Human capital transparency: the new competitive advantage

May 2022  |  SPECIAL REPORT: BUSINESS STRATEGY & OPERATIONS

Financier Worldwide Magazine

May 2022 Issue

The impact of information asymmetry is alive and well in 2022 and has found a new application: human capital. Information asymmetry occurs when one party has more information than another, generating inefficiencies in decision making to the detriment of the party with less information, and in the aggregate, results in economic inefficiencies.

Joseph Stiglitz, winner of the Nobel Prize in Economics, posited that economic models may be misleading if they disregard information asymmetries – a warning to users of financial information. One area that is receiving increasing attention as the target of ‘full and complete information’ is human capital performance. Understanding human capital performance is necessary in determining the sustainable economic value-creating ability of any organisation.

Governance monitoring agencies set the standard for human capital disclosures

Many governance-monitoring agencies, including the Sustainability Accounting Standards Board (SASB), the International Integrated Reporting Council (IIRC) (which have recently merged) and the World Economic Forum (WEF), to name a few, have called for qualitative and quantitative information about selected aspects of human capital performance for decades, as a proxy for an organisation’s governance quality.

Even the International Organization for Standardization (ISO) has weighed in on this topic, firmly committed to the theory that transparency drives enhanced enterprise outcomes and has issued its ‘30-414:2018 standard – ‘Human resource management – Guidelines for internal and external human capital reporting’ as a way of harmonising disclosure standards.

The SEC steps in

What is different today is the attention given to the relationship between human capital performance and corporate financial outcomes. The seminal events that shifted attention to human capital impact was Ocean Tomo’s research that demonstrated that 90 percent of the market value of the S&P 500 companies were attributable to ‘intangible assets’, and the US Securities and Exchange Commission’s (SEC’s) pronouncement that human capital costs are not “just an expense”, but an investment in an “intangible asset” – creating a sea-change in how human capital investments should be considered in evaluating corporate efficiencies and value.

In November 2020, new SEC human capital materiality disclosure requirements came into effect. However, the SEC and investors were not satisfied with the quality of disclosures. In response, it is anticipated that before the end of the summer, the SEC will revise these human capital disclosure requirements to be more consistent with the very specific, rules-based and rigorous environmental impact disclosure requirements announced in March 2022.

To a great extent, this heightened attention to the impact of human capital on financial outcomes was driven by the efforts of the Human Capital Management Coalition – a cooperative of 35 institutional investors representing $6.6 trillion in assets – that actively petitioned the SEC to require more transparency for investors.

In a recent statement, Gary Gensler, chairman of the SEC, announced that “investors want to better understand one of the most critical assets of a company: its people”. Information including workforce composition (full-time, part-time, seasonal and digital, etc.), diversity (gender, race and ethnicity, etc.), stability (attrition rate, average tenure and mobility, etc.), health and safety, and the total cost of the workforce provide investors, regulators, employees, vendors and customers with an opportunity to gain insights about the way organisations treat what they often refer to as their ‘greatest asset’.

This is not just a US issue either as the amendment of the European Union’s Directive 2013/34/EU relates to disclosures of non-financial and diversity information. Japan is the most recent country to indicate enhanced human capital disclosures. The traditional view that human capital information, hidden behind ‘trade secret’ status, is a competitive advantage, now needs to be reconsidered. Secrecy contributes to information asymmetry.

Reframing the human capital challenge

When it comes to managing human capital, it is no surprise that we are still trying to interpret and respond to the changes driven by the pandemic and other social movement events of the past two years.

Managing the workforce has always been challenging and organisations have turned to adopting methods from other domains (supply chain), or a variety of optimisation techniques (including Lean and Six Sigma), all in the service of having more control over and ability to predict the impact of the labour input to the business model. The sense of control was just that – a sense, an illusion, because humans are unpredictable and recoil from being treated as anything other than what they are: unique in every which way.

The events of the last two years brought about a realisation and appreciation of the fragility of the ‘the labour supply chain’, evidenced by the ‘Great Resignation’. We have seen an avalanche of employees quitting, changing jobs, becoming independent workers or leaving the workforce altogether. Companies are scrambling to fill open positions, retain talent, replace human talent with a digital workforce, retrain or retool workers, and generally address this labour challenge.

Most organisations do this without addressing information asymmetry – not enough information to make an informed decision – mainly because they do not know how to transform human capital performance into measurable financial metrics. The traditional approach is to view human capital as a qualitative function, however, with advances in technology and quantitative rigour, organisations can not only measure human capital performance, but also transform this performance into financial indicators consistent with other financial metrics like return on assets (ROA), return on equity (ROE), return on sales (ROS) and quick ratio, to name a few.

Organisations need to adopt a ‘data analytics’ approach to understanding human capital performance. Data analytics is a way to reduce information asymmetry in the organisation and enhance the effectiveness and efficiency of allocations to the human capital function. Research by The Conference Board shows that organisations that use data analytics to understand human capital performance are outperforming their competitors on an array of financial indicators, including profitability, by up to 25 percent.

Human capital metrics allow an organisation to quantify the economic impact their investments in human capital generate. Indicators of human capital materiality, required to be disclosed by the SEC, could include metrics such as: (i) human capital return on investment (HCROI); (ii) human capital value add (HCVA); (iii) human economic value add (HEVA); and (iv) human capital market value (HCMV). All these are relatively easy metrics to calculate, track over time, correlate to financial performance – and benchmark to competitors.

These analytics not only provide business insights related to human capital efficiencies, but also are critical in preparing an organisation’s disclosure narratives.

Transparency amplifies value

Although companies may resist transparency in this area, disclosures about human capital performance will become an organisation’s competitive advantage, because the deleterious impact of information asymmetry is addressed. This, in turn, creates a stronger employer brand, which is attractive to candidates and fills open jobs, and with workers more likely to stay with organisations longer. There are also more strategic partners to trade with, which helps address supply chain and productivity issues. More investment is also generated because the organisation can show sustainable economic value creation through effective human capital deployment. Moreover, customers as consumers are growing more aware of the ethical and moral impacts of a business’s mission and operations. Communities are also supporting longer term opportunities, as high-performing organisations are able to lift economic conditions, and lower poverty and crime rates.

Organisations that treat their employees equitably in terms of pay, opportunities, training and experience, among other things, will find that sharing this information will enhance their brand, and ultimately their financial performance.

 

Solange Charas is the founder and chief executive of HCMoneyball, and Stela Lupushor is the founder and chief executive of Reframe.Work, Inc. Dr Charas can be contacted on +1 (646) 275 2022 or by email: scharas@hcmoneyball.com. Ms Lupushor can be contacted on +1 (202) 736 2677 or by email: stela@reframe.work.

© Financier Worldwide

BY

Solange Charas

HCMoneyball

Stela Lupushor

Reframe.Work, Inc.

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.