Blog: World Economic Forum offers framework for valuing human capital—will it catch on?

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With the SEC presumably about to adopt enhanced disclosure requirements for human capital next week (see this PubCo post), this new report from the World Economic Forum in Davos, prepared in collaboration with consultant Willis Towers Watson, offers a timely new framework for valuing human capital.  While the COVID-19 pandemic has increased our focus on the value of the workforce as an asset, this shift in perspective is not entirely new: SEC Chair Jay Clayton has long recognized that, while, historically, companies’ most valuable assets were plant, property and equipment, and human capital was primarily a cost, now, human capital often represents “an essential resource and driver of performance for many companies. This is a shift from human capital being viewed, at least from an income statement perspective, as a cost.” But he also recognized that developing a metric around this issue was not so easy. (See this PubCo post.) The pandemic, however, serves as a springboard: the new WEF report contends that, as “companies look to reset for the new world of work that emerges from the pandemic, they would benefit from an approach that values talent as a key asset that contributes to an organization’s sustained value creation. This calls for the development of a new human capital accounting framework, which would enable a company’s board and management to track how their investment in people is augmenting the firm’s human capital, and support the delivery of better outcomes for the business, the workforce and the wider community.” The report seeks to offer that framework. Whether it actually catches on is another question.

The new WEF report contends that “a robust framework for measuring and accounting for human capital would support a principled approach to workforce management…. Such a framework would enable a company to monitor and assess the return on its investments in its employees—in the same way as it measures returns on financial and intellectual capital; however, given the intangible nature of strong corporate culture, stakeholder leadership and employee well-being, companies have struggled to quantify the contribution of their human capital assets.” And there have been a number of efforts to measure human capital.  For example, in 2018, the International Organization for Standardization (ISO) developed an ISO standard, ISO 30414 Human resource management — Guidelines for internal and external human capital reporting intended to allow investors and others to benchmark companies’ performance on human capital management.  (See this PubCo post.)  In 2017, the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management, submitted a petition for rulemaking, asking the SEC to adopt rules requiring “issuers to disclose information about their human capital management policies, practices and performance.”  The petition, however, was not explicit with regard to the details of any proposed regulation, identifying only the broad categories of information that the proponents view as “fundamental to human capital analysis.”  (See this PubCo post.) And as noted above, the SEC proposed enhanced human capital disclosure.  According to the WEF report, however, these efforts lack “specificity, context and comparability.”

The WEF report builds on the “People” component as described in the IBC sustainability framework discussed in the sidebar, looking at how to value the skills and performance of the workforce and support investment in human capital. To view the workforce an asset rather than as an expense or liability, the report says, investments in the workforce (such as learning and development) must be captured and reflected in the overall change in workforce value. Often, the report observes, reductions in the workforce are taken as a one-time restructuring charge, while “workforce development costs are required to be expensed when incurred, resulting in a direct hit to earnings with no recognition of the value provided. This results in a set of perverse incentives whereby management is motivated to reduce investment in the workforce while being encouraged to treat talent as disposable.” The report posits the idea that, by treating investment in human capital like an investment in natural resources, such as oil and gas reserves, companies could capitalize the investment in the workforce and recognize it on the balance sheet.

The report proposes “three key human capital metrics that companies can use to drive long-term value creation”: employee experience; total cost of work/return on work; and total workforce value.

Employee experience.  This metric is not about job history. It’s a little more crunchy—it’s about the “experience” that employers create for the workforce: “At its core, employee experience is a metric that captures employee sentiment and reports on the quality of specific experiences at work.”  The model developed by Willis Towers Watson relies on an all-employee survey, with questions related to concepts such as “connection” and “contribution.”  Results are reflected on a heat map report that shows total favorable opinion scores for each concept relative to a high-performance profile. The heat map enables the company to identify areas for improvement, “root causes and actionable steps to remedy them.”  The report contends that “employee experience is predictive of business performance.”

Total cost of work/return on work.  This measure is designed to capture the changing nature of work, using “integrated and holistic measures of cost and productivity that capture the full range of ways in which work is organized and resourced, including those related to technology implementation to replace or augment work. From a holistic perspective, this means capturing the cost and productivity of all types of talent (e.g. employees, gig, outsourced) and automation on a like-for-like basis through such measures as the Total Cost of Work (TCoWTM) and the Return on Work (RoWTM).” Essentially, as defined in the report, the metric “return on work”  is equal to total revenues divided by the “total cost of work.” “Total cost of work” is determined by adding together total labor cost, vendor cost and annualized capital charge for capitalized investment.  The report contends that, as the nature of work shifts, it will be critical to track, report and align these metrics “to how company performance is measured, executives are compensated and board oversight is exercised.”

Total workforce value.  To value the workforce—which, as noted above, requires taking investment into account—the report looks for precedent to accounting for natural resources. Total workforce value would reflect the market price of all human talent (employees and non-employees) engaged in the business, adjusted for investments in developing the workforce and adding new talent, as well as for impairment or redundancy of skills or a decrease in workforce engagement.

The report acknowledges that the notion of including  a metric such as “total workforce value” as a line item on the balance sheet is a bit “challenging.” At least, the report advocates, the information could be provided supplementally in the annual report. The report suggests that any of these metrics could also be incorporated into various sustainability frameworks.

The authors of the report believe the new framework has potential to provide major benefits, hypothesizing that “had more companies made more human-centric decisions during the pandemic using a framework for human capital accounting such as the one proposed, their actions would have combined to deliver better social, economic and business outcomes. The rise in unemployment would have been smaller, governments would not have needed to provide such significant incentives to encourage companies not to lay off staff, the costs for the public sector and taxpayer would have been reduced and consumer spending would have experienced less of a hit, in turn benefiting companies’ revenues.”

The report advocates that boards consider the following as part of their decision-making processes”:

  • “ Ensuring that reported metrics include human capital in order to hold executives accountable and accurately communicate risks and rewards to shareholders
  • Actively monitoring human capital programs and management’s progress against agreed-upon metrics
  • Having stronger oversight of the company’s human capital strategies, talent management practices and employee well-being, and making human capital a board agenda item (i.e. not just leaving it to management)
  • Expanding the remits of compensation committees to include human capital governance, talent management and succession planning, and organizational development [see this PubCo post]
  • Becoming custodians of corporate culture and setting the tone for a human-centric culture in the organization—by placing the right people in the right jobs and by determining what performance is valued and which behaviors are rewarded
  • Ensuring greater prominence of sustainable human capital performance measures in executive compensation plans
  • Appointing non-executive directors with specialist human capital experience, similar to how boards view audit and legal experience as specialist skills”

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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