The rise of ESG over the past several years has cemented investor interest in incorporating environmental and social impacts into the financial investment equation. Next year, human capital management will be at the forefront of the conversation, and we’ll see investors looking for more disclosures to ensure that they are investing in companies that align with their values.
The current rumblings of a new, clarified version of the 2020 rule on human capital management are likely to transform into a final rule that provides investors with more clarity into human capital management. The new rule, however, may be just as ill-received as its 2020 predecessor.
Principle-Based Approach
In 2020, the SEC sought to improve investor access to human capital information by adopting a rule requiring companies to disclose the human capital management measures and objectives they focus on in managing their businesses—provided those measures or policies are material to the company’s business as a whole.
The SEC noted in the final rule that human capital management disclosures were industry-specific, necessitating its principle-based approach to the topic.
Before and after the SEC adopted the rule in 2020, the agency received pushback on the principle-based methodology from investors and stakeholders who claimed that it didn’t effectively provide investors with the information they were seeking. Comments on the proposed rule and, more recently, the Working Group for Human Capital Accounting Disclosure’s petition for rulemaking filed in June, have argued that human capital disclosures should deviate from the primarily principle-based approach to provide investors with a clearer picture of human capital management.
The SEC’s principle-based approach may not offer investors a complete picture of a company’s workforce because it leaves disclosures to the company’s discretion, allowing companies to miss or obscure workforce issues.
What’s Next for Disclosures: A Prescriptive Shift
But any future SEC movement on human capital management is going to be more, not less prescriptive, in the coming year, and may thus address these workforce-issue omissions.
The SEC’s expected proposed rule on human capital management is likely to require that companies make 10-K disclosures on key elements of human capital—such as workforce composition—to provide that clearer picture to investors. Currently, the list of human capital measures that may surmount to materiality outlined in Item 101(c) is not exhaustive or binding and therefore investors are not guaranteed that set of information.
And a proposed rule on climate-related disclosures may provide stakeholders with insights as to how the human capital management rule will unfold.
Though this shift would be disruptive, it would not require the SEC to reimagine disclosures. Just this year, the SEC proposed prescriptive climate-related disclosures in a rule that seeks to standardize climate-related disclosures and to allow investors a deeper look into environmental information. For example, the SEC set forth a universal definition for Scope 3 emissions that would require certain publicly traded companies to disclose information that falls within that definition in its 10-K. While the amount of Scope 3 emissions produced may vary widely based on industry, the same disclosure framework applies regardless of the industry, but investors can account for industry differences.
The prescriptive shift is likely to happen in the human capital space as well—a modification that some commenters requested for the 2020 rule. The commenters asked for the SEC to approach human capital disclosures by requiring a key set of disclosures (such as full-time and part-time employees, and seasonal workers) regardless of the industry. The comments acknowledged that there may be some variation based on industry, but argued that the same baseline of disclosures should be required. Such an elaboration in the new rule is likely to give investors more insight into what is arguably a company’s most important resource—human capital management.
Assessing the Value of a Workforce
A prescriptive approach would provide more transparency into the health of a company’s workforce. It gives investors hard numbers to analyze, and it forces companies to track and disclose metrics that they might not otherwise track or disclose.
Such an approach also shifts the focus from general assessments about a company’s workforce to quantifiable metrics, allowing investors to adjust for industry-specific differences. Turnover metrics are an excellent example: There’s a clear, industry-specific nuance in assessing the value of worker turnover metrics. Certain industries, like the hospitality industry, tend to see higher employee turnover rates than industries like finance and insurance. Higher-than-normal turnover rates in any industry likely a signal human capital management issue. Investors can use their discretion to assess the relevance of the rate for a particular business.
Similarly, many of the most pressing labor issues facing companies today—like staffing shortages, soaring labor costs, an increasingly remote workforce, and diversity, equity, and inclusion—are both easily quantified and directly linked to the success and the stability of a company.
But not every workforce issue is so clear cut. Consider company culture—it represents a major workforce challenge and opportunity that influences a company’s success and can be hard to quantify. Metrics like worker turnover and DEI assessments can offer some clues about company culture, but without its own dedicated metric, will investors leave it out of the equation?
Even though both companies and investors have asked for more clarity from the SEC on human capital management disclosures, don’t expect everyone to celebrate a prescriptive approach. Companies will almost certainly bristle at the added reporting burdens, and investors will call for more expansive reporting requirements.
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