by Cydney Posner
Much attention has been paid to the decline in spending on R&D and capital investments attributed to short-termist myopia. Hedge fund activists have been impugned for pressuring companies to return capital to shareholders in the form of buybacks and dividends at the expense of funding R&D and plant and equipment, thus curtailing innovation and long-term value creation to the detriment of shareholders and the U.S. economy. (See this PubCo post and this PubCo post.) This report from the Center for American Progress argues that there is a class of investments that has not received much attention, but has also been victimized by short-term thinking with a similar adverse economic impact: investments in the human capital and skills of a company’s workforce.
Investment in human capital, the report argues, can pay off in enhanced productivity. For example, a 2010 economic study of data from Belgian firms showed that “training increased the productivity of an individual worker at a rate nearly twice that of the corresponding increase in wages. Another study used British panel data to analyze the effects of training on productivity at the industry level and found that a 1 percent increase in the share of trained workers is associated with a 0.6 percent increase in industry productivity and a 0.3 percent increase in hourly wages.”
Nevertheless, it appears that investment in worker training has declined. One academic study using survey data documented a 27.7% reduction in the incidence of employer-provided training from 2001 to 2009, described by the study’s author as a “‘significant disinvestment in the nation’s human capital.’ [The author] further discovered that the largest decline in employer-provided training took place prior to the Great Recession.”
Although there are a number of factors that may have contributed to this decline, one potential factor identified in the Center report “is the growing pressure within boardrooms and among CEOs to generate short-term profits. Increasingly, the pressure for short-term earnings forces business leaders to forgo long-term investments in order to provide dividends and stock buybacks.” The report contends that this short-term thinking may have led to even more pronounced cut backs in expenditures on worker training and skills because those investments are buried in financial statements under the SG&A line item, which fails to capture the potential future value that companies can recoup from the investment. Unlike R&D, which is at least reflected separately as a valuable investment, the argument goes, spending on human capital is just reflected as “an increase in general overhead, a measure that managers have shown a proclivity for cutting and whose reduction is often cheered by investors.” Investors, the report maintains, “have customarily viewed high overhead as a sign of inefficient operation. As such, managers are often under tremendous pressure to avoid such increases and are even rewarded for significant cuts.” While disclosure of R&D “allows markets to identify and distinguish these investments from other expenses and thereby price in their value,” that is not the case with investments in human capital: “investors can distinguish a dollar spent toward a company’s R&D from a dollar spent on printer paper, the former being more likely to increase the future value of the firm. Unfortunately, as part of selling, general, and administrative expenses, human capital expenses remain rolled up in the same spending category as printer paper.” As a result, the report contends, “firms’ investments in their human capital are doubly penalized. Short-termism has likely caused firms to reduce their spending on human capital the same way it has on other profitable investments, but investor demands to reduce general overhead in particular have likely created an additional disincentive for investment in training.”
How to address this issue? The report calls on the SEC, as part of its disclosure effectiveness initiative (see this PubCo post), to require companies to report investments in worker training separately. In particular, the report recommends disclosure of these “four human capital variables”:
- Training investment, i.e., the aggregate amount a company spends on training workers in new skills, including training staff and tuition assistance;
- Number of full-time employees (to help put the training expenditures in context);
- Turnover, both voluntary and total, calculated on an annual basis (to indicate how much a firm’s investment declines in value); and
- Third-party contracts, i.e., the total amount spent on third-party human resources, including both third-party contracts and independent contractor expenditures.
Currently, SEC rules require disclosure of the number of persons employed by a company, and SEC staff interpretive guidance provides that, in industries where the general practice is to hire independent contractors rather than employees, companies should disclose the number of persons retained as independent contractors as well as the number of regular employees. But notably, the SEC Concept Release on disclosure effectiveness gives short shrift to the disclosures related to employees, focusing primarily on the value of disclosures regarding changes in the numbers of employees and contractors. However, the request for comment does ask whether there is any additional information about a company’s employees that would be important to investors and whether the rules should require disclosure of additional information about a company’s employees or employment practices, along with the challenges and benefits of requiring that additional information.
According to the Center, disclosure of these investments would benefit all stakeholders because it would “allow firms to demonstrate to investors that they are making productivity-enhancing investments in their workers and would supply investors with material information upon which to base investment decisions. Furthermore, to the extent that disclosure would lead firms to increase human capital investment, it should help raise workers’ wages and benefit the economy overall.” Of course, as reflected in the JOBS Act and the FAST Act, on the other side of argument are those advocating a reduction in the extent of detailed reporting that companies are required to provide even now because of the costs and burdens imposed. We’ll have to wait to see whether the Center’s recommendations make their way into the SEC’s ultimate disclosure effectiveness proposals. (Hat tip to MarketWatch for this identifying this report.)