COVID-19 Is Accelerating the Value of Human Capital
Companies that responded to the recent unprecedented bull market by strengthening their balance sheets, investing in innovation and, notably, taking care of their employees are proving to be much more resilient in the ongoing crisis. The recent outperformance of stakeholder-oriented firms builds on a longer history of outperformance by companies scoring well against a variety of environmental, social and governance (ESG) criteria, and harkens a new era of focus in the sustainable investment community on “S” issues alongside “E” issues like climate change.
Renewed Emphasis on Human Capital
While COVID-19 is shedding fresh light on social issues, the importance of human capital to the success of any enterprise is no secret. Just ask any human resources professional.
However, much of industry has yet to move beyond platitudes — e.g., “our most important asset is our people” — to incorporate thoughtful measurement and assessment of returns on human capital management (HCM) investments. Recognizing this gap between words and actions, a group of major institutional investors formed the Human Capital Management Coalition (HCMC), which started advocating the SEC for enhanced HCM disclosure by companies in 2017.
Building on the work of the HCMC, another and even broader investor coalition, led by the Interfaith Center on Corporate Responsibility, signed a statement in April urging companies to respond to COVID-19 with a focus on employee well-being. It recommended providing employees with temporary paid leave, prioritizing health and safety and taking every measure to maintain worker employment through this difficult period, among other things.
While disclosures by companies of HCM metrics have been limited, available data explains why these investors have been right to emphasize HCM. Mercer’s 2020 Global Talent Trends survey shows that 75% of companies with ESG metrics embedded into the CEO’s agenda have revenue growth rates of more than 6%, whereas only 35% of companies that have not assigned ESG metrics to their CEO reported the same growth. Additional research by Marsh McLennan Insights and Mercer shows that higher ESG scores can be an indicator of higher employee satisfaction and a greater ability to attract young talent, both of which are well understood to be drivers of long-term enterprise value.
The Rise of Stakeholders
Stakeholder management is gaining momentum. The Business Roundtable, an association of CEOs representing companies with more than $7 trillion in annual revenues, released a statement in 2019 redefining the purpose of corporations to benefit stakeholders and not just shareholders. Shortly thereafter the World Economic Forum updated its “Davos Manifesto,” first released in 1973, to now explicitly state that “a company serves not only its shareholders, but all its stakeholders.” And Larry Fink, the CEO of the largest asset manager in the world, said in his latest letter to CEOs that a company must “serve its full set of stakeholders.”
85% of business leaders already agree that an organization’s purpose should extend beyond shareholder primacy, and 68% attest to the need to make better progress on ESG issues.
All of this took place prior to the global onset of the coronavirus pandemic, which has only served to redouble focus on stakeholder-oriented management approaches. For instance, some companies that overemphasized shareholder welfare leading up to the crisis, often through debt-fueled share buybacks and dividends, found themselves in need of government support or having to make layoffs to stay solvent. This has not gone unnoticed by the public or by policymakers; here are two examples from North America:
As a condition of receiving support under the U.S. Treasury’s Exchange Stabilization Fund, which was seeded with $500 billion by the CARES Act, airlines are not allowed to buy back shares or issue dividends for the duration of such support plus one year.
The Canadian government will be implementing a bridge lending facility, which will similarly include borrower limitations on share buybacks, dividends and executive compensation.
Stakeholders vs. Shareholders and Financial Performance
All of this recent movement builds on a secular transition that was already underway from the shareholder wealth maximization (SWM) approach of investment and business management, which has dominated much of the last 50 years, to a more pluralistic vision of corporate value creation. Investment and corporate management teams can prepare for this transition by, among other things, lengthening their time horizons for financial analysis and growing conversant with HCM and ESG data and analysis.
Interestingly, per Mercer’s Global Talent Trends survey, 85% of business leaders already agree that an organization’s purpose should extend beyond shareholder primacy, and 68% attest to the need to make better progress on ESG issues. Yet, if the C-suite is clearly aligned with many investors on a new approach to business, then what is impeding progress?
Recalcitrant or slow governance may be to blame. Again, per Mercer’s Global Talent Trends report, boards have yet to mandate ESG-related targets for three-quarters of business leaders. Though a more likely barrier is that a large swathe of influential investors and business leaders still believe moving toward a stakeholder approach and away from SWM will result in worse financial performance. This viewpoint however treats the shareholder-to-stakeholder shift as a zero-sum game, which it is not. Even in a stakeholder model, shareholders remain an important stakeholder group, and financial performance remains an important thermometer for company health. What changes in a stakeholder model is the time frame for and the diversity of tools used to conduct company health evaluations.
Regardless of how this debate gets settled, several things will be clear coming out of COVID-19:
The “S” in ESG is going to receive more emphasis going forward. Among “S” issues, HCM is likely to rise to the top. And short-term, shareholder-focused “financial engineering” business strategies are going to be increasingly called into question.
The third point above is especially true if shareholder-focused strategies lead to detrimental outcomes for employees, without which no company can operate.