In order to succeed every organization must provide something valued by the people possessing the capabilities they require. An attractive brand and value proposition can enable them to build and sustain the right workforce. That workforce is a critical form of capital.
Capital comes in many forms: financial, operational, customer and intellectual. Over the last few decades intangible forms of capital have increased from 32% of market value of S&P 500 firms to 90%. Investors and other stakeholders have a right to know the condition of this critical resource so they can make informed decisions about how to allocate their investments. But organizations typically focus their reporting (e.g., 401K reports) on financial capital. Despite the frequent claims that employees are their most important asset the instances of serious attempts to measure the value of that asset are scarce.
Intellectual capital is composed of both intellectual property, which can be protected legally, and human capital, which is what the workforce knows and is able to do. The SEC has recently issued guidelines for reporting on a number of factors related to human capital. They direct the Board and executive management to assume responsibility for generating critical information and reporting on it. Although the mandates do not apply to the public sector there is an increased recognition that a parallel responsibility exists in that sector to inform stakeholders about the adequacy of the workforce and how it is being managed. Taxpayers fund the cost of the workforce and are entitled to assurance that it is being managed effectively.
Human capital management (aka human resource management, talent management or workforce management) can be defined as “how an organization attracts, retains, enables, and engages its workforce, including full-time and part-time employees, contractors, freelancers and crowdsourced workers” 1. The SEC mandates that employers who are publicly traded focus on reporting the effectiveness of workforce management strategies and programs to all stakeholders, which in addition to investors and regulators includes employees and the public. The Board, or other governance body, is being held accountable for accurate and timely reporting. How much and how the organization invests in initiatives intended to promote performance, health and safety, equitable treatment and workforce viability has become a factor that is used to value firms.
Assigning a value to human capital presents unique challenges. In the 80s there were attempts to create systems for “human resource accounting.” But in addition to discovering the complexities associated with assigning a value to human resources it became apparent that traditional accounting guidelines did not allow organizations to treat people as an asset in financial reports. This is because for something to be considered an asset it has to be owned, and employees are free to leave on Friday and not return on Monday. One of the first efforts to measure human capital was made in the early 90s by Skandia, a financial services firm, which created an annual intellectual capital statement.2 This approach put human capital on a par with financial capital and was published along with the traditional annual report. When the balanced scorecard approach became popular later that decade “learning and growth” was one of the four measures of capital, alongside financial, operational and customer capital.3 Although Generally Accepted Accounting Principles (GAAP) preclude treating a workforce as an asset in financial reports that claim “people are our most important asset” became a popular sound bite for executives who wanted to show that they value their workforce. And since the term asset is often used as a label for anything that is viewed as valuable it would seem legitimate to apply it to a workforce.
Yet it can be difficult to evaluate the effectiveness of the strategies and programs, since only qualitative measures may be available. The SEC mandates related to human capital reporting focus on tangibles such as the number of employees, investments in training, turnover and other measurable items. But the scope of reporting is being broadened to include things that can only be measured using subjective opinions. For example, reporting the average number of hours an employee receives in training each year has little value at that level of aggregation. Without knowing who received training, whether it was job related, and whether it achieved the desired results little can be gleaned from that kind of reporting.
There is a wide range across organizations when the percentage of operating costs associated with specific categories is measured. A highly automated entity such as an oil refinery may have a workforce that represents less than 5% of its operating costs. A bank will typically have more than two-thirds attributable to its workforce. The composition of the cost structure has a significant impact on the workforce management philosophy and strategy. A refinery can theoretically double pay levels for all employees without having a major impact on profits, all else remaining the same. A bank would be likely to collapse financially if it tried to do the same. This reality has an impact on what an organization’s pay levels are relative to their competitors for talent. The most commonly stated compensation is to pay “at market.” But if that “market” is not appropriately defined the posture may be unaffordable. The bank may compare its pay levels for occupations specific to banking to other financial institutions. But what market is targeted when setting pay levels for occupations that exist across industries?
Cyber security specialists may be critical to both types of organization. Software failures can shut down refinery operations and cause the bank’s systems to crash (or give money to people not entitled to it). Having an outside party capture data and hold it for ransom can be a major crisis for them both. Since cyber security knowledge and skills are transportable across industries people possessing them can move into a wide variety of organizations. Consequently, in order to meet prevailing market pay levels the bank may be forced to pay cyber incumbents higher than financial analysts even if it values the finance jobs more highly, at least on a relative internal equity basis.
Trying to reconcile relative internal values with the market values of occupations often poses a dilemma. Paying cyber analysts more than critical care nurses may create nurse discontent in a hospital. Despite understanding that the hospital needs good systems a nurse may not view the analyst role as being central to the mission and critical to performance (at least not as much as a nurse’s). This impacts the perceptions of “fairness” or “equity.” Although one remedy would be to keep pay rates confidential this is unlikely to be effective. Research tells us that when people do not know the actual pay relationships, they will guess… and those guesses will tend to assume things are worse than they are.
Another possible remedy is to purchase software systems and to contract out their maintenance. This reduces the focus on internal equity comparisons. Nurses may still despair at what the market sets as going rates for occupations, but hospital administration is at least partially off the hook. Effective communication regarding how market levels are determined might alleviate some of the angst. Making it clear that the relationship between supply and demand of knowledge/skills drives prevailing market rates, rather than value judgments made by management, can help. Some organizations assign jobs to grades in the pay structure based on relative internal value and then administer pay based on competitive market levels. This at least clarifies that the organization values an occupation, even though for the present the pay rates for incumbents of other occupations has been driven up by labor market realities.
The current focus on pay equity has increased the attention being paid to who is paid well and who is paid less. One of the unfortunate realities is that a number of occupations are dominated by incumbents of one gender (e.g., currently the majority of nurses are female, and the majority of cyber analysts are male). This “occupational crowding” has been the result of many factors, some of them illegal, but most driven by tradition and the career direction people are given. This leads to statistical anomalies when gender pay comparisons are made at an aggregated level (Company X pays its male employees 15% more than its female employees, on average). Findings such as this are magnets for regulators and journalists seeking a headline. The gender gap may lessen if comparisons are made only of “similarly situated” employees but further analysis is often neglected. Differences, even at an aggregated level, should be carefully examined and if further analysis shows similar patterns even across the same occupation or job this should be addressed.
“Why don’t you pay me as much as him/her?” This is a legitimate question for employees to ask. Every organization needs to establish a clear compensation philosophy that provides an answer to those questions.
“Three factors determine your pay:
1. The value (internal and external) of the role you play,
2. Your competence level in that role, and
3. Your contribution (performance) in that role.
Your personal characteristics are not a consideration.”
A clear communication such as this can help employees accept the process used to administer pay. The message must be believable, and the quality of pay management will determine its credibility.
One other qualifier that each organization should consider is that economic ability to pay may constrain pay levels. The pandemic has devastated revenues for many organizations, and this has made it difficult to retain the competitive position these organizations would like to maintain in their pay systems. Explaining how the business of the organization works and what impacts its success can go a long way towards a better employee understanding when they find their neighbors who work for other employers doing better economically than they are. A nurse whose neighbor works for a fintech giant may understandably be dissatisfied when making comparisons to that person, but understanding the constraints of the employer may lessen the angst.