Human Capital Disclosure & The Board

JUN
17
2020
JUN 17, 2020

Preparing The Organization For Human Capital Reporting, Whether Mandated or Not

(Originally appeared in the June 17th, 2020 'Across the Board' publication, a Board Director, Board Advisor, C-Level, and Business Leader publication reaching 26,500+ exceptional business leaders in over 70 countries with articles focused on leadership, strategy, and governance topics - sign up here)

Creating a robust talent pool within an organization has always been valued and is in many cases the differentiator between industry innovation and status quo performance. As the speed of change continually increases, it is becoming more obvious that the depth and diversity of talent is the deciding factor in not only thriving vs. surviving, but actually thriving vs. staying in business. People are core to this philosophy, so it is quite interesting that legacy methods of measuring organization and industry performance have historically and continue to be focused predominately on production and output metrics (essentially industrial production). These measurements have proven to be largely inadequate as global economies transform to a larger percentage of technology and services-based environments. This work and workforce transformation is forcing the need for transparent, robust, and more relevant disclosure of Human Capital (HC) metrics, formerly areas that have been overlooked or relegated to the realm of 'soft' or 'intangible' assets.

Human Capital (HC): The stock of habits, knowledge, social, and personality attributes, including creativity, embodied in the ability to perform labor so as to produce economic value.

Every year, the Brand Finance Global Intangible Finance Tracker (GIFT) report ranks the world's most intangible companies and those with the highest levels of intangible asset disclosure. Human Capital and culture at recent heights were estimated to comprise on average 52% of a company’s market value, according to GIFT's 2018 report, surpassing US$50 trillion for the first time in history, reaching US$57.3 trillion. In full disclosure, within GIFT's 2019 report there was, however, a decline for the first time since 2011, normally only recorded in years of recession. Even with the global market turmoil seen in the recent year+ or so, the amount of value locked inside a company's intangible assets remains huge. Human Capital and culture are therefore inextricably linked to creating long-term value in this era of disruption and a critical focus area for Boards and stakeholders at all levels, whether mandated by a regulatory body or not.

In the U.S., the Securities and Exchange Commission (SEC) agrees with these assessments and is poised to update reporting requirements to properly reflect this often misunderstood and overlooked value. In June of 2009, the SEC Investor Advisory Committee was formed to "...advise the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace." In March of 2019, this Investor Advisory Committee submitted its 'Recommendation of the Investor Advisor Committee Human Capital Management Disclosure,' proposing a modernizing of the Commission's framework for corporate reporting, specifically including numerous Human Capital reporting and Human Capital Management (HCM) disclosure metrics. Although still a reporting recommendation and not yet a ruling, this first step in the SEC's acknowledgment of Human Capital as an investible asset, and not solely a cost or expense, is an important evolution in shepherding the idea of a company's more holistic value (or lack thereof) - something every Board of Directors and leadership team globally should be immediately preparing for.

The focus on the trickle-down effects of values & culture is intensifying for organizations and Boards as best practices and requirements for HC and HCM disclosures are simultaneously evolving. Human Capital is considered unique and distinct to all other capital measurements ...and for many, a required focus area for companies to achieve goals, evolve, remain innovative, and generate returns for stakeholders and shareholders."Wealth management advisory has reached a defining moment with the addition of the HC component, effectively poised to give shareholders increasing transparency within their investment portfolios," states Kenneth Ramos, Managing Director/Investments at Stifel, a full service wealth management and investment banking firm. "Today's investors are more aware and purposeful with their investments, many with direct requests to invest in companies that are transparent and mindful of their employees' wellbeing." Even some of the more easily instituted HC and HCM policies, when implemented and measured properly, can have profound effects on the business as well as elevate public perception of an organization. "The best news is that small changes in Human Capital efficiencies will often have a greater impact on investment return than will small changes in property investments or financial capital uses – because of the leverage impact," states Dr. Solange Charas, Founder & CEO of HCMoneyball, a firm that provides a SaaS solution, HCMetrix™, to instantly calculate Human Capital and financial metrics so that performance trends can be correlated and benchmarked to competitors (see ad below for free introduction discussion). "For example, a company where Human Capital expense is at least 50% of total expense, a reduction in attrition of just 1% can potentially generate more profitability than changes in any aspect of financial capital or property and a 10% improvement in employee productivity can generate a 40% improvement in EBITDA. Now more than ever before, it is critical to understand the effectiveness of Human Capital programs and their contribution to business model success. In the past, Human Capital has been ignored mainly because an accessible and reliable way to quantify its impact didn’t exist – now it is the cornerstone of driving efficiencies in an organization’s operations and an important aspect of 'S' considerations in ESG (Environmental, Social, Governance)." The tangible aspects of once intangible areas will undoubtedly increase the speed of adoption, application, and insights.

The momentum for HC and HCM disclosure has already started, as seen through:

  • Proposed rule amendments to revise current business disclosure requirements by the U.S. Securities and Exchange Commission (SEC) on Human Capital matters.
  • The ISO International Standard for Human Capital Reporting, ISO 30414, guidelines for internal and external Human Capital reporting, is the first international standard that allows an organization to get a clear view of the actual contribution of its Human Capital (note: ISO has several other HC-related standards, but this is the first that addresses Human Capital efficiencies and transparency).
  • Prominent investment firms such as Goldman Sachs, BlackRock, and State Street Global Advisors have declared that Human Capital and company culture engagement are priorities, essentially defining the degree to which Human Capital focus offsets portfolio risk.
  • Human Capital defined as a key value driver for standards framework organizations including the Global Reporting InitiativeSustainability Accounting Standards Board (SASB), and the Embankment Project for Inclusive Capitalism(EPIC).

If the proposed SEC Advisory Committee disclosure recommendations become mandatory, the type of information public companies might be required to report to the SEC and stakeholders under its proposed rule could comprise some interesting areas, including the list below. It is important to note that reporting Human Capital performance isn’t just for the sake of report: investors are already carefully looking at how these aspects of HCM performance impact company-level results. It is critical to select relevant performance indicators, closely correlated to economic-value creation, so that the narrative can be developed in support of the company’s key messages related to sustainable Human Capital performance.

Human Capital metrics proposed for SEC consideration include (as summarized by the Human Capital Management Coalition's (HCMC) letter submitted to the SEC affirming support of the adoption of HC and HCM standards along with further recommendations): 

  1. Workforce demographics (number of full-time and part-time workers, number of contingent workers, policies on and use of subcontracting and outsourcing)
  2. Workforce stability (voluntary and involuntary turnover, internal hire rate)
  3. Workforce composition (diversity, pay equity policies/audits/ratios)
  4. Workforce skills and capabilities (training, alignment with business strategy, skills gaps)
  5. Workforce culture and empowerment (employee engagement, union representation, work-life initiatives)
  6. Workforce health and safety (work-related injuries and fatalities, lost day rate)
  7. Workforce productivity (return on cost of workforce, profit/revenue per full-time employee)
  8. Human rights commitments and their implementation (principles used to evaluate risk, constituency consultation processes, supplier due diligence)
  9. Workforce compensation and incentives (bonus metrics used for employees below the named executive officer level, measures to counterbalance risks created by incentives)

Whether an aspiring Board Director or experienced Board Director, understand that throughout your career the appetite for insiders as well as outsiders to understand how companies are managing and measuring Human Capital will increase dramatically. This will undeniably have direct links back to the Board, showcasing its ability to truly ‘live’ the organization's values and create an admirable culture - ultimately the foundation for a successful company.

Is your Board and organization prepared to support and report meaningful and detailed Human Capital disclosures?

Reach out directly to Mark A. Pfister to maximize your Board's transition to successfully satisfy upcoming HC & HCM disclosure with his Consulting & Advisory offerings.