September 2, 2021 Executive Compensation ESG & Human Capital Management Articles

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The HCM Funnel Board Considerations for Disclosures on Human Capital Management

Investor demands, societal pressures and competition for employees are pushing boards to be intentional about where and how they focus on human capital management (HCM). Leading companies view HCM as a value driver and strategic differentiator.

Boards should view HCM topics the same way they view other key strategic items — as an essential component of company oversight. But some companies are struggling to determine where to focus and how to drive real change in the organization. Many have expanded the purview of the compensation committee to include HCM metrics and some have renamed the committee to reflect this broader oversight. Additionally, increased disclosure requirements and expectations have raised the bar for clarity on how HCM ties to the business strategy. With the growing number of HCM measures, disclosure frameworks and investor perspectives, companies need to set priorities on their differentiators and areas where improvement will drive better business performance.

With the metaphor of a funnel, here is a framework for assessing HCM areas on their appropriateness for disclosure and compensation. Boards can start with all the relevant areas for the business, investors and key stakeholders and gradually filter them to the most impactful metrics (if any) for inclusion in compensation.

Stage one: Setting HCM priorities

In the widest stage of the funnel, boards inventory the HCM areas that the company already tracks and directors may add new areas to be tracked due to internal or external considerations. 

Then, the committee can determine the areas useful for internally evaluating the business, such as employee engagement, safety, diversity, equity and inclusion, depth of talent and succession planning.

Next, the committee should add in the priorities of stakeholders. Certain investors may be interested in turnover or representation of underrepresented groups among management, employees may care about pay equity, and local communities may be interested in the volunteer activities. To narrow down what might become a long list, the committee could focus on areas where the company is already distinguished or those with the greatest opportunities for improvement.

Depending on the specific areas critical to the business and the depth of review required, either the entire board or the compensation committee can do the funneling in this stage. 

Stage two: Committing to disclosure

The second stage further winnows the list to areas important enough to justify releasing those results publicly. Investors are demanding ever more details on HCM, so boards may want to push ahead on disclosing the most critical areas. These typically happen in one of three locations:

  • 10-k: Recent SEC regulations require companies to disclose material HCM metrics. Companies should be thoughtful about how much detail they provide and which topics they disclose, since an initial disclosure may create a go-forward expectation that the disclosure continues and that progress is made. 
  • Corporate Social Responsibility (CSR) Report: A variety of stakeholders (employees, customers, communities) read these reports, along with investors. Companies typically have the most leeway in CSR disclosure since it is not an SEC-filed document. Often these reports evolve to emphasize different items each year. Companies have more flexibility to tell their story and provide context here.
  • Proxy: HCM topics have increased in prominence here, driven partly by the pandemic and social unrest. Proxy disclosure provides more flexibility than the 10-K and may be more accessible to investors than the CSR report. Given the natural tie in to executive compensation, the level of HCM disclosure in the proxy may continue to increase. 

In any case, the most effective approach is to be intentional about where certain topics are disclosed.  Here is an example inventory our clients have used to catalogue which items are disclosed in each type of outlet or filing:

These are illustrative topics beyond the required disclosure in the proxy’s CD&A section.  Only the most important items are considered for inclusion in the pay program.

Clarifying the intention for each filing will help the company develop a logical and comprehensive strategy for monitoring and disclosing. Due to space limitations, some formats allow only for high-level data summaries. Boards wishing to provide more detail can cross-reference different sources or provide hyperlinks.

Boards should also consider how disclosures interact or overlap.  Some topics might be reasonable to disclose across filings, with others better suited in a targeted section of a single filing or on the company website.

Stage three: Tying to compensation

Most complicated is the third stage, where the company decides on incorporating HCM metrics into executive incentives. These metrics can help drive desired behaviors or signal a general commitment to specific improvements. Our research indicates that among larger companies, diversity and inclusion metrics are the most common HCM metric in incentives. 

While HCM metrics have gained prominence recently, we recommend boards resist the urge to move quickly here. We have seen companies benefit from starting small, such as using metrics in an individual performance assessment. Few companies have HCM metrics as stand-alone, formulaic assessments although some investors are already calling for more rigor in these goals. If incorporated into incentives, companies should select only metrics critical to driving the business, and with a clear strategic rationale for company improvement. Even if incorporated in a discretionary way, these metrics should: i) be material and measurable, ii) allow for setting meaningful goals, and iii) align with the broader company strategy and culture.

As companies track and disclose more HCM areas, boards should apply the same questions of materiality that they do to other strategic priorities. The proxy can become a “one stop shop,” highlighting the notable topics.  But HCM metrics should go into incentives only once the board has a clear and strong business rationale. 

View the full article as it was originally published.

Greg Arnold

Andrew Friedlander

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