June 14, 2021 Executive Compensation ESG & Human Capital Management Articles

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ESG & Human Capital Management

Measuring up to HCM HCM investment and reporting has intensified in promoting a diverse, equitable and inclusive society

Corporate sustainability risks and opportunities have received increasing interest from investors for the past decade.

Environmental concerns initially led the list, but attention to human capital has swiftly emerged as an additional focal point of discussion in the boardroom. Investors and other stakeholders are prodding companies to reveal more about their human capital practices and metrics. Boards are now scrambling to refine and articulate their strategies and investments in this area.

Human capital management (HCM) can be thought of as how an organisation strategically operates and invests in its workforce, with an eye towards optimising long-term value creation. It recognises human capital as a critical asset and modernises the understanding of HR departments as strategy and profit centres, not just cost centres.

HCM is therefore a sustainability topic that many stakeholders request more information about. How and why has a company invested in its workforce? Is there underinvestment that presents long-term risk? With HCM disclosure increasingly within investor crosshairs, many US corporations are bucking tradition by detailing elements of their HCM within the proxy statement.

Why Now?

It’s natural today for HCM to be overseen by boards as part of fiduciary duties. Market forces, such as disruptive technologies, income inequality, the shift to the service-based economy, have led to heightened competition for skilled labour.1 Even beyond recruitment and retention, companies are investing more in human capital to develop the agile, innovative and engaged workforces that many say are critical to meeting strategic goals.

Until recently, this elevation of HCM discussion in the boardroom had not led to widespread external reporting of HCM items. Even in an age of heightened investor engagement and expectations for good governance, regulators did not require HCM disclosure before 2020, and voluntary disclosure is sparse.

But with intangible assets like human capital representing a major portion of many business’ market value,2 large institutional shareholders in particular increasingly seek integrated reporting of financial and non-financial factors to best understand a company’s business.3,4 The pressure for disclosure has become palpable.

These trends ultimately led the Securities and Exchange Commission in 2020 to amend Regulation S-K for the first time in decades, including a requirement for HCM disclosure.5 It requires disclosing only ‘material […] human capital measures or objectives’ that are ‘used to manage the business’, with enormous leeway given to interpret these terms. While the requirement falls well short of the degree of disclosure many stakeholders are seeking, it does validate the importance of HCM reporting.

Uptake in HCM investment and reporting has also intensified in response to greater awareness of, and expectations for, a corporation’s role in promoting a diverse, equitable and inclusive (DE&I) society.6 The Black Lives Matter, Fair Trade and #MeToo movements come to mind. Beyond concerns over maintaining a competitive workforce, underinvestment in HCM has exposed companies to executive conduct scandals,7 pandemic-induced work stoppages, or even employee activism, customer boycotts and calls for divestment.8

This greater societal awareness has served to accelerate companies’ investments in employee development, culture, resiliency, labour standards, and health and safety in recent years. The next step is determining how to report such HCM investment to strengthen a company’s employer and customer brand, and relate it to long-term business strategy.

What’s Happening in 2021

Over time, HCM disclosure will likely converge to a set of norms within each industry, but today’s landscape is still highly dynamic and fragmented. Early returns point to the proxy statement as a popular vehicle for communicating HCM initiatives to investors.

We’ve analysed HCM disclosures within the proxies of 53 US corporations filed between December 2020 and January 2021, then compared them to the disclosures from the prior year.9 Only robust disclosure mattered (i.e. specific HCM practices, metrics or initiatives); we ignored vague or boilerplate statements.

Those 53 proxies showed a sudden surge in disclosure. Our findings included:

  • 33 companies (62 per cent) provided robust HCM proxy disclosure this year; only 14 (26 per cent) did so last year
  • Those with disclosure in both years expanded disclosure length by an average of 47 per cent
  • No one-size-fits-all approach: the length, location and selection of topics covered varied substantially, with no predominant set of norms yet apparent
  • The most common topics were descriptions and investments toward DE&I, culture and employee benefits and wellbeing initiatives
  • Overall workforce development, HCM governance, demographics and stability got less attention; perhaps companies are not ready to disclose such items robustly, or are doing so elsewhere10
  • Companies already considering HCM performance within executive pay programmes, as well as those with a larger workforce, were more likely to provide HCM disclosure

Where We’re Headed

If HCM follows the pattern of past new disclosure items, companies will continue to fine-tune their disclosure strategy and track how competitors approach it, quickly leading to more fulsome and consistent practices across companies over time.

For the time being, many companies looking to get ahead of their HCM narrative have turned to the proxy statement. We expect disclosure approaches will use a number of communications vehicles in the long run, with the uptake of a standardised reporting framework outside of the proxy eventually becoming the norm.

It will be easy to fall behind as stakeholders digest newly public HCM information, compare across companies, identify further disclosure opportunities, and ratchet up their requests.

Companies that offer only minimum disclosure should prepare to defend themselves. Those offering greater disclosure should continue to monitor evolving practices within their industry, from proxy statements to all other forms of communications.

All companies have something they could be doing to prepare for what’s next, from measuring more HCM metrics internally to identifying additional opportunities for strategic investment.

For example, it’s easy to understand potential future stakeholder requests for metrics such as demographic analyses of compensation, turnover and performance. Most companies are far from prepared to disclose such metrics, if they’re even being measured and analysed internally at all. The goalposts for HCM disclosure may move quickly – is your company ready?

View the full article as it was originally published.

This article was originally published in Ethical Boardroom.

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