The current treatment of human capital in financial accounting has no real defenders. Investor groups, believing that it leads to a lack of information that makes it more difficult for them to estimate the true value of companies, have led the drive for change. They have pushed companies, including those they hold significant ownership stakes in, to report more HR data—but so far
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Harvard Business Review
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with little success. It’s not that busi- nesses like the current practice, but they have a knee-jerk reaction against any additional reporting, largely because it increases the amount of work they have to do.
In 2020 the U.S. Securities and Exchange Commission, which oversees financial accounting in the United States and empowers the Financial Accounting Standards Board, responded to investor groups’ complaints by requiring that companies report on aspects of human capital that are mate- rial to understanding their businesses.
But instead of stipulating what informa- tion companies had to report, the SEC gave each the power to decide what to disclose. The results so far have been discouraging: Seventy percent of com- panies reported hardly any metrics and seemed mainly to express platitudes about their commitments to diversity and inclusion or other socially desirable outcomes. Giving that much discretion to companies defeats a central purpose of accounting: to present information in standard ways to allow comparisons.
What should be done? Businesses have every incentive to report more information about their spending on training and other things that almost everyone but financial accountants would call investments. If investors could see that a lot of “administrative expenses” were actually being used to improve employees’ ability to do their jobs, companies would look more valuable to them. The knock-on effect would push companies away from the imprudent and counterproductive prac- tices the current accounting approach encourages.
Companies that see human capital as a source of competitive advantage could also require their vendors to report on measures that indicate bad practices, such as turnover costs, and good ones, such as training invest- ments. That information helps custom- ers assess what vendors can actually do: Is the promise of reliability from a vendor credible if half its employees quit every year?
For its part, the investment com- munity needs to keep pressuring the SEC for change. It can point out that the new reporting requirements have had little effect and that there is an alternative model: the International Financial Reporting Standards (IFRS) used by companies outside the United States. Under those global accounting practices, companies can report more of the asset value of human capital. Argu- ably the best examples have been in valuing football (soccer) teams, whose assets are virtually all in players. IFRS practices allow their human assets to be amortized and the teams to be revalued when players are traded, released, and so forth.
What ultimately should we want the SEC to make companies report?
A few simple measures would go a long way. The first is simply to break out cost categories that are already reported:
• How much are companies spend- ing on workers other than their own employees? We have no sense of how efficient operations are when labor costs such as leased workers are hidden.
• How much is spent on training and other development efforts?
• What is the employee turnover rate, which measures the human capital
going out the door? How much of that is due to quitting? That information, along with the total number of employ- ees, which companies already report, will allow us to estimate the number of dismissals—a true sign of management problems.
• What percentage of vacancies are filled from within? That reveals the extent to which a company is growing its own talent or having to buy it from outside. This data is already collected by many companies’ applicant-tracking software (as is turnover data).
FINANCIAL ACCOUNTING IS the score- card that tells companies how well they’re doing. The fact that it provides such a misleading view of human cap- ital is a huge problem. While investor concerns about not being able to value companies accurately have gotten some attention, it’s a much smaller problem than the systematic distortions that hurt operating efficiency and have largely gone unnoticed. Not all the problems of the financial accounting for human capital can be addressed by the simple changes described here, but it’s hard to think of many other important issues where small changes could make as much difference.
HBR Reprint S23011
PETER CAPPELLI is the George W.
Taylor Professor of Management at the Wharton School and the director of its Center for Human Resources. He is the author of several books, including the forthcoming Our Least Important Asset:
Why the Relentless Focus on Finance and Accounting Is Bad for Business and Employees (Oxford University Press).