Opinion

Distinguishing People From Paper Clips

 

Corporate leaders know that investing in workers is good for business. According to a 2012 IBM survey, 71 percent of CEOs cited human capital as a “key source of sustained economic value.” Indeed, research shows that increasing workers’ human capital boosts firm productivity.  Yet from 2001 to 2009, the number of workers who reported receiving training on the job fell by nearly 28 percent.  What caused the decline in training?

One explanation may be companies’ increased focus on short-term profits, coupled with a lack of transparency around investments in human capital.

Policymakers, economists, and investors have become increasingly concerned that financial market pressures are causing companies to reduce or forgo investments that will pay off in the long term in favor of increasing short-term profits.

While much of the research on short-termism focuses on physical capital and research and development or R&D, which are both more easily measurable, human capital investments too are likely a casualty of short-termist thinking.

Indeed, human capital investments may face additional pressure because they are not independently disclosed, and are thus effectively invisible to investors and overlooked by managers. This exacerbates what economists call the multitask problem—when people have an incentive to perform easily measurable tasks, such as increasing reported profits, they will focus on those tasks at the expense of those more difficult to measure, such as investing in the skills of their workforce.

While R&D and physical capital investments are each separately designated on a firm’s financial statement, human capital investments are lumped in with selling, general, and administrative (SG&A) expenses – the same expense category that contains office supplies and other general overhead, or waste.

But human capital investments are not waste. According to multiple studies, investments in human capital enhance both the productivity of the individual worker and of the firm overall. For example, a British study found that a 1 percent increase in the share of trained workers is associated with a 0.6 percent increase in industry productivity and a 0.3 percent increase in hourly wages.

Investors generally view high overhead costs as a signal of an inefficient operation. For that reason, managers face significant pressure to avoid increases in overhead, and are even rewarded for making cuts. Thus, a lack of transparency of human capital investments creates a powerful disincentive for companies to invest, and may even encourage firms to decrease their existing human capital investments.

Consider a scenario in which two firms that spend the same amount on SG&A. Firm A invests heavily in its workforce, while Firm B invests minimally. To an investor, Firm A and Firm B appear to be functionally similar. If Firm B subsequently decreases its SG&A by eliminating the little training it does provide, investors are likely to view it more favorably than Firm A. In this scenario, Firm A and investors are the losers: the firm doesn’t get credit for making a smart, productivity-enhancing investment, and investors are unable to evaluate a key driver of Firm A’s economic growth.

Fortunately, there is a simple solution to the human capital measurement problem: Requiring public companies to distinguish training investments from general overhead by reporting those investments separately. The SEC, as part of its initiative to modernize corporate disclosures, should require public companies to report the aggregate amount spent on training workers, along with other key related metrics including employee turnover, in their SEC filings.

Current treatment of R&D serves as a useful analogue. R&D expenditures – which are typically viewed as a sign of potential future growth – are disclosed separately from SG&A. Although nearly all R&D expenditures are not capitalized, disclosure itself allows financial markets to properly identify and evaluate R&D investments and price their value into a company’s share price.

A change to disclosure rules for human capital would be a win for investors, firms and workers. Firms would be able to demonstrate to investors that they are making productivity-enhancing investments in their workforce, while investors would get material information upon which to base investment decisions. To the extent that disclosure would cause firms to increase their investments in worker training, it should help raise workers’ wages as well.

This policy change would not completely alleviate financial market pressures borne by firms, nor does it replace other policies that would increase public and private investments in human capital, such as apprenticeships and other worker training programs. It would, however, help introduce more transparency to the disclosure of human capital and would empower financial markets to encourage companies to make smart investments in one of their most important assets. Moreover, this modest change would put into practice the knowledge that workers are not just a cost, but also an important asset.

Angela Hanks is the associate director for workforce development policy at the Center for American Progress.

 

 

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