A Closer Look into Human Capital Management Disclosures

Human Capital Management Disclosures

In 2017, the Human Capital Management Coalition petitioned the SEC to expand disclosures surrounding the human capital management policies, practices, and performance.

In response to this request, after significant discussion, the SEC amended Regulation S-K Item 101(c) and required disclosure of a description of the registrant’s human capital resources, including “any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business taken as a whole” effective for annual reports as of November 9, 2020.  

Environmental, Social and Governance (ESG) factors are important to investors. In a recent collaboration with Responsible Investor, UBS Asset Management surveyed asset owners representing over 19€ trillion in assets across 46 countries. UBS found that 70% of asset management responders in the Americas acknowledged ESG integration as material in its day to day investment activities.

While this information is highly valued by investors, the consistency and reliability of such information is a cause for concern. In a recently released recommendation, the SEC Investor Advisory Committee expressed, “issuers are not always the primary source of ESG data that investors are using to make investment and voting the decisions…[the] patchwork of information…render[s] the information in the market inconsistent and reliable.”

Corporations are aware of the rising importance ESG information is to stakeholders. As Kier Gumbs, Associate General Counsel, Global Corporate, M&A and Securities, and Deputy Corporate Secretary at Uber Technologies, Inc., expressed when discussing the importance of human capital disclosure at the AICPA’s Current SEC and PCAOB Developments conference in December 2020, “if it is a critical business issue for a company, it is a critical issue for an investor […] these disclosures are another type of operating metric that investors are asking for.”

However, determining which matters are material to the financial statement users can be difficult. Some, like Gumbs, are unopposed to releasing ESG information to the public, but the classification of such information as material, particularly in the midst of open-ended guidance, contributes to a level of corporate discomfort. Determining which matters are material, and even defining “human capital” present challenges. The non-prescriptive guidance presents a level of risk for companies operating in the United States’ litigious environment.

Highlighting the importance of adhering to non-financial required disclosures, in February 2020, the SEC charged global alcohol producer Diageo Plc with failing to make required disclosures of known trends, “creating a misleading picture of the company’s financial results and its ability to meet key performance indicators” – indicators that are closely followed by analysts and investors. The key performance metrics referenced in the enforcement action are not part of the financial statements and are not audited; instead, that disclosure falls under “accompanying information” required by the SEC, as does the human capital disclosure. In the US, auditors for Diageo issued an opinion on the financial statements’ fair presentation in accordance with GAAP, but according to the SEC order, Diageo’s failure to provide the appropriate information meant that investors had a diminished ability to evaluate financial results “in context.” The SEC actively ensures this type of non-financial information, though unaudited, is fairly presented and not misleading to investors.  

Though human capital management is primarily considered a social issue, these metrics can potentially provide analysts with insight into future financial growth and performance. Crook et al.’s study, Does human capital matter? A meta-analysis of the relationship between human capital and firm performance, found that human capital relates strongly to firm-level performance, and suggests that “managers should invest in programs that increase and retain firm specific human capital.” Another study, “The Link Between Job Satisfaction and Firm Value, With Implications for Corporate Social Responsibility,” found that companies with a high level of job satisfaction (as measured by inclusion in the list of “Best Companies to Work For in America”) “systemically beat analyst earnings estimates” and “generated 2.3-3.8% per year higher stock returns” than peers. 

It is clear a company’s investment in developing, retaining, and attracting high quality talent has a significant effect on overall firm performance. While the open-ended guidance presents some challenges for issuers, the principles-based regulation allows the human capital disclosure to be tailored to convey the material factors and circumstances relevant to an investor across a wide spectrum of industries, regions, and periods.

This is seen in the Walt Disney Company’s annual report for the fiscal year ended October 23, 2020.

The annual report outlines the key human capital management objectives and examples of corporate action to support these objectives to attract, retain, and develop the highest quality talent. In addition to disclosing the number of corporate employees as was seen in the prior year report, the updated disclosure provides a breakout of full time and part-time employees, as well as estimates the number of employees working in the Parks, Experiences, and Products (PEP) segment. This is particularly notable, as the company later discloses the plan to terminate approximately 20% of employees working in PEP in the first half of fiscal year 2021.

The PEP segment comprised approximately 25% of entity revenues in FY20, down from approximately 38% in the prior year. As the company discloses in its discussion of business, economic, market, and operating condition risks, “peak attendance and resort occupancy generally occur during the summer months when school vacations occur and during early winter and spring holiday periods.” The COVID-19 pandemic greatly affected the company’s theme parks from operating or operating at full capacity for much of the FY 2020. The human capital management disclosures related to this segment are relevant to financial statement users because they indicate a shift in resource focus to other business segments (such as the direct-to-consumer subscription-based services), that might have otherwise been less apparent in the remainder of the report.

There has been a great deal of discussion surrounding ESG disclosures, particularly those regarding human capital. Changes in disclosure requirements reflect a transition away from viewing human capital and human capital management as merely an expense and movement towards a recognition of the intangible value human capital provides to corporations.

The non-prescriptive guidance allows management to tailor human capital disclosures to best present company-specific material information to users, but this flexibility also presents risks. Implementation is still novel, and our understanding of how entities and stakeholders will respond to these regulatory changes will continue to evolve over time. However, as the SEC’s Investor Advisory Committee expressed, “ESG is no longer a fringe concept. It is an integral part of the larger investment ecosystem of our modern, global, interconnected world.”

For more information about Audit Analytics or this analysis, please contact us.

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