Wall Street & Human Capital: From Problem to Solution

Transcription

1 Wall Street & Human Capital: From Problem to Solution Laurie Bassi, Ph.D. February 23, 2005 Updated July 2007

2 The Agenda 1. How Wall Street currently values and measures leadership and human capital 2. Short-termism the contagious Wall Street disease 3. Signs that change may be on the way 4. What HR professionals can do to cause change 5. Conclusions and wrap up 2

3 First, the Current Situation How does Wall Street (especially, its analysts) currently value and measure an organization s leadership and human capital? The answer is dismayingly short: simplistically and badly 3

4 Understanding our Terms Leadership represents the skills and knowledge of an organization s management, including the CEO as well as other executives and managers Human capital is an organization s overall collection of people, skills, knowledge (both general and job-specific) An organization can improve both its leadership and its overall human capital through a variety of investments. Examples: Employee training Leadership development Succession planning (future leadership) Systems for managing and planning employee development 4

5 Wall Street s s Valuation of Leadership Based on the good to great fallacy By focusing excessively on a small handful of an organization s top leaders, analysts confuse necessary conditions for success with sufficient conditions for success Top leaders are certainly necessary for a successful organization, but in no way are they sufficient Analysts should (but rarely do) demand information about leadership development and succession planning strategies 5

6 Wall Street s s Evaluation of Human Capital Its evaluation of human capital is even worse than its valuation of leadership In particular Confuses costs with investments (more on this later) Penalizes firms in the short-run for investing in human capital 6

7 Why Doesn t t Wall Street get this Right? Answer: Short-termism

8 Short-termism termism The Contagious Wall Street Disease 4 forces* converged to shift (or accelerate the shift in) Wall Street s focus from the long-run to short-termism: 1. ERISA forever changed the landscape of capital markets 2. Marginal tax rates dropped from 75% (in the early 1970s) to 35% for ordinary income and 15% for capital gains 3. Changes in commission structures eroded the support for fundamental analysis, reducing the long-term research focus of analysts 4. Widespread growth of stock options * A forthcoming Conference Board report (R RR), Revisiting Stock Market Short- Termism, provides an excellent summary of these forces 8

9 At the Same Time The twin forces of globalization and technology change were reducing the competitive advantage of producers, especially in high-wage, low-skill nations and sectors In many cases, the only remaining source of competitive advantage for an organization (its only differentiator ) now is its people Increased competitive pressures resulted in (sometimes obsessive) cost-cutting This made it more difficult than ever to focus on long-run value creation (including human capital management ) 9

10 Generating a Perfect Storm In the short-run, Wall Street increasingly rewarded firms that focused on cost-cutting Antiquated U.S. accounting and reporting rules treat investments in human capital development as (hidden) costs (thus firms that are serious about investing in human capital appear to be high cost firms) Stock options intended to align the interests of executives and shareholders made executives more sensitive to (and thus more responsive to) Wall Street sentiments RESULT? A landscape that made it more difficult for publiclytraded firms to make significant investments in human capital 10

11 So, Perversely at the very time when globalization was generating a premium on superior HCM as the sole remaining source of competitive advantage Wall Street was undermining that advantage. 11

12 Evidence that this is Happening? If firms invested optimally in people, then the marginal return on HC investment would be equal to the marginal return on all other forms of investment Our econometric analysis* demonstrates that the return on investments in human capital exceeds the returns on all other forms of investment The supernormal rate of return on investments in people is clear evidence of an under-investment in people * The Impact of U.S. Firms Investment in Human Capital on Stock Prices, (June 2004) by Laurie J. Bassi, Paul Harrison, Jens Ludwig, Daniel P. McMurrer available on 12

13 Additional research evidence: firms making large investments in employee training subsequently earn extraordinary returns Data represent a hypothetical research-based portfolio and not an active portfolio. Past performance is not a guarantee of future results. For more information, contact Bassi Investments info@bassi-investments.com. 13

14 What About Some Actual Portfolio Performance? Portfolio A Performance since 1/1/03* Including fees 65.8% Excluding est. fees 72.3% $50,000 invested on 1/1/03* Including fees $82,900 Portfolio B 58.2% 64.5% $79,100 Portfolio C 59.0% 65.3% $79,500 S&P 500 market index 53.5% 53.5% $76,750 *1/2/03 selected to provide common date for all portfolios. (One portfolio operated previous to that date, w/inception 12/3/01.) Returns data are updated as of 1/31/06. All data include dividend reinvestment. Except where noted, portfolio performance is reported net of all custodial and management fees. Past performance is not a guarantee of future results. For more information, contact Bassi Investments at info@bassi-investments.com. 14

15 Alternative Explanations of the Supernormal Return Explanation #1 Developing People is Risky The market views investments in people as risky, and hence demands a supernormal return on investments in it Explanation #2 There is a Market Imperfection The market incorrectly perceives (in the short-run) that firms that invest in human capital are high cost firms, and hence penalizes them for these costs in the short-run, leading firms to invest less in human capital than they would otherwise 15

16 Implications of a Supernormal Return on Training Since our estimates show that the return on investments in people exceeds the return on R&D, it is our view that explanation #2 is the correct one The inexorable conclusion is that there is a broadscale under-investment in people In other words, firms are investing in human capital despite the pressures of financial markets 16

17 So Paradoxically Those firms that resist the short-term pressures of Wall Street (and often are punished for doing so), are rewarded by Wall Street in the long-run (after the payoff to the human capital investment manifests itself in financial results) Stock options thus often have had the opposite of their intended effect: perhaps some short-term gain, but at the expense of the long-term 17

18 Signs of Change

19 Excesses are Being Reigned in* 1. The business and political climate: new demand for efforts to restore investor confidence 2. Shareholder activism is increasing 3. A debate is underway on executive pay-for-performance 4. Initiatives are supporting reporting of extra-financial measures of performance 5. Sustainability issues are increasingly being shown to have a positive impact on performance 6. Securities research is currently undergoing a values crisis * Conference Board report (R RR), Revisiting Stock Market Short-Termism, contains a good discussion of these issues. 19

20 The Pay-for for-performance Debate The use of stock options is under attack from a number of fronts Since stock options can have the unintended consequence of focusing executives attention on the short-run at the expense of the long-run, reduced reliance on them would almost certainly help mitigate a tendency to under-invest in superior HCM 20

21 Reporting of Extra-Financial Measures of Performance A Human Capital report is now required as a part of the Operating and Financial Review (U.K.) The addition of a new category Competencies and Resources is under consideration as component of the Enhanced Business Reporting Initiative (U.S.) Supportive developments are underway at the: International Accounting Standards Board European Union Account Modernization Directive International Organization of Securities Commissions 21

22 Sustainability is Profitable A growing body of research is pointing to the financial benefits of: being green superior corporate governance practices superior HCM practices We are running the first-ever investment fund, with a strategy of investing in firms that invest in their people (see slides #13-14) 22

23 The Values Crisis in Securities Research Regulatory reform along with pressures from (institutional) investors is helping to restore the financial service industry s research focus on fundamental analysis (long-term value creation) The Enhanced Analytics Initiative is a good example A group of fund managers and large asset owners who have agreed to allocate 5% of their commission to longterm analysis (incorporating extra-financial measures and measures of intangibles) And they have actually produced a report on Human Capital! 23

24 In Sum Early signs of change are on the horizon: the landscape seems to be shifting The pendulum is beginning to swing back to fundamental analysis, and a focus on the long-run The behavior of individual analysts, although lagging behind, is beginning to change slowly The environment is right for HR executives to begin to more proactively manage the conversation with analysts 24

25 What HR Professionals Can Do to Cause Change

26 Taking Proactive Steps to Manage the Conversation with Wall Street Work on continuing to shift the landscape: 1. Translate what we know into actionable insights for analysts 2. Bring six sigma rigor to human capital management 3. Arm your CEO with what (s)he needs to overcome shorttermism 26

27 Translating Research into Actionable Insights for Analysts 27

28 Creating Actionable Insights for Analysts The previous slide is a (research-based) roadmap for how human capital gets translated into business results It is a tool that we use in quantifying the relationship between HCM and financial performance It is also useful as a tool for deciding where to focus resources and analysts attention for maximizing the impact of HCM initiatives Frameworks such as this begin to bring rigor and numbers both of which are valued by analysts to the people side of the business 28

29 Bringing Six Sigma Rigor to Human Capital Management The Achilles heel of the HR profession has always been its inability to rigorously link the impact that it has on financial performance Frameworks, such as those on slide #27, can be used in combination with six sigma methodologies to get rigorous about HCM What is required is a creative approach to data collection and mining that draws on the same six sigma techniques that are used on the operations side of the business 29

30 The Six Sigma of Human Capital Management* 1. Use business units (and/or employees) as the unit of analysis for measuring the level(s) of HCM. 2. Rather than using traditional employee satisfaction surveys, use employee surveys to ask fact-based questions that enable you to assess the level (and variations) in human capital infrastructure across business units. 3. Use straight-forward, six sigma methods to link the human capital measures in step #2 to measures of business results (e.g., sales productivity, customer satisfaction). 4. Based on the findings from steps #2 and #3, develop data-driven priorities for driving business results. * A white paper that provides details on this approach is available at 30

31 Help your CEO Manage the Conversation with Analysts These are the best tools you can give your CEO for talking with analysts: A powerful, logically coherent framework that links HCM and financial performance Six sigma type of evidence that can put the soft people stuff on a level playing field with other strategic initiatives of your firm 31

32 Conclusions and Wrapping Up

33 Times are Changing The current environment is somewhat more receptive (or, at least, less hostile) to thoughtful perspectives and measures of human capital The environment could in the not too distant future become substantially more receptive than it is now This is a good time to proactively position yourself to take advantage of the changing climate 33

34 Two Things that We Can Lend to Your Efforts 1. You are welcome to borrow our HCM framework (slide #27) Also, we currently have a free benchmarking service available (through March 22, 2006), which is based on that framework. For a free benchmarking report on your organization, go to: 2. Frequently cite our holy grail findings (firms that invest in developing their people consistently outperform the S&P 500), as well as our live performance results 34

35 Contact Information Laurie Bassi, Ph.D. McBassi & Company