Should Companies Expand Human Capital Disclosure?

The cover story for the November 2011 edition of CFO magazine, "Power from the People," introduced a topic that had been discussed among human capital experts for some time but had been the subject of little media coverage. The discussion was about whether investors and other stakeholders would benefit if publicly held companies reported more information about their work forces. Human capital "disclosure" had been mostly limited to executive compensation data, executive succession plans, ..

Yes, companies surely should disclose more information about their human capital.

Laurie Bassi

Laurie Bassi

Looking at the issue from the perspectives of major stakeholders — including companies, shareholders, employees, and society as a whole — increased disclosure on human capital is unambiguously a good thing. It’s a bad thing only for companies that do a lousy job on the “people side” of their business, and human resources executives who would prefer to avoid accountability for human capital performance.

Let’s consider the perspective of each of these stakeholders, including the two exceptions noted.

Beginning with publicly traded companies, if employees are a firm’s “most important asset” — as many CEOs repeatedly proclaim — why are they reported only as costs? That begs another question: What are the problems caused by this mismatch, and how could expanded human capital disclosure ameliorate them?

For starters, CEOs are correct when they talk about human capital as important assets (even though their companies’ actions are sometimes inconsistent with those words). The fact is, companies that have consistently prioritized the people side of their business are among the best investments you can find.

Since January 2003, we have invested in a portfolio of companies that actively invest in the people side of their businesses. On an annualized basis, the portfolio has outperformed the S&P 500 total return index by 3.5 percentage points per year. That has yielded a cumulative return of 259% over 13 years, relative to a cumulative 135% for the S&P 500.

That is a dramatic result — especially given that we are amateurs who do this as a labor-of-love hobby.

Those companies have chosen to invest in their future despite the pressures from Wall Street. Although the Street typically punishes them in the short run for investing in employees’ development (since it contributes to high general and administrative “costs”), it rewards them in the long run for the increased capacity those investments create.

That’s precisely why most publicly traded companies should be in favor of expanded human capital disclosure. It would help ameliorate the Street’s pernicious short-termism and dilute a primary source of pressure that leads to chronic under-investment in people throughout the economy.

Shareholders should also welcome expanded disclosure. It would help them know better whether they are investing in companies that are positioning themselves wisely for the future, or whether certain firms are dangerously attempting to maximize quarterly earnings at the expense of future earnings.

Ditto for employees. Whether or not they own shares in their employer, they are making a major and difficult-to-diversify investment by spending an enormous percentage of their waking hours working for a given company. They too would benefit from increased disclosure and fewer disincentives for firms to invest in employees.

And anything that helps to diminish the market’s focus on short-termism would be good for society as a whole. This change in particular would simultaneously help make companies more sustainably profitable and society more equitable.

Having said that, increased human capital disclosure will not be without its costs. Many companies will have to improve the sorry state of the technologies they use to run the people side of their businesses. Some can’t even figure out how many people are working for them, much less how much the company is investing in them.

But don’t shareholders have a right to know these fundamentals? In a world where, by some estimates, more than 80% of value is created through intangible assets — all of which are ultimately created by human capital — information on people investments is material information for investors; they should be entitled to it.

And what about those two exceptions — lousy employers and human resources leaders who would prefer to avoid accountability for human capital? Okay, we’ll agree that expanded disclosure will be painful for them. But in the grand scheme of things, that’s just as it should be.

Laurie Bassi, PhD, is CEO and Dan McMurrer, MPP, is chief analyst at McBassi & Company, a leader in using human resources analytics to improve organizational performance.

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6 responses to “Human Capital Disclosure Is ‘Unambiguously a Good Thing’”

  1. “…. if employees are a firm’s “most important asset” — as many CEOs repeatedly proclaim — why are they reported only as costs?”
    The short answer is that the financial report is just that, financial. The financial measurement of people is cost. That is how the accounting system was set up. It wasn’t intended to measure anything greater than 2 dimensions. Human capital measurements will lend themselves to be subjective. Financial reports are already loaded with assumptions and estimates that the FASB has had to deal with in the 2 dimensional report. What would the standards for Human capital measurements be like? The HCSB board (Human Capital Standards Board – I just made that up) would have it’s hands full wringing with interpretations and definitions to deal with when reporting. With all that effort required, is it worth creating another reporting system? What is the marginal cost of another overhead activity for reporting? We can certainly produce a bunch of statistics, qualitative measurements, ratios and the like. Will these together be good predictors of value?

    • Firms are already disclosing all kinds of non-financial information in their sustainability and/or integrated reports. Human capital disclosure is simply the next step in that evolution. (And, like it or not , almost certainly an evolution that will occur outside the finance and accounting professions.) This evolution is currently happening largely without standards. My expectation is (as David McCann notes) that de facto standards will emerge over time. And, yes, there is (as Jeff Higgins notes) an emerging body of literature that points to the human capital measures that are good predictors of value.

    • Rich, your last sentence hits the nail on the head with what’s wrong with this issue and the direction of financial reporting/disclosures in general. Financial statement users no longer want to be on the hook for determining on their own whether there is future value in a business based on actual results. They are simply passing the buck to company management by asking them to stick their necks out even further by requiring more and more predictive assertions around the risks and value of the reporting enterprise. It’s pure laziness if you ask me, and furthermore, increases the risk of investor lawsuits for dubious reasons.

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