Human Capital Management Moves to the Front Lines

Over the past year, as evidenced by the significant media attention focused on the #MeToo movement, gender inequality concerns, pay disparities and various employment practices, human capital management has culminated into a significant environmental, social, and governance (“ESG”) topic on which investors, employees and other stakeholders expect companies and boards to be focused and make progress. And, in a December 2018 Roundtable of the Investor Advisory Committee, the Securities and Exchange Commission (“SEC”) considered, together with many of these stakeholders representing different points of view, whether human capital management issues should be the subject of mandatory disclosure.

In part, the rise of attention to human capital management reflects a sea change in our society due to the shift from an economy that thrived on making things to an economy where the biggest growth area, regardless of industry, is technology, which relies in large part on skilled employees. The ability to effectively attract and retain employees is critical to many companies and the risk of poor execution can have significant reputational, financial and other costs.

The increasing attention to human capital management has been rapid. To illustrate how quickly human capital management issues have moved to the forefront of governance agendas, consider the progression in BlackRock’s Larry Fink annual letter to CEOs. The 2016 letter mentioned ESG issues broadly, noting that such issues range from “climate change to diversity to board effectiveness.” The 2017 letter highlighted employee development and their long-term financial well-being as some of BlackRock’s engagement priorities due to how critical they are to a company’s long-term success. The 2017 letter also focused on the importance of internal training and education of employees to fill the skills gap, and the need to “increase the earnings potential of the workers who drive returns” as a way of remaining competitive in the changing economy. In 2018, the letter was titled “A Sense of Purpose,” and closed with questions for company reflection that covered, among other topics, the company’s efforts for achieving a diverse workforce, its progress on providing training and retraining opportunities for employees, and the path for preparing employees for retirement using behavioral finance and other tools that indicate BlackRock’s increasingly sharper focus on the issue.

The definition of human capital management is slightly amorphous and what is considered a human capital management issue is likely to shift over time. In general, human capital management can refer to effective employee policies, such as business codes of conduct, whistleblower policies, equal employment opportunity policies, health and safety guidelines, and training and development programs to encourage employee engagement and wellness. Human capital management also deals with the issues of culture that have been in the news as high-profile companies weather scandals that call into question company culture. Traditional compensation and employee retention issues are also often combined with human capital management, such as statistics on promotion and compensation, gender pay equity and the ability to participate in an employee stock purchase program.

Part of the difficulty in defining human capital management is due to the fact that it varies significantly between industries, and even between competitors of similar size in similar industries. For instance, the issues for a car-share company with a business model that relies on worker participation in the gig economy is different than the human capital management considerations for sizeable long-standing car manufacturing companies.

Many of the considerations for human capital management were previously thought to be under the purview of the HR department. But, as these issues escalate in importance, it is becoming clear that this is not an area that should be viewed solely as a management responsibility. Rather, human capital management has become a board-level issue linked to risk oversight and long-term strategic planning to ensure that the business model is sustainable from a workforce perspective.

Indeed, given the significant reputational consequences that mismanagement of these issues can attract, including negative publicity, adverse impact on employee morale and attrition, and other stakeholder backlash, all facets of the board are implicated in some manner. From a strategic perspective, the full board should be focused on these issues. However, as they distill into individual risk issues, it may be appropriate for the audit or risk oversight committee to be heavily involved. In addition, the compensation committee will need to ensure that compensation plans for executives and full-company compensation programs appropriately reflect human capital management considerations. The nominating and governance committee also must focus on these concerns, particularly as shareholder attention in this area increases, bringing with it a spike in the number of shareholder proposals on a wide variety of related topics. In December 2018, the New York City Comptroller underscored the need for board-level attention when he brought a number of shareholder proposals focused on employment practices, stating “when big corporations force their workers to sign away basic rights, investors have to fight back.”    

Boards should therefore be asking themselves how to best oversee these concerns. Even for boards that have been overseeing these issues for some time, the increased attention indicates that it may be appropriate for boards to review their current approach. Boards should also be analyzing the information flow; what may have been considered too granular for a board may now be appropriate, given the increased level of board involvement. In addition, boards may want access to new information that may need to be developed internally or hired externally to help companies navigate the shifting landscape.

What has become clear is that boards and companies that do not consider these issues and adapt how they view human capital management will be the subject of intense scrutiny. As these efforts and this focus intensifies, companies that have begun to address these issues internally will find that they are in a better position to engage with their stakeholders and avoid reputational backlash.