Relationship Between Entrepreneur Human Capital and HR

1. Introduction

1.2 The research topic

In modern economies the majority of firms are small firms, and these firms make a considerable contribution to the development of the socio-economic and political infrastructure (Matlay, 2002). Unfortunately, small firms also have a high failure rate. Fifty to eighty percent fail during the first five years of existence (Baumback, 1988). One of the main reasons for this high failure rate appears to be a lack of emphasis on the management of human resources in small firms (McEvoy, 1984).

A range of studies indicate that effective management of human resources is one of the most critical challenges small firms face (e.g., Mazzarol, 2003; Deshpande and Golhar, 1994; Marlow and Patton, 1993; Hornsby and Kuratko, 1990). Especially as it relates to the management of HR issues. Managerial incompetence in handling HR issues is a major source of small firm failure (Dun and Bradstreet, 2001; Baron, 2003; Hornsby and Kuratko, 2003), and the way entrepreneurs handle HR issues in an early stage severely impacts downstream success of business (Cardon and Stevens, 2004). However, Cardon and Stevens (2004) did a literature review on HRM in small and emerging firms and concluded that despite the importance of HR issues to small and emerging firms our understanding about these issues is limited. While we have begun to understand when small firms experience varying levels of HR issues (e.g., Kotter and Sathe, 1978; Rutherford et al, 2003), and what these issues are (e.g., Horsnby and Kuratko, 2003), literature lacks much of the theory necessary to understand the role the entrepreneur plays with regard to HR issues in small firms. Given that entrepreneurs play a dominant role in determining how human resources are managed in small firms (Matlay, 2002; Klaas and Klimchak, 2006), it is likely that certain personal characteristics of entrepreneurs play a more significant role in determining HR issues in small firms. Surprisingly, this relationship has received very little attention in literature.

This research study will address this gap in literature by focusing on the relationship between human capital characteristics of the entrepreneur and HR issues in small firms. Particularly, the relationship between prior education and experience of the entrepreneur and HR issues in small firms. Education and experience are generally regarded as key factors influencing small firm survival and development (Storey, 1994), and a range of studies show they are positively related to small firm performance (e.g., XXX). Given that HR issues are the main cause of small firm failure (Dun and Bradstreet, 2001; Baron, 2003; Hornsby and Kuratko, 2003), and that they have a strong negative effect on small firm performance (Cardon and Stevens, 2004), this could imply that somehow education and experience are related to HR issues in small firms. Since we do not know if that is the case, this research study will make a first attempt at getting a better understanding about this relationship.

1.3 The research objective

According to Saunders et al. (2003, p.96-98) a research study can be done either to explore, describe or explain a particular phenomenon. They argue that exploratory research is done to seek new insight into a phenomenon, to ask questions and to approach a phenomenon in a new way, that descriptive research is done to get an accurate description of events, situations or persons, and that explanatory research is done to explain the cause and effect relationship between given variables. Malhotra (1996, p.99) argues that in some cases more than one research type (exploratory, descriptive or explanatory) is used in a single study to achieve the objectives.

This research study will be of an exploratory nature, as there have been few (if any) attempts in literature at getting a better understanding about the relationship between human capital of the entrepreneur and HR issues in small firms. The objective of this research study is to more precisely define the variables that are in play in this relationship, by making a very first attempt at developing a conceptual framework linking human capital characteristics (education and experience) of the entrepreneur to HR issues in small firms.

1.4 Contribution to the literature

The contribution of this research study to the literature is threefold. First, by focusing on HRM in small firms, this research study focuses on a neglected group of firms and responds to several appeals for more research at the intersection of the human resource management and entrepreneurship fields (e.g., Barret and Mayson, 2006; Baron, 2003; Katz et al, 2000; Heneman and Tansky, 2000). Second, by looking at the role human capital of the entrepreneur plays in determining HR issues in small firms, this research study offers a new and different perspective on HR issues in small firms. Last, by making a very first attempt at developing a conceptual framework linking human capital of the entrepreneur to HR issues in small firms, this research study provides a foundation and stimulus for future research into the links between human capital of the entrepreneur and HR issues in small firms.

1.5 Key concepts

Bygrave and Hofer (1991, p. 15) argue that “good science has to begin with good definitions”, and Marlow (2006) states that “if basic concepts are not clarified or defined, then it becomes extremely difficult to develop coherent and comparable research endeavors that build understanding of a particular field of study”. Therefore key concepts will briefly be explained and defined in order to make sure that the reader fully understands the topics under investigation in this research study.

Small firms

Storey (1994, p.8) states: “there is no single, uniformly acceptable, definition of a small firm”, and defining the small firm seems to be complex and somewhat problematic (Wilkinson, 1999). First, there is the issue of size. There is no consensus as to what is actually meant by “small” with regard to the number of employees in this category. In literature the number of employees in firms classified as small range anywhere from 1 to 500 employees depending upon the study. The same problem exists with various statistical agencies across the world. CBS (Dutch statistics) defines firms having less than 100 employees as small, whereas in the European union Eurostat uses a threshold of 250 employees, and the Small Business Administration in the United States even defines firms with having less than 500 employees as small (Flanagan and Deshpande, 1996).

Second, there is also the issue of heterogeneity. Wilkinson (1999) argues that the danger of defining small firms lies in the assumption that there is a homogenous small firm sector and that all small firms within it have similar characteristics. He argues that while size may be a factor, it alone is not sufficient to explain patterns of employment relations, because a variety of influences (both internal and external) explain behavior (Wilkinson, 1999). This is in line with the view of Hornsby and Kuratko (2006). They argue that it is not a case of small versus large firms, as there are small established firms, small start-up firms, and small high growth firms, and these firms vary in ownership based on family ownership, ownership by founder, and some type of privately held stock ownership. Cardon and Stevens (2004) argue that co-joining small firms all into one overall category is problematic as the management needs of established and emerging firms, or firms with 1, 10, 50, 250, and 500 employees are significantly different from each other. This makes summarizing and providing generalizations of research findings in literature on small firms somewhat problematic.

However, despite the fact that there is no uniformity of approach to defining the small firm, for this research study a practical definition of a small firm is needed. Therefore a small firm is defined as: “a privately held firm with fewer than 100 employees in which the entrepreneur is responsible for the day-to-day management and decision making in the firm”.

Entrepreneur

There is an ongoing debate in literature about the differences and similarities between owner-managers and entrepreneurs. According to Carland et al. (1984) the critical factor that distinguishes entrepreneurs from owner-managers is innovation. They argue that entrepreneurs are characterized by a preference for creating activity, manifested by some innovative combination of resources for profit, and that owner-managers establish and manage a business for the principal purpose of furthering personal goals. In line with this Freel and Robson (2004) state that entrepreneurs initiate change with the aim of challenging the status quo whilst maximizing profit and generating new employment, and that owner-managers focus on firm durability and sustainability, limiting operational reach of the firm, either because of market constraints or by personal choice (Freel and Robson, 2004 as cited in Marlow, 2006).

However, this research study will make no distinction between an “owner-manager” or an “entrepreneur”. The most important characteristic for this research study is the dominant role the individual plays in the firm, and not whether the individual is engaged in innovative activities or not. Given that both terms represent an individual generally solely responsible for the day-to-day management and decision making in the firm (Cooper et al, 1994), this research study will treat them the same, but uses the term ‘entrepreneur’ to address this individual.

This research study defines the entrepreneur as: “an individual who independently owns a small firm and is responsible for the day-to-day management and decision making in the firm”.

Human capital

Human capital can be explained as the skills and knowledge gained by a worker through education and experience. Human capital theory (Becker, 1964) is based on the idea that people acquire individual resources to increase or enhance their productivity, and that these acquisitions are related to prior education or training, as well as prior work experiences (Brush and Manolova, 2004). In this research study the focus is on human capital of the entrepreneur and how it influences the day-to-day management and decision making in the firm.

Education

In this research study education is defined as: “formal college education, together with received specialized training”. Training is defined as: “…the process by which managers acquire the knowledge and skills related to their work requirements by formal, structured or guided means” (Deloitte, Haskins, and Sells, 1989, p.3).

Experience

According to Lee and Tsang (2001) experience consists of three main components; entrepreneurial, industrial and managerial. Entrepreneurial experience refers to “the number of previous new venture involvements and the level of the management role played in such ventures” (Stuart and Abetti, 1990, p. 151 as cited in Lee and Tsang, 2001). Industrial experience refers to experience in the industry the firm is in, and managerial experience is the total experience in management regardless of the industry (Lee and Tsang, 2001). However, for this research study experience will not be divided into three components. In this research study experience is defined as: “accumulated knowledge of practical matters in the past” (Wikipedia).

Human resource management (HRM)

Storey (2001) states there is considerable confusion among researchers whether HRM “…is a generic term, simply denoting any approach to employment management…(or) as one specific and arguably minority form of approach to employment management” (Storey, 2001 as cited in Marlow, 2006). This confusion becomes clear from the many explanations and definitions of HRM in literature. For example, Bratton and Gold define HRM as “the part of the management process that specializes in the management of people in work organizations. HRM emphasizes that employees are critical to achieving sustainable competitive advantage, that human resources practices need to be integrated with the corporate strategy, and that human resource specialists help organizational controllers to meet both efficiency and equity objectives” (Bratton and Gold, 1999). Armstrong defines HRM as “ the strategic and coherent approach to the management of an organization’s most valued assets – the people working there who individually and collectively contribute to the achievement of the objectives of the business” (Armstrong, 2006). Boselie states HRM “involves management decisions related to policies and practices which together shape the employment relationship and are aimed at achieving individual, organizational, and societal goals” (Boselie, 2002). And last, Schermerhorn (2001) defines HRM as “the process of attracting, developing, and maintaining a talented and energetic workforce to support organizational mission, objectives, and strategies”.

In this research study HRM is considered a generic term, simply denoting any approach to the management of employees, and therefore a practical definition of human resource management is needed. Schermerhorn’s definition of HRM is the most practical, and fits best with the informal, flexible, and ad hoc approaches associated with HRM in small firms. Therefore HRM is defined as: “the process of attracting, developing, and maintaining a talented and energetic workforce to support organizational mission, objectives, and strategies” (Schermerhorn, 2001, p2400).

HRM activities and HRM issues

Rutherford et al. ( 2003) argue that in literature the distinction between HRM issues and activities is not always clear. Therefore it is important to define what is meant by HRM issues and what is meant by HRM activities. Rutherford et al. (2003) define HRM issues as “people-related issues or concerns perceived by the entrepreneur or managers in the firm” and HRM activities as “specific human resource management practices used by the firm”. They explain the difference by saying: “HRM activities are (formal) practices that are put in place to deal with HRM issues” (Rutherford et al, 2003). Guest et al. (2004) make a further distinction within HRM activities between HR practices and HR techniques. They argue that for every HR practice (e.g., “recruitment”), there are several different techniques (e.g., “newspaper ads”, “online ads”, “head hunters” etc.), or for example (e.g., “selection”), and (e.g., “interviews”, “assessment centers” etc.).

This research study follows the definitions of HRM activities and issues by Rutherford et al. (2003), and acknowledges the distinction within HRM activities between HR practices and HR techniques as described by Guest et al. (2004).

1.5 Main research question and sub questions

In order to be able to complete the research objective as stated in paragraph 1.3, the main research question and several sub questions have been formulated.

The main research question states:

How is human capital of the entrepreneur related to HR issues in small firms?

In order to be able to answer the main research question, several sub questions have been formulated:

• How do HR practices and techniques differ between entrepreneurs with varying levels of human capital?
• How do HR issues differ between entrepreneurs with varying levels of human capital?
• How does the perceived importance of HRM and HRM issues differ between entrepreneurs with varying levels of human capital?

1.6 Conceptual model

Although this is an exploratory research study, some variables have been identified in literature that could play a significant role in explaining the relationship between human capital of the entrepreneur and HR issues in small firms. These variables are shown in this preliminary conceptual model

This research study builds upon ‘upper echelon’ theory and ‘human capital’ theory to explore the relationship between human capital characteristics of the entrepreneur and HRM issues in small firms. Upper echelon theory (Hambrick and Mayson, 1984) states that everything that goes on in a firm is a reflection of its top managers. It found that the nature of managerial processes and organizational outcomes are partially predicted by managerial background characteristics of its top managers. While originally applied to large firms, this theory seems to be even more applicable to small firms, given that small firms are generally build around the entrepreneur who is often primarily responsible for management and decision-making in small firms (Cooper et al, 1994). Therefore the entrepreneur can be seen as the upper echelon in small firms. Human capital theory (Becker, 1964) states that people acquire individual resources to increase or enhance their productivity, and that these acquisitions are related to prior education or training, as well as prior work experiences (Brush and Manolova, 2004).

Cooper et al. (1994) argue that education is presumably related to knowledge, skills, problem-solving ability, discipline, motivation, and self-confidence, and it enables owner-managers to cope with problems and thereby be more successful. In line with this Lee and Tsang (2001) argue that in general education has a positive effect on the growth of the firm, because education equips an individual with the analytical and technical skills essential to managing a business. Furthermore, according to Cooper et al. (1994) owner-managers who have started or managed a firm prior to launching the current firm would perform better. They argue that prior experience would better prepare them for the wide variety of problems confronting new firms. Within small firms human capital theory is concerned with the knowledge and capabilities of entrepreneurs acquired through education and experience, which influences the way these firms are managed. With regard to HRM in small firm, prior studies indicate that human capital characteristics impact the nature of HR practices and techniques in small firms (e.g., Mazzarol, 2003; Maes et al, 2004; De Winne and Sels, 2006).

Link A – B

The presumed direct link between human capital and HRM issues is based on findings by Tocher and Rutherford (2009). They found that entrepreneurs with more human capital (higher educated and experienced) were more likely to perceive HRM issues as their firms’ most critical concern. Whether these firms actually experienced HRM issues or that it was only the perception of the entrepreneur remains unclear. However, given that results in this research study come from the individual lived experiences of entrepreneurs, their perception of HRM issues in their firm must be regarded as ‘the truth’, and therefore a direct link might exist.

Link A – B – C

Based on the link A – B, it might be the case that entrepreneurs perceive that they have a lot of HRM issues, and that as a result they implement more HRM practices and techniques (reactive).

Link A – C – B

There is evidence that human capital characteristics of the entrepreneur impacts the nature of HR policy and practice within small firms (Mazzarol, 2003; Maes et al, 2004; De Winne and Sels, 2006). It might also be expected that human capital equips entrepreneurs with knowledge about a range of HRM practices and techniques, which they will put in place in order to avoid or overcome HRM issues. It is expected that more use of HRM practices and techniques leads to less HRM issues.

Link A – D – C – B

It is expected that more human capital makes entrepreneurs more aware of the value and importance of HRM and HRM issues to small firms. If entrepreneurs acknowledge the importance of both HRM and HRM issues to their firm, it is expected that they will put more emphasis on HRM and implement a range of HRM practices and techniques pro-active rather than reactive in order to avoid HRM issues. This is expected to lead to less HRM issues.

1.7 Methodology

This exploratory research study uses a two-tailed multiple case study method design. Cases were divided into two groups of extremes. One group with two cases of highly educated and experienced entrepreneurs, and one group with two cases of low educated entrepreneurs with limited or no experience. This two-tailed multiple-case study method makes it possible to use direct replication of findings within the two groups, and also to find possible contrasting situations between the two groups. For this research study interviews are chosen to acquire case study evidence, following the general interview approach by Patton (2002). In this approach topics and issues to be covered are specified in advance in an outline form, and the interviewer decides the sequence and wording of questions in the course of the interview.

For this research study I have taken several steps before I started doing case studies in order to be well prepared. The steps taken were:

• Extensive literature review on the topics under investigation
• Two interviews with entrepreneurship experts to get a better understanding about the research topics from a practitioner point of view
• The design of a case study protocol
• Conducting a pilot case study

A total of four entrepreneurs (two in each group of extremes) actively involved in running their business were selected via non-probability sampling using the REACH database. The entrepreneurs were first contacted via a generic email, and later after being selected by telephone to make the appointment. The interviews were held face-to-face at the offices of the entrepreneurs, at convenient times, in silent and comfortable rooms. The interviews were tape recorded. In order to be able to triangulate data, I also interviewed an expert on human resource management and human resource issues in small firms. The interview was held in exactly the same way as with the entrepreneurs.

1.8 Thesis outline

In order to be able to answer the main research question, the sub questions, and to meet the objective of this research study, this research study will first look at relevant literature and theories in chapter two. In chapter three the methodology used in this research study will be presented and explained. Chapter four shows the results and within case analyses of the four case studies and of the interview with the expert. In chapter five these results will be analyzed using cross case analyses. And finally chapter 6 will contain the conclusion, limitations, and implications of this research study

2. literature review

There is an abundance of literature on HRM in general. Therefore it would be impossible to do a complete literature review on HRM within the time constraints given for this research study. Since the real issue discussed in this research study is the relationship between human capital of the entrepreneur and HR issues in small firms, only prior research that is relevant from this standpoint will be discussed. It must be noted that due to definitional problems in literature on both small firms and HRM, providing generalizations of research findings is somewhat problematic. However, given that all researchers in the field are confronted with these definitional problems, I follow the approach of D’Amboise and Muldowney (1988). They reviewed all studies and papers in which the author “claimed” to be writing about small firms or any variation thereof (e.g., entrepreneurial firm, SME). In this review of the literature, I do the same.

2.1 HRM in small firms

While there is an abundance of literature on HRM, the majority is based on HRM in large firms (Wilkinson, 1999). Heneman et al. (2000) reviewed over 400 articles on HRM and found that between 1984 and 1999 only129 empirical studies focused specifically on HRM in smaller firms. Only 17 of these studies applied quantitative methods to analyze results. According to them “the literature appears to be rich in prescriptions, limited in sound descriptive surveys, and sparse in analytical research”. Similarly, Hornsby and Kuratko (2003) found that “in spite of the considerable volume and diversity of HRM research, relatively little is understood regarding the HRM-related needs, practices, behaviors, and outcomes of smaller ventures”. More recently, DeKok and Den Hartog (2006) stated that even though research on HRM in small firms has increased lately, the majority of researchers still tends to ignore small firms. Heneman et al. (2000) argue that “the deficiency of research regarding HRM in small firms is problematic for theory, research, and practice”.

When looking at literature on HRM in small firms, it seems that for long it has polarized into the ‘small is beautiful’ or ‘bleak house’ perspective (Wilkinson, 1999). According to Wilkinson (1999) the ‘small is beautiful’ scenario facilitates close and harmonious working relationships with good communication, greater flexibility, and low levels of conflict, and in the ‘bleak house’ scenario firms are dictatorially run with employees suffering from poor working conditions (Wilkinson, 1999). However, according to Ram (1991, as cited in Wilkinson, 1999) “workplace relations in SME’s may be ‘complex, informal and contradictory’ rather than simply either harmonious or autocratic”. Indeed, by now we know that “small firms are complex, varied, and influenced by a range of factors” (Loan-Clarke et al. 1999; Carrol et al. 1999; Wagar, 1998; Mazzarol, 2003, as cited in Kotey and Sheridan, 2004).

A number of studies indicate that small firms are characterized by informal, flexible and ad hoc approaches to HRM. Barret et al. (2007) explain this by saying: “the practices used to recruit, select, manage and appraise employees’ performance are not written down (for example, a list of skills and qualifications for each job), regularly applied (for example, yearly performance reviews) or guaranteed they take place (for example, employer sponsored training)”. For example, Hornsby and Kuratko (1990) studied 247 smaller firms in order to establish the progress in developing HRM practices and policies in small firms. They found that firms with less than 50 employees had very little formal HRM practices in place, and similar HRM practices were found in firms with 50 to 100 employees and firms with 100 to 150 employees. A little over a decade later Hornsby and Kuratko (2003) did a replication and an extension of their 1990 study and found evidence that suggests that human resource management practices in small firms in all three size categories has generally stagnated and even regressed in some areas over the decade. Similarly, Kotey and Slade (2005) conducted a survey of 371 small growing firms in Australia in order to establish the rate of adoption of formal HRM practices with increasing firm size. Their results showed that micro and small firms are indeed characterized by informal HRM practices, but the adoption of formal HRM practices increased with firm size with a move toward formal practices early in the growth process.

In contrast, there are also studies showing there is a greater level of sophistication of HRM practices in small firms than would be expected. However, it must be noted that these results are often derived from case studies with very small samples. For example, De Kok and Uhlaner (2001) studied 16 firms with between 10 and 41 employees and found that some of these firms used HRM practices that were more formal than expected. In line with this Duberley and Walley (1995) did a comparative case-study with sixteen organizations in the United Kingdom to study the extent to which HRM has been adopted in small firms. Although the majority of the studied firms (13) did not adopt a strategic approach towards HRM with an integrated set of policies related to corporate strategy, they found that three of the firms did indeed approximate quite closely to the model of strategic HRM.

Barret et al. (2007) state that while an informal and ad hoc approach to HRM may work for some small firms, in periods of growth the sustainability of that approach can be problematic. In line with this Arthur (1995) states that if growth is to be sustained, formal HRM practices and policies are necessary to cope with the increasing complexity as a result of greater number of employees. A study by Kotey and Slade (2005) on the rate of adoption of formal human resource management practices in 371 small growing firms in Australia indicated a move toward hierarchical structures, an increase in documentation, and more administrative processes as the firm grew. Similar results were found by Barret and Mayson (2007) when they conducted a survey of 600 small Australian firms. Their analysis showed that growth-oriented small firms were more likely to use formal HRM practices than non-growth small firms. Roberts, Sawbridge, and Bamber (1992, as cited in Wilkinson, 1999) explain this by saying: “when a firm employs more than 20 staff, the limits of informality become apparent: informal networks of recruitment dry up; informal styles of management communication are stretched; and ad hoc responses to personnel issues create problems”. In line with this Jennings and Beaver (1997, as cited in Bartram, 2005) state that when the entrepreneur becomes over-extended because the firm has grown above a certain size, the management of human resources needs to be professionalized and delegated.

However, there are also researchers like Wilkinson (1999) and Welbourne and Cyr (1999) who state that putting an emphasis on formal rules and procedures in small firms is outdated, because entrepreneurs operate in an environment where they have to make rapid decisions in order to be able to respond to market changes. They argue that ‘bureaucratic’ HRM may reduce flexibility and increase firm inertia. Similarly, Hill and Stewart (1999, as cited in De Kok, 2003) argue that small firms should be more flexible and informal to be able to cope with higher levels of environmental uncertainty.

2.2 HRM activities in small firms

According to Barret and Mayson (2007) the most commonly found HRM activities in small firms reflect operational needs and pragmatic concerns. For example, record keeping, staffing activities (recruitment and selection), and to a lesser extent motivation and retention activities (compensation and reward practices). Cassel et al. (2002) conducted an empirical study on HRM activities in small and medium sized enterprises (SMEs), and found that there is a considerable diversity amongst SMEs in relation to their use of HR practices and techniques. They stated it appeared that “key managers within SMEs, rather than taking a coherent, strategy based approach to the implementation of HRM, are taking a more ‘pick and mix’ contingency approach”. “Which practices are chosen, and the extent to which they are used and formalized is based on a number of characteristics about the SME and the current business climate within which they find themselves” (Cassel et. Al, 2002).

Although there is no generally excepted list of HR practices and techniques used by smaller firms, attempts have been made to identify practices and techniques commonly used in smaller firms. For example, McEvoy (1984) studied small business personnel practices in 84 small businesses with 25 to 250 employees located near a Midwest metropolitan area. A thirty-six item questionnaire was administered and filled in by an interviewer interviewing the person responsible for HRM in the firm. The questions focused on the usage of HRM practices like HRM structures, policy and planning, staffing, performance evaluation, employee motivation, job satisfaction and turnover, and compensation and unionization. Important findings relevant for this research study are that when firms reached an average of 73 employees the management of human resources shifted from one person (often the entrepreneur) to a newly formed separate personnel department. About 80% of the firms sampled used written personnel