strategic human capital and the performance of public sector organizations

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ManagementS C A N D I N AV I A N J O U R N A L O F

Scand. J. Mgmt. 20 (2004) 375–392

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Strategic human capital and the performance ofpublic sector organizations

Abraham Carmeli�

Department of Political Science, Graduate School of Business Administration, Bar-Ilan University,

Ramat-Gan 52900, Israel

Received 1 August 2003; accepted 1 November 2004

Abstract

Organization scientists have long considered human capital as a strategic asset that

contributes to organizational effectiveness. Whereas the strategic importance of human capital

has been widely studied in the case of for-profit organizations, measurement difficulties and

the role of human capital in the public sector have received little attention. The present study

attempts to bridge this gap by suggesting a behavioral approach to measuring organization-

specific human capital and examining its impact on the financial performance of local

government authorities in Israel. The results confirm the strategic importance of human

capital. Local government authorities that possess strategic human capital—namely, a

workforce that is highly educated, that exhibits organization-specific competencies and

experience, and that is valuable, unique, and imperfectly imitable—exhibited a better financial

performance, as measured by a three-financial ratio scale over 2 fiscal years.

r 2005 Elsevier Ltd. All rights reserved.

Keywords: Resource-based view; Strategic human capital; Local government authorities; Public sector

organization

see front matter r 2005 Elsevier Ltd. All rights reserved.

.scaman.2003.11.003

2 3 531 8917; fax: +972 3 535 3182.

dress: [email protected] (A. Carmeli).

www.elsevier.com/locate/scajman

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A. Carmeli / Scand. J. Mgmt. 20 (2004) 375–392376

1. Introduction

Research has paid a considerable amount of attention to the strategic importanceof human capital in creating competitive advantage and superior performance. Theliterature of two complementary theories—a resource-based view of the firm(Barney, 1991; Peteraf, 1993; Wernerfelt, 1984), and strategic human resourcemanagement (SHRM) (Becker & Gerhart, 1996; Becker, Huselid, Pickus, & Spratt,1997; Delaney & Huselid, 1996; Huselid, 1995; Pfeffer, 1994)—suggests thatorganization-specific human capital is of strategic importance in that it has apositive effect on the performance of the organization concerned.

Although organization scientists have widely recognized the critical role of humancapital in creating value, studies have thus far paid too little attention to (1) themeasurement of organization-specific human capital, and (2) the applicability of corearguments of both theories to organizations outside the profit-making sector.

The present study represents a first effort to bridge these gaps by providing a moreaccurate measure of organization-specific human capital, and discussing the impactof such capital on the performance of public sector organizations (local governmentauthorities) in Israel. Specifically, the study uses a relatively large sample to examinethe impact of organization-specific human capital on the financial performance oflocal government authorities. With this study I hope to extend existing research onhuman capital and to suggest new angles for a more systematic examination of someof the core concepts of the resource-based view. In addition, the study offers a routetowards overcoming a key difficulty—one of the many other shortcomings thatappear to be in the resource-based view (for a review, see Foss, 1997; Priem & Butler,2001).

2. Theoretical background and hypotheses

Human capital has been a central concept in a variety of theories. Notionsregarding the role and importance of human capital in organizational efficiency andeffectiveness can be found in (1) human relations theory, also known as ‘thebehavioral school’, which, following Hawthorne’s research, emphasizes the humanfactor in organizational failure and success (Likert, 1967; Mayo, 1946; McGregor,1960; Roethlisberger & Dickenson, 1939), (2) transaction cost economics, accordingto which organizations seek the optimal way of managing the human resourcesystem, which depends on the relation between transaction cost and the market-organization relation, as well as on the organization’s internal operations (Klein,Crawford, & Alchran, 1978; Williamson, 1975), and (3) human capital theory, whichfocuses on the educational level of the employees as a source of labor productivityand economic growth (Asefa & Huang, 1994; Becker, 1993; Mincer, 1974; Schultz,1961; Wykstra, 1971). Despite the important contributions of these theories to theevolution of the concept of human capital, it seems that the resource-based view andstrategic human resources management (see below) have made the most powerfulimpact on its dominant position in organization science.

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2.1. The resource-based view of the firm

Whereas scholars of industrial economics tend to analyze firms in terms of theirproduct market activities, the resource-based view holds that more attentionshould be paid to the internal aspect of the firms, which it analyzes them interms of their resources (Wernerfelt, 1984). Underlying the resource-based vieware two core arguments: (1) heterogeneity among organizations’ resourcesleads to differences in their competitive advantage and to variations in theirperformance (Peteraf, 1993; Prahalad & Hamel, 1990; Reed & DeFillippi, 1990), (2)organizations develop and manage organization-specific resources and capabilitiesin a way that enhances their own organization’s competitiveness in a definiteenvironment (Amit & Schoemaker, 1993; Barney, 1991; Grant, 1991; Peteraf, 1993).These resources and capabilities are key drivers of success for the firmsconcerned.

It is in this context that the core competence concept suggested in Prahalad andHamel (1990) has its place. These authors argued that the best way to win in acompetitive world is to build up long-term core competencies. Although somestudies have shown that in some circumstances or under certain conditions,competitive advantage may not necessarily lead to superior performance (Coyne,1986; Coff, 1999), researchers nonetheless recognize that it is likely to result insuperior performance (Day, 1984; Porter, 1985).

Organizations vary in their bundle of resources—both tangible and intangible.Competitive advantage is based on superior organizational resources, includingfor instance financial, physical and human resources, and on technologicalcapabilities (Hofer & Schendel, 1978). It is also supported by invisible assets,such as the knowledge, skills and experience of committed individuals(Itami & Roehl, 1987) and a core capability construct comprised of fourdimensions—skills and knowledge, technical, managerial, and values/norms(Leonard-Barton, 1992).

Some of the resources that an organization possesses are strategic, i.e., contributeto the creation of a competitive advantage and underpin its sustainability,while others are non-strategic. Strategic resources are organization-specificassets. In order to determine whether resources are strategic in nature it isnecessary to explore the extent to which they are (1) valuable (Barney, 1991, 1997),(2) rare (Barney, 1991, 1997), (3) imperfectly imitable (Amit & Schoemaker,1993; Barney, 1991, 1997; Collis & Montgomery, 1995; Dierickx & Cool, 1989;Reed & DeFillippi, 1990), (4) non-substitutable (Barney, 1991, 1997; Collis &Montgomery, 1995; Dierickx & Cool, 1989), and (5) non-transferable or tradable

(Dierickx & Cool, 1989; Peteraf, 1993). Resources that are valuable and rare are asource of competitive advantage. Resources that are valuable, rare, inimitable, non-substitutable, and non-transferable are a source of sustainable competitiveadvantage. Following Barney (1997), which advocates the combination of all theconditions that refer to degrees of inimitability, the present study views the humanresources of an organization that are valuable, rare and inimitable as strategichuman capital.

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2.2. Strategic human resource management

Since its emergence in the 1990s the strategic human resource managementmovement has been one of the most powerful elements in organization science,attracting substantial input on the part of theorists and practitioners (Ferris,Hochwarter, Buckley, Harrell-Cook, & Frink, 1999).

This line of thought draws on the resource-based view and suggests thatstrategically managed human resources are a source of competitive advantage.Substantial work on the part of many researchers (e.g., Boxall & Steeneveld, 1999;Brockbank, 1999; Dyer & Reeves, 1995; Lado & Wilson, 1994; Lepak & Snell, 1999;Mueller, 1996; Pfeffer, 1994; Wright & Snell, 1998, among others) has revealed thelink between valuable and unique human resource practices or policies on the onehand and organizational effectiveness on the other.

With the emergence of the concept of complementarities (e.g., Milgrom & Roberts,1990, 1991; Porter, 1996; Rivkin, 2000) in the literature of economics and strategicmanagement, strategic human resource management scholars have come to viewcomplementarities in human resource policies as a source of competitive advantage.Organizations are essentially complex systems (Rivkin, 2000) that comprise core,elaborative, independent and inconsistent elements (resources, activities, processesand policies) and the interconnections between some or all of these elements(Siggelkow, 2002). The interaction between the elements of an organization isadditive in that the value of one element is increased by the presence of otherelements (Milgrom & Roberts, 1990; Rivkin, 2000; Siggelkow, 2002).

Hence, strategic human resource management scholars have been emphasizing theimportance of complementarities in enabling the creation of a complex humanresource system that is both unique and difficult to imitate (Lado & Wilson, 1994;MacDuffie, 1995). However, the human resource management system is not aboutthe creation of complexity for its own sake. Rather, its primary goal is to develophuman capital that is organization-specific and of strategic importance. Here adistinction should be made between the term human resources that refer to theorganization’s human capital on the one hand, and human resources that refer to theorganization’s functions or practices on the other (Wright, McMahan, &McWilliams, 1994). This study aims to examine the effect of such human capitalas is organization-specific, valuable, rare, and inimitable on the financialperformance of local government authorities.

2.3. Strategic human capital

Studies have constantly shown the positive effect of human capital onorganizational performance. Hall (1992, 1993), for example, indicated that employeeknow-how, an essential part of human capital, is perceived as one of the mostvaluable resources associated with firm success. People are a valuable corporateresource, and companies whose strategy is based on people focus on the humanresource management practices of their employees, recognizing that these peoplepossess valuable skills that contribute to the attainment of a competitively

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advantageous position (Collis & Montgomery, 1998; O’Reilly & Pfeffer, 2000;Pfeffer, 1994).

Although empirical studies have demonstrated the strategic importance of humancapital (e.g., Farjoun, 1994), studies drawing on both the resource-based view andstrategic human resource management, have not directly measured human capitalthat is organization-specific, valuable, rare and inimitable. As Wright, McMahan,Snell, and Gerhart (2001) noted, ‘‘While this theoretical story is appealing, it isimportant to note that ultimately, most of the empirical studies assess only twovariables, HR practices and performanceya major step forward for the SHRMliterature will be to move beyond simply the application of RBV (resource-basedview) logic to HR issues toward research that directly tests the RBV’s core concepts’’(2001: 708–709). In fact, this is not unique to strategic human resource managementliterature. A few studies only have attempted to apply the resource-based viewdirectly to core concepts. Hitt, Bierman, Shimizu, and Kochhar (2001) measured twodimensions of human capital, namely quality of law school attended by partners(a proxy for articulate knowledge and prestige) and total experience as partners inthe local firm (a proxy for tacit organization-specific knowledge). In addition,Carpenter, Sanders, and Gregersen (2001) measured human capital by CEO/TMTinternational assignment experience (the number of years in which a CEO/TMTreported working on international assignments), arguing that these are the moreconservative indicators of organization-specific human capital.

Yet, although the above-mentioned study provides a unique contribution to thedirect measurement of organization-specific human capital, it only measured twodimensions of human capital. The present study attempts to extend the direct testingof human capital as an organization-specific asset of strategic importance. To thisend, I have constructed a measure of organization-specific human capital comprisingfour dimensions. These are (1) educational level, (2) job experience, (3) competenceof the organization’s members (Aryee, Chay, & Tan, 1994), and (4) the value,uniqueness and inimitability of the organizational workforce (a detailed descriptionof this four-dimensional measure is presented in the Method section below).

The present study argues that organizations possessing a valuable, unique andinimitable job-educated, experienced and competent workforce that is specific innature, namely strategic human capital, will perform better than organizations thatlack such strategic human capital. On the basis of this logic, the following hypothesisis suggested:

Hypothesis 1. Strategic human capital has a positive impact on the financial

performance of a local government authority.

As will be explained in the Method, I control for organizational demographyvariables, namely age and size (Hannan & Freeman, 1989; Morgan, 1986; Pfeffer,1982), which are important factors used in explaining organizational failure andmortality (Baum & Oliver, 1991; Levinthal, 1991). Results of previous studiessuggest that there may be differences among the types of local government authority,so it is also important to control for local authority type. The way the structure ofthe environment is perceived may shape the behavior of those working in it.

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Uncertainty attributes various environments interpreted and it refers to the way theorganization’s top management sees the conditions in the relevant task environmentas uncertain (Miller & Droge, 1986). In an uncertain environment, organizationsmay find it difficult to comprehend future developments and to respond adequately.Research repeatedly provides evidence that although environmental conditions doaccount for variations in organization performance, their impact is in fact relativelysmall (around 20 percent, see Ghemawat, Collis, Pisano, & Rivkin, 2001). Even ininhospitable environments, organizations are still able to create and appropriatevalue. This suggests that strategic human capital will have a positive impact on thefinancial performance of local government authorities, after the size, type andperceived environmental uncertainty of the local authorities have been accountedfor. Hence, the following hypothesis is suggested:

Hypothesis 2. Strategic human capital has a positive impact on the financial

performance of local government authorities, after their size, type and perceived

environmental uncertainty have been accounted for.

3. Method

3.1. The setting

The Israeli local government authorities were chosen as the subject of the presentstudy due to the steadily growing importance of local government in the political,economic and social life of the country, the community and the individuals in it. Thistendency is manifest in the increasing volume of local governmental activity, which isexpanding in relation to central government, particularly in Western countries(Goldsmith & Newton, 1988; Leach, Stewart, & Walsh, 1994; Sharpe, 1988). Localgovernment authorities provide an interesting opportunity for the study of humancapital. It has been argued that heterogeneity in human capital is responsible for agreat deal of the variation in the performance of local government authorities,especially as regards their fiscal and financial performance. The present studyattempts to examine this connection at the organizational level.

The financial state of many local government authorities in Israel is far fromsatisfactory, something that affects their ability to function and supply anappropriate quality and quantity of services. Nonetheless, while some localgovernment authorities turn in a poor financial performance, others have beensuccessful in this respect. We have found two explanations for this phenomenon. Onthe one hand, local government leaders claim that the burden of their tasks withoutthe sufficient allocation of suitable resources is the main cause of this crisis. On theother hand, the central government, and in particular the Ministry of Finance,claims that mismanagement on the past of the local authorities is largely to blame(Ben-Elia, 1998; Carmeli, 2002; Hecht, 1997). These arguments are well-establishedwithin the public and research spheres in Israel, but they suffer from their narrowapproach, and their air of declarative accusations.

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This study suggests a strategic approach to analyzing this state of affairs. First, itargues that although the local government authorities possess a certain monopolyover municipal services, they are also challenged and forcibly drawn intocompetition with each other as well as with other profit and non-profitorganizations. For instance, local government authorities compete to attractpopulation groups with above-average characteristics such as higher educationand income in order to strengthen their own financial resources. This type ofpopulation also helps to attract new businesses, while their taxes are used to enhancethe welfare of the residents in the particular local government authority. As thefinancial situation affects all organizational systems and activities, it can be expectedthat local government authorities will also tend to compete with each other in thissphere in order to achieve a better financial performance.

3.2. Sample and procedure

The participants were drawn from 263 local government authorities in Israel.These consisted of 62 municipalities, 148 local councils (excluding two industriallocal councils, as they differ in both goals and structure), and 53 regional councils.

Primary and secondary sources were used in collecting the data. Data about thefinancial performance (dependent variable) was gathered from the Ministry of theInterior reports on the annual financial statements of the local governmentauthorities in Israel. Data on the size of the local government authorities wasobtained from publication no. 1046 of the Central Bureau of Statistics in Israel(1997) through the Social Science Data Archive (SSDA) of The Hebrew Universityof Jerusalem, and from internal reports provided by the Ministry of the Interior(1999).

In addition, primary data on the two variables, human capital and perceivedenvironmental uncertainty, were obtained with the help of a structured questionnairethat was mailed to the general manager of each local government authority. Theparticipants were asked to give the name of their local government authority so thatI could link all survey or primary data with the non-survey or secondary financialdata. The survey was mailed from and returned to a university address, using anaddressed reply envelope. One hundred and six surveys were returned. Of these, only98 were useable. The average size of the local authorities comprised 29,200 residents,ranging from a minimum of 1000 to a maximum of 621,100.

3.3. Dependent variables

3.3.1. Financial performance

Drawing on previous studies that explored the fiscal and financial performance oflocal government authority systems in Israel (Carmeli, 2002; Hecht, 1997; Razin,1998, 1999), I developed a 3-item scale of local government authorities’ financialstate. In order to create more stability and accuracy in the analysis, I used threefinancial ratios, which were assessed on a ratio scale of an average of 2 years. Thefinancial ratios are (1) self-income ratio, (2) collecting efficiency ratio, and (3) current

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ratio. Each of these financial ratios is explained below. All items were subjected to aprincipal-components factor analysis with Varimax rotation. This analysis producedone factor (labeled financial performance) that explained 62.51% of the overall itemvariance. The financial performance measure (eigenvalue ¼ 3.75) had factor loadingsranging from .61 to .88, with a reliability of 0.87.

(1) Self-income ratio: defined as the ratio between all self-income and the overallincome of the regular budget. Self-income consists of all income (taxes, grants, fees)that the local authority collects direct from residents, businesses and other assets inits jurisdiction (Hecht, 1997: p. 21). The income of the regular budget consists ofproperty tax, fees, surcharges, general grants, financing from ministries and singleincomes (Hecht, 1997: p. 210). In general, the closer the ratio is to 1, the better thefinancial state of the local authority. A higher level of self-income indicates thehigher economic independence of a local government authority that is able to financeits activities for the welfare of its residents from its own resources. Local governmentauthorities that enjoy a high self-income ratio are less vulnerable to budgetarycutback decisions on the part of central governmental. Carmeli (2002) noted this asan important indicator of the fiscal and liquidity state of a local governmentauthority in Israel.

(2) Collecting efficiency ratio: defined as the ratio between the total amount offunds collected and the total amount of municipal tax that could be collected. Thefunds collected consist of property tax, water and drainage charges. The totalamount of funds remaining after collection consists of accumulated debt from earlieryears, and the current year debt minus exemptions, discounts and the cancellation ofself-incomes (Hecht, 1997: pp. 21–27).

(3) Current ratio: nominally defined as the ratio between the total amount ofcurrent assets and the total amount of current obligations listed in the balancesheet (Carmeli, 2002). As I needed to match the financial report structure ofthe local authorities, the ratio was redefined. It became the ratio between thetotal amount of current assets (excluding investments, investments for coveringbudgeted funds, accumulated deficit in the regular budget and temporary netdeficits in the non-regular budget), and the total amount of current obligations(excluding development funds, budgeted funds, accumulated surplus in the regularbudget and temporary net surplus in the non-regular budget). The currentassets consist of all current properties. They include customers, bank remainders,investments and other debtors. Current obligations consist of all the debts tosuppliers and budgeted funds. As in business firms, a poor current ratio (ratioo1)indicates severe difficulties in the short-term liquidity of a local governmentauthority, because it has no current assets to cover current obligations(see Carmeli, 2002).

3.4. Independent variables

3.4.1. Strategic human capital

To measure organization-specific human capital, I constructed a four-dimensionalscale covering (1) the educational level, (2) the work experience, (3) the competency

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of organization members (Aryee et al., 1994), and (4) the value, uniqueness andinimitability of the organizational workforce.

The measures and their constituent items refer to the organizational level, namelythe organization’s workforce as a whole. To assess educational level and workexperience—two items for each aspect have formulated as follows: (1) In my localgovernment authority, the employees have had an organization-specific educationthat enables them to do their jobs successfully. (2) In my local government authority,the employees have had an organization-specific training that enables them to dotheir jobs successfully (educational level). (3) In my local government authority, theemployees have had organization-specific job experience that enables them to dotheir jobs successfully, and (4) in my local government authority, employees possessorganization-specific professional skills that enable them to do their jobs successfully(work experience).

The competency of organizational members was assessed in an eight-item versionby Wagner and Morse (1975). Regarding the general managers/clerks, a slightlygeneralized wording was adopted, without harming the original scale. The itemswere: (5) No one knows this job better than our employees. (6) Problems here areeasy to solve once the employees understand the various consequences of theiractions, a skill they have acquired. (7) Employees do not know why, but sometimeswhen they are supposed to be in control, they feel they are being manipulated(reverse-coded item). (8) If anyone here can find the answer, it is our employees. (9)Employees go home the same way they arrived in the morning, i.e., feeling they havenot accomplished much (reverse-coded item). (10) Considering the time spent on thejob, employees feel thoroughly familiar with their tasks. (11) Doing this job well is areward in itself. (12) Mastering their jobs means a lot to our employees.

Three additional items were constructed to assess the extent to which thehuman capital of a local government authority is distinctive, i.e., meets theconditions for sustainable competitive advantage. In particular, respondents wereasked to indicate the degree of value, uniqueness and inimitability of their localauthority workforce. The value of a resource is determined by the extent to which itenables the firm to respond to environmental threats or opportunities andcontributes to the organizational effectiveness. The uniqueness of a resource isgauged by the number of competing firms that already possess the particularimportant resource concerned. The inimitability of a resource is determined by theextent to which the cost of acquiring it implies a cost disadvantage compared to firmsthat already possess it, by the number of competing firms that already possess anequivalent strategic resource, and by the extent to which the resource is transferable(see Barney, 1997).

The additional items are thus: (13) The human capital (employees) of my localgovernment authority generates considerable value for the organization. (14) Thehuman capital (employees) of my local government authority is of a very rare kind, ifnot unique. (15) It is difficult for other local authorities to imitate our localauthority’s human capital (the contribution of its employees). The measure wasassessed on a 7-point scale, from 1 ¼ ‘‘Strongly disagree’’ to 7 ¼ ‘‘Strongly agree’’.The Cronbach’s alpha for this scale was 0.91.

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3.5. Control variables

3.5.1. Size

Previous studies have suggested that the size of a local government authority has apositive effect on its performance, because of the economies of scale that it enjoys(Razin, 1998, 1999). The size of the local government authority was measured by thenumber of its permanent residents. This is the most acceptable criterion (see Carmeli& Tishler, 2004a, b; Razin, 1998, 1999), since the number of permanent residentsshould reflect the scope of the activities of a local government authority. This is aratio scale measure. The average size was 292,217 residents. Log of size was used.

3.5.2. Local government authority type

Legally speaking there are three different types of local government authorities: (1)cities (municipalities) with the largest population, normally above twenty thousandresidents, (2) local councils with less than twenty thousand residents, and normallyresponsible for only one municipal community and (3) regional councils responsiblefor more than one rural settlement. Local authority type is given on a nominal scale.Hence, two dummy variables were formed. Cities and regional councils arecompared to local councils, which comprise the reference group. This means thatthe first dummy compared the cities ( ¼ 1) to the local councils ( ¼ 0), and thesecond compared regional councils ( ¼ 1) to the local councils ( ¼ 0).

3.5.3. Perceived environmental uncertainty

Perceived environmental uncertainty was assessed by the 5-item measuredeveloped by Miller and Droge (1986), the content of which has also been examinedin organization research (e.g., Khandwalla, 1976; Singh, 1986; Waldman, Ramirez,House, & Furanam, 2001). The measure consists of five items, which are assessed ona seven-point scale from by 1 ¼ ‘‘Strongly disagree’’ to 7 ¼ ‘‘Strongly agree’’. TheCronbach’s alpha for this scale was .64. The five items were: ‘‘My local governmentauthority rarely has to change its customer practices to keep up with other localauthorities’’; ‘‘The rate at which my local government authority’s services becomeobsolete is very slow’’; ‘‘The actions of other local government authorities are quiteeasy to predict’’; ‘‘Demand and customer tastes are quite easy to forecast’’; ‘‘Theoperational/technological system is not subject to very much change’’.

4. Results

Table 1 shows the means, standard deviations and correlations among thedependent, independent and control variables (excluding the local council dummycode). The results indicate preliminary potential support for the major researchhypothesis. Human capital is significantly and positively associated with financialperformance (r ¼ .40, po0.001). In addition, perceived environmental uncertainty isnegatively related to both financial performance (r ¼ �.32, po0.001) and human

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Table 2

Hierarchical regression results for the effects of human capital on variance in financial performance

Model 1 Model 2 Model 3

b (t) b (t) b (t)

Constanta 0.33 �.66 �.16

Size (LN) �.09 (�.56) �.13 (�.92) �.12 (�.08)

Municipality .22 (1.42) .28 (1.81) .26 (1.78)

Regional council .23 (2.17�) .22 (2.22�) .19 (2.00�)Perceived environmental uncertainty .33 (3.47��) .18 (1.70)

Human capital .29 (2.74��)DR2 .11 .06

F for DR2 12.05�� 7.52��

Overall R2 .06 .17 .23

Overall F 1.91 4.62�� 5.46��

N ¼ 98��po.001; ��po.01; �po.05.

aUnstandardized coefficients.

Table 1

Means, standard deviations, and correlations

Variables Mean S.D. 1 2 3 4 5 6

1. Size (LN) 9.21 1.20 1.00

2. Municipality .24 .43 .75�� 1.00

3. Regional council .19 .40 �.13 .28�� 1.00

4. Perceived environmental uncertainty 4.54 .92 .02 �.05 .05 (.64)

5. Human capital (HC) 4.74 .92 �.01 �.03 .11 .51�� (.91)

6. Financial performance .00 .78 .05 �.10 .18 .32�� .40�� (.87)

N ¼ 98; two-tailed tests; reliabilities are in parentheses.��po0.001; ��po.01; �po.05.


capital (r ¼ .51, po0.001). No significant relationship was found between size andfinancial performance (r ¼ �.01, p ¼ n.s.).

The results of the regression analyses are presented in Table 2. A three-stepregression analysis was run. The variables of size and local government authoritytype were entered in the first equation (Model 1). In the second step (Model 2), thevariable of perceived environmental uncertainty was added. Finally, human capitalwas added in the third step (Model 3). Model 1 shows that compared to other typesof local government authorities (municipality and local council), regional councilsexhibit better financial performance (Model 1, b ¼ :23; po.05). This finding still heldwhen both environmental uncertainty (Model 2) and human capital (Model 3) wereadded. The results of Model 2 indicate a modest link between perceived

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environmental uncertainty and financial performance (b ¼ �:33; po.01). Thissuggests that, compared to local government authorities which achieved a betterfinancial performance, financially poor local government authorities view theenvironment in which they operate as uncertain. However, the relationship betweenperceived environmental uncertainty and financial performance became insignificantwhen human capital was entered into the regression equation (Model 3, b ¼ �:18;p ¼ n.s.).

Hypothesis 1, which posited a positive effect of human capital on financialperformance, was supported (Model 3, b ¼ :29; po.01). In addition, the results ofModel 3 corroborate the importance of human capital in explaining variations in thefinancial performance of local government authorities. Human capital explained anadditional 6 percent of the variance in the financial performance of local governmentauthorities, after the size, type, and perceived environmental uncertainty of thelocalities had been controlled for. This finding lends support to Hypothesis 2.

5. Discussion

The primary aim of this study has been to seek a more explicit and direct way ofmeasuring organization-specific human capital, and to try to understand the effect ofsuch human capital on the financial performance of local government authorities inIsrael. I argued that the build-up of strategic human capital should take account oforganization-specific educational background, job-specific experience and work-specific experience, and that the human capital should also be valuable, rare and noteasily imitable. The development of such human capital has a positive effect onorganizational performance.

5.1. Theoretical implications

Although human capital theory has emphasized the importance of well-educatedand trained employees, it has not pinpointed the importance of building up humancapital that is strategic in the sense of being organization-specific. Although genericskills are of importance and may be a source of competitive advantage, the relativeimportance of organization-specific skills is even more important, because it enablesan organization to better utilize its human capital in a specific context (cf. Carpenteret al., 2001; Castanias & Helfat, 1991).

The resource-based view has had the most powerful influence on the evolution ofthe strategic human resource management perspective. However, studies have rarelymade a direct examination of the core concepts involved. Hence, in explainingvariation in organization performance the role of organization-specific resources andcapabilities in relatively large samples has not been thoroughly investigated. Thepresent study offers a rather different approach to measuring organization-specifichuman capital. It is presumed that by using senior managers to evaluate humancapital at the organizational level (rather than evaluating human capital at the levelof individual employees) it may be possible to provide a way of overcoming the

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difficulty involved in measuring intangible core resources (see Carmeli & Tishler,2004b). Despite this difficulty, scholars have long recognized the fact that humancapital, like other intangible resources such as reputation are most likely to produceand to sustain competitive advantage (Barney, 1991). This applies especially whenthe elements constitute an intangible resource, as in our case, and are interactive in away that causes them to reinforce one another. At a higher level, for instance, whenhuman capital is aligned with other resources such as organizational culture andcompetitive strategy, a higher rent is likely to be produced (Teece, Pisano, & Shuen,1997). However, it also has to be recognized that although organization-specificresources and complementarities in an organization’s resources are regarded asvaluable resources, if they are too specific and tightly interactive they may impedeadaptations to new environmental conditions (see Levinthal, 1997).

Our results clearly indicate the importance of strategic human capital. This is oneof the few studies that not only attempts to test the core concept of the resource-based view and the strategic human resource management perspective direct, but ithas also been conducted in a somewhat neglected sector—that of the publicorganizations. As a result the study serves to extend the applicability of boththeories.

Although the study has emphasized the value of organization-specific humancapital, there are still major theoretical questions to be answered. Here one should beaware that highly organization-specific human capital can have some disadvantagessuch as inflexibility, weak adaptability and transferability problems. Hence, scholarsneed to pay more attention to the conditions under which organization-specifichuman capital is substantial.

5.2. Managerial implications

The major implication for managers concerns investment in the creation ofstrategic human capital that is specific to the organization and that best serves thecontext in which the firm operates. Organizations, perhaps not surprisingly, foundthat strategic human capital requires that the human resource management systembe carefully designed, and should focus its concern on two major issues. First, thehuman resource management policies should be unique and contextual, thusenabling the establishment of organization-specific human capital. Second, humancapital must fit well and interact positively with (complement) other importantorganizational elements. Having a highly job-specific skilled workforce, for example,may not yield a higher rent unless there is fit between culture and human capital.

That human capital makes an important contribution to the performance of theorganization is one of the two main assertions of the strategic human resourcemanagement scholars. There are of course many ways of developing strategic humancapital, such that the organization is strategically distinguished from its rivals. But,we should also recognize the importance of the management of human capital once itis in place. According to the resource-based view, both the development and themanagement i.e., the deployment of the firm’s assets (cf. Amit & Schoemaker, 1993)are crucial to the generation of a competitively advantageous position. Developing

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strategic human capital means that a firm adopts certain ways of developing itshuman capital with a view to its strategic value. Hence, firms should recognize thatsignificant value can be generated by human resources that are developed andmanaged in a way that transforms them into strategic human capital.

Although our measure of human capital has not examined organization-specificvalues, human resource managers must consider this aspect when building up thehuman capital and the policies upon which an organization-specific workforce isbased. Managers also need to recognize that organizations are complex systems.That is, no individual element can account for variation in rent generation andappropriation; there are usually core elements that have critical roles in generatingthis rent. Hence, building human capital that is aligned with other core elements iscrucial to its exploitation for rent generation and value appropriation.

5.3. Limitations and directions for future research

Several limitations of this research should be mentioned. Although I believe thatthe behavioral approach to measuring human capital overcomes some of theinherent difficulties involved in the measurement of intangible resources in general, ithas to be recognized that the approach does have certain limitations, primarily sinceit employs perception rather than objective observations. The use of key informantsto collect data in the field of management is certainly a predominant approach(Gupta, Shaw, & Delery, 2000) and generally speaking research suggests that keyinformants do provide reliable information (e.g., Miller, Burke, & Glick, 1998;O’Reilly, Snyder, & Boothe, 1993; Wright et al., 2001). It does have limitations,however, especially as regards the misinterpretation and inflation of the data.Despite the many complexities involved, future studies might benefit from a morebalanced approach combining both objective observations and perception. Wecannot argue for causality because the present study has not applied a longitudinaldesign. However, the direction of the relationship (strategic human capital -organizational performance) is consistent with the major premise of the humancapital literature, according to which such human capital as distinguishes anorganization strategically from its rivals is a major source of competitive advantageand promoter of superior performance. Future research could produce a strong casefor the role of human capital by applying a longitudinal design. Finally, the presentstudy has tested the role of human capital in a somewhat neglected sector. Althoughthis is clearly useful it is still just an initial exploration of the sector in question,which means that we have to be cautious in interpreting the results. Further studiesare needed in order to establish the applicability of our model to this and other not-for-profit sectors.

6. Conclusion

The findings of this study have thrown some light on a new approach to themeasurement of organization-specific human capital, and the testing of its strategic

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importance in a relatively neglected sector. The approach provides resource-basedresearchers a way of overcoming one of the major barriers to a direct examination ofthe theory’s core concept. Our study shows that human capital is a multidimensionalconstruct. Researchers and human resource managers might both benefit fromobserving and understanding the way in which dimensions constitute strategichuman capital. Although this is just a first introductory study of the subject, it ishoped that both the resource-based view and strategic human resource managementresearchers will pursue the line of research presented here, with a view to testing thecore concepts of the relevant theories more precisely.

Acknowledgement

I would like to thank the editor and two anonymous reviewers for their helpfulcomments and suggestions on earlier drafts. The editorial work of Nancy Adler isgreatly appreciated. I have also benefited from the thoughts and suggestions of theparticipants in research seminars at Tel-Aviv University (Department of PublicPolicy) and the University of Haifa (Department of Human Services). All remainingerrors are mine.

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Abraham Carmeli received his Ph.D. from the University of Haifa. He was a visiting assistant professor in

the Department of Management at LeBow College of Business at Drexel University and a visiting

researcher in the Department of Industrial Economics and Strategy at Copenhagen Business School. He is

now a faculty member in the Graduate School of Business Administration and the Department of Political

Science (joint appointment) at Bar-Ilan University. His current research interests include complementa-

rities of intangible resources, managerial skills, top management teams, organization prestige and image

and individual behaviors. His research has appeared or been accepted for publication in such journals as

Corporate Reputation Review, Journal of Managerial Psychology, Local Government Studies, Managerial

and Decision Economics, Organization Studies, Public Administration, Public Administration Quarterly and

Strategic Management Journal, among others.

strategic human capital and the performance of public sector organizations

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