Physical capital is unlikely to be affected by institutions because, regardless of institutions, machines and equipment are likely to run the way they are designed. However, organization capital, which is capital embodied in the key employees of a firm, is likely to be affected by institutions. The prevalence of SOEs in China provides a rare opportunity for testing the role of institutions in investment and efficiency of organization capital. Based on data from Chinese listed firms, this study confirms the importance of organization capital as a production factor in China based on consistent evidence from OLS, fixed effects and the Levinsohn-Petrin (2003) models. Service is likely to rely more on organization capital than non-service. The coefficients of organization capital in the production function are close to those of Tronconi and Marzetti (2011) but the ratio of organization capital to book assets is much smaller in China.
A simple theoretical model capturing some important characteristics of the human resource management practice in SOEs is constructed in this study to discuss the source of low employee turnover and low efficiency of organization capital in SOEs. Demoting or firing a formal employee is difficult in SOEs and therefore the wage of employees
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cannot be adjusted to reflect their true ability when they demonstrate ability lower than expected. The model argues that excess payments to employees whose ability is previously overestimated are one of the reasons that SOEs have relatively low employee turnover and relatively low organization capital efficiency.
The empirical evidence is consistent with the predictions of the simple model. SOEs, on average, have around 3.5% more organization capital compared with private enterprises, which is likely to be a result of the relatively low employee turnover in SOEs. The result is robust across two measurements of organization capital: the level of organization capital and the ratio of organization capital to book assets, after controlling for size, leverage, industry and year effects. The difference in organization capital efficiency is also significant. SOEs on average have lower organization capital efficiency than private enterprises. The difference is robust across three key measurements of firm performance: CFOA (operation cash flow of asset), ROA (return of asset) and Tobin’s Q.
This study provides an important basis for policies promoting organization investment in China. Organization capital has become an important production factor for China according to the results of this study, and a further increase in productivity requires further investment in organization capital. Moreover, this study reveals the importance of continuing reforms in SOEs of China. The efficiency of organization capital is relatively low in SOEs because human resource management practice is inflexible and external effective supervision is relatively weak. According to Zhang (2006), managers of SOEs are selected and reviewed by bureaucrats instead of capitalists, which indicates relatively
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weak supervision from the bureaucrats because the bureaucrats do not own the capital of the SOEs. To improve the efficiency of organization capital in SOEs, the wage system and human resource administration system in SOEs should be more flexible and marketized, which would aim to reduce excess payments to employees as well as to provide more incentives for management to work hard. Specifically, the current bianzhi system in SOEs should be eliminated and contract-based employment should dominate. Once the bianzhi system is extinguished, direct interventions from the government and inflexibility in human resource management is minimized because the key employees in SOEs will no longer be parts of the bureaucratic system. Then firms can adjust excess payments to previously overpaid employees more easily. Moreover, further privatization is needed to allow private power to be involved in the corporate governance of SOEs. For instance, top managers of SOEs should be selected via the professional manager market instead of through appointment from the government. With supervision from private power, the efficiency of organization capital in SOEs is also likely to increase.
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