making human capital work as a boardroom issue

  • Date:01 Oct 2005
  • Type:CompanyDirectorMagazine

Making human capital work as a boardroom issue

 

Boards scrutinise the way in which money is spent within the corporation but what about the human capital that is either mis-spent or wasted? Leo D’Angelo Fisher reports

 

It’s a well worn mantra: people are a company’s most valuable asset. In current management parlance, a company’s workforce is its “human capital” and a growing body of research has established that the effective management of that capital is a critical driver of a company’s performance and market value.
With pressure growing for boards to consider the full spectrum of non-financial indicators that contribute to a company’s profitability and long-term health, human capital is staking its claim for a slice of boardroom attention.
Lyle Potgieter, chief executive officer of Melbourne-based consultancy IXP3 Human Capital, says investment in human capital contributes not only to short-term performance, but also to the underlying health of the company and its ability to meet business goals in the longer term, “which makes human capital a management issue, a board issue and a shareholder issue”.
“The bottom line is a snapshot in time, but a human capital balance sheet provides directors with the knowledge of how well a company’s human capital is being managed and resourced to contribute to future performance and long-term value creation,” he says.
While Potgieter reports “some recognition at board level”, human capital struggles to leave an imprint on boardroom agendas.
Bob Moses, chairman of listed pharmaceuticals company Antisense Therapeutics and former chairman of drug discovery company Amrad Corporation, says a company’s employees are “an asset of the company as important as any other tangible or non-tangible asset”. But many boards remain reluctant to immerse themselves in human capital issues.
“There are two components to the neglect of human capital at the board level,” says Moses. “Mechanisms for measuring and reporting on the value of human capital are not standardised, and there’s also a tendency for boards to be preoccupied with the financials of a company.”
According to Peter Howes, chief executive officer of Brisbane human capital consultants InfoHRM, it could take another decade before human capital becomes a standard reporting item at boardroom level. Howes says the HR profession must shoulder some of the blame for this.
“The challenge for the human resources profession is to demonstrate how workforce characteristics impact on business performance,” he says. “The profession has got to state its case in more compelling terms.”
Not that Howes is ready to let boards off the hook: “Board members have a fiduciary responsibility to understand the factors that impact on organisational performance, including the workforce.”
According to the US-based Human Capital Institute, human capital management encompasses “talent strategy, acquisition, development, engagement, management and measurement”. Human capital management is responsible for developing “measurable, real-world strategies that [enable companies to] attract and retain high-performing people, build a diverse, inclusive workplace, and leverage individual and team performance throughout the enterprise”.
The positioning of HR or human capital management as a strategic management discipline has been a work in progress for more than 20 years, but more recently attempts have been made to quantify the benefits.
Based on surveys of major listed companies around the world, since 1999 US-based human capital consulting firm Watson Wyatt has produced the Human Capital Index (HCI), which identifies HR practices that are linked to superior financial performance and shareholder value.
In August, Watson Wyatt released its 2005 index, establishing that companies with superior recruiting practices outperform competitors with less effective practices in terms of financial performance and shareholder value.
The growing body of research into human capital issues is placing growing scrutiny on workplace practices.
A survey of HR managers in the Asia-Pacific region by Dr Alan Nankervis, research director of Curtin University’s school of management in Perth, reflected the frustration felt by some HR professionals that boards are proving slow to acknowledge the value of human capital management.
The study, Performance Management: A Seven Country Study, reviewed the performance management practices of companies throughout the region, including Australia. The study quoted one respondent’s exasperated complaint: “Directors need to understand [the] value of performance review.”
But directors who place a strategic value on human capital would be concerned by Nankervis’ finding that Australian organisations are not linking the performance of their employees to the attainment of organisational goals. According to the survey, only 2.4 percent of the 992 Australian HR professionals surveyed reported using performance management systems to set employee performance objectives, suggesting a serious disconnect between HR departments and the upper echelons of senior management.
“The most successful implementations of performance management are in organisations which use the system as a line-management tool in order to achieve business goals and to better engage and develop employees,” Nankervis says.
Proponents of human capital practices as a measure of a company’s health are finding unlikely allies in the hard-nosed investment community.
Melbourne-based fund manager Portfolio Partners recently announced that it would use companies’ human capital practices as a measure of their long-term profitability. Portfolio Partners will survey Australia’s top 200 ASX companies on their human capital policies and practices.
In the US, boutique fund manager Bassi Investments uses human capital indicators – such as training expenditure per employee – as predictors of future corporate profitability and sharemarket performance.
Founded by former economics professor Laurie Bassi, Bassi’s funds are based on the underlying investment strategy that companies which invest in their employees are better positioned for long-term success. Bassi’s core fund, the Human Capital Fund, has consistently outperformed the benchmark S&P 500 index since its inception in 2003.
Institutional investors are increasingly recognising the importance of non-financial issues and intangibles as longer-term indicators of performance. In 2004, a group of European fund managers launched the Enhanced Analytics Initiative, aimed at encouraging brokers to move beyond traditional fundamental analysis. Under the initiative, fund managers will allocate 5 percent of their broker commissions on the basis of how well brokers integrate analysis of non-financial issues and intangibles into their research, including employment standards, human resources, executive remuneration, as well as corporate governance, environmental and social issues, and reputation risk.
Raj Thamotheram, London-based chairman of the EAI, says there are no plans to expand the initiative to Australia, but notes that “many EAI members do have strong links in Australia so we are hopeful that firm interest from potential members in Australia will come”.
While encouraging the broker community to expand its research horizons, EAI does not recommend preferred models or guidelines for analysing non-financial and intangible issues.
“EAI is taking a ‘let a thousand flowers bloom’ approach at this stage. We feel that this is the best way to liberate the creativity of research houses,” Thamotheram says.
Prominent company chairman and director, Trevor Rowe, says the lack of best-practice measurement and reporting standards for human capital practices is an issue for boards, but insists this does not deter “more enlightened boards” from focusing on human capital issues such as employee education, training and workplace safety.
“Enhancing individuals’ satisfaction in the workplace is important not only in the context of career development, but also in improving the productivity of the workforce. A more satisfied workforce is more productive and more committed to the enterprise. More enlightened boards understand this,” says Rowe, who is chairman of Australian Investment Banking at Citigroup Global Markets and is a director of the Australian Stock Exchange.
Rowe says the biggest impediment to boards taking a greater interest in the development and resourcing of human capital is the financial markets’ focus on short-term results.
“Unfortunately, there’s too much emphasis on short-term results. Directors have to be able to stand up and say we’re taking the right decisions in terms of the long-term interests of the enterprise,” he says.
David Burton, executive chairman of listed medical diagnostics company, Compumedics, agrees.
Burton describes investment in human capital as a fundamental strategy of the company, but admits he’s testing the patience of shareholders by not following the familiar path of “making empty-headed cost cuts one year in order to celebrate profits the next year”.
In May, Compumedics issued a profit downgrade, announcing that its previous profit guidance was unlikely to met, despite on-target revenues for 2005 of around $40 million. The reason for the profit downgrade was Compumedics’ “aggressive ... investment in world class sales and marketing personnel” in the US, Asia and Europe.
“We’re not building a company just for the next quarter,” says Burton. “I’ve been quite resilient in standing my ground. It takes strength to do that because it goes against the popular trends of the market, but I’ve got my teams in place and now we’re seeing the results.”
Compumedics has expanded its core sleep diagnostic and monitoring technology into the fields of neurology and cardiology through acquisitions in the US and Germany. With medium-term plans to become a global medical diagnostics company with sales of $100 million, the Compumedics board agreed to the recruitment of a sales and marketing force “that was akin to our world-class excellence in technology”.
Burton is critical of abiding market perceptions that an emphasis on human capital implies going soft on fundamental disciplines.
“You can only afford to adopt this kind of [human capital] strategy if you have the processes and productivity in place. We have less than 3 percent of a $1.2 billion global market and we’re not going to be able to take a bigger piece of that market if we don’t have due focus on both human capital and business fundamentals,” Burton says.
“Shareholders are entitled to expect returns on their investment and formal orthodox disciplines need to be respected, but if investors really want value I hope they can appreciate the model of this company, including our investment in good people and infrastructure.”