Monday, January 24, 2022

Study suggests SEC rulemaking could meaningfully enhance human capital disclosures

By Lene Powell, J.D.

Ahead of an expected SEC rule proposal on human capital management disclosures, new research provides hard data in this much-watched area. A study found that previous SEC rules have significantly increased disclosures in this area, particularly among companies that might not have otherwise provided this information. The study also found that managers appear responsive to stakeholder demands for human capital information, and that disclosures tend to be accurate and informative rather than opportunistic.

The study, Human Capital Disclosure, was conducted by finance professors at Vanderbilt University Owen Graduate School of Management. The study identified eleven key human capital disclosure topics. “Attract & Retain” was by far the topic with the most extensive discussions, followed by, in order of frequency: Integration, Workforce Reductions, Unions, Data Security, Health and Safety, Trade Secrets, Competition, Bribery, Morale, and Diversity.

Effect of SEC rules. The study is timely in light of an expected forthcoming SEC rule proposal that is widely anticipated to propose specific requirements for human capital disclosures. SEC Chair Gary Gensler has indicated that a proposal is in the works, and with a 3-2 majority it is expected he will have the votes to issue the proposal.

The study first looked at a 2005 rule change that required companies to include a section in their 10-K to highlight key risks of doing business (Item 1A). Although significant discretion was afforded to companies about what information to include, the study found a 20% increase in human capital disclosure after 2005.

Next, the study found that human capital disclosures really ramped up after the 2020 rule. Despite the rule’s fairly general requirements, Attract & Retain (A&R) statements increased by 40% following the rule change. Notably, the rule suggested, but did not require, that companies should consider disclosing “measures or objectives that address the development, attraction and retention of personnel.”

The increase was especially strong for companies that were previously under-disclosing based on a model of predicted disclosure.

“[T]he 2020 SEC rule change was also effective in ‘shocking’ firms that were under-reporting human capital information based on our determinants model,” wrote the researchers.

Response to stakeholder demands. The researchers observed that human capital disclosures are very important to institutional investors. In a 2019 survey cited in the paper, 83% of institutional investors said detailed disclosure is “highly important” for evaluation of human capital management, ahead of climate change (76%), cybersecurity risk management (68%), bribery and corruption (63%), and supply chain management (56%).

The data met expectations that managers are more forthcoming with disclosures when the information is demanded by key market participants and stakeholders. The study found that companies with greater levels of institutional ownership and analyst following provide more A&R disclosures.

Disclosure tends to be strategic and informative. The study attempted to tease out whether A&R disclosures are more informative or “opportunistic.” The researchers noted that some studies show that managers might strategically withhold value-relevant information lest rival firms gain a competitive advantage. The researchers call this “proprietary disclosure costs.” However, cutting against this incentive, companies can increase their ability to attract and retain employees by disclosing good news.

Overall, the study found that managers increase the intensity of human capital disclosures in response to greater product and labor market competition. This suggests that strategic considerations outweigh proprietary disclosure costs, said the researchers.

Specifically, over three measures, the researchers found disclosures to accurately reflect employee flow.
  • There is a strong positive relation between within-firm employee turnover increases and subsequent A&R disclosure intensity.
  • Increases in components of employee hiring and separation tend to be followed by additional firm-level disclosures of A&R information in the subsequent 10-K—especially when a larger fraction of the workforce is classified as high-skill based on their occupation.
  • As the stability of the firm’s “stock” of human capital grows, managers reduce the intensity of discussions pertaining to A&R risk.
The fact that disclosure changes reflect actual variation in the underlying workforce support the idea that managers are forthcoming about A&R risk, said the researchers.

Findings can inform SEC rulemaking. The researchers conclude that the study’s findings have important implications for academics, policymakers, and practitioners.
  • The finding that past SEC rule changes were effective at increasing human capital disclosure may lend support for the upcoming rule proposal—particularly because the increase was especially pronounced among under-reporting companies.
  • It is useful for the SEC to be able to show data that human capital disclosures accurately capture value-relevant aspects of the underlying stock and flow of human capital.
  • Finally, the study introduces novel measures of the flow of human capital beyond simple turnover, providing specific metrics for the SEC to consider in the upcoming rulemaking.