Companies should give thoughtful consideration to their disclosure of human capital management, or HCM, topics as more companies trend toward increased disclosure of environmental, social and governance matters in their annual proxy statements and other public disclosures.
HCM is increasingly becoming a key area of focus for stockholders and proxy advisory firms, as well as the US Securities and Exchange Commission, which proposed a new disclosure requirement for human capital measures last year as part of its ongoing effectiveness review and modernization project for corporate reporting and disclosure.
Although there is no requirement to provide HCM disclosure at this time, companies have begun to provide voluntary disclosure in response to growing demands from stockholders and proxy advisory firms for more information on human capital issues. Now is a good time for companies to understand and consider HCM disclosure and governance trends and how they may impact practices going forward.
Importance of HCM
Companies have long recognized the importance of human capital as key to creating value. HCM generally refers to the manner in which a company manages its workforce in a variety of areas — such as recruitment, retention, talent development, training, health and safety, productivity, diversity and inclusion, and culture — which together form an integral part of a company’s competitive strategy driving long-term value and risk mitigation.
In recent years, shareholders, proxy advisory firms and regulators have paid more attention to the value of human capital as an intangible asset combined with the link between effective HCM and lower employee turnover, higher productivity and improved long-term company performance.
Investors have historically lacked the data needed to assess HCM performance, which has prompted calls for increased disclosure by companies as to how this highly valuable intangible asset should be measured and assessed.
SEC Proposal for Required HCM Disclosure
On Aug. 8, 2019, the SEC proposed amendments to certain disclosure requirements under Regulation S-K, including Item 101 on the description of the business, as part of the regulator’s project to update and modernize corporate reporting and disclosure requirements.1
The proposed amendment would require companies to include, as a disclosure topic, a description of the company’s human capital resources, including any human capital measures that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the company’s business. These human capital measures might include, depending on the nature of the company’s business and workforce, measures or objectives that address the attraction, development and retention of personnel.
Currently, Item 101(c)(1)(xiii) requires disclosure of the number of people employed by the company, which dates back to a time when companies relied significantly on plant, property and equipment to drive value.
The proposed amendment reflects a principles-based approach, understanding that the human capital measures and objectives considered material for any particular company should depend on the nature of the company’s business and workforce, while the exact measures or objectives included in a company’s disclosure may evolve over time and depend on the industry.
The SEC has solicited comments on the proposed human capital disclosure, including specific questions, such as:
- How to define human capital, and
Whether to provide other nonexhaustive examples of measures or objectives that may be material, such as:
- The number of full-time, part-time, seasonal and temporary workers;
- Stability of the workforce (e.g., voluntary and involuntary turnover rates);
- Average hours of training per employee per year;
- Human capital trends (e.g., competitive conditions and internal rates of hiring and promotion);
- Worker productivity; and
- Progress that management has made with respect to any established objectives regarding human capital resources.
Calls for HCM Disclosure by Investors
In addition, companies have been faced with calls from institutional investors for HCM disclosure in recent years. In 2017, a group of institutional investors sent a letter to the SEC urging companies to disclose additional information about their HCM policies, practices and performance, including categories of information regarding workforce demographics, stability, composition, skills and capabilities, culture and empowerment, health and safety, productivity, human rights, compensation and incentives.2
Since then, institutional investors continue to identify HCM as a key issue to discuss during shareholder engagement and are asking companies for more information around their HCM strategy and process. In particular, BlackRock Inc. views HCM as “a potential competitive advantage” and expects “disclosure around a company’s approach to ensuring the adoption of the sound business practices likely to support an engaged and stable workforce.”3
The California Public Employees’ Retirement System states that “proper management of human capital is vital to the success of companies we invest in,” and “we seek to understand their strategies surrounding workforce, diversity, culture, and organizational decision-making.”4
Similarly, proxy advisory firms Institutional Shareholder Services Inc. and Glass Lewis & Co. LLC have incorporated ESG issues into their proxy voting guidelines, in addition to separately assessing board gender diversity and gender pay gap.
The particular methodologies for how ISS and Glass Lewis intend to take into account individual measures and objectives for HCM when making voting recommendations to investors remains to be seen as the framework for HCM disclosure continues to evolve.
Impact of HCM Disclosure on Directors
With an increased emphasis on HCM reporting and disclosure, directors are being asked to exercise more oversight over HCM matters. This is in stark contrast to several years ago when directors were focused on the oversight of executive compensation and succession planning while relying on management to be responsible for issues affecting the employee population generally.
Today directors need to be prepared to answer questions from institutional investors on HCM matters as frequent topics include demographic data of the employee population, retention, talent management, organizational culture, diversity and inclusion, health and safety, productivity and compensation.
Companies should consider having the full board provide general oversight of HCM matters and allocating specific oversight responsibilities to the compensation committee or other appropriate committee as needed.
The compensation committee is often best suited to oversee HCM strategy and implementation but this will typically involve an expansion of the traditional role and duties of the compensation committee which may require changes to the compensation committee charter to reflect such duties.
To further demonstrate a broader role of HCM oversight, some companies have changed the title of the compensation committee to the “compensation and human resources committee” or “compensation and management development committee” or similar variation.
As a general framework for expanding HCM oversight by compensation committees, the compensation committee should work with management to identify the HCM components and key performance indicators that create value for the company while giving consideration to any particular HCM issues that are important to the company’s investors which can be gathered through shareholder engagement.
Once those key HCM components are identified, the compensation committee should coordinate with management to establish goals for each component, including identifying areas of risk, and determine how to measure and periodically assess the company’s achievement of those goals.
It is important to maintain the committee’s role as one of oversight and monitoring rather than day-to-day management. Compensation committees may also wish to engage independent advisers to further ensure that the appropriate components of HCM for the company are properly being considered. The compensation committee should provide periodic reports to the full board on the status of HCM initiatives.
Ultimately the board will need to formulate responses to requests and comments from institutional investors as part of shareholder engagement and determine the extent to which HCM measures should be disclosed in the annual proxy statement, annual report or other public disclosures.
Growing Trend of HCM Disclosure in Proxy Statements
In response to growing pressures to provide more information on HCM to investors, many companies are taking action to voluntarily provide HCM disclosure in their annual proxy statements as a way to stay ahead of the issue as disclosure practices and requirements continue to evolve.
One of the most frequent topics of disclosure is a company’s description of the board’s oversight of HCM, as well as corporate culture. It appears that the boards at many companies are retaining general oversight responsibility while assigning certain responsibilities to the compensation committee or other committees as appropriate.
Some companies disclose specific components of HCM that are subject to board or compensation committee oversight, which can be helpful to give investors an idea of those HCM matters that are important to directors. At this stage, many companies are not disclosing details as to how the board or committee exercises its oversight over HCM matters.
In addition, many companies are starting to provide disclosure of a general commitment to HCM matters, with some companies identifying key performance indicators in certain areas but not necessarily quantifying them or providing a sense of the extent to which the company is making progress in achieving its goals.
Without mandated disclosure by the SEC, companies are taking varying approaches to the disclosure of HCM in proxy statements in areas that are important to investors, such as retention, talent management, organizational culture, diversity and inclusion, health and safety, productivity and compensation, as well as demographic data of the employee population.
In a recent study, EY reviewed the human capital disclosures contained in the proxy statements of 82 companies in the Fortune 100 as of Sept. 5, 2019.5 Approximately 40% of the companies surveyed included general disclosure of board or committee oversight of HCM matters.
With respect to the type of HCM information disclosed, the following percentages of companies surveyed included disclosure in the following areas:
- 50% included workforce diversity disclosures, with under one-third of those companies providing some measure of workforce diversity;
- 34% included workforce compensation disclosures, with most of those companies discussing pay equity and efforts to eliminate gender and diversity pay gaps, while 40% disclosed measurement data of pay equity, such as gender pay ratio and minority pay ratio;
- 22% disclosed culture initiatives;22% included workforce health and safety disclosures, with less than half of those companies disclosing any key performance indicators;
- 22% included workforce skills and capabilities disclosures, with half of those companies providing at least one quantified key performance indicator; and
- 6% included workforce stability disclosures, with most of those companies disclosing key performance indicators, and only a few companies quantifying them.
While more companies are providing HCM disclosure in their proxy statements, some companies have started incorporating HCM-related performance metrics into their executive compensation programs. HCM, together with other ESG measures, are most commonly found as a metric under short-term incentive plans provided to executive officers and, to a lesser extent, long-term incentive plans.
HCM metrics as key performance indicators are typically weighted at very small percentages in incentive programs or may be combined with other nonfinancial performance metrics while this practice continues to evolve.
As a further sign of boards becoming more involved in HCM matters, many companies are highlighting the HCM experience of directors in their proxy statements. EY found that 44% of the companies surveyed disclosed human capital-related experience in at least one director biography, with some referring to diversity and inclusion, culture initiatives or background in human resources.
With investors calling for more information on how HCM is measured and assessed, and the SEC considering a proposed amendment to add human capital measures as a disclosure requirement, many companies are proactively addressing these issues by providing voluntary HCM disclosure in their annual proxy statements, which can be one of the most effective tools to communicate with investors and demonstrate a company’s commitment to HCM.
Now is the time for companies to revisit their HCM disclosure or consider adding HCM disclosure for the first time as they prepare their proxy statements for the 2020 proxy season.
Article first published in Law360 on 24 February 2020.
1 SEC Proposed Rule No. 33-10668, “Modernization of Regulation S-K Items 101, 103, and 105,” Aug. 8, 2019, https://www.sec.gov/rules/proposed/2019/33-10668.pdf.
2 Human Capital Management Coalition SEC petition for rulemaking, July 6, 2017, https://www.sec.gov/rules/petitions/2017/petn4-711.pdf.
3 BlackRock, Investment Stewardship, Protecting and enhancing our clients’ assets for the long term, https://www.blackrock.com/corporate/about-us/investment-stewardship#engagement-priorities.
4CalPERS, Human Capital, https://www.calpers.ca.gov/page/investments/sustainable-investments-program/human-capital.
5 EY, How and Why Human Capital Disclosures are Evolving, Nov. 15, 2019 https://corpgov.law.harvard.edu/2019/11/15/how-and-why-human-capital-disclosures-are-evolving/.
The post US: Considering Human Capital Management In Proxy Disclosures appeared first on Global Compliance News.