What's Been Driving HR This Generation?

The old days, when HR was actually seen as an advocate for employee interests, have essentially disappeared. Now, the profession is facing its most serious challenge: justifying its existence by showing how its actions benefit shareholders.

Friday, May 12, 2017
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When HRE launched 30 years ago, the action around managing people was all in labor relations. The conflicts between unions and management were still epic, and company futures were on the line. Corporations such as International Harvest and Eastern Airlines went under, in large measure, because of conflicts they couldn't resolve with their unions.

Human resources back then was, frankly, a pretty sleepy affair. In the org charts, it reported to "Industrial Relations" and mainly governed the white-collar workforce. The decisions of the HR staff of course mattered enormously to the business, but they weren't very exciting. The model set up after World War II was crafted by industrial psychologists along with industrial engineers who hired, trained, promoted and paid employees based on well-established, predictable models. In the main, they were only tinkered with and varied relatively little across the great corporations.

HR doesn't look like that now. So what happened? I laid out the story in the late 1990s in a book called The New Deal at Work. Certainly, there were economic forces at work -- the deregulation of industries that made it more difficult to pass labor costs onto consumers and the rise of foreign competitors in manufacturing that had better quality (Japan) and were dramatically cheaper (China). These factors pushed companies to take on and, in most cases, break their unions. Labor relations became less important in most companies, and HR took its place. If it exists at all today, labor relations now reports to human resources.

But what happened to human resources itself is a different story. That engineering-based model we saw from the 1950s through the 1990s is almost unrecognizable now, nonexistent in newer companies and altered dramatically in the great corporations where the single biggest change has been the shift from developing talent from within to outside, lateral hiring. Careers went from "lifetime" -- driven by promotion-from-within to lateral, moving across companies, as employers started to dump employees in downturns or when stock prices needed a boost, and then hire new ones when business came back.

What drove that change?  Ideology. The force of ideas. In this case, the idea was that the goal of for-profit companies should be to maximize shareholder value. There was no pronouncement or piece of legislation that made this happen, although more conservative judges did start looking more favorably at lawsuits initiated by shareholders. It was a battle of ideas in a country where the political climate was moving to the right.

From the 1950s through the 1980s, in most business schools, students were taught that the goal of a company was to balance the competing interests of its stakeholders: shareholders yes, but also customers, employees and the broader community, and their interests were seen as equal in importance.  By the end of the 1990s, I doubt there was any business school teaching or promoting that model. In its place was this notion of maximizing shareholder value as the governing principle.

Where did that argument come from? At first from economics departments, in which mathematical models became prominent. These departments were trying to gain the precision of the physical sciences, and those models needed simple and clear motivations to work. Everyone who took an economics class from the 1980s on learned that workers were the selfish agents of owners who, in turn, were trying to maximize profits because that approach led to clear predictions. Finance departments were created in business schools after economists began to create sophisticated new models to understand the movements of some aspects of financial markets, and they taught the shareholder-value model explicitly.

Soon, we had a generation of business leaders who were brought up with the new shareholder-value model. As investors figured out new ways to make money -- leveraged buyouts at first, then private equity, then hedge funds -- the power of financial models and the assumptions behind them grew. CEO compensation moved swiftly to reward shareholder value, board membership changed to reflect that shift and, when the new companies that started in Silicon Valley such as Apple and their Seattle counterparts Microsoft and Amazon picked a business model, it wasn't the old stakeholder approach. (Amazon's Jeff Bezos famously came straight from Wall Street.)

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What did this mean for human resources? First, it meant that there was no longer any explicit importance attached to the interests of employees as a group. The old days when HR was actually seen as an advocate for employee interests (in part to keep unions out) disappeared quickly, and HR now had to justify its existence by showing how its actions benefited shareholders. This challenge continues to be the most serious problem facing HR as a function, in part because much of what it does cannot be measured easily. On the company balance sheet, much of what HR does gets lumped into "administrative expenses," which are liabilities companies try to minimize to improve their share prices.

Second, the fact that much of what HR does is a long-term play -- developing talent, improving morale -- now butts up against the much more immediate concerns of shareholder value as mediated by investment analysts who typically know little about management and less about human resources. All that long-term functionality got squeezed out and new tasks, such as managing downsizings, came into play. That is where things still stand today.

Here's a contemporary example of shareholder value at work in HR: You know the spurt of stories we are hearing about companies moving to "unlimited vacation time"? Do you think it was really about helping employees? No. It was an effort to get rid of paid-time-off as those accruals count as liabilities on company balance sheets. So if you eliminate them, profits look better and share prices go up.

The fact that so many HR functions are now outsourced to vendors was initially driven by shareholder-value concerns, seeking lower operating costs, especially in those administrative expenses. The surprising upside of this outsourcing is that it created what is now an enormous industry of vendors that paradoxically have raised the status of the HR function through advocacy and marketing. The downside is another new and fundamental challenge for HR, and that is figuring out which vendors are selling smoke and which ones are providing solutions to real problems.

Peter Cappelli is the George W. Taylor Professor of Management and director of the Center for Human Resources at the Wharton School.

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