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ESG
Measuring the value of human capital
Matt Lanstone
Head of ESG Research and Investing
Emma Doner
ESG analyst

Human capital refers to skills, knowledge and experience possessed by an individual or population, viewed in terms of their value or cost to an organization or country. Within our Environmental, Social and Governance frameworks at Capital Group, human capital is identified as one of the largest drivers of value.


 


The importance of human capital


In our analysis of companies, we see several clear areas where human capital can have a material effect on financial results:


· Attracting, developing and retaining the right people


· Supplying sufficient training for workers to take on new skills and technologies


· Building diverse, innovative, purpose-driven cultures


· Maintaining positive labor relations and preventing strikes and stoppages


 


Five essential indicators to measure human capital


We believe there are five indicators that enable companies to effectively measure and report on human capital management. We consider these to be the most valuable to investors and most reasonable to report across all industries and countries.


Quantitative data is critical to helping us differentiate companies, understand risk and opportunity and ask evidence-based questions to management. From that foundation, qualitative data, either disclosed in company reporting or shared through dialogue with management, can provide context.


 


High importance, low disclosure


Despite the importance of human capital, very little information is currently disclosed by companies. We measured the level and consistency of human capital disclosure within sectors and regions and found gaps that are largely driven by regulation. Poor, inconsistent disclosure could mean that human capital is undervalued by the market.


Without this disclosure, it is more difficult to understand elements like minimum wage, median wage and productivity, and to determine the impacts from upward wage pressure or increased competition for talent. Other major reporting gaps are around areas such as diversity, employee turnover and investment in skills and training.


 


Three major trends underscore the investment implications


Three secular trends are making the need to accurately measure and value human capital increasingly clear:


 


1. Persistent inequality could increase employee activism and work stoppages


Low wages, pay gaps and inequality are persistent across many industries and regions. In the U.S., workers’ compensation is a declining share of GDP, hourly compensation isn’t keeping pace with productivity, and significant gender and racial pay inequity remain (and has potentially widened throughout the pandemic).


Employees across almost all industries are coming together more frequently to push for change. Demands include anything from increasing wages and benefits to halting potentially unethical defense contracts to ending racial and gender discrimination. For example, in January 2021, more than 200 Google and Alphabet workers formed the Alphabet Workers Union. Members of the union contribute 1% of their yearly compensation toward union dues, which would be used to help compensate individuals for lost wages during a strike.


Sharp increase in workers participating in strikes in 2018 and 2019


Annual work stoppages involving 1,000+ workers 1947 – 2020


Source: U.S. Bureau of Labor Statistics


General Motors’ six-week worker strike in 2019 resulted in US$3.6 billion in lost production (44% of the company’s earnings before interest and taxes in 2019). It’s reasonable to predict that the number and length of work stoppages will continue to increase given the economic strain on low- and medium-wage workers compared to high-wage workers throughout the pandemic.


 


2. Changing workplace preferences


Before the coronavirus pandemic, U.S. unemployment was at record-low levels and employees had record-high confidence in finding new jobs. This led to an increased rate of changing jobs. As economies recover and reopen, many employers report difficulty finding hourly workers.


Employees have started looking for benefits beyond basic wages (after reaching a minimum level), including work-life balance, health benefits, financial planning benefits, training opportunities and a purpose-driven culture.


Employees and job seekers report valuing work environment, training and development higher than financial compensation


2021 most wanted job characteristics:


Source: Mercer Global Talent Trends 2021


In 2021, while compensation is still the highest priority for employees, benefits related to health and financial well-being are increasingly important. Employees also report being more motivated by the opportunity to do purposeful work versus the opportunity to get promoted. In contrast, the same study released in 2017 reported that employees’ most wanted job characteristics were: (1) fair and competitive compensation, (2) opportunity to get promoted and (3) leaders who set clear direction.1


Company culture may be intangible, but it is essential to attracting, retaining and motivating people. One notable academic study found a link between employee satisfaction and long-term value over a 28-year period. The research concluded that the "100 Best Companies to Work for in America" earned an annual four-factor alpha of 3.5% from 1984 to 2009, 2.1% above industry benchmarks.2


 


3. The need for innovation and new skills


As trends such as digitalization, automation and energy transition take hold, workforces will start to look dramatically different. There could be more competition for hiring and retaining employees with highly sought-after skills — such as those supporting cloud computing, big data and e-commerce.


Several forward-looking companies have taken steps to retrain their current workers rather than hiring new ones. Amazon’s US$700 million investment in worker training and PWC’s US$3 billion investment4 in upskilling are two examples.


Corporate balance sheets have already transformed from tangible to intangible assets, including things like patents, software, brands and data, all of which are driven and sustained by human innovation. In 2020, approximately 90% of S&P 500 value was in intangible assets, which is in sharp contrast to 32% in 1985. This shows the pace of digitalization within firms, which is often faster than workers can develop new skills.


Breakdown of tangible and intangible assets in the S&P 500


Components of S&P 500 market value


Source: Ocean Tomo Intangible Asset Value Market Study, 2020


Summary


Most industries will be materially affected by ongoing human capital trends, if not experiencing the impacts already. Increased systematic human capital disclosures are an opportunity to understand how companies manage people, differentiate leaders and laggards, and identify those that can create a competitive advantage.


 


1. Mercer, “Talent Trends: 2017 Global Study,” (Mercer LLC, 2017).


2. Alex Edmans, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices.” Journal of Financial Economics, September 2011.


3. Amazon, “Amazon Pledges to Upskill 100,000 U.S. Employees for In-Demand Jobs by 2025,” press release, July 11, 2019.


4. PwC, “PwC network invests $3bn globally in digital training and technology to support clients and communities,” press release, November 5, 2019.



Matt Lanstone is a global head of research and investing in ESG with 28 years of industry experience. He holds a first class bachelor’s degree in economics and accounting from the University of Bristol.

Emma Doner is an ESG senior manager with 8 years of industry experience. She holds an MBA in finance & sustainable development from ESLSCA in Paris and a bachelor’s degree in international business management from Missouri State University.


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