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Meeting investor needs with human capital reporting

The disruptive effects of technological change occupy a lot of space in the business press, and for good reason. Investment markets have witnessed significant value destruction in sectors exposed to disruption over the past 15 years, and there is much more to come with rapid advances in automation, big data, machine learning, and artificial intelligence. Some commentators describe these forces as combining to create a Fourth Industrial Revolution, with profound implications for businesses.

Few companies or industries will escape investor scrutiny as technology-enabled business models proliferate to compete with incumbents. In this rapidly changing business landscape, the information available to understand risks and opportunities is increasingly inadequate for investors to develop informed views on a company’s future prospects. 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 continue to struggle with.

How are people managed in the face of disruption?

Rarely are we adequately told how people are managed and organised strategically to respond to risks and opportunities from disruption. Technology is only one response to disruption. Disclosure of human capital management falls well short of market needs, especially viewed from the perspective of investors seeking to gain insights into a company’s future prospects. Where human capital reporting is absent and strategic human capital risks are material, companies may not be meeting their disclosure requirements.

For the majority of companies, a significant portion of company value is deeply connected to its people, through intangible value. 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, the majority of value is held in intellectual property, brands, and people. It follows that investors need information beyond that available in financial accounts to inform invest decisions.

Companies should explain more effectively how they are applying people to maximise long-term value. Companies with superior management and advanced communication of their people strategies should be rewarded in investment markets, or should be less severely punished where businesses are highly exposed to disruptive forces.

The biggest challenge to improving human capital disclosure is joining up relevant human capital information with corporate strategies and actions. It’s common practice to disclose metrics on employee engagement or employee turnover at highly aggregated levels, which may be meaningless. Such disclosures have limited value to investors seeking to understand, for example, how a company is positioned to respond to disruptive risks and opportunities in its markets.

Addressing reporting gaps

Fortunately, Australian listed companies have an existing structure to frame investor-focused human capital disclosure in annual reports through the Operating and Financial Review (OFR). OFR reporting requirements were introduced in Australia about five years ago. It’s not a big leap to see multiple linkages here to human capital, where delivery of strategy requires significant organisational restructuring, retention of key people, or acquisition of skill sets in high demand. Human capital linkages are also apparent in other OFR reporting areas including operational status, prospects and risks.

A leading example is Primary Health Care (ASX:PRY), whose business success relies fundamentally on attraction and retention of health care professionals (HCPs) to achieve targeted return on capital invested in its medical centre, pathology and imaging service assets. Primary discloses material information in the OFR on strategic changes to HCP contractual arrangements designed to improve attraction and retention of HCPs, HCP expenditure trends, and tailored metrics on HCP attraction and retention rates for exposed business segments. Such reporting remains the exception in the ASX however, hence there is significant scope to extend and improve human capital disclosure.

Restructuring in response to disruption

Rather than an additional reporting burden, human capital disclosure is an opportunity to give greater confidence to investors about future prospects. This is especially the case where business models are vulnerable to disruption, and human capital led responses are required to engender greater workplace agility and flexibility. For example, ANZ divulged that it would comprehensively restructure its work organisation by removing hierarchies and bureaucracy, adopting organisational structures akin to those in fast-moving tech companies as a direct response to disruption risks.

Disclosure approaches to communicate fundamental human capital reorganisation on this scale is only beginning to emerge. For example, how do workforce reorganisation strategies integrate with business strategies? How is ongoing operational delivery affected by the reorganisation of human capital for product groups? What are the key human capital-related risks to execution of workforce strategies? How is progress on execution of human capital strategies measured? What bearing is human capital management likely to have on 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. Most analysts achieve a more complete picture by analysing industry structure, and gaining comfort with the quality of company management, for example. Enhanced disclosure of human capital management fills information gaps to round out assessment of outlook.

Advancing meaningful human capital disclosure is a less onerous task where corporates are some way down the track of integrating their strategic and human resource functions. The opportunity to link with investor relations to improve reporting outcomes should be apparent, and the task should be one of making a case for greater integration of human capital strategies and actions in reporting. 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 market will make the case.

 

Pauline Vamos is CEO of Regnan Governance Research & Engagement. She was CEO of the Association of Superannuation Funds of Australia (ASFA) between 2007 and 2016.

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