Hire, Fire, or Train: Innovation and Human Capital Responses to Recessions

• Date: 01 December 2015
• DOI: http://doi.org/10.1002/sej.1207
• Author: Lasse B. Lien,Eirik Sjåholm Knudsen
• Published date: 01 December 2015

HIRE, FIRE, OR TRAIN: INNOVATION AND HUMAN

CAPITAL RESPONSES TO RECESSIONS

EIRIK SJÅHOLM KNUDSEN* and LASSE B. LIEN

Department of Strategy and Management/STOP, NHH Norwegian School of

Economics, Bergen, Norway

Research summary:We examine how firms’ relative emphasis on exploration and exploitation

influence their human capital responses to recessions. We hypothesize and find that the higher

the focus on exploration, the more firms invest in training, the more likely they are to hire, and

the more likely they are to lay off employees during a recession. Finally, we also find that

exploration-oriented firms are more likely to combine the accumulation of human capital

through training, with both hiring and firing. This indicates that firms focusing on exploration

more actively pursue the opportunities created by increasedlabor market imperfections during

recessions. These results contribute to the literature by highlighting how recessions affect

firms’ flow of human capital investments, and subsequently stocks, depending on their strategic

orientations.

Managerial summary:We examine how firms’ strategic orientations influence how they

respond to recessionsin terms of their human capital. We find that the higher the strategic focus

on exploration of new opportunities, the more firms invest in training, the more likely they are

to hire, and the more likely they areto lay off employees during a recession. The opposite is the

case for firms with a higher focus on exploiting existing (cost) advantages. Finally, we find that

exploration-oriented firms are more likely to combine the three human capital responses. In

sum, our findings indicate that firms emphasizing innovation and exploration of new opportu-

nities more actively pursue the opportunities created in labor markets during recessions.

Copyright © 2015 Strategic Management Society.

INTRODUCTION

Environmental change is a core issue for research

in strategic entrepreneurship (Ireland, Hitt and

Sirmon, 2003; Ketchen, 2007). One reason for this is

that environmental change creates entrepreneurial

opportunities via new or increased factor market

imperfections, while at the same time threatening

existing advantages (Alvarez and Barney, 2007).

In this sense, environmental change is a key driver

for the existence of entrepreneurial opportunities,

which makes it a crucial matter for the study of

entrepreneurship.

One particularly dramatic and wide-reaching type

of environmental change is a recession. Recessions

are known to create both grave threats and great

opportunities (Rhodes and Slater, 2009; Sull, 2009).

For example, threats might be related to contractions

in demand, changes in customer preferences

(Petersen and Strongin, 1996), or changes in access

to finance (Bond, Harhoff, and Van Reenen, 2005;

Ivashina and Scharfstein, 2010). Opportunities

might include assets being available at fire sale

prices (Shleifer and Vishny, 2011), reduced price of

talent (Greer, 1984), or reduced opportunity costs of

employees’ time (Aghion and Saint-Paul, 1998;

Keywords: recession; human capital; exploration and exploita-

tion; strategic entrepreneurship

*Correspondence to: Eirik Sjåholm Knudsen, Department of

Strategy and Management/ STOP, NHH Norwegian School of

Economics, Helleveien 30, 5045 Bergen, Norway. E-mail:

eirik.knudsen@nhh.no

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Strategic Entrepreneurship Journal

Copyright © 2015 Strategic Management Society

Strat. Entrepreneurship J., 9: 313–330 (2015)

Published online 21 September 2015 in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/sej.1207

Hall, 1991). How firms respond to these challenges

and opportunities should, therefore, be an obvious

matter of interest for the strategic entrepreneurship

literature.

Unfortunately, how firms respond to recessions

has received limited attention in mainstream strategy

(Agarwal et al., 2009; Bromiley, Navarro, and

Sottile, 2008; Garcia-Sanchez, Mesquita, and

Vassolo, 2014). If we take the entrepreneurship field

to include the small business literature, there are

several studies that look into firms’ responses to

recessions. As one would expect, these studies have

mainly focused on the impact of size and age on how

firms respond (Bumgardner et al., 2011; Churchill

and Lewis, 1984; Latham, 2009; Varum and Rocha,

2013). However, neither the strategy literature nor

the entrepreneurship literature has focused on the

effect of strategic orientation on firm responses.

In this article, we aim to address this gap by study-

ing how firms’ strategic orientations affect their

responses to recessions. Specifically, we examine

how the relative emphasis on exploration/innovation

in firms’ strategies affects how they respond with

respect to human capital. Our focus is on human

capital because strategy research indicates that

human resources are particularly important drivers

for competitive outcomes (Campbell, Coff, and

Kryscynski, 2012; Coff, 1997) and because some of

the most characteristic and heterogeneous effects of

recessions are related to employment and labor

market imperfections (Davis and Haltiwanger, 1999;

Keynes, 1936). While the aggregate pattern is that

labor demand falls in recessions, labor economists

have documented substantial variation across firms

with respect to hiring, firing, and investments in

training (Davis and Haltiwanger, 1990; López-

García, Montero, and Moral-Benito, 2013). Our

aim here is to better understand the role of strategic

orientation in explaining this heterogeneity.

Using a random sample of 1,248 Norwegian

firms, we find that increased emphasis on explora-

tion is associated with higher investments in train-

ing, greater likelihood of layoffs, and—perhaps

surprisingly—greater likelihood of hiring. We also

find that emphasis on exploration increases firms’

likelihood of combining training, with both hiring

and firing. These findings indicate that such firms are

more actively pursuing opportunities created by

labor market imperfections than firms that empha-

size exploitation. This is consistent with Simsek and

Heavey (2011), who find that firms engaging in cor-

porate entrepreneurship (exploration) are more

prone to invest in human capital. One difference

between our work and theirs is that we investigate

this behavior in the context of an environmental

shock that brings about increased opportunities and

threats via increases in factor market imperfections

in the ‘market’ for people.

The rest of the article is organized as follows: first,

we present theory and develop hypotheses regarding

the behavior of firms with regard to human capital in

recessions. Then, we test our hypotheses empirically

on a dataset from the recent recession, before dis-

cussing implications of our findings.

THEORY AND HYPOTHESES

Human capital and strategic orientation

Perhaps the core issue in the strategy field is to

explain performance differences between firms and

variation in the persistence of performance differ-

ences (Hoskisson et al., 1999; Rumelt, Schendel,

and Teece, 1994). The resource-/capability-based

view sees both performance differences and the

sustainability of such differences as fundamentally

decided by an underlying heterogeneity in the stocks

(or bundles) of resources/capabilities firms can

deploy in product market competition (Barney,

1986, 1991; Peteraf, 1993; Wernerfelt, 1984). The

study of the core issue in strategy is, therefore, to a

considerable extent, a study of how key asset stocks

are acquired, accumulated, deployed, and divested.

The causal chain from resources to product

market outcomes is that firms’ resources affect their

relative ability to perform different activities well.

These activities, in turn, affect firms’ relative poten-

tial to create and capture value in different product

market positions that ultimately determine financial

outcomes. The resources and capabilities a firm pos-

sesses (and lacks) shape a firm’s choice of strategy at

time t, while the choice of strategy at time twill

affect how a firm seeks to add, modify,and extend its

resource base at time t+1. Different strategies may,

therefore, either be a cause of different asset stocks,

a consequence of differences in asset stocks, or both.

Either way, this logic simply implies that firms with

different strategies: (1) are likely to have different

resource stocks; and (2) will act differently with

respect to how they alter these resource stocks.

Firm strategies can vary in innumerable ways.

However, broad categories have been used to reduce

this variation and extract the essential differences. A

Copyright © 2015 Strategic Management Society

DOI: 10.1002/sej

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Strat. Entrepreneurship J.,9: 313–330 (2015)

E. S. Knudsen and L. B. Lien