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This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum. Author: Hilger Pothmann, Regional Head of Human Resources, Deutsche Bank AG, Region East, in Germany & Mark Loon, Deputy Pro-Vice-Chancellor for Research and Enterprise, Bath Spa University
“People are at the heart of all that we do” is often heard and cynically viewed as lip-service.
The recently published ‘Guidelines for Internal and External Human Capital Reporting’, produced by the International Standard Organization (ISO), is about to change this perception as it aspires to truly place people at the centre of organizations. This new standard will disrupt the way companies think, value and report on their human capital, and deliver what investors look for; sustainable growth and returns.
The past
Through the decades, CEOs, asset managers, investors and rating agencies from around the world have witnessed the weakening links between market values and accounting information, such as cash flows and book values of companies.
As a result, traditional instruments, such as multiples of the price-to-earnings ratio, have lost some of their gloss as indicators of growth. Between the 1960s and 1990s, the correlation between earnings and shareholder value was traditionally around 90%, which means that up to 90% of the market value of a firm (stock price multiplied by shares outstanding) could be predicted by the financial performance of the firm.
However, since the 1990s, this percentage has dropped to well below 50% – in both rising and falling markets. If this is anything to go by, financial performance is losing its crown as the main predictor of market value. If tangible financial information has lost its impact, what about intangibles?
Earnings growth vs. PE ratio for the S&P 500
The Present
Human resources
Saying that it is difficult to articulate and measure the impact of human resources (HR) on investment decisions is an understatement. Many have tried, many have failed.
Does a company’s strong learning and development initiatives have any influence on how the firm is valued? Why shouldn’t a company that invests more in their people be more valuable than a company that does not? How do we report on investments in human capital? What data is required? Are these data sets comparable and how do we report them?
These questions are all relevant. So while it is intuitive that a firm that prioritizes human capital is more sustainable than short-term orientated firms, what is the stumbling block to getting this recognized by financial markets?
Data
It is all about data on HR. We have to make things more transparent. We have to pave the way for benchmarks within HR to enable financial investors to credibly assess the quality of HR mechanisms and processes between competing companies, and then include this information in respective financial evaluation models.
HR data is not just for investors in the financial markets but also for talent in labour markets and for governments, who continuously endeavour to align these markets. Potential employees look for fair and prosperous employment opportunities while governments try to ensure there is adequate talent to fuel sustainable economic growth.
Disruption is growing
The Human Capital Coalition has filed a petition at the Securities Exchange Commission (SEC) in the US, requesting formal governance for reporting Human Capital information by all listed companies. Ernst & Young Consultants have launched an impressive global momentum called the “Embankment Project for Inclusive Capitalism” (EPIC), as part of their Environmental, Social and Governance practices. Increasingly, more financial market participants and academics are focusing on Human Capital information.
The future
There is something emerging within the discipline of measuring Human Capital. Experts from around the world, with 22 countries actively participating, have developed Human Capital Reporting guidelines under the International Standardization Organization (ISO 30414).
By clearly defining key Human Capital involving areas such as diversity, compensation, training, leadership and sources of organizational data, ISO has created a path for benchmarking Human Capital intangibles. This will provide urgently needed transparency on measures such as leadership competencies, dependencies on external workforce, employee engagement and commitment, and workforce productivity to name a few.
Investors, rating agencies, governments and potential employees will really benefit from this. Having rules and comparable data provides stakeholders with another way of evaluating and understanding companies better.
Because the correlation of market value and earnings of listed companies has become weaker, people are seeking new ways to evaluate companies.
Right now, HR work is hidden in the field of intangibles. It is very difficult to measure. There is no (widely accepted) direct link to economic results.
This is going to change. ISO 30414 provides definitions, frameworks and rules around people related data/information.
Stakeholders will list them as intangibles alongside other relevant performance data on companies. As a result, assessing whether a company is set up for sustainable growth becomes much more valid. This disruption also provides a massive opportunity for HR professionals as they understand HR practices, and how HR systems capture and crunch data.
The human capital standard is not just for companies listed on the stock exchange. For example, in the future it could be possible that an SME reduces its loan interest payments if it can prove to lenders that it is able to balance short and long-term needs to drive sustainable growth.
These SME owners not only have a proven business model now, but have engaged employees who are able to adapt to market changes in the future to protect, and grow, market share. The proof of the SME’s investment in human capital through ISO 30414 will reassure lenders of its sustainability. This is the future.