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CARLSON, UPTON, AND SEAMAN 531

Journal of Small Business Management 2006 44(4), pp. 531543


The Impact of Human Resource Practices and
Compensation Design on Performance:
An Analysis of Family-Owned SMEs
by Dawn S. Carlson, Nancy Upton, and Samuel Seaman
A sample of 168 family-owned fast growth small and medium enterprises (SMEs)
was used to empirically examine the consequences of ve human resource practices
on sales growth performance. The results suggest that training and development,
recruitment package, maintaining morale, use of performance appraisals, and com-
petitive compensation were more important for high sales-growth performing rms
than for low sales-growth performing rms. In addition, we examined the use of
incentive compensation in the form of cash, noncash, and benets and perks for four
different levels of employees in family-owned SMEs. The ndings suggest that high
sales-growth performing rms used more cash incentive compensation at every level
in the organization.
Small and medium enterprises (SMEs),
the majority of which are family-owned,
play an important economic and societal
role in the United States (Shanker and
Astrachan 1996). Family-owned busi-
nesses account for 60 percent of total
U.S. employment, 78 percent of all new
jobs, more than 50 percent of gross
domestic product, and about 65 percent
of all wages paid (Family Firm Institute
2002). When asked about the principal
challenges facing them as they grow
their rms, family and nonfamily SMEs
alike, point to human resource concerns
(Hoover and Hoover 1999; Deshpande
and Golhar 1994) While both groups
identify labor shortages a primary
concern, family-owned SMEs state that
attracting and retaining strong nonfamily
executives and dealing with insufcient
Dawn Carlson is associate professor of management, Hankamer School of Business, Baylor
University.
Dr. Upton is employed in her family oil and gas business as president and chief operating
ofcer.
Dr. Seaman is professor of decision sciences, Graziadio School of Business & Management,
Pepperdine University.
Address correspondence to: Dawn Carlson, One Bear Place #98006, Department of Man-
agement, Baylor University, Waco, TX 76798. E-mail: Dawn_Carlson@baylor.edu.
or poorly trained human capital are
signicant barriers to business success
and growth. Despite the importance of
family-owned SMEs to our economy and
to job growth, there is little empirical
research to assist managers and CEOs
facing some rather daunting human
resource challenges (Heneman, Tansky,
and Camp 2000; Upton and Heck 1997).
Instead, much of the work done with
regard to human resource management
(HRM) practices and performance
focuses on large organizations and not
on the SMEs that are so prevalent in
the marketplace today. Literature on the
relationship between human resource
practices and performance in small,
family-owned businesses is virtually non-
existent (Upton and Heck 1997). There is
considerable need then, for empirical,
comparative examination of the relation-
ships between determinants of perform-
ance, such as human resource practices,
and ownership structure (Westhead and
Cowling 1998). Further, Sharma, Chris-
man, and Chua (1997, p. 18) suggest,
. . . determinants of performance hold
the most promise for contributing to the
advancement of the [family business]
eld.
This research responds to the need for
empirical, comparative analysis of the
factors effecting family-owned SME per-
formance. We compare HRM practices
within a sample of high and low per-
forming family-owned SMEs split based
on sales growth. We examine the effects
on performance by primary HRM prac-
tices, such as recruitment package, per-
formance appraisal, compensation and
benets, maintaining morale, and train-
ing and development. First, differences
in importance placed on each of these
human resource areas are explored and
then their relationship to performance is
determined. Finally, differences in the
use of various forms of compensation
(that is, cash incentives, noncash incen-
tives, and benets and perks) across four
different organizational levels (CEO to
total employees) and their effect on per-
formance are explored.
We begin by providing an overview
of HRM practices and their link to
organizational performance. Next, the
importance of the HRM issues and com-
pensation design is discussed. Although
very little research examines HRM
practices at family-controlled SMEs,
the extant literature is reviewed and
hypotheses are put forward. We then
empirically examine differences in HRM
practices for high and low performing
family-owned SMEs. Next, we look at
the design of incentive compensation
systems across high and low performing
family-owned SMEs. Finally, based on the
results, we discuss practical implications
for the management of family SMEs and
for future research.
HRM Practices and
Performance
There are few studies that identify
HRM practices in SMEs and even fewer
that focus on the relationship between
HRM practices and performance
(Heneman, Tansky, and Camp 2000).
Over the past decade, several studies
have reported the relationship between
HRM practices and performance in large
organizations. While there is some
debate as to the extent to which we can
apply the HRM practice/performance
results from large to small rm, these
ndings are of interest and provide the
basis for theoretical examinations of the
smaller rm (Chandler and McEvoy 2000;
Deshpande and Golhar 1994).
HRM practices such as employment
security, selectivity in recruiting, high
wages, incentive pay, employee owner-
ship, participation and empowerment,
promotion from within, training, and
skill development are just a few of the
practices acknowledged as having great
value to the organization (Pfeffer 1994).
Recent research has empirically shown
the positive relationship between HRM
532 JOURNAL OF SMALL BUSINESS MANAGEMENT
practices and important organizational
outcomes such as productivity, turnover,
and rm performance (Delaney and
Huselid 1996; Huselid 1995; Arthur
1994). These studies persuaded many in
the management sciences that an explicit
set of HRM best practices or as Huselid
(1995, p. 635) termed themhigh per-
formance work practicesexist. Subse-
quent studies seem to support the notion
that there are a bundle of HRM practices
that can impact a rms performance
(Huselid, Jackson, and Schuler 1997;
Delery and Doty 1996).
In this study, ve HRM best practices
are considered: training and develop-
ment, performance appraisals, recruit-
ment package, maintaining morale, and
setting competitive compensation levels.
Perceived Importance of
HRM Functions
The strategic use of human resources
is important for the performance of the
organization. Further, the adoption of
a set of best practices for managing
employees is believed to have a positive
effect on organizational performance
(Wright and Snell 1998; Applebaum and
Batt 1994; Pfeffer 1994). In a recent
study, human resources was identied
as an area of signicant importance to
an organizations success (Heneman,
Tansky, and Camp 2000). Thus, the
importance placed on an HRM function
in an organization might demonstrate
how critical that function is to a given
organization. We identify ve strategic
best HRM practices for this research:
training and development, performance
appraisals, recruitment package, main-
taining morale, and setting competitive
compensation levels.
An overview of HRM research sug-
gests that these ve HRM practices have
an inuence on organizational perform-
ance. Specically, greater training hours
have been linked to higher performance
(Gowen and Tallon 2003; Huang 2001;
Huselid 1995; MacDufe 1995). A strong
positive relationship has been found
between performance appraisals and
enhanced organizational performance
(Chang and Chen 2002; Delery and Doty
1996; Huselid 1995). Effective practices
for recruiting and selection, especially
those considering the compensation
element are related to performance (Ich-
niowski and Shaw 1999; Huselid 1995).
Employee motivation has been shown to
have a signicant impact on productivity
and performance (Gelade and Ivery
2003; Huselid 1995). Finally, design of
compensation systems including the
consideration of external equity has
been linked with performance (Mak and
Akhtar 2003; Youndt et al. 1996; Huselid
1995).
HRM Practices and
Performance in the
Family Firm
Little is known concerning human
resource practices in family-owned rms
and their effect on performance (Reid et
al. 2002). Anecdotal evidence suggests
that family businesses, rife with nepo-
tism, eschew human resource practices
(Gersick et al. 1997). However, two
national surveys that focused on family
rms conducted under the auspices of
Mass Mutual (1993/1994), did not
support this notion. They discovered that
about half of the respondents reported
that they used written job descriptions,
set compensation plans, provided formal
and regular employee reviews, and had
a written employee manual. An in-depth
analysis of the MassMutual data by Astra-
chan and Kolenko (1994) found signi-
cant differences in HRM practices for
family versus nonfamily employees. They
found that employee reviews, compen-
sation plans, appraisal, and personal
development plans were used signi-
cantly more frequently in family rms for
nonfamily employees than for family
members.
CARLSON, UPTON, AND SEAMAN 533
534 JOURNAL OF SMALL BUSINESS MANAGEMENT
Poza, Alfred, and Maheshwari (1997)
studied 26 family businesses as part of
the Discovery Research program at Case
Western. They found that nonfamily
managers were signicantly less satised
with the managements ability to handle
growth and the extent to which the nec-
essary processes were in place to facili-
tate growth. Further, the nonfamily
managers were signicantly less satised
with the fairness of the compensation
system and more satised with feedback
from performance appraisals.
Reid and Adams (2001) found signi-
cant differences between family and non-
family SMEs in Northern Ireland. Labor
costs for the nonfamily business was
much higher and nonfamily SMEs were
more professional in their HRM prac-
tices. For example, it was signicantly
more likely that a nonfamily business
would have an HRM manager, use
appraisal systems, set merit/performance
related pay for managers, and keep
detailed HRM records. Although both
family and nonfamily businesses
reported that employee training and
development was their most important
challenge, family businesses reported
spending signicantly less on training (as
a percentage of total salaries and wages)
than nonfamily businesses.
Although there is ample evidence that
HRM practices inuence performance,
within the family business literature
there is little research which support
these links or examine its implications.
However, there persists a belief that HRM
in family-owned businesses could be a
signicant competitive advantage (Hab-
bershon, Williams, and Kaye 1999). Ward
(1988) proposes that family businesses
may have a unique ability to create a
more family-oriented workplace, which
leads to greater employee loyalty. Astra-
chan and Kolenko (1994) found a posi-
tive correlation between HRM practices
and gross revenues in family-owned
businesses. Similarly, Leon-Guerrero,
JcCann, and Haley (1998) found a posi-
tive relationship between family business
revenues and the use of formal HRM
practices, such as formal employee
reviews, written job descriptions, and
incentive compensation plans.
Based on these ndings, we propose
that the importance placed on specic
HRM practices by the rm will be related
to higher performance and offer the fol-
lowing hypotheses:
H1: The importance placed on training
and development will be positively
related to performance.
H2: The importance placed on perform-
ance appraisals will be positively
related to performance.
H3: The importance placed on designing
competitive compensation systems for
recruitment package will be positively
related to performance.
H4: The importance placed on main-
taining morale will be positively
related to performance.
H5: The importance placed on setting
competitive compensation levels will
be positively related to performance.
Compensation Design
Pfeffer (1994) argued that one of the
elements of what effective rms do with
people is the use of incentive pay. The
design of compensation systems in terms
of the form of incentive compensation
used is critical to the success of the
organization. In fact, empirical evidence
has found that pay mix is related
to nancial performance (Gerhart and
Milkovich 1990). More specically, in
examining human resource practices, the
use of incentive compensation is posi-
tively related to organizational perform-
ance (Huselid 1995; Delaney and Huselid
1996). The theory suggests that using
incentive compensation better motivates
individuals to perform than by simply
relying on xed rewards.
In a recent study, Stevens and Hill
(2001) focused on differences in execu-
tive compensation in large organizations.
They found that low performing rms
use higher xed salaries and fewer incen-
tives while high performing rms use
lower xed salaries and a greater percent
of overall compensation is incentive pay.
This would suggest that higher per-
forming rms are using various forms
of incentive compensation such as cash
incentives, noncash incentives, and ben-
ets and perks more than low perform-
ing rms.
Furthermore, the family business lit-
erature has examined the relationship
between pay and performance within
the agency theory context. Gomez-Mejia,
Tosi, and Hinken (1987) reported that
family business owners prefer pay to be
tied to performance. However, family
rms are less likely to share ownership
with employees (Stoy Hayward 1990), as
this would dilute the familys control.
Thus, it is more likely that family rms
will use some form of incentive that does
not give up control. This will allow for
incentives to be tied to performance and
yet still retain family control, which has
been associated with higher rm per-
formance (McConaughy et al. 1998).
Therefore, while little research that
focuses on family-owned SMEs exists, the
little evidence available would suggest
that the higher performing rms are
more likely to use some form of incen-
tive compensation system.
Based on this research, we predict
that those organizations that are high
performing are more likely to offer a
greater amount of incentives in order to
address motivation and retention issues.
Thus, we offer the following hypotheses
for family-owned SMEs:
H6: Cash incentives will be positively
related to performance.
H7: Noncash incentives will be positively
related to performance.
H8: Benets and perks will be positively
related to performance.
Methodology
Sample
Data were drawn from the 1998
Survey of Innovative Practices admi-
nistered by the Kauffman Center for
Entrepreneurial Leadership at the Ewing
Marion Kauffman Foundation, Ernst &
Young LLP, and the Entrepreneur of the
Year Institute. The survey is completed
by companies selected from the mem-
bership of the Entrepreneur of the Year
Institute. Companies completing the
survey are sales-growth-oriented, as this
is one of the judging criteria. Data gath-
ered on the rms spanned the years 1995
through 1998. Details of the data gather-
ing process are detailed in Survey of
Innovative Practices (Cox and Camp
1999).
Sample Selection. There is a lack of
consensus regarding how much owner-
ship is necessary to qualify a rm as a
family business. Ward and Dolan (1998)
suggest that ownership be measured by
voting power, as it is a better indicator
of family business behavior and struc-
ture than relative economic interest.
Chua, Chrisman, and Sharma (1999) state
that there is no specic delineation of
how much ownership is necessary to
qualify the rm as a family business.
Ward (1986), however, denes control
by percent ownership of stock with 50
percent ownership considered in control
for privately held rms and 30 percent
for publicly held rms. Following this
categorization, family ownership was
determined by the percent of stock that
was held by the CEO or CEOs family
members. Those that were greater than
50 percent were included in the sample.
Furthermore, in order to focus on SMEs,
only those organizations with less than
500 employees were included. Finally,
the sample was split into thirds based on
performance and the middle group was
CARLSON, UPTON, AND SEAMAN 535
dropped. This resulted in a sample of 168
family-owned rms.
Variables
Importance of HR Function. In order
to determine the importance placed on
each function, the respondents were
asked how their ability to manage the
function impacted the growth of the
rm. This perceptual question was
reported on a ve-point Likert scale with
anchors of no impact (1) to big impact
(5). Four items were asked to assess the
importance placed on the different HRM
functions: training and development,
appraising employee performance, main-
taining morale, and setting competitive
compensation levels. A fth question
dealt with the recruitment package as it
focused specically on how designing
competitive compensation impacted the
rms ability to recruit and retain key
employees.
Compensation Design. The respon-
dents were asked to provide the actual
percentage of compensation expense
broken down by base salaries, cash
incentives, noncash incentives, and
benets/perks with the total to equal 100
percent. They did this a total of four
times, once for each of the following:
total employee compensation, CEO com-
pensation, key sales managers, and other
key managers.
Performance. Within entrepreneurship
literature, sales growth is considered the
best growth measure because it reects
both short and long-term changes in
the rm, is easily obtainable, and is a
common performance indicator among
entrepreneurs themselves (Barkham et
al. 1996; Hoy, McDougall, and Dsouza
1992). Davidsson and Wiklund (2000)
provide an in-depth analysis of growth
measures in research and advocate sales
growth as the performance indicator of
choice when examining activities such as
HRM. However, the traditional measure
of growth: g = (S
t1
S
t0
)/S
t0
is biased
toward initial size of the rm. The bias
is in favor of rms that initially had a
smaller size. To overcome this bias, the
Sales Growth Index was used. This is
calculated by multiplying the average
annual increase in sales volume by the
average rate of change in sales revenue.
Cox and Camp (1999) note that the sales
growth index is not biased toward either
initially large or small rms and repre-
sent a better measure of entrepreneurial
growth. In order to best represent dif-
ferences in performance, the sample was
split into thirds with the top third repre-
senting the high performing rms, and
the bottom third representing the low
performing rms.
Results
As illustrated in Table 1, the high per-
forming rms were about the same age
as the low performing rms, and were
larger as measured by sales and report
about the same CEO tenure. The average
age of the rms were similar; with the
high performing group being an average
of 23 years and the low performing 26
years old. Although the average sales of
the high performing rms is much higher
than that of the low performing rms,
the use of the sales growth index mini-
mizes the size differential. The tenure of
the CEO in the high performing rms
(13.5 years) was slightly shorter than that
of the low performing rms (14.9 years).
Low performing rms pay out signi-
cantly more in base salary ( p < .001) to
total employees than high performing
rms. Results for the variables of interest
are reported further.
The hypothesized relationships of
interest were tested using LOGIT regres-
sion. To test H1 through H5, each of the
HRM practices was used as an inde-
pendent variable and performance was
used as the dependent variable. The
results for these regressions can be
found in Table 2. H1, the relationship of
training and development with perform-
536 JOURNAL OF SMALL BUSINESS MANAGEMENT
CARLSON, UPTON, AND SEAMAN 537
ance, was supported. Thus, high per-
forming rms placed more importance
on training and development than did
low performing rms. H2 was supported
as the relationship between the impor-
tance placed on performance appraisals
and performance was signicant. The
relationship of designing competitive
compensation for recruitment and
performance (H3) was supported. This
would suggest that placing emphasis on
designing competitive compensation in
recruiting is more common for high
performing rms. H4 was supported, as
the impact of maintaining morale was
signicantly different for high and low
performing rms. Thus, higher perform-
ing rms placed more emphasis on main-
taining morale in their organization than
did low performing rms. Finally, H5
was supported, as the importance placed
on setting competitive compensation
levels was greater for those organizations
that were high performers.
To test H6 through H8, LOGIT was
also used with the same dependent vari-
able of performance. However, in this
case, each hypothesis was tested four
times, one for each particular set of
employees that was examined. Thus, the
impact of percentage of incentives on
performance was examined four times:
(1) CEO, (2) sales managers, (3) other
key managers, and (4) total employees.
This was repeated for cash incentives,
noncash incentives, and benets/perks.
The results can be found in Table 3. H6,
which examined cash incentives, was
supported across all four groups. Thus,
the use of cash incentives for all levels
of the organization was signicantly
related to higher performing rms. H7
and H8, the examination of noncash
incentives and benets and perks with
performance, was not supported. Across
all four sets of employees the use of both
noncash incentives (H7) and benets
and perks (H8) was not signicantly
related to performance.
Discussion
Based on previous human resource
research, we hypothesized that ve
critical human resource practices would
be positively related to performance
in family-owned rms. Our ndings
revealed that importance placed on each
of these ve human resource issues
training and development, performance
appraisals, recruitment package, main-
taining morale, and setting competitive
compensation levelswere all areas in
which high performing family rms
placed signicantly greater importance
than low performing family rms. These
ndings suggest that these human
resource activities do in fact have a
positive impact on performance.
Table 1
Descriptive and Summary Statistics
Variable Low Performing High Performing
Mean S.D. Mean S.D.
Age of Firm (Years) 25.89 17.54 23.34 17.56
Tenure of CEO (Years) 14.91 10.18 13.52 9.53
Sales ($) 12,841,627 19,299,011 52,054,709 53,898,578
Sales Growth Index ($) 2,410,194 21,688,954 59,378,824 389,158,093
538 JOURNAL OF SMALL BUSINESS MANAGEMENT
These ndings are consistent with
existing research of several national
surveys in which family rms identied
recruiting and training and development
as two HRM areas of critical importance
to business success (Hoover and Hoover
1999). High performing family rms are
signicantly more likely to recognize and
prioritize these areas. Further, this is
consistent with research of large organi-
zations, which has shown that these
human resource practices are critical to
organizational success (Huselid 1995).
This research extends previous research
by demonstrating that these previous
ndings hold for family-owned SMEs.
The second aspect of our study exam-
ined the design of compensation struc-
tures and their impact on performance
for family-owned SMEs. Across four dif-
ferent levels of the organization (CEO,
key managers, sales managers, and total
employees) the results supported the
importance of using cash incentive-based
forms of compensation. However, the
results did not support the use of
noncash incentives, and benets and
perks. Thus, this research would suggest
that in family-owned SMEs, cash incen-
tives in compensation across all levels
of employees might well lead to higher
performance.
While nonfamily rms may use equity
to recruit, retain and motivate employ-
ees, family businesses are prone to keep
stock within the family. Therefore, they
must devise other ways to reward high-
performing managers. According to this
research, high performing family rms
are effectively rewarding employees with
cash incentives.
The current research provides a
number of contributions to the existing
research relating human resources and
family-owned rms. First, the clear need
to address human resource issues in
Table 2
Logit Regressions to Determine If Human Resource
Management Practice Impact Performance
Intercept 1.39** 1.28*** 1.09* 1.35* 1.44**
Training and 0.34**
Development (0.0471)
Performance 0.36**
Appraisals (0.0129)
Recruitment 0.28*
Package (0.0812)
Maintain Morale 0.31*
(0.0910)
Competitive 0.36**
Compensation (0.0478)
a
Estimated coefcients are listed rst; p-values below in parentheses.
*indicates signicance at the ten-percent level.
**indicates signicance at the ve-percent level.
***indicates signicance at the one-percent level.
CARLSON, UPTON, AND SEAMAN 539
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family rms is addressed by providing an
empirical examination of these issues on
performance (Upton and Heck 1997).
Second, a range of human resource
functions is considered providing a rich
perspective of the relationship of HRM
practices and performance in family-
owned rms. Finally, by looking at three
different forms of incentive pay and
across four different levels of the organ-
ization, we get a broad picture of the
extent to which the use of cash incen-
tives is critical for company success.
As with all research there are also
some limitations of the current study.
First, we used single item measures of
the HRM practices which may not have
captured the many facets involved in
each of the practices. Second, the sample
is one of convenience: fast-growth SMEs.
As such, the ndings may not be gener-
alized to all family rms or all SMEs.
However, for those SMEs that hold fast
growth as a strategic goal, these ndings
may be of some benet. Third, family
rms may pursue different goals than
nonfamily rms (Greenwald and Asso-
ciates 1993/1995). However, in this
sample, all the rms are sales-growth-
oriented. These ndings may not gener-
alize to family rms that are pursing
other growth goals.
Future Research
Future research needs to focus on
determining what specic activities are
associated with the HRM areas identied
and how those specic activities impact
performance. Reid and Adams (2001)
reported that although nonfamily and
family businesses believe training and
development is their most important
challenge, family businesses spent less
on this. It would be interesting to see if
training and development expenditures
are signicantly different between high
and low performing family businesses
as previous research has found a link
between development expenditures and
performance, inuenced by ownership
structure (Hill and Snell 1989). Further,
development of higher-order variables or
clusters of human resource variables,
which may serve as discriminators
between high and low performing organ-
izations, warrant future attention.
Another avenue for future research is
to examine how high performing family
rms disburse base salary as compared
to cash incentives. We do not know if
there is a family effect going on in
which lower base salaries and higher
cash incentives are distributed. In other
words, are low performing rms paying
family members differently than high
performing rms? If so, what effect is this
having on performance?
In conclusion, human resource man-
agement is a complex set of activities
that are enacted within the organization
to support overall corporate strategies.
Our study is focused on a sample of high
and low performing family SMEs. While
we examine several HRM practices, it
may be that some are more effective than
others within certain industries or cor-
porate strategies. That said, by placing
importance on the human resource
aspect of the rm, a family-owned SME
might be able to effectively use HRM
such that it has a positive impact on
performance.
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