Ernst & Young Annual Report for Corporate Boards Stresses Need to Address Human Capital Investment

For regular ESM readers, this EY Report, ‘Top Priorities for U.S. Boards,’ echoes themes of recent articles on the new focus on human capital investment and accounting, as well the need to address the growing activity of ESG (Environmental, Social and Governance) investors. 

 

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The EY Center for Board Matters annual recommendations to board members reflects a growing focus on human capital and related issues. This report provides more evidence that pressure has increased on top management to develop a more systematic approach to their human capital processes and investments, and to the disclosures by public organizations to shareholders. 

 

Out of the seven key board priorities for 2018 cited in the report, three of them specifically address human capital strategies and the impact on management, accounting and investment issues reported in recent ESM articles and in the Enterprise Engagement curriculum and ISO 9001 and ISO 10018 Quality People Management principles. The human capital priorities identified by Ernst & Young analysts include:

 

1) Balancing short- and long-term capital allocation pressures from shareholders.

2) Overseeing culture and talent in a time of innovation and transformation

3) Engaging with stakeholders on long-term governance and environmental and social issues

 

The report’s introduction sets the overall tone for the white paper: “In this time of uncertainty, disruption and economic growth, companies are challenged to achieve short-term objectives while taking steps to survive and thrive in the long term. Accordingly, boards of directors are expected to understand and provide oversight of new risks and strategic opportunities. Meanwhile, investors, employees and customers are calling on companies to demonstrate their values and explain their positions on an array of issues. These forces and topics…are

complicating and expanding the board’s agenda.” 

 

Here is a summary of the three key topics related to human capital management. 

 

Ernst & Young believes the table is set for a longer-term approach to investments, rather than the shorter-term approach that has prevailed over the last few decades. The report asserts that “passive investing, or so-called ‘permanent capital,’ is quickly becoming the norm for many investors. These and other factors require large institutional investors with long-term investment mandates to better understand how companies allocate capital to investments that will provide competitive growth and long-term sustainability. These dynamics should embolden management to increase their capital allocated toward investments and with a focus on the long term. The ability of management to convey and execute a long-term strategy, backed by an investment strategy mixed between asset replenishment, re-skilling of staff, innovative research and development, and strategic mergers and acquisitions and joint ventures, should compel investors to stay the course for the long run.”  

 

Given the extensive evidence that companies with a high level of enterprise-wide engagement significantly outperform the S&P 500, the chances grow that organizations will invest some of the money allocated for stock buybacks into investments with more sustainable shareholder benefits. See ESM: “News Analysis: More Voices Call for Investment in Human Capital.” 

 

Highlighting an issued raised by some in the accounting profession (see ESM: “Accounting Profession Faces Increased Pressure to Address Human Capital Reporting,”) Ernst & Young analysts write, “Intangible assets comprise a significant amount of the S&P 500 companies’ market capitalization, and much of that capital can be attributable to the companies’ workforce. As business models continue to transform and industry convergence accelerates, stakeholders are asking boards about their oversight of culture and the related transformation of human capital. From building a culture where innovation thrives, to defining the company’s purpose, to investing in retraining their workforce to meet the demands of evolving business models, a company’s culture and talent strategy is even more critical to competitive strength and long-term value creation.” 

 

The report goes on to say that “Talent strategy should build on the company’s operating norms and practices. A dynamic working environment built on teamwork, inclusiveness and a strong code of ethics (e.g., equal pay and opportunity, and protection against harassment and discrimination) can create a culture of innovation and performance. A company’s purpose, which serves as the foundation of the organizational culture, ensures alignment between leadership and the workforce and brings a common view of how the business will evolve. Studies show that today’s employees are three times more likely to stay with a purpose‑driven company. Talent strategies should also be directly informed by corporate strategy and aimed at building organizational agility, flexibility and resiliency. For management and boards, having a clear view of critical capability needs and skills of the business going forward, and developing long-term workforce plans, are emerging as top priorities.”

 

As for customer engagement, “across many industries, companies have placed a significant focus on customer intimacy and the overall customer experience in recent years. However, they are finding that the success of these initiatives directly relates to an equal focus on the employee experience. Therefore, having a ‘people first’ culture just might be the answer to long-term success.” 

 

The report asks board members: “Does the company have a compelling purpose, and do the board, management and employees understand what the organization is working toward and why?... How can the company optimize its workforce assets (traditional, virtual, contingent and digital robotic technologies) to attract and retain the best talent, achieve its short- and long-term strategies, and mitigate risks?” 

 

The EY report cites the need to address growing investor interest in ESG issues and for an enterprise approach to engagement and human capital engagement. “This past year, some of the largest institutional investors (the Investor Stewardship Group) issued a voluntary corporate governance code for U.S.-listed companies, intended to support collaborative investor and company efforts to create long-term value. Many of the founding members already had in place individual policies, engagement practices and proxy voting guidelines in support of long-termism.” 

 

“At the same time, investors and other stakeholders, including employees, customers and communities, have begun to weigh in about a company’s views, culture and purpose in a broader societal context. These market dynamics and related developments are highlighting governance practices that reflect a long-term, multi-stakeholder view. It is also increasingly clear that addressing the key interests of a broad base of stakeholders is vital to the long-term sustainability of a business. These practices relate to traditional business matters as well as an expanding body of governance matters. This includes a shift from the more traditional governance issues, such as performance-based compensation, majority voting and annual director elections, to increasingly high-profile environmental and social topics, such as climate change, political spending and lobbying, diversity and inclusiveness, health care, immigration and more. Boards and management should engage on long-term business, environmental and social matters more than ever before. They also need to understand the priorities of their key active and passive investors and other stakeholders, offer engagement and, where appropriate, adjust their governance practices to address investor and stakeholder priorities in ways that foster long-term

business growth.”

 

“As activist hedge fund investors continue to grow in number and seek corporate targets, a long-term business strategy inclusive of many stakeholders, with strong execution and governance practices aligned to the interests of long-term investors, can be a critical advantage—and defense.” 

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