How should companies report their human capital strategy?

Large corporates need to disclose more information about their longer-term human capital strategy

Large corporates need to disclose more information about their longer-term human capital strategy to shareholders and investors in the face of an increasingly disruptive environment, according to an environmental, social and corporate governance (ESG) expert.

The preservation of a company’s share value and growth has never depended as fundamentally on human capital strategy and effective management of their people as it does today, said Pauline Vamos, CEO of Regnan, an ESG research and engagement consulting firm.

“We hear companies claim that ‘people are our most important asset’ so often that it has almost become clichéd.

“Yet the reality is that for the majority of companies today, a significant portion of company value is deeply connected to its people – that is, the value created through the knowledge, skills and capabilities that reside in employees, as well as their shared knowledge as a group,” she said.

“However, the true value story of a company’s people is rarely told well in corporate disclosures.”

Without a fulsome picture of a company’s human capital strategy communicated to the market, it is likely that valuations will be misinformed and Vamos said this “affects the entire investment chain”.

Regnan recently launched a paper Strategic Human Capital: Closing a material gap in corporate disclosure, which provides provide guidance to corporates on improving disclosure of issues of material significance related to human capital and people strategy.

Strategic human capital management represents a significant information gap which can shed light on these risks and opportunities, as well as a company’s future prospects, according to Vamos.

However, she observed that disclosure in this area has not kept pace with the changing business landscape to date.

For example, rapid technological change – including advances in automation and artificial intelligence – are reshaping the modern business environment, requiring new organisational and strategic responses.

“The true value story of a company’s people is rarely told well in corporate disclosures”

Most listed companies generally fare “quite poorly” when it comes to corporate disclosure and human capital management, according to Vamos – especially from the perspective of investors seeking to gain insights into a company’s future prospects.

“If you were to survey experienced investors most would say that financial data provides a limited picture of corporate health, and investment attractiveness,” she said.

“Most analysts would try to get a more complete picture by analysing industry structure, and getting comfortable with the quality of company management, for example.

“But in our current age of disruption, the information available to understand risks and opportunities facing companies is insufficient.

“Can companies protect existing products from new online competitors? Can they adapt their business models to grow new markets?”

These are the types of questions investors are struggling with, and Vamos said few companies or industries will escape investor scrutiny as new business models proliferate with rapid advances in automation, big data, and artificial intelligence.

“We hear companies report that they are acquiring digital and technologies in response to disruptive threats,” she said.

“But rarely are we adequately told how people are managed and organised strategically to respond to risks and opportunities. This is the key information gap in our view.

“After all, technology is only one response to disruption – if the company is not organisationally prepared to take full advantage of technology than returns are less likely to follow.”

The biggest challenge for companies and HR is in joining up relevant human capital information with corporate strategies and actions, as this requires closer integration of corporate functions that may be siloed under existing organisational structures.

This lack of cross-function integration is very apparent in most current reporting on human capital management, which tends to be disconnected from materially relevant drivers of company value.

“For example, it’s common practice to disclose metrics on employee engagement or employee turnover at highly aggregated levels,” said Vamos.

“Such disclosures have limited value to investors seeking to understand, how the company is positioned to respond to disruptive risks and opportunities in its markets.”

“Without a fulsome picture communicated to the market, we believe company valuations will be misinformed”

While value around people is largely considered intangible, Vamos noted that it is still important to understand it.

This under-recognised proportion of corporate value has grown with the decline of manufacturing in OECD economies and increasing representation of service-oriented businesses, technology and finance.

Today, she said the majority of value is held in intellectual property, brands and people.

“So companies should explain more effectively how they are applying people to maximise long-term value,” said Vamos.

“Without a fulsome picture communicated to the market, we believe company valuations will be misinformed.

Companies with superior management and advanced communication of their human capital strategy should be rewarded in investment markets, or should be less severely punished where businesses are highly exposed to disruptive forces, according to Vamos.

“We’ve seen this play out over the last year as investors have tried to understand how retailers will be affected by the entry of Amazon into the Australian market, resulting in wild fluctuations to retail company valuations,” she observed.

“The mispricing of stocks resulting from poorly informed views work their way through investment chains, affecting fund manager portfolio returns, and ultimately the returns achieved by asset owners and superannuation funds.

“In short, poor communication of human capital adds to market inefficiency.”

Listed companies are faced with communicating to multiple stakeholders, including their own employees, communities, and investors.

“We would say that the last group, investors, are least well served by current human capital disclosure practices, which tend to be oriented toward non-investor stakeholders via CSR, ESG, or sustainability reporting,” Vamos said.

There is an existing structure to frame investor-focused human capital disclosure in annual reports through the Operating and Financial Review (OFR).

OFR reporting requirements were updated in Australia about five years ago to address the types of gaps Vamos described.

“Poor communication of human capital adds to market inefficiency”

The OFR seeks contextual and qualitative information on key business strategies, including significant plans that are part of those strategies.

“It’s not a big leap to see multiple linkages here to human capital, where for example, delivery of strategy requires significant organisational restructuring, retention of key people, or acquisition of skill sets in high demand,” she said.

“Human capital linkages are also apparent in other OFR reporting areas including operational status, prospects and risks.

“The key point to take out here is that human capital information should be disclosed in a value-relevant context.”

These disclosures will inevitably include qualitative information, but should be connected to overarching disclosure elements.

Vamos said human capital metrics fit naturally here to support qualitative disclosures, but granularly focused on measures that can illuminate progress on material aspects,

“We expect to see greater demand for these types of integrated reporting formats as our increasingly inadequate reporting structures catch-up with the realities of 21st century business,” she said.

“Additions to statutory reporting and listing requirements in the UK and South Africa reflect these changing investor expectations.”

Where HR functions are already well connected into the senior executive, investor relations and strategic functions, Vamos said the opportunity to link up to improve reporting outcomes should be apparent.

“To the extent that HR execs are closely involved in building high-performance work environments aligned to strategic objectives, the task should be one of making a case for greater integration of human capital strategies and actions in reporting,” she said.

“Where it is clear how human capital information can assist to demonstrate sound human capital management via OFR reporting, HR executives are well placed to shape these communications.

“This is clearly a bigger hill to climb where HR functions are siloed or disconnected from other functions.

“If the company is highly exposed to disruption and management actions to address risks are poorly communicated, the markets themselves will make the case.”

Click here for Regnan’s Strategic Human Capital: Closing a material gap in corporate disclosure paper. Image source: iStock