How boards can approach human capital management
Human capital management is fast becoming an important topic for corporations and investors alike, and governance teams and directors need to be prepared to tackle the challenges and opportunities it entails.
Earlier this year, in his annual letter to chief executives, BlackRock CEO Larry Fink urged leaders to pay more attention to their human capital management efforts and disclose more information about these practices, repeating themes from his 2018 letter. In State Street Global Advisors’ letter to board members this year, the investment management firm likewise urged board members to focus on corporate culture, which State Street links to human capital management.
The goal of human capital management is to enable an organization’s employees to contribute significantly to their organization’s productivity. Although the term is just now becoming commonplace, the underlying concepts of human capital management – including diversity, inclusion, talent development, succession planning and workplace culture and misconduct – are deeply familiar to boards.
According to BlackRock, research indicates that successful human capital initiatives make companies more profitable. Organizations that actively promote their workers’ well-being have positive operating margins, whereas organizations with a disengaged workforce tend to lose money. State Street cites recent research demonstrating that intangible assets, such as workplace culture, make up on average 52 percent of an organization’s market value.
To give corporate directors, executives and general counsel a framework for discussing these issues, we have flagged recent developments, created suggested agendas and listed possible policies and practices that could improve a company’s human capital management.
Although many companies are still grappling with how to integrate a culture of best-in-class human capital management, we have seen developments that signal a movement toward more corporate disclosure in this area.
In recent weeks, for example, the SEC’s division of corporation finance has declined to grant no-action relief to a couple of companies that were seeking to exclude from their proxy statements shareholder proposals asking for more disclosure of certain human capital management metrics – specifically, the companies’ global median gender pay gap and issues related to retaining female talent.
Some companies, when faced with shareholders’ requests for more disclosure on this topic, have opted to negotiate with the shareholders, rather than pursue no-action relief. Since the start of this year, Ameriprise Financial and Mondelēz International have withdrawn no-action request letters after reaching compromises with shareholders on human capital issues. Both companies agreed to revise their compensation clawback policies to include certain types of misconduct.
Some companies have even wholeheartedly embraced BlackRock’s mission. Last year, Philippe Donnet, the CEO of international insurer Generali, wrote directly to Fink to applaud his message and inform him that his board had approved a charter of sustainability commitments. The charter prioritizes the goals of ‘build[ing] a work environment that inspires our people to give their best’ and ‘reach[ing] a tangible impact in the communities where we operate.’
Some investor groups, including the Human Capital Management Coalition, a group of institutional investors with a combined $2.8 trillion in assets, have petitioned the SEC to require companies to disclose more information about their human capital practices. But SEC chair Jay Clayton on February 6 said he was ‘wary of jumping in with rules or guidance that would mandate rigid standards or metrics for all public companies. Instead, I think investors would be better served by understanding the lens through which each company looks at [its] human capital.’
All of this leaves companies facing a puzzling predicament. Should they adopt the human capital management policies advocated by BlackRock, State Street and others? How much should they disclose to the public about their policies and goals and the strength of their human capital management system?
The SEC does not mandate that they disclose this information, but BlackRock, State Street and other influential investors are asking for it, and the SEC has backed shareholders that want to include proposals on these topics in proxy materials. Boards and management need to establish an agenda and process to address this multi-faceted topic. Even companies that choose not to disclose much of this information can still be committed to advancing the goals of human capital management.
AGENDAS FOR BOARDS AND MANAGEMENT
Some companies and their boards have already taken steps to put a higher priority on human capital management, including revising policies, identifying metrics to measure the status of their progress and creating a reporting structure to make sure this information reaches the board and top management.
For years, consumer products company Newell Brands has given its compensation committee expanded responsibility for functions that are part of human capital management. Named the organizational development and compensation committee, this four-director group assists the board in overseeing the company’s human capital and talent management strategies and succession planning, as well as the implementation and progress of the company’s inclusion and diversity initiatives. Newell has committed to give the committee the funds to hire an outside consultant or law firm to help advise on these topics.
Companies that are considering steps like these should start with a meaningful discussion that may include the following issues and the pros and cons of making changes at this time:
- Human capital management strategies that foster a healthy company culture and prevent unwanted behavior
- Policies to protect employees (for example, codes of conduct dealing with whistleblowing and sexual harassment) and procedures to allow the board to assess their effectiveness
- Diversity, including the composition of the board, senior management, management and employee ranks
- Relationships between human capital management performance and executive compensation
- Processes for succession planning for directors and senior executives.
- Policies to encourage employee engagement, including wellness programs, support of employee networks, training and development and stock participation programs
- Processes for ensuring employee health and safety
- Talent management to facilitate the growth of its next generation of leaders
- Voluntary and involuntary turnover, measured on various dimensions, such as by seniority, gender and ethnicity
- Statistics on gender and other diversity characteristics, as well as promotion rates for and compensation gaps across different demographics
- Systems to oversee the supply chain, including seasonal workers, contractors and subcontractors.
RESPONSIBILITY FOR OVERSIGHT
As an initial issue, boards must determine who will take primary responsibility for human capital management. One third of the 30 companies included in the Dow Jones Industrial Average have given their compensation committees broader responsibilities that include many human capital management functions, according to a September 2018 report by the Semler Brossy Consulting Group.
Given the importance of human capital management, the full board may still want to revisit this topic periodically. Although boards should not engage in the day-to-day management of operations, they should make sure they have visibility into situations where problems can arise. Directors should consider the pros and cons of these oversight practices that some companies have adopted:
- A requirement that the board be alerted immediately if a senior executive is alleged to have committed misconduct or there appears to be a pattern of misconduct within the company. As recent events have demonstrated, directors may come under fire for lax oversight, insensitivity or gross disregard if their company has a pattern of sexual harassment complaints
- A quarterly review of reports about complaints made to the company’s employee and compliance hotlines
- A requirement that the board be advised before the company enters into any workplace misconduct settlement that exceeds a specified dollar amount or involves management above a certain level
- A regular review of the company’s code of conduct, particularly sections on sexual harassment policies and training procedures, making sure the company has adequate reporting and enforcement mechanisms
- Amending employment agreements and equity plans to require that individuals comply with the company’s code of conduct and not engage in sexual misconduct.
TALENT DEVELOPMENT AND SUCCESSION PLANNING
Building and sustaining a successful organization that will thrive in the future requires systematic evaluation of the organization’s talent pipeline. When reviewing talent and succession planning, boards and management should consider the pros and cons of the following practices:
- Ensuring the CEO has a talent development plan in place for each of the company’s senior executives
- Annually reviewing succession plans for the CEO and other senior executives
- Identifying talent gaps and taking steps to fill those gaps through executive development or recruitment
- Hiring a third party to give an independent perspective on succession and the talent pipeline
- Ensuring directors have the opportunity to get to know senior executives and future leaders.
REPORTING OF HUMAN CAPITAL MANAGEMENT METRICS
As we have discussed, the SEC has declined to change its rules to require the public reporting of policies and metrics on human capital management. At the same time, powerful investors controlling trillions of dollars of capital are advocating for the public disclosure of this information. In deciding the best course of action for their companies, boards should discuss the following:
- The availability of verifiable company information relevant to human capital management
- The ease or difficulty of gathering information that is not available
- The cost of crafting and maintaining enhanced disclosures and subjecting them to disclosure controls and procedures
- The sensitivity of this information
- The materiality of this information to shareholders
- The impact of this information on employees
- The competitive advantage this information represents
- Disclosure practices of competitors and highly regarded companies
- Whether the information positions the company as a leader in human capital management.
We have seen a swift evolution of issues and norms involving human capital management and expect this pace of change to continue. Although each organization will encounter unique issues, boards should monitor this trend and remain proactive. Those that engage in informed discussions in a well-defined, structured process will be best prepared to make the right choices for their organizations, investors and employees.
Melissa Sawyer is a partner and Jared Snyder is an associate in the M&A group of the New York office of Sullivan & Cromwell
The views and opinions expressed in this article are those of the authors and do not necessarily represent those of Sullivan & Cromwell LLP or its clients.