Human Capital Challenge Highlights a Need for New Social Reporting

Frameworks for reporting on environmental, social and governance (ESG) are typically an outside-in way of looking at risk assessment. The starting point is that businesses can have a negative impact, and investors need a standardised framework to be able to assess, price and compare risk. 

While this approach has worked well for environmental reporting as the world seeks to curb carbon emissions, social reporting has been left behind. Today, a lack of consensus on reporting the ‘S’ in ESG means many companies are unsure of what progress looks like. 

The challenge of building a wider and more nuanced picture of social value and impacts is exercising ESG standard-setters, who are trying to agree on internationally accepted benchmarks, says Catherine Douglas, Director of ESG Consulting for Morrow Sodali London. 

‘’The ‘social’ pillar of environmental, social and governance is today attracting rapidly increasing interest from investors, regulators and other stakeholders globally,’’ says Douglas. 

“However social factors can be particularly hard to define, and as we have seen with environmental reporting demands, disclosure requirements and frameworks can evolve rapidly.’’ 

The issue is becoming more important as social issues rapidly assume the same risk profile as climate change. The COVID-19 pandemic, and more recent events including the Ukrainian conflict and an inflation-driven cost-of-living crisis, have helped catapult issues such as wellbeing and social inequalities to the forefront for investors and others. 

These include human capital, measurement of which has become more of a focus as businesses learn to view their workforces as critical business assets to be maximised rather than operating costs to be minimised. 

In the US, for example, the Securities and Exchange Commission (SEC) introduced  new standards in 2020  to improve reporting on human capital. However in 2022, an  expert working group called  for these to be overhauled as “US accounting principles provide virtually no information on firm labor’’. 

The working group’s report to the SEC reflected on the rise of the human capital firm in the 21st century. It noted that while intangible assets represented just 17% of the market value of the S&P 500 in 1975, that had increased to 90% by 2020, yet reporting had not kept pace with this tectonic shift in corporate balance sheets. 

Measuring such value is notoriously difficult, but it is a large and growing challenge that the world can no longer avoid grappling with, says Douglas. Morrow Sodali is a leading provider of corporate governance, ESG strategic advisory and shareholder services to clients around the world, and Douglas is currently researching data points and metrics to enable companies to more consistently report non-financial disclosures. 

“Boards of directors are now realising they have much work to do to raise reporting standards on the ‘S’ in ESG to match the good progress that has been made with regard to the E and the G,’’ says Douglas. 

“In the case of human capital, for example, it is now widely accepted that companies which truly value people are more successful, and that the measurement and management of corporate performance must evolve to incorporate human capital metrics alongside those for financial and environmental performance. 

“But there is no agreement on how to assess the wellbeing of corporate workforces, for example, or how people feel about their job and their employer.’’ 

In the US, the SEC is currently evaluating a wide range of human capital-related indicators, including workforce turnover, skills and development training, compensation and benefits, workforce demographics including diversity, and health and safety, but until now has largely left it up to companies to determine what measures are most appropriate for their businesses to disclose. 

ISO 30414, which provides international guidelines for human capital reporting, lists several additional potential reporting areas including compliance and ethics, leadership, organisational culture, succession planning and workforce availability. 

Douglas says the development of social impact reporting standards, including human capital reporting, is an area in which Morrow Sodali is taking a global leadership role by working to define a comprehensive range of corporate social impact KPIs. She says they have identified over 150 so far, although any one company may utilise far fewer. 

“No one has yet arrived at a decent framework to set thresholds for what constitutes a unit of impact for social outcomes, and Morrow Sodali is at the forefront of addressing this complex issue,’’ she says. 

“A credible, comparable and broadly accepted approach to social measurement will be essential to enable companies to truly value people. As with environmental value, stakeholders from consumers and employees to regulators are increasingly punishing those who fail to foster social value. Social is the next big thing.’’