Human capital refers to the skills, knowledge, and experience possessed by an individual or population, viewed in terms of their value or cost to an organization or country. Within many environmental, social and governance (ESG) frameworks, human capital is identified as one of the largest drivers of value.

The importance of human capital

There are several clear areas where human capital can have a material effect on financial results:

• Attracting, developing, and retaining the right people;
• Supplying sufficient training for workers to take on new skills and technologies;
• Building diverse, innovative, purpose-driven cultures; and
• Maintaining positive labor relations and preventing strikes and stoppages.

Five essential indicators to measure human capital

There are five indicators that enable companies to effectively measure and report on human capital management. These parameters are considered to be the most valuable to investors and most reasonable to report across all industries and countries.

Quantitative data is critical in helping to differentiate companies, understand risk and opportunity, and ask evidence-based questions to management. From that foundation, qualitative data, either disclosed in company reporting or shared through dialogue with management, can provide context.
 

High importance, low disclosure

Despite the importance of human capital, very little information is currently disclosed by companies. We at Capital Group measured the level and consistency of human capital disclosure within sectors and regions and found gaps that are largely driven by regulation. Poor, inconsistent disclosure could mean that human capital is undervalued by the market.

Without this disclosure, it is more difficult to understand elements like minimum wage, median wage, and productivity, and to determine the impacts from upward wage pressure or increased competition for talent. Other major reporting gaps are around areas such as diversity, employee turnover, and investment in skills and training.

Three major trends underscore the investment implications

Three secular trends are making the need to accurately measure and value human capital increasingly clear:

1. Persistent inequality could increase employee activism and work stoppages

Low wages, pay gaps, and inequality are persistent across many industries and regions. In the U.S., workers’ compensation is a declining share of GDP, hourly compensation isn’t keeping pace with productivity, and significant gender and racial pay inequity remain (and has potentially widened throughout the pandemic).

Employees across almost all industries are coming together more frequently to push for change. Demands include anything from increasing wages and benefits to halting potentially unethical defense contracts to ending racial and gender discrimination. For example, in January 2021, more than 200 Google and Alphabet workers formed the Alphabet Workers Union. Members of the union contribute 1% of their yearly compensation toward union dues, which would be used to help compensate individuals for lost wages during a strike.

General Motors’ six-week worker strike in 2019 resulted in US$3.6 billion in lost production (44% of the company’s earnings before interest and taxes in 2019). It’s reasonable to predict that the number and length of work stoppages will continue to increase given the economic strain on low- and medium-wage workers compared to high-wage workers throughout the pandemic.
 

2. Changing workplace preferences

Before the COVID-19 pandemic, U.S. unemployment was at record-low levels and employees had record-high confidence in finding new jobs. This led to an increased rate of changing jobs. As economies recover and reopen, many employers report difficulty finding hourly workers.

Employees have started looking for benefits beyond basic wages (after reaching a minimum level), including work-life balance, health benefits, financial planning benefits, training opportunities, and a purpose-driven culture.
Employees and job seekers report valuing work environment, training, and development higher than financial compensation.

Source: Mercer Global Talent Trends 2021

In 2021, while compensation is still the highest priority for employees, benefits related to health and financial well-being are increasingly important. Employees also report being more motivated by the opportunity to do purposeful work versus the opportunity to get promoted. In contrast, the same study released in 2017 reported that employees’ most wanted job characteristics were: (1) fair and competitive compensation, (2) opportunity to get promoted, and (3) leaders who set clear direction¹.

Company culture may be intangible, but it is essential to attracting, retaining, and motivating people. One notable academic study found a link between employee satisfaction and long-term value over a 25-year period. The research concluded that the "100 Best Companies to Work for in America" earned an annual four-factor alpha of 3.5% from 1984 to 2009, 2.1% above industry benchmarks².

3. The need for innovation and new skills

As trends such as digitalization, automation, and energy transition take hold, workforces will begin to look dramatically different. There could be more competition for hiring and retaining employees with highly sought-after skills—such as those supporting cloud computing, big data, and e-commerce.

Several forward-looking companies have taken steps to retrain their current workers rather than hiring new ones. Amazon is one of those with a US$700 million investment in worker training.

Corporate balance sheets have already transformed from tangible to intangible assets, including items such as patents, software, brands, and data, all of which are driven and sustained by human innovation. In 2020, approximately 90% of S&P 500 value was in intangible assets, which is in sharp contrast to 32% in 1985. This shows the pace of digitalization within firms, which is often faster than workers can develop new skills.

1. Mercer, “Talent Trends: 2017 Global Study,” (Mercer LLC, 2017).

2. Alex Edmans, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices.” Journal of Financial Economics, September 2011.

3. Amazon, “Amazon Pledges to Upskill 100,000 U.S. Employees for In-Demand Jobs by 2025,” press release, July 11, 2019.