firm size (that is, fewer than 19 employees, 20–49, 50–99, and 100 or

greater), years of operating experience, years of experience in current job, organizational

level of the HR management function, and HR versus non-HR respondents. With the

exception of selective staffing and years of operating experience (especially for those

with 10–19 and 20–29 years of operating experience), no statistical difference in the con-

structs in the model was found. Hence, the tests provided additional confidence that

implicit theory did not have a significant impact on the present study.

Results

Validation of the hypotheses

Senior executives of Australian small- and medium-sized professional service firms

reported that the level of strategic involvement of the organization’s HR management

area was high (mean ¼ 5.12, SD ¼ 1.25). Small- and medium-sized professional

service firms reported an above average level of adoption of HR management practices

(mean ¼ 4.39, SD ¼ .79). The level of IC is reported to be above the mid-point (mean

¼ 15.12, SD ¼ 2.33). The level of perceived performance was also above the mid-point

(mean ¼ 60.20, SD ¼ 9.50). Table 1 shows the descriptive statistics, internal reliability

coefficients, average variance of estimates (AVEs), and inter-correlations between the

constructs.

Results of the path analysis are shown in Figure 2 and the path coefficients are reported

in Table 2. As shown in Figure 2, the model explained 39.3% of the variation of perceived

firm performance of small- and medium-sized professional service firms. The path has a

medium global goodness-of-fit index (31.4%), as determined by Wetzels, Odekerken-

Schroder, and van Oppen (2009, p. 187).

As reported in Table 2, three path models were analysed. The first analysis (model 1)

was based on the simple paths of HR involvement � HR management systems � pro-

fessional service firms’ performance. There was support for H1 as there was a positive and

statistically significant path from HR management area’s involvement to HR management

systems. H2 was supported as an HR management system that has a direct effect on the

performance (coefficient ¼ .49, t-statistic ¼ 7.54, p , .001).

A second analysis was conducted by incorporating IC into model 1. The global good-

ness-of-fit index increased from 0.25 to 0.314 and it also enhanced the R2 of professional

service firms’ performance. There was support for H3 whereby an HR management system

had a positive and statistically significant path leading to IC. H3 was supported. After

introducing IC into the path model, the path from an HR management system to pro-

fessional service firms’ performance was no longer statistically significant. Hence, H2

was no longer supported. H4 was also supported as there was a positive and statistically

significant path from IC to performance (coefficient ¼ .49, t-statistic ¼ 4.14, p , .001).

IC was found to fully mediate the positive effect of an HR management system on pro-

fessional service firms’ performance (Sobel ¼ 3.32, p ¼ .0009); hence, providing

support for H5.

Discussion and implications

This study first set out to examine the extent of HR management practices being adopted in

small- and medium-sized professional service firms and if HR practices (acting like a

cohesive system) impact the level of IC and firm performance. The empirical findings

provide strong empirical support for the presence of HR management practices being

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strategically adopted by small- and medium-sized professional service firms. The HR

area’s involvement in strategic decision making was found to create a level of IC required

for enhancing firm performance. The findings have several theoretical and practical

implications.

The strategic involvement of the HR management function in small- and medium-

sized professional service firms has a positive impact on enhancing the firm’s perceived

performance, via IC. In particular, the HR department in small- and medium-sized firms

plays several roles. First, its involvement in strategic decision making is perceived to

have a positive effect on the design of a coherent set of human capital-enhancing HR prac-

tices essential for creating the level of IC required to positively impact performance. These

HR practices are found to directly impact the levels of human, social, and organizational

capital. As noted in the introduction, this is particularly important in professional service

firms whose product is the talent of their people.

Secondly, consistent with previous research conducted in Australia, small- and

medium-sized firms, both manufacturing (Teo et al., 2011) and service sectors, have

adopted a human capital-enhancing approach to HR management as a means of creating

the scarce resource (such as the level of IC) required for competitive advantage. This

finding corroborates the research undertaken within the professional service sector

(Chang & Chen, 2011; Georgiadis & Pitelis, 2012). Human capital-enhancing HR prac-

tices are being used to create a level of IC essential for professional service firms to lever-

age knowledge as a source of core capabilities in achieving competitive advantage

(Jackson et al., 2003). These HR practices were found to be relevant for both manufactur-

ing and service firms.

This study identified a coherent set of human capital-enhancing HR practices (or HR

management system) being used by Australian small- and medium-sized professional

service firms to impact their IC and firm performance. These practices have previously

been found to be adopted in the Australian context (Rodwell & Teo, 2008; Teo et al.,

2011). However, as previously noted, these studies did not consider the same sample of

firms, nor did they incorporate the mediating role of IC. The study also showed that

these HR practices, or HR management system, have a positive impact on the level of

IC. The full mediation effect of IC on human capital-enhancing HR management

system � professional service firms’ performance is consistent with the finding of a

recent study by Yang and Lin (2009).

Figure 2. Results of PLS analysis.Note: Only significant paths are shown in the figure. n ¼ 165, ∗∗∗p , .001. A method factor (hier-archical level of HR management function from CEO) was incorporated into the above model tocheck for the effects of common method bias. The analysis showed that none of the paths originatingfrom this method factor was significant. The global goodness-of-fit index reduced by 0.03 afterincorporating the method factor into the path model.

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Practical implications

HR areas were found to be involved in strategic decision making. While the analyses do

not ensure causality, the findings show that the HR management function is at least well-

positioned within the organizational structure to have input into the firm’s strategic man-

agement process. Nearly half of the responding organizations reported that the most senior

executive in the professional service firms has overall responsibility for HR management.

Therefore, senior executives can ensure that HR management function is strategically

involved and incorporated into their firm’s optimal level of its IC, and ultimately,

leading to higher professional service firms’ performance.

The above finding provides empirical support for the strategic role of the HR area in

smaller firms (Timmons, 1999). This finding corroborates prior studies on the status of HR

areas in small- and medium-sized firms (Sels et al., 2006; Teo et al., 2011). It is not unusual

for these owner–managers to take direct responsibility for HR functions. The significance

of owners–managers taking direct control is that it provides the firm with flexibility in

responding to changing environmental and competitive factors. The findings also corrobo-

rate that the literature stating HR management has to be located at a relatively high struc-

tural position in order to be influential and able to participate in strategic decision making

(Becker, Huselid, & Ulrich, 2001). These senior executives could, therefore, assert their

influence and explain the value-adding contribution of the HR area’s involvement in stra-

tegic management to other key stakeholders.

Any small- and medium-sized firm that does not have an influential HR area is likely

underutilizing the strategic use of this resource, particularly since this function can be a

supportive player in further increasing the firm’s IC. Additionally, for this size of pro-

fessional service firms, IC should be assessed and developed cohesively. In other

words, a smaller firm that thinks it can only afford to develop its human over social

capital and organizational capital is missing the interactive effect these components

have on each other. Therefore, senior executives and/or owner/manager of small- and

medium-sized professional service firms should ensure that HR areas are capable of

having the appropriate influence and involvement in strategic decision making as they

would contribute to the management of IC in the professional service firms.

Consistent with other studies conducted in the small- and medium-sized sector (e.g.

Sels et al., 2006; Teo et al., 2011), the current study reinforces the importance of the

HR department in strategic decision making. As noted in the current study, irrespective

of whether the HR department is undertaken by the owner or a professional manager

and whether the function is near the CEO, the presence of a strategic and influential depart-

ment is crucial in implementing the necessary HR management system required for firm

performance, via its IC. While this study did not specifically examine the extent of accep-

tance of the HR department, it does infer that HR practitioners must possess the skills and

capabilities to add value to senior management. This finding is consistent on what has been

found on HR management in large organizations (e.g. Golden & Ramanujam, 1985;

Wright et al., 1998).

Limitations and future research implications

While this study relies on the responses provided by the most senior executives within the

professional service firms instead of gathering responses from multiple respondents from

each organization (Wright et al., 2001), the respondents were knowledgeable of the macro

aspects within their organization. Two tests were conducted to check for common method

variance, which led to the conclusion that the effect of common method bias was minimal.

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However, future studies may collect data from multiple respondents to test the model

developed in the current study. Particularly, gathering information from both the owner/

manager and the head of HR in order to compare their responses would be interesting.

This comparison would allow researchers to know if these two parties have differing

opinions of the status of the HR management function in a firm and its strategic relevance.

The hypotheses tested in this paper can also be tested in larger professional service firms

and other sectors of interest which was not the focus of this study.

This study relies on data collected from professional service firms in different indus-

tries. As such, a perceptual indicator of firm performance was measured. The difficulty in

getting industry-specific data will make it difficult to compare firms within this sample

beyond a perceptual level of performance. Additionally, typical of most small- and

medium-sized firms, objective performance indicators are unavailable as most of the

firms are not publicly listed and are reluctant to provide financial performance data for

research purposes. Although perceptual data introduce limitations through increased

measurement error and the potential for common method bias, it is not unprecedented

to use them to measure firm performance (Delaney & Huselid, 1996). Dess and Robinson

(1984) show that perceived organizational performance is a good proxy for an objective

performance indicator.

A longitudinal research design could be used in future studies. For instance, longitudi-

nal performance data, similar to the approach used by Subramaniam and Youndt (2005),

should be collected to better understand the effect of time on HR management, and IC on

performance. Additionally, longitudinal studies would give us a better test of causation

regarding which came first: (1) high HR involvement or a strongly executed HR manage-

ment system, which set the stage for future high HR involvement; (2) high IC or high per-

formance, which led to greater investments in IC. Another way forward is to collect

individual-level data within one professional service firm in order to analyse the effect

of HR management and IC on employee-level outcomes, similar to Whitener (2001).

In conclusion, the HR area in small- and medium-sized professional service firms is

becoming more critical, as the function adds value by supporting the implementation of

a collective HR management system, which is necessary for increasing IC in professional

service firms. This research model and findings contribute to the debate on the impact of

HR management on IC among knowledge employees. An HR management system and IC

appear to be two necessary conditions for effective firm performance in small- and

medium-sized professional service firms.

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Appendix. Sample of the questionnaire items used in the survey

Strategic Involvement of Human Resource Management Function (reflective scale)

. Provide input into the organization’s long range-strategic planning

. Meet with the organization’s manager to discuss HR issues

Human capital enhancing Human Resource Management systems (second order reflective latentvariable comprising four reflective scales):

Selective Staffing (Cronbach’s Alpha ¼ .75)

. My company adopts very extensive selection processes (for example, uses tests, interviews,etc)

. We select managers by matching managerial characteristics with the strategic plan of theorganization

Training (Cronbach’s Alpha ¼ .64)

. We have very extensive training programs for members in all work units

. Management gives a great deal of priority to training initiatives

Developmental Performance Appraisal (Cronbach’s Alpha ¼ .79)

. My organization provides a great deal of effort in measuring employee performance

. Our managers/supervisors regularly discuss with employees their individual performance

Compensation (Cronbach’s Alpha ¼ .64)

. Compared to past years, this year’s pay level in my organization is generally higher

. My company very closely links pay with individual performance

Intellectual Capital (second order formative variable comprising three first order reflective scales):

Human Capital (Cronbach’s alpha ¼ 0.90)

. Our employees are highly skilled

. Our employees are widely considered the best in our industry

Social Capital (Cronbach’s alpha ¼ 0.88)

. Our employees are skilled at collaborating with each other to diagnose and solve problems.

. Our employees share information and learn from one another.

Organizational Capital (Cronbach’s alpha ¼ 0.73)

. Our organization uses patents and licenses as a way to store knowledge.

. Much of our organization’s knowledge is contained in manuals, databases, etc.

Perceived Firm Performance (Formative Scale)

. Ability to attract essential employees

. Ability to retain essential employees

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