Formalizing the HRM and firm performance link: the S-curve hypothesis

Abstract

This study incorporates theory from economics to formalize the HRM–firm performance relationship. We propose and test a new theoretical model that predicts optimal points of investment in the HRM system where greater benefits are returned. The model also identifies investment levels that lead to negative and diminishing returns. In developing the intersection of HRM and economics we realize an opportunity to challenge the consistent adoption in the literature of what we call “linear logic”, or the assumption that continuous investment in HRM yields benefits at the same rate. Hypotheses were tested using data collected over two years from subsidiary leaders of a large European multinational corporation (MNC) operating in 27 countries. Financial performance data were gathered over three years, as well as economic data pertaining to industry, country, and regional effects. The results reveal that the relationship between investing in the HRM system and firm marginal benefit is nonlinear in the shape of an S-curve. Our findings provide insights on investment levels where the HRM system can have a positive influence on firm performance. Implications for theory and practice are provided.