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Outsourcing and Organizational Performance: The Employee Perspective

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We develop a conceptual framework that integrates and extends existing explanations of outsourcing’s effects on the government workforce and organizational performance. We then test our logic using 5 years of panel data (2010-2014) from U.S. federal agencies. The evidence presents modest negative effects of outsourcing on organizational performance as perceived by employees. The analysis also reveals that outsourcing affects perceived performance through its influence on job satisfaction.
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Outsourcing and Organizational Performance: The Employee Perspective
Gyeo Reh Lee1,* , Shinwoo Lee2 , Deanna Malatesta1, and Sergio Fernandez1,3,4
1Indiana University, Bloomington, USA
2University of South Florida, Tampa, USA
3University of Pretoria, South Africa
4University of Johannesburg, South Africa
*Corresponding Author:
Gyeo Reh Lee, School of Public and Environmental Affairs, Indiana University, 1315 E. 10th Street,
Bloomington, IN 47405, USA. Email: gyeolee@iu.edu
Abstract
We develop a conceptual framework that integrates and extends existing explanations of
outsourcing’s effects on the government workforce and organizational performance. We then test
our logic using five years of panel data (2010-2014) from US federal agencies. The evidence
presents modest negative effects of outsourcing on organizational performance as perceived by
employees. The analysis also reveals that outsourcing affects perceived performance through its
influence on job satisfaction.
Keywords: Outsourcing, Government Contracting, Organizational Performance, Job Satisfaction
1
Since the advent of the New Public Management Reforms in the 1980s, governments
have relied extensively on the private sector for the production and delivery of public services
(Pollitt & Bouckaert, 2011). Outsourcing is an important policy tool employed in the name of
greater efficiency and a decided preference for business-like practices. Yet, we have made only
limited progress in understanding the broader consequences of outsourcing (Heinrich, Lynn, &
Milward, 2009). Most of the research focus has been outward on the efficiency and effectiveness
of public functions and services (Williamson, 1985, 1991), while government personnel’s
perspective on the effects of outsourcing on organizational performance has been rarely
evaluated. This renders fractional explanations of outsourcing outcomes (Lindholst et al., 2018).
This research provides an exploration of the impact of outsourcing on organizational
performance from the perspective of public employees. As one of the key public sector
constituents, government employees have different interests, thoughts, and values that set them
apart from other constituents. In particular, public employees have witnessed the continued
expansion of government outsourcing for the several decades as an alternative tool for delivering
public services, and therefore, hold certain expectations about the consequences of
outsourcingboth good and badfor themselves and their organizations. A huge literature on
work-related attitudes indicates that what employees think and how they feel about their
organization, its policies, and its leaders influence their motivation, behavior, and ultimately their
performance (Ostroff, 1992; Riketta, 2008). Thus, analyzing how government outsourcing
influences employee perceptions and attitudes can foster a broader understanding of how this
practice affects public organizations.
To explore how government outsourcing influences employee perceptions of
organizational performance, we bring together disparate literatures on public-private
2
partnerships, transaction cost economics (TCE), principal-agent problem, public service
motivation (PSM), psychological contract, and job satisfaction to propose a logical explanation
of why and how outsourcing may affect perceived organizational performance among federal
employees. While the traditional approach in developing theoretical grounds has predominantly
relied on a unidimensional, either positive or negative, outcome of government outsourcing, we
take a comprehensive approach considering both dimensions. Empirically, we use panel data
(2010-2014) associated with US federal agencies. Findings explain some of the variation in job
satisfaction and perceived performance that appears in the Federal Employee Viewpoint Survey
(FEVS) results reported by US Office of Personnel Management (OPM). Our theoretical and
empirical approaches contribute to offering the evidence on federal employees’ evaluation on
outsourcing outcomes in terms of organizational performance.
The next section provides a theoretical framework that connects outsourcing, employee
job satisfaction, and perceived organizational performance. The methods section explains the
sampling strategy, data sources, variables, and measures. We then present our findings, and
conclude with a discussion of implications for theory and practice, limitations, and research
extensions.
Theoretical Framework
This section lays out our theoretical framework to account for how outsourcing affects
organizational performance as perceived by employees, both directly and indirectly through its
influence on job satisfaction.
Employee Perceptions of Organizational Performance
The conceptual domain of organizational performance, one of the central concepts in the
field of management, is incredibly broad, with a wide range of approaches developed by experts
3
to describe and measure organizational performance (Quinn & Rohrbaugh, 1981; Cameron &
Whetten, 1983; Rainey, 2014; Amirkhanyan et al., 2014; Andersen et al., 2016). The perceptions
of stakeholdersinternal as well as external figureshave been prominently operated in major
approaches to organizational performance, including the Competing Values Approach (Quinn &
Rohrbaugh, 1981) and the Balanced Scorecard (Kaplan & Norton, 1996). Reviews of research on
organizational performance attest to the importance of employee perceptions of organizational
performance as one of key facets of this concept and a critical source of performance information
(Boyne, 2002; Andrews et al., 2006; Andersen et al., 2016).
Employee perceptions of organizational performance further our understanding of
organizational performance in two ways. First, knowledge of how employees perceive
organizational performance can be used to infer how well the organization is actually
performing. A growing body of evidence reveals moderate to strong correlations between
perceptual or subjective measures of performance and more objective or archival measures of
performance, indicating that both types of measures converge on the underlying concept of
organizational performance. To be sure, some researchers like Meier and O’Toole (2013a,
2013b) warn against the use of perceptual measures of performance in public management
research. Their analysis reveals weak correlations between perceptual and objective measures of
performance, with the former found to be inflated and prone to producing spurious results. In a
similar vein, Heneman’s (1986) meta-analysis reports a relatively weak correlation of 0.27
between perceptual and objective performance measures. A wide range of studies, however,
reveals stronger correlations between these two types of performance measures (Dess &
Robinson, 1984; Nathan & Alexander, 1988; Bommer et al., 1995; Dawes, 1999; Ketokivi &
Schroeder, 2004; Wall et al., 2004; Vij & Bedi, 2016; Singh et al., 2016). These studies report
4
correlations between perceptual and more objective measures of performance between 0.50
(Walker & Boyne, 2006) and 0.60 (Dess & Robinson, 1984; Dawes, 1999; Wall et al., 2004);
Nathan and Alexander’s (1988) meta-analysis reports correlations as high as 0.90. Bommer et
al.’s (1995) meta-analysis also finds a correlation between the two types of measures (r = 0.30)
that becomes much stronger (r = 0.71) when perceptual and objective measures of performance
tap the same dimension of performance (e.g., effectiveness or efficiency). Further, Wall et al.
(2004), Ketokivi and Schroeder (2004), and Singh et al. (2016) find sufficiently high correlations
between perceptual and objective measures of performance to warrant treating the former as
reliable and valid measures of performance. In short, while not interchangeable, employee
perceptions of performance are sufficiently correlated with more objective measures to allow one
to make reasonable inferences about how well an organization performs.
In addition, employee perceptions of organizational performance are valuable because
they are correlated with various antecedents of organizational performance. Research on
employees perceived image of their organization, including its values, mission, capacities, and
performance, indicates that more positive images lead employees to identify more strongly with
their organization (Dutton et al., 1994; Rho et al., 2015). Organizational identification, in turn,
has been found to be related to a range of antecedents of performance, including cooperation
(Dukerich et al., 2002), extra-role behavior (Rho et al., 2015; Van Dick et al., 2008), job
satisfaction (Van Dick et al., 2004; Van Dick et al., 2008), motivation (Pratt, 1998), and
organizational commitment (Dutton et al., 1994). Thus, knowledge of employee perceptions of
performance can be used to infer something about employee behavior and attitudes that influence
organizational performance.
5
The Direct Link between Outsourcing and Performance
Public organizations have undergone significant reforms over the last few decades,
including the growing use of market-based practices, such as outsourcing that are associated with
the New Public Management (NPM; Hodge, 2000).1 Proponents of NPM-oriented reforms
postulate that these reform efforts will improve public organizations’ performance through
increasing administrative efficiency and effectiveness (e.g., Osborne & Gabler, 1992).
Anticipated gains from government outsourcing are grounded on the proposition that
governmental organizations lack competition and private ownership (Petersen, Hjelmar, &
Vrangbæk, 2018). Governmental organizations rarely experience competitive pressures and can
avoid bankruptcy conditions that undermine efficiency (Petersen, Hjelmar, & Vrangbæk, 2018;
Fukuyama, 2018). Private organizations, on the other hand, face competition and ownership
constraints in their business. Provision of public services by private or nonprofit organizations,
therefore, is expected to produce high quality services more efficiently.
The literature on public-private partnerships also emphasizes the expertise both private
and nonprofit organizations hold. Public agencies can utilize their expertise and experience in
providing public services through outsourcing with these organizations (Berrios, 2006).
Particularly, nonprofit organizations are treated as a good alternative to public agencies due to
their proximity to the communities and lower labor costs (Denhardt, Denhardt, & Blanc, 2014).
Further, the network management literature implies that when managers have expertise in
contract management and the ability to handle issues of control and accountability, outsourcing
can be a means of improving organization performance (Agranoff, 2006). Outsourcing can also
enable agencies to focus on core activities and competencies (Quinn & Hilmer, 1994), and help
them respond more rapidly to changes in demand.
6
Notwithstanding, other streams of research posit negative consequences of government
outsourcing in terms of organizational performance. Transaction costs economics (TCE) is
perhaps the predominant theoretical approach to evaluating the outsourcing decision
(Williamson, 1985, 1991).2 According to TCE, the optimal choice between direct public
provision (hierarchical governance) and outsourcing (market-based governance) is that which is
comparatively most efficient, considering the sum of transaction costs. The efficiency calculation
is altered by the characteristics of the exchange. For a simple example, consider a government
contract for technology to process applications for drivers’ licenses. Technology changes rapidly
so the value of the product and services are not easily knowable. In such an uncertain
environment, TCE predicts an in-house solution. In general, the theory predicts that market-
based solutions are more efficient for simple exchanges, but in-house solutions are more efficient
for complex exchanges. A relatively small body of TCE focuses on performance results, and the
body of evidence yields mixed results. For example, Leiblein, Reuer, and Dalsace (2002) find
that neither outsourcing nor internalizing resulted in better technological performance. In
contrast, Silverman et al. (1997), Masten et al. (1991), and Nickerson and Silverman (1999)
point to negative effects, including lower organizational survival rates and lower earnings.
In any case, agency costs negatively affect performance. Jensen and Meckling (1976)
succinctly summarize the link between agency costs and performance when they assert, “…
divergent interests lead to a reduction in welfare experienced by the principal (p. 308). In the
context of outsourcing, agency cost arises when the agent (supplier) is given discretion to make
decisions that affect the principal (government).3 The root of the problem is information
asymmetry. If it were costless for the principal to observe the agent’s behavior, the agent would
behave no differently than the principal, which is to say all actions would be in the principal’s
7
best interest. However, professional services have an elusive quality and the principal cannot
always determine if poor results are a function of the agent’s behavior or of other circumstances.
For example, government can never be sure it obtained the ‘best work’ of an engineer or an
attorney. Suppliers are inclined to take advantage of the situation by shirking or self-dealing.
Hart, Shleifer, and Vishny (HSV; 1997) expose this problem using the example of outsourcing
prison services. Formally modelling the outsourcing decision, HSV show the private provider’s
motive to cut costs and compromise on quality can be too strong to overcome. The problem is
most acute when service quality cannot be fully specified, and therefore contracts are
incomplete, the typical case when government outsources professional services (e.g., Alonso &
Andrews, 2016; Walker, Boyne, & Brewer, 2010).
There is no scenario where agency costs disappear. Government can take steps to
mitigate abuses associated with the principal-agent problem, for example, by hiring independent
third-party monitors, placing contractual limits on the supplier’s decision authority, or adding
bonding requirements to the contract. The government can also attempt to align the parties’
interests by including incentives and penalties in the contract. All of these actions increase
overall transaction costs. Moreover, government cannot entirely correct the problem; the infinite
number of potential contingencies will always leave room for supplier opportunism. This is the
very nature of incomplete contractinga world where contingencies can never be fully known
and quality can never be fully specified.
The various theoretical perspectives we advanced point to both positive and negative
associations between outsourcing and organizational performance. We, therefore, present
competing hypotheses:
Hypothesis 1a: Outsourcing has a positive relationship with organizational performance.
8
Hypothesis 1b: Outsourcing has a negative relationship with organizational
performance.
Outsourcing’s Indirect Impact on Performance
Reformers contend that market-oriented reforms will lead to improvements in
productivity and performance, even though this assertion often fails to garner empirical support
in research (Feeney & DeHart-Davis, 2009; Meier & O’Toole, 2009). On the other hand, the
literature on organizational change indicates that organizational changes or reforms can engender
conditions that adversely affect work motivation and other attitudes toward work (Isabella,
1993). As such, outsourcing can affect organization performance through its influence on
employees not displaced by outsourcing (Mone, 1997), particularly their job satisfaction.
Outsourcing’s effect on job satisfaction. Research on reinvention suggests a number of
possible advantages of outsourcing that employees may experience. First, government
outsourcing may bring less red tape for employees to follow (Vrangbæk, Petersen, & Hjelmar,
2015). Evidence shows that reinvention reforms lead to lower levels of red tape (Naff & Crum,
1999; Moynihan & Pandey, 2007), and if employees view the reforms as reducing red tape,
implementation of reforms can positively affect PSM (Davis & Stazyk, 2014). The NPM
movement highlights deregulating internal administrative and streamlining procurement
processes in fostering efficiency and effectiveness while leaving more discretion (or
empowerment) for employees in managing partnerships with contractors to agencies (Thompson
& Riccucci, 1998). Hence, lower levels of red tape and higher levels of PSM as consequences of
outsourcing can result in higher job satisfaction among employees.
Also, scholars have emphasized the benefit of expertise and creativity that employees and
government agencies can gain through outsourcing with external actors (Lindholst et al., 2018;
9
Van Slyke, 2009). Government outsourcing may provide governmental officials with “learning
opportunities in which the knowledge of or ideas for improved routines, methods, processes
and/or how to undertake specialized tasks were transferred from private contractors to public
clients or became available through contractual relations (Lindholst et al., 2018, p. 1058).” Given
certain autonomy in managing the partnership with contractors, government officials may be
able to improve their productivity with new ideas and methods that facilitate better work process
and innovation in their organization.
Another potential positive outcome of government outsourcing in terms of employee job
satisfaction is higher responsiveness to external constituencies (Thompson & Riccucci, 1998).
Private sector contractors typically put a priority on customer satisfaction, and nonprofit
contractors often maintain close relationships with service recipients and local communities. As
agencies outsource their services and programs, their employees can witness increasing
responsiveness of those services and programs, and those who possess a strong public service
orientation will experience higher job satisfaction (Vrangbæk, Petersen, & Hjelmar, 2015).
Meanwhile, there are reasons to believe outsourcing may negatively affect job
satisfaction. Research on organization reform and work stress suggests that government
outsourcing can trigger events that harm employee work attitudes (Isabella, 1993). Psychological
contract theory predicts the situations where employees withdraw themselves from their
workplace both psychologically (i.e., lower job satisfaction) and physically (i.e., quit). The
psychological contract is unique to each individual and multidimensional, including relational
and transactional dimensions (Freese & Schalk, 2008). The relational dimension is associated
with intrinsic expectations (e.g., how people are treated). The transactional dimension is
associated with tangible expectations (e.g., pay and job security). If the organization does not
10
live up to an employee’s expectations, the psychological contract is violated. Government
outsourcing seems to negatively affect both transactional and relational dimensions of
psychological contract established in employer-employee relationships.
First, research on work motivation among public employees suggests that government
outsourcing can hurt public employees’ intrinsic motivation. In particular, public service
motivation (PSM) scholars make a case for the unique characteristics of those who choose to
work for government, pointing out that government employees have a predisposition to respond
to intrinsic motivations that are grounded primarily or uniquely in public institutions, more so
than their private sector counterparts (e.g., Perry & Wise, 1990).4 According to the literature,
individuals with a high sense of public purpose are more likely to choose government jobs
(Houston, 2000). Empirical studies support these general points. In addition, public employees
appear to value different types of rewards compared to their counterparts in business, placing
more value on public service work than monetary rewards (Rainey, 2014; Wittmer, 1991).
The literature does not imply that all public employees accept a job with government for
reasons other than public service motives. Some employees may have preferred the convenience
of the location, the pay structure, opportunities for advancement, or perceived job security.
However, we posit that, even in the absence of public service motivation, government employees
expect the policies and practices of the organization to emphasize public values. A public
organization signals its values in various ways, but perhaps most importantly through its mission
statement. Mission statements of public organizations almost invariably claim lofty public
service values, such as equity, protection from harm, fairness, transparency, and equal
opportunity. For example, the Department of Labor (DOL) vows to promote the welfare of wage
earners (DOL, 2018). Government employees will be aware of the organization’s outward
11
commitment to values rooted in public service, either because they perceive an alignment
between the organization’s values and their own public service motivations or because the
organization’s mission is a consistently visible signal of those values. This awareness becomes
part of what the employee comes to expect from the organization. Therefore, if an agency
continues outsourcing services and programs with a strong motive on imposing market-oriented
values (i.e., efficiency), employees may perceive a breach with what they value and expect
public organizations to pursue, or simply a breach of the psychological contract. Agency, then,
may experience reduced work motivation and job satisfaction among employees who no longer
embrace the values being promoted through outsourcing (Dahler-Larsen & Foged, 2018).
Second, government officials and scholars alike have expressed concern with the
downsizing and displacement of public employees (Hodge, 2000; Savas, 2000). Research
indicates that employees react to changes in job security as if the organization broke an
important promise and violated its psychological contract (Robinson & Rousseau, 1994;
Rousseau, 1990). This may happen to public sector employees. While the public sector is known
for providing job security to employees (Vrangbæk, Petersen, & Hjelmar, 2015), government
outsourcing often involves eliminating units, positions or programs, as well as reducing full-time
employment (Morrison & Robinson, 1997; Fernandez et al., 2007). Public employees not
displaced by outsourcing may come feel that their job security is threatened, thereby reducing
their job satisfaction (Spector, 1997).
In sum, we present two contrasting hypotheses regarding how outsourcing affects
employees’ job satisfaction:
Hypothesis 2a: Outsourcing has a positive relationship with employee job satisfaction.
Hypothesis 2b: Outsourcing has a negative relationship with employee job satisfaction.
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Job Satisfaction and Performance. Early human relations theorists proposed that satisfied
workers would be more productive. The most comprehensive meta-analysis of empirical studies
on the link between performance and job satisfaction show the two concepts to be correlated at
about the 0.30 level, with higher correlations for more complex jobs (see Judge et al., 2001). An
earlier meta-analysis indicated that the strength of the job satisfaction-performance relationship
varies by aspect of job, with much lower correlations for satisfaction with pay and higher
correlations with intrinsic features of the job (Iaffaldano & Muchinsky, 1985). Job satisfaction
can positively affect performance by improving levels of energy, activity and creativity, as well
as by improving memory and analytical abilities (Judge et al., 2001; Brief & Weiss, 2002). Job
satisfaction can also influence performance by increasing organizational commitment and
organizational citizenship behavior and reducing turnover and absenteeism (Judge et al., 2001;
Cooper-Hakim & Viswesvaran, 2005; Harrison et al., 2006; Meyer et al., 2002). We, therefore,
propose the following hypothesis:
Hypothesis 3: Employee job satisfaction has a positive relationship with organizational
performance.
Linking outsourcing, job satisfaction, and performance. To this point we have
hypothesized direct links between outsourcing and performance, outsourcing and job
satisfaction, and job satisfaction and performance. The causal path we have described implies a
possible indirect link between outsourcing and performance, that is, outsourcing may influence
performance through its effect on one’s attitude toward the job. From this perspective, job
(dis)satisfaction is a link in the causal chain that explains observed effects between outsourcing
and performance.
13
Previous studies support the causal structure proposed. For example, Harrison, Newman,
and Roth (2006) show job satisfaction impacts commitment, which in turn affects performance.
However, the extent of mediation is important to our claims. Specifically, if job satisfaction fully
mediates the relationship between outsourcing and performance, research focusing solely on
outsourcing may tell us little about its effect on performance. However, if job satisfaction only
partially mediates relationships, outsourcing explains some variance in organizational
performance that job dissatisfaction cannot explain. Thus, testing mediation effects is essential
for understanding why outsourcing might impact organizational performance. Accordingly, we
propose a fourth set of hypotheses relevant to causal structure.
Hypothesis 4a: Job satisfaction fully mediates the relationship between outsourcing and
organizational performance.
Hypothesis 4b: Job satisfaction partially mediates the relationship between outsourcing
and organizational performance.
Methods
Data
Our sample consists of data from three sources: the US Office of Personnel
Management’s (OPM) Federal Employee Viewpoint Survey (FEVS), OPM’s Fedscope, and the
US Office of Federal Procurement Policy’s (OFPP) Federal Procurement Data System (FPDS).
The Federal Procurement Data System (FPDS) includes federal agency-level information on
contracts, such as the number of contract actions, award amounts, and contract types. The FPDS
offers information on outsourcing for cabinet-level departments and independent agencies, and
this hinders us from obtaining data for subunit agencies within cabinet-level departments.
Therefore, our unit of analysis is the federal agency, including cabinet-level departments and
14
independent agencies. Our sampling strategy involves merging data from each source to obtain
information for different federal agencies across time. The result is an (unbalanced) panel data
structure with 132 observations, inclusive of years 2010 through 2014. The FEVS survey is
administered yearly by the OPM and obtains scores from over 400,000 employees in about 80
agencies related to satisfaction, engagement, and perceptions of the workplace environment and
human resource management practices. OPM’s Fedscope is a searchable database that provides
yearly information on the composition of the federal civilian workforce. Individual survey
responses are obtained from all levels, including nonsupervisors, supervisors, managers, and
senior leaders in an agency, and they are aggregated and measured as proportions of all
responses.5
Dependent Variable
The dependent variable, organizational performance, is a perceptual measure of
performance derived from responses to the FEVS survey item: “My agency is successful at
accomplishing its mission.” The item is Likert-type with five response categories anchored at
strongly agree and strongly disagree. The value is calculated as the proportion of all respondent
employees who expressed some level of agreement (strongly agree or agree). As aforementioned,
perceptual measures of performance are moderately to strongly correlated with archival
measures (Dess & Robinson, 1984; Nathan & Alexander, 1988; Bommer et al., 1995; Dawes,
1999; Ketokivi & Schroeder, 2004; Wall et al., 2004; Vij & Bedi, 2016; Singh et al., 2016). In
addition, employee perceptions of performance influence organizational identification, an
antecedent of various attitudes and behavior that influence organizational performance (Dutton
& Dukerich, 1991; Dukerich et al., 2002; Dutton et al., 1994; Pratt, 1998; Van Dick et al., 2008;
Rho et al., 2015).
15
Independent Variables
We focus on two main predictors. Data for the first predictor, outsourcing activity, comes
from the FPDS. The variable is measured as the total number of contract actions per employees
in each federal agency, including new and modified contracts with external organizations.
Amendments are considered inefficient to the organization because they entail wasteful ex post
haggling (Williamson, 1985). Extant research suggests nearly 70 percent of contracts are
amended, many of which are not simple changes in language but rather substantive changes to
work scope or implementation processes (Susarla et al., 2009). We allow a time-difference (1-
year) between the outsourcing measure and dependent variable. We executed the diagnostic test
suggested by Bellemare et al. (2017), and the result indicates that the use of a lagged explanatory
variable (outsourcing activity) is appropriate in addressing potential reverse causality between
outsourcing activity and organizational performance.6
The second main predictor, job satisfaction, is an indicator from the FEVS: “Considering
everything, how satisfied are you with your job?” The measure is a global score accounting for
an employees’ overall level of satisfaction with the job. The value is the proportion of
respondents who are satisfied with their job, calculated from five response categories and
anchored at strongly agree and strongly disagree.
Control Variables
The extensive literature on organizational performance reveals other factors that may
affect performance as well as outsourcing and job satisfaction, including working conditions,
workplace climate, the composition of the workforce, organizational resources and supervisory
practices (Peters & O’Connor, 1980; Pfeffer, 1997; Rainey, 2014; Spector, Dwyer, & Jex, 1988;
Quigley et al., 2007; Fernandez & Moldogaziev, 2011). Accordingly, we control for a range of
16
factors using data from the Federal Employee Viewpoint Survey (FEVS). The relevant survey
indicators tap into respondents’ perceptions and are measured with a Likert-type response set,
anchored at strongly agree and strongly disagree. Control measures are computed from
individual respondents by agency and then aggregated to the agency level at each yearly interval.
They include: physical conditions; resource sufficiency; skill opportunities; and knowledge
sharing. In addition, human resource capacity is reflected in the demographic makeup of an
organization. Accordingly, we compute yearly agency averages for the proportion of the total
agency workforce who are female (gender), supervisors (supervisory status) and minorities
(minorities). We also control for average age of the workforce (worker age) and total number of
employees (agency employees).
Modeling
Panel data methods offer several advantages over cross-sectional data by increasing
variability, reducing omitted variable bias and enabling the study of dynamic phenomena. The
panel data structure allows for testing aggregated information from individual’s respondents at
the agency level and estimating relationships among variables over time (2010 to 2014).
Our dependent variable is a ratio with values between 0 and 1. Given the unbalanced
panel data structure, we use a generalized estimation equation (GEE) model (Papke &
Wooldridge, 2008). We also use an organizational fixed-effects estimator to control for time-
invariant unobserved heterogeneity and reduce omitted variable bias (Wooldridge, 2010).
Finally, year dummy variables are included to control for unobserved organizational
characteristics that may vary over time.7
Our baseline panel regression model for agency i in year t is
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Organizational Performanceit = ai + b1Outsourcing Activityit-1 + b2Job Satisfactionit + g1Yrt +
Xitb + eit,
where Organizational Performance is agency i’s performance in year t as the proportion of
employees reporting positive perception on their agency’s mission achievement; ai stands for
agency fixed characteristics; Outsourcing Activityit-1 represents the number of actions that
agencies take relating to outsourcing per employee in year t-1, Job Satisfactionit represents the
proportion of employees who were at least satisfied with their job in agency i in year t, Yrt is a
vector of year dummy variables (with 2010 as the reference year), and Xit is a vector of the
control variables mentioned above.
Results
Table 1 presents descriptive statistics, reporting the mean, standard deviation, and median
values for each variable. Focusing on the median for the dependent variable, organizational
performance, values range from a low of 75.90% (2011 and 2013) to a high of 78.03% (2010).
The values presented are the percentages of positive responses aggregated at the organizational
(agency) level. With respect to the variable job satisfaction, we consider even minor year to year
fluctuations as meaningful given that satisfaction is considered a fairly stable characteristic
(Staw, Bell, & Clausen, 1986). The values in our sample range from a low of 64.52% (2014) to a
high of 69.71% (2011). Outsourcing activity measured as total contract actions per employee
vary from year to year in our sample. Focusing on the median values because of the skewed
distribution, the table reveals a value of 0.78 total actions per employee in 2010 decreasing to
0.76 in 2011, peaking at 0.84 in 2013, and then decreasing to 0.79 in 2014.
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Table 1. Descriptive Statistics
Year
2010
2011
2012
2014
Total
Organizational
Performance
Mean
.775
.766
.763
.752
.765
Median
.780
.759
.772
.763
.769
Std. Dev.
.10
.08
.07
.09
.09
Outsourcing Activity
Mean
68,813
88,399
121,472
101,424
92,152
(Total Actions)
Median
8,244
10,314
14,293
14,228
10,434
Std. Dev.
178,567
263,193
370,418
344,652
297,680
Outsourcing Activity
Mean
3.636
3.166
3.243
1.945
2.787
(Total Actions
Median
.824
.821
.789
.885
.835
per Employee)
Std. Dev.
12.690
10.337
9.764
3.109
8.809
Job Satisfaction
Mean
.697
.648
.658
.645
.660
Median
.698
.645
.661
.645
.657
Std. Dev.
.05
.06
.05
.07
.06
Resource Sufficiency
Mean
.525
.456
.487
.463
.478
Median
.523
.449
.485
.467
.474
Std. Dev.
.09
.10
.09
.09
.10
Knowledge Sharing
Mean
.730
.735
.735
.756
.738
Median
.727
.729
.736
.746
.733
Std. Dev.
.06
.06
.04
.06
.06
Physical Conditions
Mean
.728
.722
.703
.724
.720
Median
.707
.714
.707
.707
.710
Std. Dev.
.09
.08
.06
.08
.08
Skill Opportunities
Mean
.670
.630
.650
.639
.644
Median
.679
.629
.642
.620
.640
Std. Dev.
.09
.07
.07
.09
.08
Supervisor
Mean
.244
.194
.196
.205
.207
Median
.213
.177
.183
.185
.184
Std. Dev.
.11
.06
.06
.07
.07
Minority
Mean
.401
.379
.381
.339
.377
Median
.349
.346
.351
.337
.346
Std. Dev.
.16
.14
.12
.07
.13
Gender (Male)
Mean
.491
.478
.478
.501
.489
Median
.497
.479
.490
.512
.497
Std. Dev.
.12
.11
.11
.10
.11
Age
Mean
46.53
46.66
46.81
46.70
46.75
Median
47.02
47.08
47.08
47.31
47.31
Std. Dev.
2.90
2.76
2.26
2.22
2.59
Total Employees
Mean
39,474
40,367
46,273
48,782
42,643
Median
9,818
11,023
14,284
15,350
12,588
Std. Dev.
67,009
68,363
72,757
77,228
70,127
Sample Size
34
33
28
27
135
19
Table 2. Results of Panel Generalized Estimating Equation (GEE) Regression Model
Model 1
Model 2
Model 3
Model 4
Model 5
Model 6
Variables
Job Satisfaction
Performance
Performance
Job Satisfaction
Performance
Performance
Outsourcing Activity
-.013**
-.043***
-.039***
(Total Actions per Employee)
(.032)
(.010)
(.011)
Outsourcing Activity
-.018***
-.052***
-.045***
(Total Actions)
(.009)
(.018)
(.016)
Job Satisfaction
0.138***
.130***
(0.052)
(.043)
Resource Sufficiency
.027
.254***
.244***
.033
.266***
.254***
(.034)
(.057)
(.049)
(.027)
(.039)
(.037)
Knowledge Sharing
.111***
.110*
.052
.101***
.077*
.028
(.027)
(.063)
(.058)
(.020)
(.039)
(.039)
Physical Conditions
-.003
.164**
.164***
-.006
.153***
.155***
(.035)
(.066)
(.063)
(.026)
(.032)
(.038)
Skill Opportunities
.127***
.023
-.046
.131***
.038
-.030
(.025)
(.046)
(.053)
(.016)
(.032)
(.042)
Supervisor
-.010
.065***
.070***
-.012
.052***
.057***
(.016)
(.018)
(.020)
(.010)
(.014)
(.015)
Minority
.033
-.001
-.020
.031
-.006
-.024
(.038)
(.043)
(.034)
(.024)
(.028)
(.024)
Gender
.026
-.001
-.014
.020*
-.020
-.029
(.019)
(.037)
(.038)
(.011)
(.026)
(.026)
Age
.078**
.061
.019
.084***
.076
.034
(.040)
(.084)
(.081)
(.023)
(.049)
(.046)
Total Employees
-.006
.011
.015
.006
.052*
.050*
(.028)
(.049)
(.045)
(.015)
(.029)
(.025)
Constant
1.092***
.749***
1.132***
.738***
1.099***
1.067***
(0.088)
(.040)
(.093)
(.031)
(.066)
(.053)
Agency Fixed-Effect
Yes
Yes
Yes
Yes
Yes
Yes
Year Fixed-Effect
Yes
Yes
Yes
Yes
Yes
Yes
N
132
132
132
132
132
132
Wald chi-square
667.08***
894.58***
929.76***
960.38***
1455.13***
921.2***
Note: Bootstrapping standard errors are in parentheses
* p<0.1, ** p<0.05, *** p<0.01
20
Table 3. Estimated Marginal Effects of Outsourcing Activity and Job Satisfaction on Organizational Performance
Model 1
Model 2
Model 3
Model 4
Model 5
Model 6
Variables
Job Satisfaction
Performance
Performance
Job Satisfaction
Performance
Performance
Outsourcing Activity
-0.003***
-0.008***
-0.007***
(Total Actions per Employee)
(0.002)
(0.003)
(0.003)
Outsourcing Activity
-0.004***
-0.010***
-0.008***
(Total Actions)
(0.002)
(0.003)
(0.003)
Job Satisfaction
0.025**
0.023*
(0.010)
(0.010)
21
Table 2 presents results for generalized estimation equation (GEE) models, each with 132
observations, all of which are statistically significant overall (Wald chi-square < 0.001). For a
more intuitive interpretation of results, Table 3 presents estimated marginal effects of key
independent variables from Models 1-6.
As shown in Table 2, we regress organizational performance on outsourcing activity and
other covariates, excluding job satisfaction, in Model 1 (and Model 4). In Model 2 (and Model
5), we regress organizational performance on both outsourcing activity and job satisfaction as a
mediator, along with other covariates. In Model 3 (and Model 6), we regress job satisfaction on
outsourcing activity and other covariates. While the first three models (Models 1-3) measure
outsourcing activity as total actions per employee, the latter three models (Models 4-6) measure
it as total actions. Explanatory variables in all models are standardized to allow for a comparison
of effects across variables. We discuss findings from the former models (Models 1-3) for a more
intuitive interpretation.
Hypotheses 1a and 1b predict outsourcing activity is associated with organizational
performance. We observe a direct negative relationship between these two variables. Even when
controlling for the potential effect of job satisfaction on organizational performance in Model 2,
the results indicate an increase in outsourcing activity leads to a decrease in organizational
performance. The estimated marginal effect, -0.008 (p<0.01), of total actions per employee in
Model 2 implies that performance decreases by about 0.8 percentage points for every 9.40 (1
standard deviation) increase in outsourcing actions per employee. Thus, Hypothesis 1b indicating
the negative relationship between outsourcing and organizational performance is supported.
Hypotheses 2a and 2b predict outsourcing is associated with job satisfaction. We find
outsourcing activity has a negative impact. The estimated marginal effect of -0.003 (p<0.05)
22
implies that a 1 standard deviation increase in total actions per employee (about 9.40 per year)
reduces the proportion of employees satisfied with their job by 0.3 percentage points. Thus,
Hypothesis 2b is supported. This result is consistent with the findings from research on the
negative effects of organizational changes and reforms on employees’ well-being (Korunga et
al., 2003; Mikkelsen, Osgard, & Lovrich, 2000; Noblet, Rodwell, & McWilliams, 2006;
Moynihan & Pandey, 2007; Yang & Kassekert, 2010). The reduction in agency personnel,
functions, and budgets associated with outsourcing may generate discomfort for federal
employees who perceive outsourcing as a threat to their job security (Hobföll, 1998).
Hypothesis 3 predicts a relationship between job satisfaction and organizational
performance. An estimated marginal effect of job satisfaction in Model 2 of 0.025 (p<0.01)
implies that a 1 standard deviation increase (about 6 percentage points) in the proportion of
employees who are satisfied with their jobs will lead to an increase of about 2.5 percentage
points in the proportion of employees who perceive their agency as effective in accomplishing its
mission. Thus, results lend support to the positive association between job satisfaction and
organizational performance. As job satisfaction research indicates, federal agencies can expect
better performance when employees are more satisfied with their job (Brief & Weiss, 2002;
Harrison, Newman, & Roth, 2006).
Hypothesis 4 predicts two possibilities with respect to the causal structure. Specifically,
Hypothesis 4a predicts job satisfaction fully mediates the relationship between outsourcing and
organizational performance. Alternatively, Hypothesis 4b predicts job satisfaction partially
mediates the relationship between outsourcing and organizational performance. To test the
mediation hypothesis, we followed the approach of Kenny, Kashy, and Bolger (1998). When
using multivariate regression models, a mediating effect is confirmed when the following
23
conditions in our model are met: (1) a statistically significant relationship between outsourcing
and job satisfaction; (2) a statistically significant relationship between outsourcing and
organizational performance and between job satisfaction and organizational performance; (3) an
absolute value of the estimated coefficient of outsourcing that becomes lower or becomes
statistically insignificant once job satisfaction is included in the regression model. For a full
mediation, the independent variable, outsourcing, must not relate with the dependent variable,
organizational performance, when the mediation variable is added to the equation.
The absolute value of an estimated marginal effect of outsourcing decreases from 0.8
percent in Model 1 to 0.7 percent in Model 2. That is, the magnitude of a negative effect of
outsourcing activity on organizational performance is partially reduced by including job
satisfaction. This finding refutes Hypothesis 4a but supports Hypothesis 4b. That is, job
satisfaction partially mediates the relationship between outsourcing activity and organizational
performance.
In regard to the control variables, we find that knowledge sharing among employees,
opportunities to improve employee skills, total employees, proportion of employees who are
minorities and male, and average employee age do not explain variation in organizational
performance (see Table 2, Model 3). On the other hand, employee perception of resources,
physical conditions in the workplace, and the proportion of supervisors are positively associated
with organizational performance.
As a robustness check, we tested additional models. First, given the potential risk of
common method bias due to our current data structure, we performed both Harman’s single
factor test and Brewer’s split sample method test. The results indicate that using a single survey
instrument in measuring both job satisfaction and organizational performance does not result in
24
common method bias.8 Next, we considered alternative measures of outsourcing, including total
spending and net changes in total actions. We also tested a two-way fixed effects (FE) regression
models. In all of these cases, the results are consistent with those reported.9
Discussion and Conclusion
Government outsourcing has been a long-standing interest to both scholars and
practitioners. The literature on outsourcing outcomes has focused on certain evaluation criteria
mostly market-oriented valuesemphasized by external constituencies. Although the literature
points to potential changes in working conditions and management practices resulting from
outsourcing, and alludes to how these changes can affect employee attitudes, a firm
understanding of outsourcing from the perspective of government employees remained elusive.
This study hypothesized that government outsourcing affectseither positively or negatively
employees’ perceptions of how well their organization performs, directly but also indirectly
through outsourcing’s influence on employees’ attitudes toward their job.
Our findings do not support the traditional narrative that market-oriented practices
improve organizational performance in the public sector. We rather report evidence of the
negative impact of outsourcing on perceived performance and a viable causal mechanism linking
outsourcing to organizational performance. Specifically, as government outsourcing activity
increases, employees report lower agency performance. Further, an increase in outsourcing
lowers job satisfaction, precipitating a further decrease in perceived performance. These findings
raise doubts on the potential benefits of outsourcing predicted by proponents of the NPM.
A main claim in this research is that comparing direct production to outsourcing, or to
any other governance mode for that matter, requires a more complete picture of comparative
governance costs, including those that relate to human resources, such as job satisfaction and
25
turnover. The finding from this study on the direct negative relationship between outsourcing and
perceived organizational performance indicates that transaction costs, including agency costs,
may be greater than anticipated and may outweigh the benefits of outsourcing. Public managers
should seek ways to reduce agency costs that federal agencies may experience, while
strengthening monitoring and evaluation of contractors frequently to mitigate abuses associated
with the principal-agent problem.
Our findings also show that an increase in outsourcing can harm public employees’ job
satisfaction, and thus organizational performance (see Judge et al., 2001). These findings
highlight critical roles of managers in designing and implementing internal managerial practices
to instill positive outcomes of government outsourcing in employees’ job satisfaction. For
example, given the critical role of organizational innovativeness in improving organizational
performance (Han, Kim, & Srivastave, 1998), agencies can benefit from creating work
environments which allow their employees to gain new expertise and methods from contractors.
In addition, as recent studies have emphasized (e.g., Christensen, Paarlberg, & Perry, 2017), the
managerial strategy to allow employees to interact with service beneficiaries will positively
stimulate employees’ intrinsic motivation. Therefore, agencies need to provide their employees
with various opportunities to observe the quality of outsourced services and to interact with the
beneficiaries of those services. More importantly, leaders should frequently and openly
communicate with employees to determine if they perceive government outsourcing as fulfilling
its promises.
In addition, this research presents theoretical implications. This research underscores an
aspect of transaction cost theory that is understudied. Although the focus of TCE is on
transaction costs, there is more to Oliver Williamson’s argument. Specifically, “...economizing
26
takes place with reference to the sum of production costs and transaction costs, whence tradeoffs
in this respect must be recognized” (Williamson, 1985, p. 22). Internal production costs arguably
include effects on the workforce. To overlook these effects, good or bad, is to ignore the “human
value of the enterprise” and to naïvely assume organizations can achieve their missions without
attention to what employees expect in return for their efforts (Mayo, 2001).
This research also offers a path for future work on the psychological contract. Although
the literature on the psychological contract is well-established, the research is still considered
nascent. As a result, research findings are mixed and questions remain regarding the links
between different dimension of the psychological contract and a range of outcomes. The
literature describes the psychological contract as a construct comprised of a socio-emotional
dimension that is relational and subjective in nature, as well as a transactional, more short-term
dimension based on extrinsic rewards such as pay. The distinctiveness of public sector
employees may be explained by conceiving of a third “public value” dimension to the
psychological contract. Specifically, those who work for government are likely to be motivated
by public values. In addition, the mission statement of the organization signals a set of values
uniquely associated with public institutions. The combination of values, either inherent in the
individual or communicated in the organization’s mission statement, or both, form the basis of
employee expectations, the psychological contract. The increasing trend of outsourcing changes
the nature of the job and value priorities. The resulting modified organizational value system can
be conceived as a violation of psychological contract. Work by Freese and Schalk (2008) on how
to measure psychological contracts is a good starting point.
Some limitations to this study should be mentioned. To begin with, the results should be
interpreted with caution as our main objective was to test a plausible explanation for the
27
underlying causal mechanism with respect to the link between outsourcing and organizational
performance. Although the logic we advance bears out in tests, the causal path is likely to be
more complex and nuanced. For example, levels of job satisfaction may in part depend on
individual attributes we have not considered, and other factors such as commitment may mediate
the relationship between job satisfaction and performance. Additional tests for moderation and
mediation would further reveal the mechanisms at work. In addition, the aggregated data
structure in our approach may result in loss of information among individual responses. In
particular, interpreting the results of organizational level analyses calls for care to avoid making
unsubstantiated inferences about how individual employees feel about work. While an individual
level analysis would test the robustness of our results, replication of this study with individual
level data is not feasible since FEVS does not offer any information to identify individual
respondents across time. A future study could try to determine how outsourcing influences
perceived performance at the individual level with a multilevel analysis of cross-sectional data.
Finally, unobserved contextual variables at the agency level may affect the relationship
between outsourcing and organizational performance. For example, agencies may vary in their
use of strategies for planning and managing outsourcing initiatives. Each agency may differ by
its inherent relationships with agents. Due to the data limitations, this research was not able to
include these factors in the empirical models. Yet, these agency characteristics are in general
time-invariant within a short-period of time, and therefore, our approach to include agency fixed-
effects estimator in the regression models should assuage concerns about omitted variable bias.
28
Notes
1. We define government outsourcing consistent with Hodge (2000), as the delivery of public
services by agents other than government employees. In contrast, privatization is
accompanied by a change in ownership.
2. For an elaboration of TCE theory, see Williamson (1985, 1991) and Gibbons (2010).
3. The agency cost problem has been extensively addressed in legal and economic literature
(see Jensen & Meckling, 1976).
4. The literature on PSM is thoroughly reviewed elsewhere (see Perry, 2000; Perry, Mesch, &
Paarlberg, 2006).
5. We also analyzed our empirical models for two separate employee groups: supervisors and
non-supervisors. The results were consistent across two different groups, and are available
upon request.
6. The result is available upon request.
7. While cluster robust standard errors are recommended to address the potential risk of serial
correlation and heteroscedasticity in panel data methods, they may not be optimal when the
number of clusters are small: bootstrapping standard errors can mitigate this problem
(Bertrand, Duflo, & Millainathan, 2004).
8. The Harman test indicates that a single factor explains about 38% of entire variance in the
survey items, a result not considered problematic (Fuller et al., 2016). The Brewer split
sample method presents consistent results in both the level of fit-statistics (Wald Chi-squared
values) and magnitude of estimated coefficients of key explanatory variables.
9. The results are available upon request.
29
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