Increasingly, investors are interested in how companies treat their employees, with one working group calling for mandatory disclosure of financial information relating to human capital.
In June, the Working Group on Human Capital Accounting Disclosure – a group of academics, former US Securities Exchange Commission officials and market participants – petitioned the SEC to introduce rules for “public companies to disclose sufficient information to allow investors to assess the extent to which firms invest in their workforce”.
The working group believes investors need additional information to understand whether – and how – public companies invest in their workforces, and it is pushing for mandatory disclosure of such details. In its letter to SEC chair Gary Gensler, it says publicly listed companies have changed in recent years.
Intangible assets, including human capital, are becoming increasingly important to listed companies’ profitability but, despite this, only about 15 per cent of them disclose labour costs, according to the group.
Further, the letter highlights the importance of analysing listed companies’ operational costs to understand losses reported for accounting purposes, noting that in 2020 about half of US listed companies reported negative earnings – something the group attributes to the fact that many of those companies are relatively young and guesses that investors are betting on future growth. Of those operational costs, says the letter, labour is likely to be the most significant component.
The petition asks the SEC to address this lack of transparency by requiring companies to disclose: the portion of labour costs that is considered an investment in future growth; granular information that enables investors to assess a company’s investment in its workforce (such as on training and equity compensation, for example); as well as disaggregated income statements showing what portion of disclosed income statement accounts is attributable to labour costs.
Intangible value
Sofia Martos, partner in law firm Kirkland & Ellis’s ESG and impact practice group, says the working group’s petition demonstrates the pressure on the SEC to expand its human capital management disclosure requirements. It was timed for maximum impact, given the SEC’s regulatory agenda on climate and broader sustainability concerns.
She adds that, with the working group including former SEC officials Robert Jackson Jr, Joseph Grundfest and John Coates, it suggests the petition will be carefully considered.
Cambria Allen Ratzlaff is managing director and head of investor strategies at non-profit research organisation JUST Capital and co-chair of the Human Capital Management Coalition. She says HCMC supports the petition, which raises critical points about the “urgent need for labour cost disclosure, including the sheer prominence of intangibles as the dominant source of value in the capital markets and the presence of net loss firms”.
The petition closely aligns with HCMC’s push for foundational data from companies on their workforce, including segmented labour costs, workforce composition broken out by full-time, part-time and contingent or contracted labour, and turnover.
Kristin Hull, founder, CEO and chief investment officer at investment manager Nia Impact Capital, says US companies have to complete EEO-1 forms that break down their workforce by race and gender. Nia asks the companies it invests in to publish these forms on their website. “They have to make them anyway, so why not let investors, the public or potential hires see them?” says Hull.
She adds that if the SEC required this information to be published, it would make Nia’s job a lot easier since it would not need to ask each individual company to publish this information.
Shareholder proposals
Human capital disclosure is becoming an increasingly popular topic in shareholder proposals. Recent data from think-tank the Conference Board reveals that during 2022, a record number of human capital management proposals were filed and passed. Focusing on Russell 3000 companies, shareholders filed 155 human capital management-related proposals – up from 136 filed in 2021, 11 in 2020 and 12 in 2019. Of these 155 proposals, 14 were passed, compared to 13 in 2021, five in 2020, and three in 2019.
First introduced in 2021, racial equity and civil rights audits – which seek to determine whether a company’s products, services or corporate practices impair the civil rights of stakeholders, including ethnic and other minorities – were frequently proposed this year.
In 2021, nine filed proposals were voted on but none received majority support. In 2022, however, shareholders of Russell 3000 companies filed 43 proposals for a racial equity or civil rights audit, of which 31 were voted on and eight passed.
Hull says Nia Impact Capital uses shareholder resolutions as a matter of last resort. “We do not start with the shareholder proposals. We really try to get as much done as we can behind the scenes. We are having conversations with our companies, we are sending emails, we are arranging Zoom calls,” she says. Filing proposals are only used when the conversations are not moving at the speed the manager is requesting.
She says that shareholder proposals can be seen as “slightly controversial and adversarial” and “we want to have a win-win relationship with our companies”. Additionally, filling proposals can be timely and costly since it involves using legal teams.
Financially material
Colleen Honigsberg, professor of law at Stanford University and a member of the Working Group on Human Capital Accounting Disclosure, says investors are leading the charge because they recognise that this information is financially material – they want more information on the workforce to help them assess a company’s fundamental value.
She says disclosure on investment in the workforce is most important. “There is empirical evidence that this information is financially material, and that it is not fully priced in current stock prices.”
Allen Ratzlaff says the Covid-19 pandemic has highlighted the importance of human capital disclosure. JUST Capital’s preliminary research in the total returns of Russell 1000 Index shows companies that were better employers going into the pandemic appeared to exhibit stronger financial performance after the pandemic started. “We’re digging into this a bit more, but it’s certainly not surprising,” she says.
Hull also says when the pandemic hit the US, employers that had positive relationships with employees saw greater staff loyalty whereas those that didn’t had high labour turnover. This demonstrates why it is important to learn more about how a company treats workers, Hull adds.
Meanwhile, current affairs also played their part. Martos says: “The surge in interest in transparency related to workforce diversity data in the wake of George Floyd’s murder [in 2020] was unprecedented.”
Though the number of proposals seeking disclosure of EEO-1 reports actually dropped sharply in 2022 to seven from 47 in 2021, she believes this does not signal a decline in interest in human capital disclosure from shareholders, but may indicate companies’ improved responsiveness on this topic.
(Photo credit: Bloomberg)