A draft standard proposing the statutory disclosure of human capital metrics in the United States is causing quite a stir among CFOs and HR professionals. The standard, “Guidelines for Reporting Human Capital Metrics to Investors,” is being proposed by the Society for Human Resource Management (SHRM) with the aim of helping investors make more-informed decisions about the companies in which they are planning to invest.
It’s an interesting proposition because of the widening gap between the value of a company represented by its net assets in the balance sheet and its market capitalization. Thirty years ago, there was a strong correlation between companies’ net assets and their market value, but with the relative demise of manufacturing (at least in developed economies) this tight relationship has all but disappeared and nowadays market capitalization can be more than 30 times net assets. The difference is presumed to be accounted for by brand value, goodwill, and human capital—the accumulated store of knowledge within the company. If that’s the case, doesn’t it make sense to measure the value contributed by human capital and to disclose how it is being nurtured. The new standard is designed to support this transparency. Reporting is required in six areas: spending on human capital, ability to retain talent, leadership depth, leadership quality, employee engagement, and human capital discussion and analysis. In addition, it is proposed that the new standard has “teeth” because it is based on the principle of “report or explain”; for example, shaming businesses into explaining why they are not disclosing if they decide to duck the standard.
But the standard has not been welcomed with open arms, especially by CFOs concerned about the time-consuming burden of producing yet more disclosures, and questioning whether the inclusion of HR metrics will really be of value to investors.
Even the HR profession is divided. The Human Resources Policy Association (HRPA) objected strongly to the proposed requirements, stating, “The proposed standard would have companies disclose almost every corporate cost associated with the hiring, retention, and training of employees and contingent workers, plus detailed information regarding how the company is organized and staffed.”
“Moreover,” the HRPA continues, “the information produced by these metrics would not be comparable from one company to another, therefore making it of little use to investors. Further, companies disclosing the information would be placed at a considerable competitive disadvantage relative to organizations seeking to raid their talent; competitors trying to gain insights into how they are organized, staffed, and structured; and hedge funds and other entities seeking financial prey.”
It is clear the HRPA was very concerned that companies would be left exposed by putting the internal workings of their companies on public display.
But the issue of comparability strikes at the heart of disclosure. CFOs are already acutely aware of the difficulty of making meaningful financial comparisons across different accounting standards—for example, US GAAP and IFRS that have benefited from years of discussion, codification, and best practices. How much more difficult would it be to achieve comparability without agreement on specific HR measures? And even the interpretation of agreed measures is contingent on a deep understanding of the business and the market environment in which it operates.
Take, for example, the straightforward measurement of staff attrition rates. High attrition is normally considered undesirable but in an up-or-out culture of a thriving consultancy business, for example, that continually needs new talent it could be considered a desirable objective. By the same token, low attrition in a DIY retailer may be viewed as attractive since grey hairs may be valued by customers seeking help and advice on home improvements. Furthermore, outside of US borders, the comparability of HR metrics is likely to be severely distorted by different labor laws around the world.
So where do we go from here? The notion that financial statements and narrative reporting do not provide much insight into the important contribution that people make to the bottom line is a fair criticism. But these are difficult times and not many CFOs have an appetite for more disclosure. There is also the thorny problem of choosing metrics that accurately reflect the shareholder value created by the workforce and are therefore useful to investors. It’s a tall order to satisfy—especially without giving away the crown jewels to competitors. What’s clear is that in an environment where talent strategy is the #1 initiative on CEOs minds, CFOs must work hand-in-glove with chief HR officers to ensure that human capital management is included in strategic business planning, and that its performance against objectives is as closely tracked as any other capital asset.