Background
Over the last 50 years we have seen the rise of intangible assets (including human capital) making up more and more of organizations’ value and in some cases becoming their most valuable assets. Compare below the top five global companies by market capital in 2018, including Alphabet, Google’s parent company, with most of their assets being intangible assets, to the top five companies in 1975, including Exxon Mobil, an oil and gas company, whose assets were almost entirely tangible.
Source: AON & Ponemon Institute, 2019
Leaders recognize this shift, often stating, “Our people are our greatest asset.” However, words demand action: employees understand their worth and are expecting more from their organizations than ever before. Yet when it comes to valuing an organization, people are often left out the equation.
The First Step in a Much Longer Journey
The United States Securities and Exchange Commission (SEC), which enforces what organizations must disclose in their 10-K, a key tool that gives a summary of an organization’s financial performance and is often used in the valuation of publicly traded organizations, published in August 2020 an amendment that made human capital disclosures mandatory.
The new amendment to Item 101(c) requires the registrant to “provide a description of the registrant’s human capital resources, including in such description any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business taken as a whole.”
Before this amendment, the SEC required only the disclosure of the number of persons employed by the registrant.
This new amendment becomes effective November 9, 2020. But what does it mean for organizations? Well, therein lies the problem. It is purposefully vague and can mean a variety of things depending on the interpretation of each organization. Essentially, the SEC is recognizing the importance of human capital without providing clear guidelines on how organizations should measure and report on it. Instead they suggest using “various human capital measures and objectives that address the attraction, development, and retention of personnel as non-exclusive examples of subjects that may be material, depending on the nature of the registrant’s business and workforce.”
The SEC does not mandate any specific metrics, but it does offer some examples that can be tailored to the specific context of each organization. While this allows for more freedom than a one-size-fits-all approach, it can also be interpreted as the right to continue as before. This presents two risks:
- If organizations continue down the same path without changing their reporting, they will be caught off guard when the SEC inevitably imposes stricter rulings in the future.
- Organizations that insufficiently disclose are subject to lawsuits or pressure from investors to disclose more.
Organizations that decide to increase their human capital reporting must also be wary. With greater ability to tailor the metrics to each organization comes greater pressure to manipulate the metrics to become more attractive to investors. For example, take turnover: without a standard measure, this can be calculated in a variety of ways that make it appear higher or lower to fit a variety of narratives.
Although these rulings only apply to organizations governed by the SEC, the size and reach of the SEC means its standards have the potential to extend beyond its borders. So, while your organization may not be directly impacted, the rulings are still worth paying attention to.
Act Now or Be Caught Flat-Footed
The SEC’s new rulings may leave HR wondering what exactly is HR supposed to be reporting on and what human capital metrics does HR need to start measuring to meet those requirements. While it is up to the interpretation of your organization or HR itself, do not wait for more guidance on what to measure or you will risk missing out on an opportunity to be proactive.
Human capital reporting will only evolve to become a larger part of organizational reporting as we continue to shift toward a world where talent makes up more and more of organizations’ assets. While some organizations will choose not to report a lot of human capital metrics in the immediate future, HR needs to be prepared for the onset of stricter guidelines or enforcement from the SEC by having at least some human capital metrics available. Not only is the SEC looming behind HR for metrics, but also, perhaps of more concern for HR, senior leadership will be looking for answers on what human capital metrics HR considers material to an understanding of the business, and HR should be prepared to answer.
The first step in identifying metrics that are material to an organization is understanding the organizational strategy and the human capital risks to executing the strategy. Consider an organization where the majority of the workforce is set to retire within the next ten years. Metrics such as:
- Average age of the workforce
- Percent of critical roles with two or more ready successors
- Average number of years or moves that successors take to become ready
- Turnover of potential successors
could be material to an understanding of the registrant’s business.
To select metrics that matter, use McLean & Company’s Become a Data-Driven HR Function. For more information on the different types of human capital metrics organizations can measure, use McLean & Company’s HR Metrics Library.
Keep calm and measure on.
Works Cited:
“2019 Intangible Assets Financial Statement Impact Comparison Report.” AON & Ponemon Institute LLC, 2019. Accessed 5 Nov 2020.
“Final Rule: Modernization of Regulation S-K Items 101, 103, and 105.” Securities and Exchange Commission, 2020. Accessed 5 Nov 2020.
By Catherine Schroeder