Firms outsource human resource (HR) services for cost savings, efficiency, service improvements, access to HR expertise and increased flexibility (Bendorf and Barge, 2005, Lee, 2007, Marquez, 2007 and Oshima et al., 2005). Transaction cost economics (TCE) along with capital market and resource based theories suggests an association between outsourcing HR services and overall firm performance (e.g., Lai & Chang, 2010). Yet the existing outsourcing literature has not established an empirical link between human resource outsourcing (HRO) and firm performance, nor has a link been established to the equity capital markets. Prior HRO research primarily addresses the client's decision to outsource (e.g., Adler, 2003, Delmotte and Sels, 2008, Klaas et al., 2001 and Kosnik et al., 2006), characteristics of outsourcing clients (Klaas et al., 2001), the outsourcing relationship (Lievens & Corte, 2008), and the effect of outsourcing on employees (Fisher et al., 2008 and Kessler et al., 1999). Given the far-reaching effect of the HR function within the firm, understanding the outsourcing decision impact is critical for managers desiring to improve profitability and equity market impact.
Managing a firm's workforce effectively and strategically can increase shareholder value by 10 to 20% (Becker & Huselid, 2003). This underscores the economic importance of the HR system. Outsourcing HR services can potentially improve organizational efficiency and HR service performance, as well as provide significant cost savings. In fact, some estimate that transforming human resources to optimize efficiency can result in labor cost savings of $9.8 billion for a typical Fortune 500 company (Hansen, 2008) and should lead to improved firm performance.
Understanding the market and operating performance effects of outsourcing is important to stakeholders and investors, and closes a gap in the HRO literature (Shen, 2005). This study extends the HR literature in several ways. First, prior studies have lacked proprietary HRO data, and have constructed proxies for outsourcing costs or relied on surveyed managers' perceptions of performance following outsourcing (e.g., De Vita et al., 2010, Dickmann and Tyson, 2005, Gainey et al., 2002, Gilley et al., 2004, Klaas et al., 1999 and Lilly et al., 2005). Heretofore, with few exceptions, researchers have not conducted empirical archival studies seeking to link HR management to corporate performance or market value (Abowd et al., 1990 and Jiang and Qureshi, 2006). Second, in addition to operating performance, this study investigates the capital market reaction to firms announcing administrative HRO contracts. Third, the reported results statistically control for the boundary condition, optimality of the outsourcing decision. Finally, the study addresses outsourcing HR services which can directly and indirectly affect firm performance through the services provided to and treatment of employees.
Whereas human resource outsourcing encompasses a broad range of functions, Klaas et al., 1999 and Klaas et al., 2001 distinguish the particular types of HR functions examined in this study, namely, HR generalist, transactional, human capital and recruiting. HR generalist activities include for example, performance appraisal, planning and EEO/diversity. Transactional activities are payroll, benefits and HRIS. Human capital activities include training and development and employee assistance, while recruiting involves staffing functions. The focus of this paper is on administrative HR services including payroll processing, benefits administration, employment verification, staffing, training, and workforce management.
In summary, within the HRO performance literature, this study is distinct in investigating overall stock market and operating performance of client firms to pinpoint empirically and systematically, the impact of outsourcing critical administrative HR functions on financial performance using archival financial data as an alternative to perceived financial operating performance.
Results supporting H1 are reported in Table 2 and document a significant positive mean abnormal return the day after the announcement (+ 1) (AR = 0.22%, p < .10) and a reversal five days after the announcement (+ 5) with a significant negative mean abnormal return (AR = − 0.29%, p < .10). The abnormal returns are consistent with previous IS outsourcing event study research ( Hayes et al., 2000). The cumulative abnormal return (CAR) over a two day event window (0, + 1) is statistically and economically significant (CAR = 0.43%, p < .05) with a mean abnormal gain on equity of $87,226,650 (p < .01) winsorized at 2% to mitigate the effect of outliers. The abnormal gain on equity is the market value of equity fifteen days prior to the outsourcing announcement multiplied by the abnormal return the day following the announcement. The statistical tests are based on the standardized prediction error ( Patell, 1976) and standardized cross-sectional method ( Boehmer et al., 1991 and Cowan, 2005).
