Human capital

Shareholders will increasingly insist on fuller statements of HRpractices. So is there commercial advantage in publishing a statement of personnel practices in your Report and Accounts? By Caroline Horn

There are a number of tools that the City and investors use to value a company. Glance through a batch of Report & Accounts, and you conclude that HR practices have not, traditionally, been among them. But the trend towards measuring a company’s performance against a combination of factors – not just the balance sheet – is raising the stakes for personnel departments.

Marc Thompson of Templeton College, Oxford, has been reviewing studies into the correlation between business performance and HR practice. “What is happening is that firms realise that intangible assets are expanding the difference between the book value of a company and its market value,” he says.

“So the question is, what are those intangible assets?” Only a very small percentage of Microsoft’s market capitalisation, for example, is in tangible assets. The rest concerns its R&D, intellectual property, risk management and reputation, as well as its people management.

Accountants are starting to think about how to measure these intangible assets and a range of reporting standards are being developed. These will cover areas such as people management, a firm’s brand value and knowledge management. It will probably take another five years, however, before HR practice is given a value in a company’s Report & Accounts.


Lack of understanding


The lack of current understanding about how HR practices can contribute to the bottom line is reflected in the fact that few corporates give more than a passing glance to their HR strategy in their Report & Accounts – other than saying, typically, “People are our most valuable asset”. In a study carried out by the IPD three years ago, two-thirds of the 50 companies surveyed had some reference to their HR practice but only two managed to produce more than one paragraph – and that was because they were having to explain redundancies. More recently, says Nigel Crouch, an industrialist with the DTI’s Innovations Unit, firms have started to highlight personnel issues more, but much of it can be read as platitudinous.

Shaun Tyson, professor of HR management at Cranfield School of Management, says the lack of detail about personnel strategies in a company’s Report & Accounts is understandable. “The Report & Accounts is essentially a calling card. It is received by people who want to know what a company is doing and it is presented in a positive manner. It is not a detailed or truthful account of the company – it is a PR exercise.”

A company could, however, use its Report & Accounts as an opportunity to showcase its future development, particularly in terms of personnel, says Tyson. “What I would expect to see in a company’s Report & Accounts is more about capability and development of capability – to know more about what this company is capable of doing. That takes us back to its people. Companies use Report & Accounts to talk about specifics regarding their sales and activities, rather than, ‘We are developing a capability in this area, and this is how we will develop our people to achieve it’.”


Creating an ’employee brand’


Some firms are starting to focus on the processes or practices they believe will add value to their bottom line. Simon Barrow, chairman of management consultancy People in Business, which specialises in communications and relationships in the workplace, says, “There is one company we have had some dealing with in oil and gas exploration. When they talk to financial analysts they focus on their recruitment policies – how they plan to recruit and keep the best geologists and accountants – and so create an ’employee brand’ that will help them beat their competitors.”

John Stevens, director of professional policy at the IPD, believes that more firms should be doing this. “Companies like Boots and Lucas Aerospace have made a real effort to present full HR statements in the past, and to some effect. Investment houses are starting to realise that they have to be able to look behind the raw figures and the more difficult subjects are R&D, risk, reputation and people management. Referring to subjects like these in a Report & Accounts gives some sense of their importance.”

But while Barrow is pleased at the increasing evidence that people are taking an interest in how HR practices can affect a business’s performance, he says, “I think there is a long way to go. The powerhouse in this case is corporate finance departments of the City deal-makers, and they are interested in the immediate deal rather than the development of lasting value.”

Professor Ray Richardson of the LSE agrees, “Interest in HR practices is beginning to happen on a minor scale in the US, where the position of HR or an HR director – if they are particularly charismatic – might influence the share price. But it is a long way from happening in the UK.”

If the impact of HR practices is to become more visible, HR departments need to have internal systems that provide accurate and reliable measurements. Barrow adds that these need to be reviewed at senior level, and by external reviewers.

He says there are a range of HR issues that should be considered when valuing a company. These include the typical current information such as structure, contracts, compensation agreements, pension schemes and union relations but, he argues, issues such as employee movement trends, the results of employee research, the company’s record in industrial tribunals and employment law issues, should also be considered. “These are all quantifiable but it is only the smarter City people and smaller merchant banks who are asking these questions.”

A number of recent studies suggest that the City should be doing more to find out about HR strategy before concluding deals. The IPD’s study into research in this area – The Impact of People Management Practice on Business Performance, by Professor Ray Richardson of the LSE and Marc Thompson of Templeton College, Oxford – highlights a number of research papers that explore the correlation between a business’s performance and its HR practice.

Stevens says that one study, which involved about 60 UK manufacturing firms, “showed that it was people management development processes that proved to be most important issues in terms of profitability, rather than R&D or risk management. People management made a bigger bottom-line contribution.”

Another recent study, carried out in the US by HR consultancy Watson Wyatt, goes so far as to suggest that it is possible to put a value on particular HR policies, and that a company’s HR policies can affect its share price by as much as 30 per cent (Personnel Today, 26 October).

Watson Wyatt carried out a year-long study to identify whether, and how, different HR practices might impact on a company’s share performance. It identified 30 HR practices which it grouped into key areas, including recruiting excellence, clear rewards and accountability, a collegial and flexible workplace, communications integrity and prudent use of resources. From that, it developed its Human Capital Index (HCI), a measuring tool for the effectiveness of a corporate’s HR strategy.

“At a time when virtually all companies say people are their most important asset, this study begins the process of helping them quantify that importance,” says Professor Ira Kay, North American director of Watson Wyatt’s human capital group and one of the study’s authors.

“We found a clear relationship between the effectiveness of a company’s human capital and shareholder value creation. Companies with a high index had high shareholder value; those with a low index had low shareholder value.” Watson Wyatt is now carrying out studies in Europe to clarify whether the same kind of results can be expected among European companies.


Forming opinions


Steven Dicker, partner at Watson Wyatt, says its system will provide analysts with the tools they need to measure company performance. “Analysts will tell you that they look at a company’s published accounts. But they will also want to go into a company and form their own opinion, although most analysts are unable to form an opinion of HR practice. We are providing them with a way to do so.”

Dicker adds that corporates also need to be more aware of how particular HR policies affect a company’s performance. “Any HR tool can be seen to be good but companies need to know which delivers a bottom line or which are simply nice to have. Training people to step into the next position may not have value for your company because the person you have trained may simply go to other company. That can waste a company’s resources.”

If personnel directors consider such practices inherently valuable, they will have to show they are closely linked to business performance, says Dicker. “There is a lot of indiscriminate training goes on. Train people for the next role, by all means, but lock them in so that they fulfil the company’s requirements.”

As analysts and shareholders start to demand more information on HR practice, personnel departments will fall under increasing scrutiny, warns Lynda Gratton, professor at the London Business School. But without proper training and better recruitment, there is a danger that consultants will be brought in to drive HR strategy, in line with the City’s requirements. “HR professionals need to move more into business areas and have more of a bridge with other disciplines,” says Gratton. “They need to know more about business strategy.”


Adding value


Ray Richardson agrees, “HR directors have to be able to give the numbers that show they are adding value to the business. Not many companies are doing this in a professional way and their work is not linked to any measurable outcome.” As well as the lack of interest in HR practices in a company’s Report & Accounts, it could also account for the fact that so few – about 16 – of the FTSE 100 corporates have a personnel or HR director on their main board, according to data compiled by Hemmington-Scott.

This growing interest in HR can be seen as a threat, says Dicker, but he adds, “It is also an opportunity to sit at the top as HR director. What we want to put into a director’s hands is the ability to show that well thought-out policies are adding value, although it will also show up HR departments that do not add value.”

Measuring good practice, he adds, will help to drive a corporate forward. “Measurable outcomes will enable a company to show best practice and best value. If a corporate has great practice but the City does not believe it, it becomes harder or more expensive to get capital. What this offers is a way to get easier access to capital because the City wants to give you the resources. HR is an opportunity to drive the company forward.”

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