What if human capital could be valued and its contribution quantified in the form of productivity or return? What if the return on human capital could be definitively linked to business results? While intriguing, these questions are largely muted by the fact that no clear formulas or standards have existed upon which organizations could rely, for answers.
Yet, why do standards for HR and Human Capital matter? Aren’t existing reporting requirements enough? More to the point, why does ISO 30414 Human Resource Management – Guidelines for Human Capital Reporting for Internal and External Stakeholders matter1? Why should organizations invest time and money to quantify the value of their human capital and report on their performance?
To answer this, it is key to understand the fundamental changes impacting the way work is done. The rise of the computer, software, internet, big data and other technology has forever changed the way organizations operate, with economies shifting from industrial-driven to technology and services-driven. This can be proven simply by listing the top five most valuable companies in the world today; Apple, Amazon, Alphabet (Google), Microsoft, Facebook, only one of whom existed 20 years ago, while none existed 40 years ago. Therefore, in today’s services, data and internet driven world, most would agree that finding, hiring, motivating and retaining top talent has become more critical to success and more difficult to achieve ever as tech worker costs continue to increase.
There is near universal clarity and agreement that human capital has an impact on organizational success. On this broad strategic point, the investment community, Boards of Directors, CEOs, CFOs, management, governments, Human Resources and workers themselves agree. There is also significant evidence supported by research, showing the effects of human capital upon financial performance. The research is echoed by CEOs of leading global organizations who often say people are their most valuable assets and source of competitive advantage. All agreement ends however, when questions of how to properly reflect the importance of human capital, typically in terms of reporting and disclosure, come up. Yet between company management and investors, , it would seem that investors/owners will get their way and therefore it may be valuable to better understand their perspective.
The Investor and Capital Markets Perspective – The existing gap in human capital reporting has made it impossible for investors and other groups to fairly assess true workforce impact and the effectiveness of management regarding human capital as exemplified by quotes from various investment and capital markets organizations. This is why many investor groups have banded together in coalitions to more effectively push for change.
According to the Embankment Project for Inclusive Capitalism (EPIC) formed by the Coalition for Inclusive Capitalism in 2017, and made up of 32 companies, asset managers and asset owners, with approximately USD 30 trillion of assets under management, this conflict and gap can be highlighted thusly:
“If businesses want to prepare for a rapidly changing future, they might want to invest in employee training or innovation programs – even though that means they have lower dividends or short-term profitability. However, without a clear way to measure and communicate to investors why these trade-offs will pay off in the long term, many businesses feel compelled to put them off or avoid them entirely. And when businesses stop investing in the future, our entire economy suffers.”
Embankment Project for Inclusive Capitalism (EPIC)
“The fact is, the best businesses are defined by more than their short-term profitability. They drive broad-based prosperity by creating value for shareholders, customers, employees, and society alike. When they invest in giving employees the most in-demand skills, for instance, it is clearly good for their business.”
Larry Fink, Blackrock CEO, the world’s largest asset management firm
“The people who constitute a company’s workforce are in many cases a firm’s most valuable asset – indeed this view is ascribed to regularly by many companies. However, all too commonly they are viewed and reported as a cost.”
“Where is the Workforce in Corporate Reporting?”
National Association of Pension Funds UK Limited© (NAPF) White Paper, June 2015
As institutional investors and markets increasingly press to see more information on effectiveness of talent deployment in organizations they invest in, they have firmly acknowledged Human Capital, as a major source of value creation, customer satisfaction, productivity, risks, innovation, and more.
The following summarizes six reasons why standards for human capital matter:
- Companies need smart, effective employees to compete, so understanding and quantifying human capital is critical for success and future growth internally within the organization.
- There is broad agreement by investors, Boards of Directors, CEOs, CFOs, governments, Human Resources and workers that human capital has an impact on organizational success.
• CEO’s state “Our people are our most valuable asset,” or “It all starts with people.” Shouldn’t such valuable asset information be disclosed to key stakeholders.
- The current disclosure gap obscures talent management effectiveness and material human capital risks to investors. With no visibility into utilization of a firm’s single largest expense, investors must rely on social media tidbits or simply make judgements on no information at all.
- Organizations have a fiduciary duty to communicate existing and potential future risks deemed material to their business. Human Capital is clearly material to virtually any organization’s current and future success, therefore a fiduciary responsibility exists to provide greater information to shareholders, creditors and others.
- What gets measured gets managed. For most organizations, human capital is not well measured except as a cost. This suggests unbalanced reporting with only the cost side of the equation represented and the value-add investment side missing.
- Regulatory securities commissions, require extensive disclosure of all major assets including financial assets, physical assets, and technological assets such as patents. However, there is minimal disclosure of human capital which is, for most organizations, their largest annual operating expense.
According to Deutsche Bank’s Cross discipline research report “Valuing Human Capital”, dated February 13, 2019, as they conducted a deep dive into the accounts of individual European stocks. The result was a surprising relationship between Human Capital ROI and subsequent share price movements, Returns on Equity, and a firm’s overall staff costs.
“Just one unexpected outcome is that future share price returns are more
correlated to Human Capital ROI than they are with a company’s return on equity.
Furthermore, we found that firms with different levels of staff costs and Returns
on Equity have a very different Human Capital Return on Investment”.
Deutsche Bank research report “Valuing Human Capital”, dated February 13, 2019
Standards and Required Disclosure of Human Capital is Already Here – The US Securities and Exchange Commission (SEC) recommended in August 2019 as a part of its “Disclosure Effectiveness Initiative” to update listing company disclosure requirements (known as Regulation S-K), to a more principles-based approach. As a part of these changes, the SEC has recommended discussion and disclosure on three primary areas including: human capital talent attraction, human capital development and talent retention (with workforce costs), workforce productivity and employee engagement as secondary areas of focus for discussion and disclosure.
Now with the release of ISO global standard (ISO#30414:Dec2018), there are metrics in a clear global standard which organizations and stakeholders alike may utilize to finally begin to answer many of the questions around talent such as:
- Is the human capital value growing, static or declining?
- Are leaders doing a good job managing employee engagement, retention and performance?
- Which organizations are truly great at growing their own talent?
Internal vs. External organization use – While much focus has been on external disclosure of human capital reporting information for publicly listed organizations, perhaps the greatest singular value from the completion of the Human Capital Reporting Standard is a vastly improved understanding and insight about its own workforce. Completing the ISO HC Reporting Standard metrics arms an organization with the ability to better measure, manage and optimize their human capital talent.
While some aspects of human capital are hard to measure, many other aspects are measured readily, and if the right metrics are combined in a thoughtful, logical flow, insights and a story can emerge regardless of internal vs. external use.
While arguments can be made that additional reporting adds compliance costs for organizations, how can organizations legitimately say they are disclosing all ‘material’ business information without providing adequate reporting about their ‘most valuable asset?.
In the end, who can argue with the value of better information to measure, manage, and even predict workforce productivity and performance?