As noted in thecorporatecounsel.net, the EY Center for Board Matters has released a new study of human capital disclosures. Human capital has recently become recognized, especially by many institutional investors, as among companies’ key assets in creating long-term value. SEC Chair Jay Clayton has observed that, in the past, companies’ most valuable assets were plant, property and equipment, and human capital was primarily a cost. But now, human capital and intellectual property often represent “an essential resource and driver of performance for many companies.” According to EY, a “company’s intangible assets, which include human capital and culture, are now estimated to comprise on average 52% of a company’s market value.” And human capital has “emerged as a critical focus area for stakeholders. There is clear and growing market appetite to understand how companies are managing and measuring human capital.” These developments have led the SEC to propose adding human capital as a topic for discussion in companies’ business narratives. (See this PubCo post.) To see how companies are voluntarily disclosing their practices regarding human capital and culture—and perhaps in anticipation of a new SEC requirement—EY undertook to review the proxy statements of 82 companies in the 2019 Fortune 100. The study may prove to be especially useful for companies trying to understand the contours of human capital disclosure, whether or not the SEC ultimately goes ahead with its proposal to require material human capital disclosures.
In general, EY found that disclosures were at an “early stage.” EY had two key observations: “One, many companies voluntarily highlight management’s general efforts around certain human capital issues (e.g., diversity and inclusion or broader workforce compensation). However, these disclosures often do not identify key performance indicators (KPIs) or quantify them. Two, many companies broadly address board oversight of human capital management or culture, and more assign related committee oversight responsibilities, but the depth and clarity of these disclosures vary and may not provide a complete picture of the board’s governance in this important area.”
In its review, EY found the following types of disclosure related to human capital management:
- Workforce diversity (50%) — Under this topic, companies discussed their efforts to enhance diversity, including “initiatives to empower women and minorities and bring them into leadership positions, diversity statistics and recruitment goals around diverse talent, employee affinity groups, supplier diversity initiatives, collaborations with diversity organizations, and external rewards and recognition.” EY reports that almost a third of those addressing this topic provided data.
- Workforce compensation (34%) — With regard to compensation of the broader workforce, companies discussed efforts to achieve pay equity (e.g., identify and eliminate pay gaps for women and minorities), minimum wage increases and general approach to comp. Around 40% of those addressing this topic provided specific performance data around pay equity (in addition to the CEO pay ratio) such as the “pay ratio for female to male employees, the pay ratio for minority to nonminority employees and in some cases a measure of the adjustments made to help close the gap. A quarter of the companies reported a specific new minimum or starting wage (usually $15 per hour but in some cases $11 per hour).”
- Culture initiatives (22%) — EY describes “culture” as a “distinct intangible asset companies should monitor and address to drive their strategy and enhance long-term value. Culture is the strength in people that can energize a business. It is how people collaborate, how decisions are made, how value is created and protected, and how people motivate each other.” Beyond compliance with codes or executive comp, companies identified as culture initiatives “employee surveys and benchmarking reports, employee town halls, unconscious bias trainings, leadership team events, and the inclusion of culture-related messaging and feedback via onboarding processes, performance reviews and exit surveys. Half of the companies that discussed culture initiatives said that they use employee surveys to measure culture. Some of the other KPIs mentioned included diversity hires, employee engagement, turnover and issues escalation resolution. With limited exceptions, the companies did not provide quantitative results for their disclosed KPIs.”
- Workforce health and safety (22%) — In this context, companies discussed topics such as “employee health and wellness resources and benefits, and, in some cases, safety metrics for the company and its suppliers. KPIs included recordable injury rates and the number of employees participating in certain health and wellness programs, but less than half of those addressing this topic disclosed KPIs and very few provided data.”
- Workforce skills and capabilities (22%) — The discussion here related to “employee re‑skilling, training, and leadership development programs and related resources….Half of the companies that discussed workforce skills and capabilities provided at least one related quantified KPI measure. This information generally included the aggregate amount of money or employee hours invested in training programs, or the number of employees participating in internal training or career planning programs.”
- Workforce stability (6%) — The few companies addressing this topic identified “employee engagement scores and certain turnover rates (e.g., turnover rate for high‑performing personnel) as KPIs; few provided quantified results for their KPIs.”
With regard to board oversight, EY generally found the proxy disclosure to lack specificity. While about 40% companies recited that the board oversees HCM or culture or that the audit committee oversees employee codes and the comp committee looks at pay equity, the disclosure lacked detail: EY “found that proxy disclosures would benefit from more specificity around what dimensions of human capital management and culture are overseen by the board and how the board is executing that oversight.”
In addition, in discussing the qualities and experience desired for directors, almost a third of companies “included human capital-related experience among the skills and areas of expertise sought at the board level.” In describing the backgrounds and experience of their directors, 44% of companies “cited human capital-related experience in at least one director biography in describing the key reasons that person is qualified to serve on the board.”
Frameworks and KPIs
Use of a framework can help to standardize disclosure and provide comparability among companies, a characteristic that investors are clamoring for, as discussed in this PubCo post. Among the frameworks identified by EY that view human capital as a key driver of long-term value are
- The Embankment Project for Inclusive Capital (which proposes metrics and narrative disclosures related to talent),
- SASB (which provides detailed, industry-specific standards related to, among other things, human capital) (see this PubCo post),
- The Global Reporting Initiative (GRI) (which covers “human capital topics such as recruitment and retention, labor and management relations, health and safety, training and education, diversity and pay equity”), and
- International Standards Organization (ISO) (which, in ISO 30414:2018, “provides guidelines and metrics for human capital reporting, including diversity, organizational cultural, health and safety, recruitment and turnover, skills and capabilities, and more”). (See this PubCo post.)
Many frameworks identify KPIs that may be useful in communicating about human capital. According to EY, examples of KPIs could include:
- for diversity—diversity across different employee groups, ratio of labor types;
- for compensation and pay equity—total sum of pay, pay equity ratios;
- for attraction, recruitment and turnover—voluntary turnover rates, including for high performers;
- for culture, including alignment with purpose, values and strategy—standardized employee surveys;
- for training, learning and development—return on investment in talent, total training hours and spend; and
- for engagement, health and well-being— engagement index score, absenteeism rate, employees participating in wellness programs
EY predicts that, in the future, “[d]isclosures and company practices will likely continue to be impacted by trends around technology and demographics. A preferred disclosure framework is likely to emerge, with commonality among the KPIs communicated (especially within industries). Boards will likely develop a stronger relationship with the Chief Human Resources Officer (CHRO) and continue to redefine the scope of their oversight of this space. And companies are likely to further integrate disclosures on human capital, culture and other long-term value drivers across a variety of reports beyond CSR or sustainability reports.”
Questions for the Board
EY suggests the following questions for the board:
- “Does the board set the tone at the top regarding the strategic importance of human capital and culture by dedicating the appropriate level of time and attention to these topics, including at the full board and committee levels?Does the board have the right composition and resources to appropriately oversee culture and talent management in the wake of disruptive talent trends and transformation?
- In today’s information age, where the role of the CHRO is akin to the role of the CFO through the industrial age, is the board spending enough time meeting with the CHRO to oversee talent strategy and performance?
- Is the company communicating its culture and values across the workforce such that each individual employee fundamentally understands how her or his day-to-day responsibilities and performance drive strategy and aligns to the company’s purpose?
- Is the board regularly reviewing with the CHRO talent and culture metrics similar to its quarterly updates on financial metrics with the CFO? How is the company integrating human capital metrics and performance into earnings calls, analyst meetings and its external financial reporting to better communicate long-term value?
- How are culture and talent goals integrated into incentive compensation programs? How is the company monitoring and adjusting for any unintended consequences?”
By: Cydney Posner at Cooley LLP and Cooley (UK) LLP