This is one genie that’s not going to be stuffed back into its bottle.
A climate ripe for extensive disclosure of human capital data is blanketing the corporate world, with European companies taking the initial lead. The United States has been lagging well behind, but in August the Securities and Exchange Commission proposed that companies be required to report on human capital “to the extent such disclosures would be material to an understanding of the registrant’s business.”
Over the past two years, a litany of events has combined to create a groundswell of momentum for such disclosure. (See “It’s About Time” below.)
Propelling the idea is the ever-broadening consensus among stakeholders that effective assessments of a company’s performance and prospects require solid information on workforce costs, productivity, and how employees are hired, developed, and managed.
Most notably, disclosure guidelines issued last December by the International Organization for Standardization are expected to have a powerful impact. (See “What ISO 30414 Calls For.”)
Companies in Europe generally take standard-setting organizations more seriously than do U.S. companies. “Given that many [European] companies are talking about implementing the standard as soon as possible, it will soon be possible to incorporate human capital issues into fair value analysis,” noted a recent research report by Deutsche Bank. (See “Bank On It.”)
Says Hilger Pothmann, the bank’s head of human resources for the Eastern region of Germany and a member of the ISO task force that created the standard, ISO 30414: “The awareness and transparency around this in Europe since the beginning of this year have been extraordinary. There is also some very positive momentum in Asia and Australia.”
In the United States, especially considering the SEC’s recent proposal, an eventual, similar move to transparency appears likely — even if it takes some time — as global investors grow accustomed to having human capital information at their disposal when investing in Europe-based companies.
“As soon as it becomes a differentiator in the market, as more investors make decisions based on this type of information, everyone will jump on it,” says Rob Etheridge, head of group workforce management and analytics for Deutsche Bank, which along with fellow German companies Allianz and SAP is a leading voice in the disclosure movement. “It will inevitably spread in the Americas, where the capital markets play such a large role in dictating the activity and concerns of CFOs and CEOs.”
From there, Etheridge adds, “It should become the norm for any public company that wants to demonstrate the value created through good human capital management.”
According to Vicki Villacrez, CFO of telephone and cable services company TDS Telecom, today’s investors and analysts are viewing human capital metrics through two lenses: material risk and corporate values.
“Investors want to invest in companies with a moral compass, and disclosure on issues like human capital is one way to measure that and give investors greater context,” says Villacrez. “Topics such as diversity, human rights, labor, safety, employee volunteerism, and charitable giving are increasingly important context to highlight material risks, illustrate company values, and show how a business generates results.”
Some U.S. companies have cited competitive concerns in resisting calls for human capital disclosure by organizations like the Human Capital Management Coalition (HCMC), a group of 26 institutional investors with some $2.8 trillion under management.
“They’re worried that they’d be spilling their secret sauce,” says Cambria Allen-Ratzlaff, the group’s chair and the corporate governance director at the United Auto Workers Retiree Medical Benefits Trust. “But I think having examples of large multinational companies reporting this information should allay some of those concerns.”
The HCMC is hardly the only group of institutional investors worldwide that is making no secret about its thirst for such information. Several of them, collectively representing more than $100 trillion of assets under management, are engaged in various formal and informal efforts to coax human capital data from companies. They are also lobbying government agencies to mandate more human capital disclosures.
Some of the world’s largest asset managers, including BlackRock and State Street, have also made it known, in one way or another, that their sights are trained on such data.
Asked about the ISO standard, Allen-Ratzlaff says, “It’s much more efficient for investors to have clearly defined standards. In the United States, the conversation is around how much should be voluntary and how much compulsory. But we’re just looking for efficiency.”
She adds: “That’s not to say we don’t recognize that some human capital information might be more relevant to certain industries, or to certain companies within industries, depending on their business strategy. But there still needs to be standards [like ISO has put forth]. I think it’s hard for someone to say that data on turnover or total cost of workforce isn’t relevant to all companies.”
The SEC’s September proposal suggested that companies be required to report on “any human capital measures or objectives that management focuses on in managing the business.” Concern over industry-to-industry variables was one reason for the commission’s delay in taking action on human capital disclosures.
To be sure, SEC chair Jay Clayton sounded a positive note earlier this year. “The historical approach of disclosing only the costs of compensation and benefits often is not enough to fully understand the value and impact of human capital on the performance and future prospects of an organization,” he said.
But he also suggested that each industry, and even each company within a specific industry, has its own human capital circumstances. “For example, I would expect that the material human capital information for a manufacturing company will be different from that of a biotech startup, and different from that of a large health care provider,” he said.
“Because of those differences and the principles of materiality, comparability, and efficiency,” he continued, “I am wary of jumping in with rules or guidance that would mandate rigid standards or metrics for all public companies.” Apparently, he’s now changed his mind.
But Clayton’s earlier position was in line with the views of CFOs at some large U.S. companies. At recent meetings with Stanley Black & Decker, institutional investors’ environmental, social, and governance (ESG) leaders have shown significantly heightened interest in human capital metrics, notes Donald Allan, the toolmaker’s finance chief. “The question,” he says, “is how to make the reporting requirements helpful to investors and ensure they provide the right context for evaluating the disclosure, as company size and the scope and nature of business varies so widely.”
At AFLAC, finance chief Fred Crawford says the company believes diversity and proactive investment in human capital are key factors in the company’s long-term success. Not only investors but also companies that “walk the talk” will benefit from disclosure, by virtue of positively differentiating themselves from the field, he adds.
“However, as with any metrics approach, there are potential tradeoffs, as metrics alone do not often tell the entire story and can, in some cases, mislead,” says Crawford. “Human capital is a highly qualitative dynamic, and no uniform definition has emerged to enable dependable comparisons.”
Crawford further notes that he frowns on one-size-fits-all regulatory mandates. In any event, in the case of human capital management, they’re unnecessary, opines Crawford. “Investors will vote with their dollars and governance bodies with their ratings approach,” he says.
Allianz, for its part, in March 2019 publicly released a 53-page document, “Allianz People Fact Book 2018,” which may contain the most extensive human capital disclosure any company has yet made.
The report wasn’t the result of a brand-new effort. Allianz has been at the forefront of external reporting on human capital since 2010. But the volume of information disclosed has grown incrementally year by year.
“As we receive positive feedback, we’re constantly working on this with our relevant stakeholders at a high level, and we’re in various networks where this is discussed and [ideas are] exchanged,” says Jochen Fehringer, head of workforce intelligence for the world’s largest insurer.
While work on the 2018 fact book was completed before ISO unveiled its new standard, it contains most of the information the standard calls for, according to Jeff Higgins, a former CFO who was the lead U.S. representative on the ISO task force.
“I would consider Allianz to be the first company that is essentially compliant with the standard,” Higgins says.
Pointing to highlights of the insurer’s disclosure, he notes that it not only reports on salaries and wages but breaks them down into several sub-components, “which few companies do.”
Allianz also revealed its workforce turnover rate, which was 15.8%. The metric “often comes up as companies’ biggest fear” when it comes to human capital disclosure, says Higgins.
“They say, ‘If we’re losing more people than our peers, how bad does that make us look?’ I tell them that it depends: if they’re bringing in tons of young talent and simply don’t have enough growth opportunities, they might actually look good. It’s only bad if they’re making poor decisions or not taking care of people.”
Also, Higgins observes, Allianz provided a level of detail on workforce diversity beyond what the ISO standard calls for. It broke down both its management ranks and overall workforce by gender in each of eight worldwide regions.
By comparison, even given the intensifying climate of demand for such data, U.S. companies are unlikely to make such detailed disclosures unless forced to — but therein lies a contradiction.
“Allianz, Deutsche Bank, and SAP would not tell you that they’re the most advanced companies in the world at analyzing their human capital data,” says Higgins. “The companies that are very good at that are mostly in the United States. They’re just not disclosing very much.” He cites Johnson & Johnson and United Parcel Service as examples of particularly advanced U.S. companies in this area.
“Yes,” says Deutsche Bank’s Pothmann, confirming Higgins’ statement, “I would say that a majority of organizations that are well on their way in this area are U.S.-based.”
Human capital disclosure isn’t just good for investors. There’s pretty convincing evidence that companies that disclose more of such information perform better.
That conclusion came out of a separate effort to define standards for human capital reporting that was a key aspect of the early activities of the Embankment Project for Inclusive Capitalism (EPIC).
EPIC — a broad global project spearheaded by Ernst & Young and involving large corporations, asset managers, and asset owners — is aimed at establishing metrics that measure long-term value creation. Sue Hohenleitner, vice president of finance for innovation at Johnson & Johnson, chairs EPIC’s working group on human capital deployment.
For human capital reporting, EPIC came up with a somewhat similar but less-detailed set of recommended metrics than did ISO. However, extensive research was performed to support the standards creation effort.
In March 2019, Anthony Hesketh, the lead researcher, filed a comment letter with the SEC’s investor advisory committee, which had been having its own discussions about the value of human capital disclosure.
According to Hesketh, a senior lecturer at Lancaster University Management School in the United Kingdom, about 15% of S&P 500 companies consistently report their total human capital costs. Among those, 60% were consistently in the top-performing 100 companies in the index from 2015 through 2017, as measured by EBIT (earnings before interest and taxes) margin. Only 6% of the companies were consistently in the bottom 100 performers.
Using a measure he calls return on investment in talent (ROIT), calculated similarly to return on invested capital, Hesketh was also able to show that the deeper the disclosure, the greater the economic returns from talent.
Based on an index he developed to measure the volume of data points companies report on their investor relations websites, the ROIT for companies in the upper quartile of human capital reporting levels was nearly three times that of those in the lowest quartile.
Hesketh didn’t claim a cause-and-effect relationship between disclosure and performance. Members of EPIC’s human capital working group “favor the interpretation that well-run businesses that are confident enough to articulate their metrics around human capital in quantum form might be better placed to make financially accretive material interventions,” Hesketh wrote in the study report.
He concluded that “even the slightest performance gain from a more transparent approach to disclosing and managing human capital resources might be substantial for the U.S. economy.”
Shortly after receiving Hesketh’s comment letter, the investment advisory committee recommended that the SEC consider imposing human capital disclosure requirements on publicly held companies.
And, after a large asset management firm did its own analysis of the performance of companies that reveal higher-than-normal levels of human capital information, it is said to be preparing an investment fund that will be populated with stocks of companies that comply with ISO 30414.
“The financial materiality of human capital to firm valuation has evaded the accounting industry’s grasp for half a millennium,” wrote Hesketh. The way things look now, a new epoch may be at hand.
David McCann is deputy editor of CFO.