While human capital management can play a significant role in a company’s financial performance, investors face significant challenges in attempting to incorporate human capital metrics into investment analyses, a recent study has found.
The analysis of 92 studies that focus on HR links to corporate financial performance found that a large majority of the studies – conducted over several decades and encompassing dozens of countries and industries – reported positive correlations between corporate HR policies and investment outcomes such as return on equity, return on investment and profit margins.
The 92 studies comprised 56 HR specific studies and 36 training specific studies. Of the 92 studies, there was a positive correlation between HR and financial performance in 67 studies, while there was a positive correlation in 45 of the HR studies and 22 of the training studies.
“Companies should adopt suites of complementary policies that comprise a coherent HR strategy, which in turn should fit in to their overall business strategy, said co-author of the report, Aaron Bernstein, from Harvard Law School’s Labor and Worklife Program.
“Investors should ask companies to explain their HR strategy and how it relates to overall business strategy and publish measures of their HR policies and key performance indicators of their success.”
Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute (IRRCi), which supported the research project, said it is intuitive that companies that have sound human resources policies and invest in employee training will perform better.
“Now, we have a meaningful connection between human capital management and financial performance,” said Lukomnik, who explained that for this information to become actionable for investors, there needs to be a level of disclosure and standardisation that does not exist.
“To date, there hasn’t been an outcry from research providers or investors pressing companies to report publicly on their human capital policies and outcomes,” he said.
For example, there are no standard metrics or definitions and there is no clear consensus about which HR policies in what combinations have the most impact on financial outcomes.
What measures to report?
Academic literature shows that successful HR strategies can vary by country, by industry and by an individual company’s competitive strategy, and Bernstein said investors should ask companies to outline their HR policies and provide detailed metrics that show how they are implemented.
“For example, companies can offer data on what percent of their workforce receives training, perhaps by occupation and/or market, as well as their annual training expenditure,” he said.
“This should be accompanied by an explanation of how the firm expects the training to benefit performance, such as improving employee and/or customer satisfaction, product or service quality, or productivity.”
The report, The Materiality of Human Capital to Corporate Financial Performance, said investors should consider asking companies for the following information with respect to HR and training:
- A description of the company’s training policy.
- How a firm’s overall HR policy relates to its business strategy.
- The kinds of employees trained and whether training is provided in or outside the company.
- Whether and how the company measures the direct and indirect costs of the training.
- Outcomes that characterise successful implementation of policies and how they are measured. These might be immediate in terms of increased worker knowledge and skills resulting in improved productivity or customer satisfaction. Or, they might result in lower turnover with associated cost savings.
- Measures of the impact that implementation has had on company profits and other measures of financial performance.
The study also recommends that investors seek similar kinds of information about the bundles of HR policies the companies employ.
HR leaders and reporting
There are a number of steps HR leaders can take within organisation to help generate and deliver this information, according to Bernstein.
“First, if they haven’t done so already or done it seriously enough, they need to be really clear in their own minds about the answers to the questions above,” he said.
“Second, they need to engage employees at all levels of the organisation to see how their experience of the policies aligns with what the company thinks they should be achieving.” Many leading companies use internal surveys on how employees feel about key HR policies, which allows them to track progress over time and to benchmark against rivals.
HR executives also need to be able to explain to the CEO and other senior executives how a proposed cohesive HR strategy can produce tangible performance gains for the company, Bernstein added.
“The goal should be to gain support for the strategy, and to work with the investor relations team to get the story out to the investment community,” he said.
“Investors are increasingly aware of the importance of HR policies, but most do not enough familiarity with the subject to know what they should ask companies to say about it.
“Companies with a convincing HR story and strong data to back it up are likely to receive a welcome reception from many institutional investors.”
The future of HR reporting
Investors can be expected to increasingly asked companies questions along the lines described above, according to Bernstein.
“This is likely to bring calls for metrics that characterise a company’s HR policies and the performance outcomes associated with them,” he said.
“Eventually this is likely to evolve into KPIs that become part of standard company reporting.”
The European Union is currently engaged in a two-year process of developing metrics that companies will be required to report publicly starting in 2017, and HR policies are one element of that discussion.
Bernstein noted that US firms are subject to the law for their European operations, which is likely to put pressure on them to publish such data for their US and other units as well.
Read more on the future of human capital reporting here.
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