Most of the attention these days on ESG seems to be focused on the environmental piece of the acronym, or more specifically on climate change and decarbonization. While recent regulatory developments also appear to emphasize the ‘E’, with the introduction of mandatory climate-related financial disclosures via the International Sustainability Standards Board (ISSB), we can’t forget that companies rely on more than natural capital to succeed.
Human capital is core to almost every company’s strategy, after all. While many companies will espouse the critical value of employees, the COVID-19 pandemic brought these claims to a head. Suddenly, our reliance on essential service workers was highlighted, work from home became the norm, and the labour market tightened with stronger competition for talent.
The Current State of Disclosure
Despite investors always recognizing the material nature of human capital, it remains one of the disclosure topics that is not standardized or widely discussed in quantitative terms. While qualitative commentary about employee satisfaction and workforce management may be there, a robust set of metrics is not.
In the U.S., the Securities and Exchange Commission (SEC) introduced a principles-based approach to human capital disclosure in 2020. However, without a more prescriptive approach, investors are not getting the specific data points to compare and benchmark their portfolio companies.
Just Capital is one source of information for U.S.-based companies that maintains a database on the Russell 1000 Index using 28 data points. As of March 2023, 12 of the data points had disclosure rates below 20% and 20 out of 28 had disclosure rates below 40%. According to the same source, workforce diversity disclosure had the best disclosure rates.
Similar trends exist in Canada with only 23% of S&P/TSX Composite Index companies seeming to disclose voluntary turnover rates, according to Bloomberg. CPA Canada looked at ESG leaders in Canada to identify high-level trends in social disclosure in 2022 (Full Report). Despite its small sample size of 25 companies, the findings are consistent. While human capital management was one of the most commonly disclosed topics, the language and terminology used were inconsistent. In fact, 20 different phrases are identified in this report related to human capital management, making the job of investors more difficult when trying to analyze performance.
Investor Expectations
It is possible to get a sense of what investors expect around human capital management based on shareholder proposal data, the evolution of disclosure frameworks, and industry sentiment. Within the context of the knowledge economy, demands for flexibility and the transformation that artificial intelligence (AI) will bring, it seems clear that the workforce is changing. Investors need to know how companies manage this critical resource to drive long-term value creation.
Board Oversight
If you are unsure about what to disclose to shareholders, start with what is reported to your own Board regarding human capital. Many compensation committees are expanding their mandates to fully embrace oversight of human capital strategies. Boards often review employee turnover, retention rates for high performers, and employee engagement survey results, among other datasets. When shareholders elect directors, it is our expectation that they oversee the management of people as one of the most valuable assets within a company.
The time and attention given to talent issues at the Board level is a direct reflection of the culture of an organization. Some Boards are experimenting with ways to tap into the employee voice beyond the employee engagement survey. This may involve spending time with junior employees or establishing employee advisory committees.
Invest in People
As an indicator of investor interest, human capital is second only to climate change in terms of how frequently it is identified as material in the sector-based standards of the Sustainability Accounting Standards Board (SASB). Investors look for evidence of strong health and safety systems, fair labour practices, and investments in employee training and wellness.
Given the widespread application of the Corporate Sustainability Reporting Directive (CSRD) in the European Union (EU), it would be wise for companies to refer to this. Even those companies headquartered outside the EU will be required to comply if they are doing a certain level of business in the region. The list of human capital metrics included in this directive is much more prescriptive than the current principles-based approach of the SEC.
Foster a Diverse and Inclusive Workforce
Equity, diversity, and inclusion (EDI) is one of the most frequent subjects of social shareholder proposals in the U.S. and Canada. These range from addressing Board diversity to racial equity to pay gaps based on factors like gender and race. While the overall number of proposals filed dropped in 2023, over 100 were submitted in the U.S. alone, with the highest support levels going to pay gap disparities and reporting on the effectiveness of EDI programs.
Shareholder proposals in Canada are less frequent, with only 14 filed in 2023. However, investor expectations remain high, illustrated by a racial equity audit proposal filed last year at RBC that received 42% support.
As Chair of the Investor Group of the 30% Club Canada, I would also point companies to our Statement of Intent. This is supported by more than 20 of the largest asset owners and asset managers in Canada and outlines our expectations of companies regarding diversity.
What’s Next for Corporations?
As the ESG reporting landscape moves from a voluntary to mandatory system with the likes of the CSRD and ISSB, companies need to evolve how they talk about talent. They will need to move from largely qualitative ad hoc case studies to hard data. What becomes even more important to investors is what this data tells us about your company. The data must be supported by relevant commentary that links everything together into a cohesive story. Looking closely at human capital metrics will not only serve the needs of investors but allow Board directors to play an active role in overseeing key talent risks.
Jennifer Coulson is Vice President, ESG, Public Markets, at BCI.