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The humanfactor
hicken and egg. Catch-22. An
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The right time
Across the board there is a sens... September 2015 HR 2928 HR September 2015
more you help them understand the value of
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  1. 1. September 2015 HR 2524 HR September 2015 The humanfactor C hicken and egg. Catch-22. An impasse. Pretty opaque. A mess. These are just some of the terms used by experts to describe to me the state of human capital reporting and the investment community’s understanding of the value of people. But could the tide be turning? Signs suggest so, and that change is rapidly gaining pace as various interested parties across the worlds of investment management, HR, and management more generally attempt to find an answer to the question that’s been puzzling business for decades: how can you quantify the value of people to future organisational performance? “Investors are interested in the more nebulous aspects of human capital management (HCM) because it’s material to the business, the share price, and their investment,” says Andrew Ninian, director of corporate governance and engagement at The Investment Association. “We want to show there’s value in good HCM and that investors should be aware of the issue. The starting point is good reporting. Have that and investors can take a view on if HCM is adding value and leading to a better performing company.” The Investment Association’s “embryonic” working group on human capital reporting is just one example of an initiative here.Others include 2015 reports from the CIPD (Human capital reporting: Investing for sustainable growth) and the NAPF (Where is the workforce in corporate reporting?); Dave Ulrich’s forthcoming book on a leadership capital index to help investors make decisions based on organisational leadership capability (see p30 for exclusive insights from Ulrich); the continuing ‘integrated reporting’ movement; an attempt to rank the largest listed companies on the London Stock Exchange by how well they manage human capital by the Maturity Institute; and a recent report by culture consultancy Walking the Talk and investment consultancy Stamford Associates that found 94% of investors say culture plays an“important”part in their decisions. For Paul Kearns, chair of the Maturity Institute, the relevanceofhumancapitaltoinvestmentmanagement is a no-brainer.“It may be much less tangible, but it is much more valuable in the whole equation,”he points out. “The intangibles have always been interesting, but people have not been sure what to do with them. The financial crisis has shown that if we don’t take this seriously we will be stuck in the same place. Investors have seen plenty of evidence of what underlying damage has been caused by poor people governance. They need lower risk and better returns – it’s a simple equation. HCM is now acknowledged as a huge opportunity waiting to be tapped.” The investment community is finally waking up to the value people bring to business, but HCM reporting remains a challenge. KATIE JACOBS investigates how HR could help bridge the gap
  2. 2. September 2015 HR 2726 HR September 2015 The right time Across the board there is a sense that this concept – the bringing together of investors and HR – is very much an idea whose time has finally come; thrown into sharp relief,as Kearns alludes to, by the shock waves of the banking crisis and the desire by many to codify a more responsible and sustainable way of running businesses. In his book Ulrich writes: “Now is the time [to offer] investors a much more comprehensive way of assessing leadership as part of their firm valuation process.” And in a recent Harvard Business Review essay, David Creeland and John Boudreau conclude: “There is a slow and steady movement toward giving investors more precise information about things that have traditionally been reported only vaguely or not at all”, to include human capital management. Intangibles such as people are also becoming increasingly important to UK plc. Research by innovation charity Nesta estimates the value of intangible assets grew from £50.2 billion to £137.5 billion between 1990 and 2011, rising since the recession where the value of tangible assets has fallen. Ninian adds that there’s a“recognition”among certain investors that “we may be undervaluing those companies who are doing HCM well”.“There’s an opportunity there,” he adds. “If we recognise that we will get more value from those companies.” Will Pomroy, the NAPF’s policy lead on corporate governance and stewardship says the drive for increased awareness on human capital reporting came from NAPF members “engaging with the likes of Sports Direct”, and “an increasing frustration” as the media seized on zero-hours contracts.“It seemed perverse that as an investor you had no way of knowing that was the business model being used,” he explains.“The strategic report isn’t shining a light on business models as much as investors might want. Information about how companies use their workforces is completely missing.” Increasing transparency is another push factor. “The world has become more transparent, faster, and more critical of business, so the alignment of investor relations and HR has to be closer than it’s ever been,” believes Alex Gordon-Shute, partner at Ithaca Partners, an executive search firm that specialises in corporate affairs, investor relations and HR. “Your investors see what your employees see and your employees sees what your investors see. The moment there is a disjoint the company is in real trouble. You lose trust on both sides, which means losing productivity and shareholder value.” Push versus pull That there is an appetite and need for better HCM information in corporate reporting is pretty clear. The problem is, says Neil Stevenson, managing director, global implementation at the International IntegratedReportingCouncil(IIRC),thattheinvestor and business communities have reached “a bit of an impasse”. “There’s this ‘chicken and egg’ thing – this constant refrain that investors don’t engage with the information because it’s not good enough, and companies saying: ‘Why should we produce this information when investors never ask for it?’” So who should jump first? In Stevenson’s opinion the pull should come from businesses. “Companies own the resources, it’s their value creation, their business prospects, so why don’t they start?” he asks. “Then we can put pressure on investors to use that information. But we can’t put pressure on investors to take more of an interest in information that isn’t provided to them. We need to break that cycle. We will need to educate analysts and investors about the things that are important.” However, there’s also a view that investors need to be the ones providing the pull – while many HR professionals know instinctively that investment in goodpeoplemanagementleadstosustainablesuccess, having investors asking questions about it would serve to push it up the senior leadership agenda. Yes shareholder value alone can seem like a pretty blunt instrument, but expanding the corporate governance agenda to genuinely include HCM can only serve to improve matters for all stakeholders. “If investors start asking the questions it will put pressure on CEOs to perform better, then CEOs will turn to HR,” believes Kearns. “Once we have the investor community bought into the idea that human capital is not that intangible and is important then the chain reaction will start.” An anonymous source working in private equity is frustrated that the majority of investors are missing a trick when it comes to even considering this area, telling HR magazine: “The investment community overly emphasises certain routes to value and doesn’t place enough emphasis on [HCM].[Investors and analysts] should be demanding more information on this. If your job is to understand what the true underlying performance of a company is and what the lead indicators are of future performance, then to not be asking about this is remiss.” John Dawson, investor relations director at Rolls Royce and formerly National Grid, adds that “unless investors are supportive, managers won’t change”. He uses Cadbury’s as an example of how important investor support is:“Cadbury’s placed a huge amount on its culture and as a result did not perform as highly as some of its ‘black and white’ peers, and was taken over. The great and good talk about the importance of behaviours and values, but if investors aren’t supportive it leaves companies vulnerable to takeovers.” Could SRI go mainstream? Unsurprisingly the investor groups showing the most interestinHCMreportingarethoseontheresponsible sideof investment,oftentermedESG(environmental, social, governance) or SRI (socially responsible investing).But the investors working in this space that HR magazine spoke to were confident in their approach becoming the rule rather than the exception. “ESG is going mainstream,” believes Leon Kamhi, head of responsibility at Hermes Investment Management. “It’s increasingly a theme in mainstream funds, not specialist ones. It’s where the market is going. Asset managers are clamouring for fund managers to act responsibly on their behalf.” But, he acknowledges: “Some are talking the talk rather than walking the walk.” Chair of the Investor Relations Society Sue Scholes says her members (IR directors) are getting “more and more questions” from investors around the topic of HCM, but she points out: “There are different groups of shareholders. Some don’t know what you do; they are trading by machine very fast. But as the [HCM] agenda moves forward we are seeing better co-ordination in these areas among the more long- term thinking institutions.” And she adds: “You get the shareholders you deserve. The Thestateofhumancapital reporting When it comes to assessing a company’s future performance, should human capital be seen as a risk factor or a value factor? “The so-called ESG (environmental, social, governance) stuff is often put in the risk area,” says the International Integrated Reporting Council’s Neil Stevenson. “Having it as a risk factor does encourage engagement, which is to be welcomed, but it does feel rather pessimistic.” But now he believes there is an opportunity for a new era of corporate reporting, one that takes intangibles into account, to change that. “This sort of reporting can highlight the value opportunity and move [HCM] from risk to value creation. It offers good return for investors – no one is saying this is about less ROI.” Stuart Woollard, managing partner at Organisational Maturity Services, agrees that since the global financial crisis, “most actions in the HCM space [have been] risk-related”, but that the time is right to move from risk-mitigating to value-adding. “Now we can more easily put forward a value-based argument, which fits in with the much broader questions being raised by many about the nature of the capitalist system,” he says. “Our big idea has been linking human capital to sustained value.” So while the risk factors associated with HCM areas such as poor succession planning for key roles, a lack of critical skills, and unethical behaviour, have been useful for getting HR issues on the wider business agenda, perhaps the time has now come to focus on where good HR strategy can add value to future organisational success. HCM:Fromrisk-mitigatingtovalue-adding Once we have the investor community bought in the chain reaction will start What do FTSE 100 companies currently report on? Source: Where is the workforce in corporate reporting, NAPF Workforce composition (number of part-time and/ or temporary staff): 11% Total head count: 94% Levels of staff turnover or attrition: 47% Total investment in training and development: 24%
  3. 3. September 2015 HR 2928 HR September 2015 more you help them understand the value of the business, the more high quality shareholders you will get.” Some are more sceptical. A former reward director now working in investment management, who asked not to be named, says although there is vague awareness around the value human capital can bring “there is still a long, long way to go” adding: “CEOs are surprised by being asked questions around culture and day-to-day there isn’t a huge amount of debate about the value people are adding. There’s a big tendency to focus on the numbers. I have never seen a slide on corporate culture in an investor presentation. Companies need to help investors to get it on the agenda.” Louise Aston, director of Business in the Community’s (BITC’s) Workwell campaign, goes even further. “While responsible investors are beginning to get this, normal investors are light-years away,” she says. Interestingly while BITC was ahead of the game in this area, campaigning for public reporting of wellbeing-related information about four years ago, Aston is now taking a step back, believing organisations need to get their own houses in order before they start trying to engage investors in HCM information. “Clearly, bringing a profound shift in attitudes and behaviour will take time, [so we are] shifting our focus away from public reporting and concentrating instead on supporting companies to accelerate the pace of change internally,”she says. From the HR director perspective, the group HRD of a FTSE-listed firm tells HR magazine he doesn’t sense investors are “mature enough” to ask for HCM metrics, but he thinks “increasingly they want to see that you have that side under control”. He adds that at a recent investor dinner every guest approached him to ask about leadership capability and succession planning. “The two main optics investors get are succession planning and making sure there’s a clear line of sight between the strategy and the organisation,” he says. “The question I often get asked is, if they spoke to someone on the frontline would they say the same [as me]?” The HR reporting problem All this is irrelevant unless we crack how to actually report on people issues. When it comes to judging the future value of an organisation through the lens of human capital, there are a couple of seemingly inextricably linked problems facing investors. The first is something HR and business more widely has been grappling with for years: there are no recognised comparable standards around measuring the value of people. Leading on from that comes the question: when you lack credible data can you trust the information provided by an organisation’s senior leadership team? The CIPD’s report concluded that while investors are increasingly interested in human capital measures as indicators of performance, most of their information in this area comes from personal contacts and casual conversation – hardly rigorous. “While we know the merits and importance of HCM, trying to get consistent information to quantify it in an investment context is a lot harder,” says Iain Richards, head of responsible investment, EMEA at Columbia Threadneedle Investment. “What can or should be measured and disclosed? Will it be meaningful, consistent and comparable?” Stephen Dando, a former HRD and trustee board member of the Engage for Success movement, adds that the HR profession hasn’t “made it easy” for investors because of a lack of standardised metrics. “People can present their set of numbers any way they like,” he says. “It’s a mess. There’s so little established benchmarking and structure around [reporting] it allows [organisations] to present data in the most favourable way. [Narrative reporting] is better than nothing, but it’s freeform reporting. You can write it the way you want to. With financials numbers are numbers – you can read them, pump them through models, analyse them. It’s not perfect but it’s more systematic, structured and logical. I’m not saying the numbers should be solely deterministic but you’ve got to start with a robust set of numbers,and then you tell your story and people can believe it or not.” “Culture is difficult to assess when you are using data provided by the company and one-to-one meetings with management,” agrees Dawson. “Do you accept at face value what you’re being told? How do you properly assess it? Companies need to accept not everything they publish is going to be rosy, and HRDs have an important role. Just looking at [benchmarkslike]GreatPlacestoWorkandemployee surveys is too simplistic. There needs to be more that you can build into your measures and more holistic ways of looking at things.” Andrew Ninian, director of corporate governance and engagement at the Investment Association, advocates “identifying the metrics that are most important to your business and structures, and demonstrating what is happening to them over time and what you are doing to drive them in the right way”. “You need to explain why this metric is relevant, what you are trying to achieve, and how far you have progressed. Just talking about KPIs doesn’t tell investors enough.” Hermes Fund Management’s associate director Tim Goodman adds that while compliance- related metrics will often appear on a report these don’t give a full enough picture. “Companies will report on things like lost time injury rates, but aren’t sickness rates, wellness rates, and mental health absence far more powerful indicators of how well a company is being managed?” he asks. “Companies often do what’s legally required, but if they are serious about this agenda they should think about internal KPIs for measuring performance. Don’t just lob out engagement statistics. Wellness and mental health stats tell us more.” There’s also a desire from the investment community for organisations to move beyond a focus on executive pay. “At our quarterly IR forum, which brings together investor relations directors and investors, we heard strongly that people want the debate to move on from executive pay and remuneration,” says Investor Relations Society chair Sue Scholes. “They want to move the conversation to talking about other governance issues like board composition, succession planning and supply chain.” There’s also a growing recognition of the importance of matters pertinent to the whole workforce. Recent NAPF research found that members put greater weighting on whole workforce issues such as health and safety records (65%), and pay and conditions of employees (58%), than the level and structure of management pay (48%) when making investment decisions. “Investors are now provided with page after page of reporting about pay and other governance matters. It is possible to know exactly what metrics an executive is rewarded against. It is however, not uncommon to have little idea about how many employees an organisation employs,” says NAPF chief executive Joanne Segars. “As investors we are there to hold companies to account and encourage good practice,” concludes Hermes’ head of responsibility Leon Kahmi. “We are looking for a happy, productive workforce – what data do you have that reflects that?” For those HR directors considering where to start in producing metrics that can both add value internally and help investors assess your organisation, the recent NAPF report, Where is the workforce in corporate reporting?, offers four suggested categories. While some of these areas may be overly simplistic (for example, the issues inherent in engagement scores), they offer a good jumping off point for developing stronger metrics. 1. The composition of the workforce Core metric: Total number of employees and workers. Additional metrics: Proportion of full-time, part-time and contingent labour; diversity of ages and gender; divergence between benefits awarded to full- time employees and to part-time or temporary staff. 2. The stability of the workforce Core metric: Employee turnover in a defined period. Additional metrics: Regrettable turnover; remuneration policies and ratios; number of applicants per post; offer/acceptance statistics; levels of skills shortages; industrial relations issues; retention rates after parental leave; benefit entitlements of employees. 3. The skills and capabilities of the workforce Core metric: Total investment in training and development. Additional metrics: Average hours spent on training per worker and for each employee category; number of courses taken; leadership/career development plans; internal hire rate; the proportion of professionally qualified employees. 4. Employee satisfaction Core metric: Employee engagement score(s). Additional metrics: Absentee rates; number of accidents and work-related fatalities; lost days to injury; occupational diseases rate. Themetricsthatmattertoinvestors Some of this isn’t unique to HCM. Richards points out that there are also inherent issues with the financial data presented to investors by organisations, but explains that starting from a comparable base means investors are able to look deeper, something they are unable to do with human capital data. “As investors we are all too aware that people can hide behind numbers, and we do have to spend time re- engineering them,”he explains.“However, on human capital we aren’t even at a stage where we are able to contemplate doing that.” As Dando alludes to, when there is information about people on an annual, strategic, CSR or even integrated report, it tends toward the shallow and cliché-ridden. And lumping HCM information in with the CSR report can also, perhaps inadvertently, see it labelled as ‘fluffy’ rather than strategically important. In the words of the IIRC’s Stevenson:“We have to put an end to this mantra of ‘our people are our greatest asset’; we need to find a way of describing the value that asset is bringing in a way that helps investment decisions.” Togetaroundthechallengesof biasandinconsistent data some investors are turning to more sophisticated tactics. According to the Walking the Talk research, investors who are interested in culture use on average 5.9 different sources of information to assess it, and Dawson says he has noticed bigger investors and hedge funds seeking out third party research. “A lot of people are resorting to triangulating testimonies,” Day-to-day there isn’t a huge amount of debate about the value of people
  4. 4. September 2015 HR 3130 HR September 2015 DaveUlrichonthemarketvalueofleadership In an exclusive article, Dave Ulrich explains why he thinks the time is right to bring HR and investors together. When two disciplines collide, bad or good things can happen. Bad things happen when the collision fragments a discipline into disparate parts. Good things happen when discipline collisions inform each discipline. The intersection of HR and investors has the potential to benefit each discipline. In recent years, HR professionals have worked to define and create value for key stakeholders. Clearly, HR drives positive employee outcomes (productivity, wellbeing), helps execute business strategies (strategic HR), and enhances customer share (HR from the outside in). But HR’s value may be further enhanced when it demonstrates the impact on a firm’s financial performance, focused on market value. In recent years, investors have learned that defining the market value of a firm may be based on earnings, but goes beyond that. For decades, GAAP and FASB standards have required financial reporting of earnings, cash flow, and profitability. Recently these financial outcomes have been found to predict about 50% of a firm’s market value. Investors have shown increased interest in intangibles like strategy, brand, R&D, innovation, risk, and information flow. These intangibles predict firm profitability. A next step for investors is to analyse the predictors and drivers of intangibles. Wise, long-term investors recognise that leadership matters. In our research, we found that investors allocate about 30% of their decision-making on the quality of leadership. Quality of leadership becomes a predictor of intangible value, which in turn produces financial results. To move firm valuation discussions from financials to intangibles to leadership requires synthesising HR, organisation, leadership, intangibles, and financial insights in a quest to offer a simple valuation solution while acknowledging the complexity of the overall problem of value. My forthcoming book, The Leadership Capital Index: Realizing the Market Value of Leadership draws on a useful metaphor for how to include, conceive, and audit leadership in the assessment of firm value. A leadership capital index is like a financial confidence index – Moody’s or Standard & Poor’s. It offers a more thorough way to assess leadership. Most acknowledge that leaders affect an organisation’s value, but they use simplistic and intuitive approaches to apply that insight. I believe it is time to offer a more rigorous way of evaluating leadership through the eyes of investors to more fully determine a firm’s value. To create a leadership capital index, I also looked at dozens of studies by consulting firms and experts who attempted to put substance behind the assessment of leadership. In general, these studies offered deep insights on one piece of an overall leadership puzzle. Some focused on compensation practices, others on personal style, and still others on organisation governance and design. Few attempted to prepare a comprehensive approach to leadership as a whole. I believe that a leadership ratings index would have two he says. “They are talking to former employees and using testimonials rather than data. It’s a pragmatic approach – expensive but it yields results.” Looking beyond metrics Not everything can come down to numbers and it’s not as simple as, in Richards’ words, “bringing it down to a formula like market cap divided by number of employees, which would be wrong”. “It’s about really understanding how human capital contributes to the success of the business, workingouthowtomeasurethatandcommunicating it consistently,” says Scholes. “Some needs to be in numbers[tomake]peoplepayattention,butnumbers don’t tell the whole story.” All the investors HR magazine spoke to agreed that a mix of quantitative and qualitative reporting was most effective.“Metrics are important for any fund manager to take this seriously,” says the NAPF’s Pomroy. “But those metrics should be company- specific and qualified with qualitative information to flesh out that story.” Much like financial data often is, in other words. Rather than seeking to impose a strict reporting framework there’s also a desire from investors for companies to report on what really matters to them, as every business will have different strategic priorities. “With data you can end up making false comparisons,” acknowledges Tim Goodman, associate director at Hermes Fund Management. “Qualitative analysis and face-to-face meetings can differentiate between good and bad performance in a much richer way than just looking at data. Companies should be reporting on the metrics that tell a richer story.” That acknowledgement of the value of qualitative information,although with a solid grounding in hard metrics, should be music to HR’s ears. But Susannah dimensions, or domains: individual and organisational. Individual refers to the personal qualities (competencies, traits, characteristics) of the key leaders in the organisation. Organisation refers to the systems (often called human capital) these leaders create to manage leadership throughout the organisation and the application of organisation systems to specific business conditions. Using these two domains, previous leadership and human capital work may be synthesised into a leadership capital index that investors can use to inform their valuation decisions and HR professionals to enhance their impact. Five leadership factors define the individual domain of a leadership ratings index that covers half of leadership capital. They are: 1 Personal proficiency: to what extent does the leadership demonstrate the personal qualities required of an effective leader? 2 Strategist: to what extent does the leadership articulate a point of view about the future and strategic positioning? 3 Executor: to what extent does the leadership make things happen and deliver as promised? 4 People manager: to what extent does the leadership build competence, commitment, and contribution of their people today and tomorrow? 5 Leadership differentiator: to what extent does leadership behave consistent with customer expectations? Leadership capital not only includes personal or individual leadership traits, but also investments made to build future leaders within the organisation. To build future leaders, leaders create organisation cultures and invest in human resource practices (often called human capital) in five domains: 1 Culture capability: to what extent has the leadership created a customer focused cultural capability that is shared throughout the organisation? 2 Talent: to what extent has the leadership invested in practices that manage the flow of talent into, through, and out of the organisation? 3 Performance accountability: to what extent has the leadership created performance management practices (e.g.,compensation) that reinforce the right behaviours? 4 Information: to what extent has the leadership managed information flow to gain information asymmetries? 5 Work: to what extent has the leadership created organisation and work practices that deal with the increasing pace of change in today’s business setting? The intersection of HR and investor fields benefits both. HR becomes even more central to the business and investors have more comprehensive data to determine firm value. A leadership capital index is a wonderful beginning of this journey. Dave Ulrich is the Rensis Likert Professor at the Ross School of Business, University of Michigan Clements, former deputy chief executive of the CIPD andfounder of IthacaPartnersHR practice,questions if “HR people get the idea of shareholder value”. “A lot of HR professionals have grown up feeling that shareholder value and people engagement are incompatible; they have got to realise that they are one and the same,” she says.“While some HR people have a commercial idea of business and are bought into [shareholder value], others see it as the thin end of the wedge and think people issues are above it.” She draws a comparison between CSR and HR reporting: “How did CSR reporting come to be? HR people failed to get people issues on the agenda but CSR played a blinder and got [their] issues to be reported on every year.” And she warns if HR doesn’t seize this opportunity to take the same ownership of people reporting, it might be taken out of its hands.“There are a series of people on the edge of HR – investor relations, legal, corporateaffairs–tryingtoworkouttheirplace.If HR doesn’t stake out‘people’now, someone else will.” Kearns believes investors are “only going to get more and more frustrated” by the lack of people- related reporting and that “the next people who are going to get it in the neck are HR directors”.According to The Maturity Institute’s analysis of top FTSE companies the average score for capability in human capital management was 51.5%. “This represents a colossal shortfall in value that is being lost by shareholders, customers, employees and society at large,”says Kearns.“This is an accountability agenda.” It’s easy to be sceptical. Previous initiatives to quantify the value of people have failed; however it could be argued those initiatives lacked the necessary pull from communities outside of HR – a pull that evidently now exists. But crucially, despite the interest from the investment community, this issue is about more than just providing shareholder returns. It’s about good governance and the business community at large recognising the value excellent people management and effective HR strategies bring to all stakeholders, including employees. As Dando puts it: “This is as strategic as it gets in the HR field. There is no better way of reinforcing the relevance of all things human capital.” HR Companies should be reporting on the metrics that tell a richer story