hrQ Ahead of the Curve on Increased Transparency of Human Capital Data

On Aug. 26, the U.S. Securities and Exchange Commission mandated human capital disclosure by public companies selling securities in the United States. These companies must now disclose human capital information that a reasonable person would want to know while deciding to buy or sell a company’s stock.

The rule is effective Nov. 9, and there is no grace period. Publicly traded companies need to disclose material human capital information with their Nov. 30, Dec. 31, or Jan. 31 quarterly or annual public financial release.

A year ago, our own hrQ Corporate Vice President Brian Wilkerson responded to questions raised by a CFO magazine article on this topic titled, “Human Capital’s Big Reveal.” Below we examine the pros and cons of more transparency in human capital data being available to investors.

1. What is the ISO 30414 standard, and what is it designed to address?

The standard is a series of 23 metrics in 9 categories that are designed to provide a balanced view of the strength of human capital management within an enterprise. Some of the metrics organizations have been measuring for years, such as turnover and productivity, while others such as ethics, leadership, and skills and capabilities are new frontiers for a number of organizations. Even those who have some level of measurement in those areas rarely disclose it. Like many corporate governance changes, the push for the standard was partially influenced by challenging human capital issues that we have seen in the news, particularly ethics issues or situations where the departure of a key executive was not handled well, and company performance was impacted. Just as important, many investors are realizing that human capital is an essential component of business success and it has been one of the most opaque elements of evaluating a company for too long.

2. What are some of the contributing factors that caused the standardization and disclosure of human capital data to become an essential area of focus by the SEC?

Ethics issues have certainly been a large driver. Repeatedly we have seen the impact of ethics issues on stock performance, and in most cases, there were warning signs within the company that issues were present. More disclosure could help give investors (and frankly, regulators) early warning of potential issues within a company. But again, more and more investors are realizing that people not only account for much of the cost of a business but are also a key source of performance and innovation, so more transparency in that area is important to be able to truly evaluate companies. For years now, we have been telling Boards of Directors that they need to be able to understand five critical areas about their companies:

1) Your key talent and what hold you have over them
2) The adequacy of your talent acquisition capabilities, including long-term talent relationship management
3) Your culture as it relates to accountability and effective performance management processes
4) Your culture and work environment and the degree that they support innovation
5) The effectiveness of your workforce planning capabilities

This type of trend pushes corporate governance in a similar direction – helping investors see whether a company has a human capital strategy and capabilities that position it for short and long-term success.

3. The article mentions a distinction between material risk and corporate values as two ways to view human capital metrics. Can you break that down for us?

Material risk is linked to some of the ethics issues I referenced previously. But poor human capital practices impact organizations in other ways, such as not having the right leadership pipeline to ensure continued business success or having a culture or work environment that leads to key talent departing and taking their innovations with them, or not being able to meet your goals because of short-staffing. The corporate values piece has become an increased focal point as both investors and potential employees become more concerned with corporate social responsibility and want to know the values of the organizations they are investing in, doing business with, and working for. The popularity of sites that provide employee reviews of company culture and work environment, for example, have become increasingly popular and the push for more disclosure follows a similar trend.

4. What are some of the difficulties in applying objective regulatory standards on human capital measures in vastly different industries?

Frankly, I think the “difficulty” is overblown. Certainly, the relative emphasis on a given measure may vary from industry to industry, and I think that is something that is easy for investors to understand. Capital-centered business will value certain metrics more than knowledge-centered businesses and vice-versa, but in the end, many of these metrics are important for all companies. I would even argue that the continuing evolution of artificial intelligence is pushing companies to rethink their human capital strategies and will make it even more important for investors to understand the real state of human capital in a business as A.I. will increasingly create competitive parity in low and medium-skilled tasks and jobs.

But more importantly, there are some areas of human capital that are much more difficult to measure and, I would argue, just as important to understand in order to evaluate a company. Culture is one example; innovation is another…those are not easily represented by a number or even a collection of numbers, but in some industries are absolutely critical to the success of the business. That is not an argument against the standard disclosure measures, but rather a caution to investors that even with the standard metrics, one must dig deeper to get the full story.

5. Why has there been such an uptick in investors analyzing human capital data trends as part of their investment strategy?

In addition to the reasons I have discussed before – mitigating risk, understanding the critical role of human capital in company success, socially responsible investing practices, etc. I think as a society we are becoming increasingly used to having detailed information about nearly any topic at our fingertips. We can find details about the lives of celebrities, products, social movements, etc. In a way, this is a natural extension of where have moved as a society.

6. There seems to be some reluctance by U.S. firms to share human capital data with a high level of transparency to both investors and competitors. Can you give specific examples of the possible areas of concern by companies opposed to human capital data disclosure?

Certainly. I think one of the easiest risks to understand is the risk of having talent “stolen” from a company. This already happens frequently without these types of disclosures. Certain companies look to other companies in their industry from which to hire talent because they have strong hiring and development practices. Search firms use the media, presentations at conferences, and a host of other sources to identify top talent and try to recruit them away. These types of disclosures could certainly increase some of those risks. The example the article uses of turnover of younger talent because of a lack of opportunities is a perfect example. If a competitor or external recruiter can identify that issue from this disclosure information, they can more effectively target their efforts.

The answer to that is the same as it has always been – build a strong employment brand, make managers better, build an attractive work environment, give employees the opportunity to find meaning in their work, and create opportunities to grow and develop, and you will be able to attract and retain top talent regardless of what you disclose about your human capital.

There is also a segment of companies that really doesn’t want the outside world to know that they have a toxic culture or a bad work environment. They don’t want to have investors shy away because of that, or perhaps they have efforts going on to fix their issues but aren’t quite there yet.

While these are legitimate concerns, the value that these disclosures bring to investors and employees outweighs the risks.

7. In layman’s terms, what is ROIT, and how does it support a data disclosure and performance link?

Return on Investment in Talent has been a measure for many years. However, different companies measure it different ways, which has led to a murky understanding of what it really means. In simple terms, it is a measure of what kind of return you get for what you are spending on talent, just like Return on Assets or Return on Equity that are common measures in investing. If there is a standardized way to measure it, then theoretically, investors can compare the difference in ROIT across firms and determine who is better managing their human capital.

I say theoretically because I think the measure as discussed doesn’t really tell the right story. For years, we have been talking about Return on Discretionary Investment for Talent. To explain it simply, every firm and every industry has a price of entry for talent – you have to pay at least competitive wages and have a baseline of benefits, and you have to have a certain level of investment in training just to compete. What is more important is what a company invests above and beyond that price of admission and what return they get on those investments. For example, if they pay well above market, what does that buy them? Retention? Better skills and capabilities? How does that translate into the performance of the firm? Do they receive a differentiated return on those discretionary investments? While much more complicated to measure, it is much more meaningful in comparing the performance of firms.

I think, as the article said, there is a link between disclosure and performance to some degree, but there is not enough evidence to support that disclosure *causes* improved performance. That causal link is what has eluded us for decades. For years, we have had studies that show firms that win awards for their human capital tend to outperform their industry, but which one is the cause of the other? Do companies who perform better financially because they have the human capital practices to win those awards, or do they have the resources to better manage human capital because they perform better financially? Disclosure is in the same place – we are far from establishing the causal link between disclosure and performance. That said, I think disclosure brings enough benefits to be worth the effort. In addition to addressing many of the issues I have raised, disclosure makes it more difficult for companies to deprioritize investments in human capital. I can say with certainty after almost 25 years of doing this kind of work that ensuring firms are making the right investments in human capital will have a transformational impact on companies and their performance.

For more information on how hrQ can help you provide visibility into your human capital data and increase the efficiency of your organization, reach out to us today. We’re looking forward to learning more about your company and your people strategy.