Human capital management moves to the forefront as an investor concern

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For 2018, BlackRock has identified human capital management as one of its engagement priorities, echoing the exhortation from BlackRock CEO Laurence Fink in his 2018 annual letter to public companies: with governments seeming to fall short, it is up to the private sector to “respond to broader societal challenges”; companies must look to benefit their broader communities and all of their stakeholders, including employees, and that involves investment in efforts to create a diverse workforce, to develop retraining programs for employees in an increasingly automated world and to help prepare workers for retirement. (See this PubCo post.)  With that mission in mind, in this post on The Harvard Law School Forum on Corporate Governance and Financial Regulation, Michelle Edkins, Managing Director and Global Head of Investment Stewardship at BlackRock, discusses Blackrock’s approach to engagement with companies on the topic of HCM. While, as an investor concern, HCM may not have the high profile  of board diversity, climate change or executive comp, it may well be on its way.

What is HCM? Edkins defines it as, among other things, “employee development, diversity and a commitment to equal employment opportunity, health and safety, labor relations, and supply chain labor standards.” The EY Center for Board Matters describes HCM as comprising a wide range of topics such as attracting, retaining, training and engaging the entire range of the workforce, the relationship of company culture to hiring and retention, and diversity and inclusiveness. Specific issues include addressing the changing definition of work for millennials, technology-driven displacement of workers, worker training and broader company efforts to address projected skills shortages. (See this PubCo post.)

But concern with HCM is not simply a response to societal challenges. Because of the intense competition for talent, Edkins writes, BlackRock views each company’s approach to HCM as an investment issue and a “factor in business continuity and success. In light of evolving market trends like shortages of skilled labor, uneven wage growth, and technology that is transforming the labor market, many companies and investors consider robust HCM a competitive advantage.” That conclusion, Edkins maintains, is borne out by a number of studies:

“Research has consistently shown the importance of human capital to company performance. Companies included in Fortune magazine’s ‘100 Best Companies to Work For’ lists earned, over the long-term, excess risk-adjusted returns of 3.5%.  Another report surveyed a multitude of studies on human capital and found that there is a positive correlation between human resource initiatives and investment outcomes such as total shareholder return, return on assets, return on earnings, return on investment and return on capital employed.  A survey concluded that companies that had a workforce that was not engaged had an average one-year operating margin below 10%; however, those that consistently promoted workers’ well-being had an average one-year operating margin of 27%.”

That view is shared by other institutional investors. In its compilation of investors’ top priorities for companies for 2018 (involving interviews with over 60 institutional investors with an aggregate of $32 trillion under management), EY identified HCM as one of investors’ top five priorities. For many investors, EY reported, hiring and retention of the best talent can be key to remaining competitive over the long term, and company culture can play a role.  For example, some investors indicated that “companies that are strongly identified with a culture of improving the environment or benefiting communities have an advantage in attracting top talent, demonstrating that people want to work in companies that have good corporate citizenship.” (See this PubCo post.)

In terms of engagement, BlackRock views HCM as both a board and a management responsibility. The role of boards in the oversight of their companies’ strategies and defining of corporate purpose can “help ensure the effective strategic implementation of HCM throughout their organization. Companies that can better articulate their purpose are more likely to build strong relationships with their employees (and customers), and have a clear sense of their strategic objectives,” factors that are essential to long-term growth. As fiduciaries on behalf of investors, and as participants in setting the tone at the top, Edkins suggests, boards are expected to be focused on the opportunities and risks associated with HCM.

In its “Investment Stewardship” priorities, BlackRock has previously indicated that, as part of its engagement with companies on HCM, it seeks to ensure companies are adopting the “sound business practices likely to create an engaged and stable workforce.” With regard to the board’s role, BlackRock looks at how boards “oversee and work with management to improve performance in these areas. Such engagement also provides a lens into the company’s culture, long-term operational risk management practices and, more broadly, the quality of the board’s oversight.” For example, issues such as “uneven wage growth” can affect the loyalty and engagement of the workforce: in an interview with Reuters, Edkins observed that “‘ [p]ay that doesn’t seem to achieve some sense of equity within a company is likely to make an unattractive place to work.’” (See this PubCo post.)

Edkins advises that, for its engagements with boards, directors should expect (and be prepared for) BlackRock to raise issues such as these:

• “Oversight of policies meant to protect employees (e.g., whistleblowing, codes of conduct, EEO policies) and the level of reporting the board receives from management to assess their implementation
• Process to oversee that the many components of a company’s HCM strategy align themselves to create a healthy culture and prevent unwanted behaviors
• Reporting to the board on the integration of HCM risks into risk management processes
• Current board and employee composition as it relates to diversity
• Consideration of linking HCM performance to executive compensation to promote board accountability
• Board member visits to establishments or factories to independently assess the culture and operations of the company”

For members of management, BlackRock sees HCM as “central to their everyday duties.” Edkins advises that, for its engagements with management teams, management should expect (and be prepared for) BlackRock to raise issues such as these:

• “Policies to encourage employee engagement outcomes and key drivers (e.g., wellness programs, support of employee networks, training and development programs, and stock participation programs)
• Process for ensuring employee health and safety and complying with occupational health and safety policies
• Voluntary and involuntary turnover on various dimensions (e.g., seniority of roles, tenure, gender, and ethnicity)
• Statistics on gender and other diversity characteristics as well as promotion rates for and compensation gaps across different employee demographics
• Programs to engage organized labor and their representatives, where relevant
• Systems to oversee matters related to the supply chain (including contingent workers, contractors and subcontractors)”

In her post, Edkins also encourages management to provide more transparency on the company’s HCM practices. To that end, one group of institutional investors has even submitted a rulemaking  petition to the SEC attempting to convince the SEC to adopt new regulations mandating more disclosure related to HCM. In a 2017 petition for rulemaking, the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management, has asked the SEC to adopt rules requiring “issuers to disclose information about their human capital management policies, practices and performance.”  Although the petition is not explicit with regard to the details of any proposed regulation, it does identify the broad categories of information that the proponents view as “fundamental to human capital analysis”:

1. “ Workforce demographics (number of full-time and part-time workers, number of contingent workers, policies on and use of subcontracting and outsourcing)
2. Workforce stability (turnover (voluntary and involuntary), internal hire rate) Workforce composition (diversity, pay equity policies/audits/ratios)
3. Workforce skills and capabilities (training, alignment with business strategy, skills gaps)
4. Workforce culture and empowerment (employee engagement, union representation, work-life initiatives)
5. Workforce health and safety (work-related injuries and fatalities, lost day rate)
6. Workforce productivity (return on cost of workforce, profit/revenue per full-time employee)
7. Human rights commitments and their implementation (principles used to evaluate risk, constituency consultation processes, supplier due diligence)
8. Workforce compensation and incentives (bonus metrics used for employees below the named executive officer level, measures to counterbalance risks created by incentives)”

The proponents contend that disclosures regarding human capital management will benefit investors and the public, as well as promote capital formation. More specifically, the petitioners argue that, because human capital is responsible for innovation and implementation of day-to-day operations, it is “key to getting and maintaining competitive advantage,” and its “paramount importance” is widely recognized.” There are also material risks, the petition maintains, related to human capital management, which can damage corporate reputation, generate legal liabilities and undermine relationships with key stakeholders. In addition, the petition contends that a “wide range of investors have shown interest in obtaining information that will enable them to analyze the effectiveness of companies’ human capital management practices,” especially in the “larger context of concern over short-termism.” (See this PubCo post.)

Of course, given the deregulatory emphasis of the current administration—and the fact that the SEC still has to implement a number of rules mandated by legislation—adoption of new HCM disclosure regs seems unlikely to make it onto the SEC’s agenda anytime soon.