Why has human capital become such a hot topic of conversation? Some will say that this is due to the COVID-19 pandemic. Others will argue that human capital has always been, and will continue to be, a company’s most valuable asset.
Human capital has gained new importance, as investors and stakeholders have greater expectations of a company’s social and environmental responsibility. Diversity, equity, and inclusion (DEI), human capital, talent acquisition, and workforce retention are especially critical.
In August 2020, the SEC issued a long-awaited amendment to Regulation S-K, the regulation that contains detailed disclosure requirements applicable to registration statements, proxy statements, periodic reports, and other filings under federal securities law. To modernize Regulations S-K, Items 101, 102, and 105, the SEC adopted amendments and established a disclosure review program to change the regulatory and business landscape of disclosures that have not undergone significant revisions for over 30 years. The amendments also discourage repetition and the disclosure of immaterial information. The final rules became effective on November 9, 2020.
This marked the first time that a human capital disclosure was required. Under Item 101(c), public companies are required to disclose information about their human resources, including the number of people employed, distinguishing between full-time and part-time employees; the number of employees per department; and human capital management policies, practices, and performance. According to the final amendments and after considering public comments, Item 101(c) requires the following disclosure: “…to the extent such disclosure is material to an understanding of the registrant’s business taken as a whole, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business.” (Final Rule: Modernization of Regulation S-K Items 101, 103, and 105)
There is significant concern, however, regarding the accuracy of that information, which poses some interesting questions:
- Would such disclosures be meaningful to investors?
- In the absence of a human capital definition from the SEC, how subjective would those disclosures be when driven by management’s interpretation?
- Would the absence of interpretive guidance on human capital disclosures result in information that might not be relied upon?
Every registrant has its own metrics and definitions of human capital, which will limit comparability. Former SEC Chairman Jay Clayton commented that “it is important that the metrics allow for period-to-period comparability for the company … [it] should be viewed through the eyes of management, whether the focus is on turnover rates, education, or experience of the workforce, availability of workers to fill open positions, or other factors.” (“Modernizing the Framework for Business, Legal Proceedings and Risk Factor Disclosures,” https://bit.ly/3ORi39u)
Gary Gensler, the current SEC chairman, wants “more information on human capital disclosure, or how corporations interact with their employees… this builds on past agency work and could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.” (“SEC Chair Gensler is taking a deeper look at ESG investing issues,” https://cnb.cx/3gOoYDX)
A Redefined Role for Boards
Direct oversight of human capital has not historically been part of boards’ job description. As the focus turns to disclosure requirements, boards are increasingly charged with looking at the long-term sustainability (internally and externally) and strategic direction of companies. Not only do they have to help the company meet SEC disclosure requirements, but they also have to take several steps to implement these changes.
The enhanced prominence of environmental, social and governance factors (ESG) in recent years has shifted the focus of disclosure. Stakeholders are increasingly trying to understand companies’ methods of managing and measuring human capital.
Historically, boards’ focus has been on key executives and management teams. Today, boards need to go beyond that, overseeing and regularly assessing not just executives, but also the full workforce that drives the business and represents the company’s most important asset. Despite its importance, human capital has historically been difficult to value, making it a challenge for reporting and measurement purposes.
Reporting and Measuring Human Capital
Although the SEC has not defined human capital, the Sustainability Accounting Standards Board (SASB) established five primary sustainability aspects, one of which is human capital. According to the SASB, the human capital sustainability dimension “addresses the management of a company’s human resources (employees and individual contractors) as key assets to delivering long-term value” (https://bit.ly/3B0QkOe). The SASB addresses three areas relevant to human capital management: employee health and safety, employee diversity, inclusion and engagement, and labor practices.
Even though SASB has defined key areas relevant to human capital, companies still struggle to measure it. Looking at relative and actual statistics, peer competitors and boards can help companies see how they compare to others in the marketplace and whether there are areas for improvement. Companies need to consider full-time, part-time, and seasonal employees, as well as independent contractors, and they need to evaluate how management, health, and diversity in each of these categories relate to the company’s overall risk management and business plan.
Data quality is fundamental, not only for accurate disclosures, but also for an entity’s reorganization as they evaluate what works and what needs to change. As such, companies should be skeptical of the accuracy and reliability of the data collected and analyzed.
In addition to SASB, there are also other nonfinancial information initiatives, such as the Task Force on Climate-related Financial Disclosures (TCFD); the Climate Disclosure Standards Board (CDSB), which aligns with TCFD; and the International Integrated Reporting Council (IIRC), which formed the Value Reporting Foundation together with SASB. These recognized standards and frameworks share the common goal of helping stakeholders to understand the impact of ESG factors within their organizations and shift their mindset beyond the numbers.
Another standards setter, the Global Reporting Initiative (GRI), allows internal and external stakeholders to determine an organization’s impact on sustainable development, including on its workforce and society. It is astonishing to think that the CDSB goes back to 2007, but took until 2022 to seriously consider various factors to measure and adequately disclose human capital. How many more years will it take for uniformity on metrics and strategies?
The Workplace of Tomorrow
The COVID-19 pandemic, despite being catastrophic for many people worldwide, may have had a positive impact on the future of work. Many individuals took a closer look at their lives, careers, and families, and reevaluated what is important to them, including quality of life, the role of work, and where they would like to be in the future. The mass transition of the workforce forced leaders to address and revamp the work environment, compensation, and employee benefits in order to retain existing, and acquire new, talent.
The pandemic redefined the relationship between an employer and its employees. Businesses have been forced to shift their mindset towards their workforce and to showcase how employees matter. They represent more than a salary—they need to be heard, engaged, and empowered.
Executives have become more transparent than ever before, not only with employees regarding companies’ mission, financial results, and long-term goals, but also with other stakeholders. This helps employees feel more connected, despite the remote working environment. Physical presence is no longer required to feel connected. Communication, transparency, and direction bring value, and value is the CFO’s transition into sustainability. As more and more companies are developing finance teams dedicated to sustainability and innovation, the role of the CFO is migrating to the CVO (Chief Value Officer).
The author’s firm, Mazars, believes that investing in human capital is essential, as the shelf life of skills is shortening. Developments in technology and digitization are continuous; knowledge gained today will be outdated tomorrow. Therefore, creating a learning culture by continuously investing in human capital is key to maintaining and strengthening companies’ competitive positions. New processes and necessary technologies need to be in place, led by sound governance that supports employees throughout the organization.
The tone at the top is not just about financial results and compliance; it’s about overall leadership and organizational culture. It is about valuing people and rewarding commitment, effort, and integrity, and it is the key to overcoming difficult times. It is more essential now than ever for CEOs to have a consistent voice and strategy, a well-defined purpose, vision, and principles that are clear not only to external stakeholders, but also to the company’s workforce. Firms’ human capital management should be aligned to their organizational culture as well as the appropriate governance over social, economic, and environmental factors. Tailored management solutions can help smooth the integration of the new cultural changes into the company’s work-force while avoiding costly operational disruptions.
A Global Effort
Addressing human capital is an organizational as well as a global effort, stretching across borders, sectors, and industries. As companies work on measuring this critical factor, they are revamping the way they operate, requiring more soft skills in the new world of work. The pandemic was challenging, but it also created opportunities. In the current market, adaptability, flexibility, agility, and resilience are critical. Companies gain by incorporating DEI flexibility.
Businesses also need to be agile in terms of the work environment due to the wide acceptance of remote working, which allows organizations to broaden their search for candidates and hire employees that are not defined by a job type or the necessity of face-to-face interaction. Innovation and technology will continue to change how the workforce and human capital evolve, and they will be an even greater business factor in the upcoming years. For, as the philosopher Heraclitus said, “nothing lasts except change.”