#DeloitteESGNow — Human Capital Measures Up
Introduction
Over the past several years, the focus on human capital
management under the broader environmental, social, and governance (ESG)
umbrella has steadily increased. The concept of the social enterprise — an
organization whose mission combines revenue growth and profit-making with the
need to respect and support its environment and stakeholder network —
has grown from an intriguing new idea into a concrete business
reality and marketplace expectation. In 2017, the Human
Capital Management Coalition, a group of institutional investors with $2.8
trillion in assets under management, petitioned the SEC for rulemaking to require disclosure of
nine categories of information on human capital management policies, practices,
and performance. Accelerated by focus on corporate purpose and ESG from groups
like the Business Roundtable and influential investors such as
BlackRock and State Street Global Advisors, human-capital-related
disclosures have been pushed to the forefront of discussion.
The COVID-19 global pandemic and rising social justice movement
have further advanced conversations about corporate purpose, ESG performance,
and, ultimately, human capital. In particular, these actions spotlight the dependency of companies on their workforce
and give them an opportunity to demonstrate how investing in human capital
management drives value as a result of engagement, innovation, and productivity.
Viewed by investors as material to a company’s ability to create long-term value
and execute strategy, an understanding of the ways in which an organization
perceives and manages its human capital can be essential to evaluating the
company's risk profile. In its recently released quarterly stewardship report, the BlackRock Investment
Stewardship team disclosed that its shareholder engagement efforts that focused
on human capital management issues increased 188 percent over the past year.
This Heads Up discusses the growing market movement
toward enhanced human capital management disclosure, both as a result of the
SEC's final rule that amended and modernized Regulation S-K and
of gathering momentum in the marketplace toward more standardized and relevant
ESG disclosures, including human capital metrics. The Heads Up also
provides considerations related to identifying and evaluating human capital
disclosures in light of the amendments to Regulation S-K.
Evolution of Human Capital Management Disclosures
Against the backdrop of rising stakeholder capitalism and as
part of an ongoing initiative by the SEC’s Division of Corporation Finance to
improve the effectiveness of disclosure requirements for both investors and
companies, the modernization of Regulation S-K marks the first significant
update to these disclosure requirements in 30 years. The
amendments, which are effective November 9, 2020, significantly update the
description of business under in Item 101. While companies will still be
required to disclose the number of their employees, they must also specify “any
human capital measures or objectives that the company focuses on in managing the
business, to the extent material to an understanding of the registrant’s
business taken as a whole.” The SEC acknowledged in the final rule that
disclosures may vary from industry to industry and from company to company and
that it therefore chose to not explicitly adopt a definition for the term “human
capital”; rather, it expects the meaning of the term to evolve over time.
Disclosures should be tailored to a company’s particular
business, workforce, facts, and circumstances. The amendments establish a
principles-based approach to disclosure and provide a means by which
organizations can describe their commitment to, and measurable actions
associated with, the human capital aspects of their value creation model. As
expectations of investors, customers, employees (current and prospective),
governments, and other stakeholders increase, these disclosures may be viewed as
an increasingly important indicator of an organization's long-term performance
and success.
In the final rule, the SEC noted that in feedback on the
proposed amendments, numerous commenters supported the use of specified metrics
or certain standards or frameworks for providing human capital disclosure.
Chairman Jay Clayton addressed this topic at an open meeting of the SEC,
indicating that in this initial increase in regulatory emphasis on human capital
considerations, the SEC would not attempt to prescribe specific or rigid
metrics. However, he emphasized that while the requirements are
principles-based, he expects to see "meaningful qualitative and quantitative
disclosures" as well as the actual metrics companies use to manage their
business.
Resources for Identifying Human Capital Disclosures
Many companies already disclose human capital measures in some
form and format; however, such information may exist in disparate places and may
not be subject to the same controls and procedures that are used for financial
reporting. Companies may also internally track certain metrics that are used for
making key decisions but currently excluded from external reporting. At present,
human-capital-related disclosures in companies' Forms 10-K are of varying
degrees of robustness. Such disclosures include information ranging from the
number of employees (as required before the final rule) to details such as
full-time or part-time status, racial and ethnic diversity of the workforce,
employee retention programs, and worker safety and training programs. Creating
an inventory of current and future metrics, whether publicly disclosed or
not, can be an efficient starting point in understanding what a company may wish
to include in the financial filings. Companies may also review any public
statements or commitments made by senior management to understand the types of
information investors and other constituents could expect to see disclosed. To
create such an inventory as well as to select the appropriate metrics and
maintain the integrity and consistency of the data, multiple internal functions
will most likely need to coordinate their activities, including human resources,
environmental, health and safety, and finance functions.
To demonstrate the value and effectiveness of investments in human capital,
companies should inventory and prioritize measures of human capital management
through a materiality lens by, for example, measuring how diversity and
inclusion lead to an enhanced ability to attract talent and drive strategy; how
health, safety, and wellness improve productivity; and how training enhance
innovation and speed to market. Regardless of how companies describe their
material human capital management measures, the definitions and metrics they use
should remain constant from period to period. Disclosures might include metrics
that are (1) reported internally to senior management and to the board of
directors, (2) used for performance evaluation, or (3) used in determining
compensation. For example, they may consider the following metrics:
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Theme
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Metrics for Consideration
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Governance and culture
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Diversity, equity, and inclusion
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Labor practices and policies
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Recruiting, training, development, and retention
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Rewards
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Numerous companies apply recognized ESG standards when disclosing human capital
measures in their sustainability or ESG reports. To meet the requirements of
Regulation S-K, registrants may also consider using these standards to help them
identify relevant disclosure metrics. There is increasing market movement toward
embracing ESG reporting standards and subjecting the disclosures to more formal
controls and procedures. Use of these or other recognized reporting frameworks
as a starting point for identifying material human capital metrics for
disclosure is a major step forward in providing the capital markets with
consistent, relevant information. Recognized standards include those from the
following organizations:
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The Sustainability Accounting Standards Board (SASB), whose materiality map identifies and compares disclosure topics, including human capital in different industries and sectors.
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The International Business Council (IBC) of the World Economic Forum (WEF), which is facilitated by the Big Four firms. The WEF's IBC published a report in September 2020 identifying core metrics and disclosures for four "pillars" (i.e., Governance, People, Planet, and Prosperity). Core human-capital-related metrics and disclosures are included under the "People" pillar. This organization's efforts represent an enormous step toward achieving internationally recognized ESG standards as well as a comprehensive and coherent reporting system.
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The Global Reporting Initiative, which has created a set of global standards for sustainability reporting and includes guidance on various human capital management topics such as diversity, equal opportunity, and occupational health and safety, to name a few.
Credible and Reliable Human Capital Management Disclosure
Human capital management disclosures in a company’s financial
filings should be subject to robust disclosure controls and procedures. As part
of its oversight responsibilities, a board of directors should consider the
roles of the compensation committee, nominating or governance committee, and
others involved in overseeing human capital measures and familiarize itself with
the metrics to be included in the financial filings. The audit committee should
be involved in understanding whether there are appropriate disclosure and
internal control procedures associated with such metrics. In addition, since the
market may use human capital disclosures in investment decisions, audit
committees should oversee external assurance, which can play an important role
in signaling the quality of the information to the market and give decision
makers more confidence in the quality and reliability of human capital and ESG
information in general. Statistics indicate, however, that only 29 percent of S&P reporting companies obtained external
assurance on their sustainability or ESG reports as of 2019, and of those
companies, not all included human capital metrics within the scope of assurance.
Conclusion
To comply with the new SEC requirements related to human
capital, registrants will need to carefully consider the themes discussed above
and assess which disclosures or metrics would be meaningful to stakeholders. We
believe that enhanced human capital management disclosure offers companies an
opportunity to positively support a broader narrative on the company's purpose.
Investors and other key stakeholders are likely to continue to seek more
consistent and comparable metrics. Consequently, companies that are able to
clearly communicate the material human capital measures and objectives that
management focuses on may reap benefits when interacting with investors,
employees, suppliers, and their communities.
Appendix — SEC Updates Regulation S-K Business Description
The SEC’s final rule amending Regulation S-K requires registrants to disclose a
description of the company’s human capital resources, including any human
capital measures or objectives on which management focuses, to the extent that
these are material to the company’s business as a whole. In the final rule, the
SEC emphasized the importance of human capital disclosure for investors and
noted that human capital is typically an “important driver of performance.” The
amendments identify certain measures and objectives but note that these are only
examples of relevant subjects, not mandates. Human capital disclosures should be
tailored specifically to a company’s unique circumstances.
Questions for Companies to Consider
The following are examples of questions that companies should consider when
identifying and evaluating their disclosures related to human capital:
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Who needs to be involved in developing the narrative (e.g., the finance, human resources, environmental, health, and safety (EHS), sustainability and ESG functions; business leaders; boards; board committees)?
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How is existing performance measurement around human capital, when viewed through a materiality lens, driving enhanced value for the business?
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How is the company already communicating its human capital or broader ESG strategy to the market and other stakeholders?
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Has the company considered reporting information under recognized standards, such as SASB standards?
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What additional controls and procedures will the company need to institute to subject any new disclosures to the same level of internal controls as other information in the Form 10-K?