Fulfilling the Board’s Expanded Oversight Role in Human Capital Management

Over the past few years, many boards have expanded their oversight and consideration of human capital management (HCM) to encompass issues beyond executive hiring and compensation. Before the COVID-19 pandemic, technology and the culture change brought by a new generation of workers had already commenced an irreversible shift in paradigm that established HCM as a board-level issue with vital strategic and risk oversight implications.

The pandemic, widespread protests for racial justice, the global #MeToo movement, election uncertainty and other recent developments have further sharpened the attention given to HCM as companies take, or fail to take, measures to protect and support employees, manage staffing levels and promote business continuity in the face of widespread economic crisis, geopolitical tensions, rising unemployment, corporate scandal and social unrest. Far from being ordinary course matters siloed in human resource departments, HCM issues can have far-reaching consequences for companies and their employees and, in some cases, be subject to significant scrutiny by investors, regulators and the public, resulting in additional reputational and financial risks.

As a driver and consequence of the increased importance of HCM, investors and other stakeholders have continued to intensify and calibrate their calls for greater attention, accountability and transparency.[1] These efforts have yielded significant results; many boards have adapted their practices and are considering HCM issues on a regular basis,[2] and on August 26, 2020, the SEC amended its rules to require public companies to disclose their human capital resources to the extent material.[3] In addition, there have been increasing calls for enhanced diversity reporting by shareholders and others both inside and outside the shareholder proposal process.

Last year, we recommended that boards identify key indicators that would help them assess the health of the management/labor relationship and the company’s return on investment on its workforce. Here, we renew and expand that recommendation in light of the new SEC disclosure rule and further suggest that companies continue to fine-tune and formalize the processes and allocation of responsibility for HCM oversight at the board level.

Defining HCM Measures

In order to best consider HCM matters, companies should clearly define the factors and information that they measure, monitor and disclose. These could include measures of employee satisfaction and development (including diversity, pay equity and representation of minorities and women in management), measures of employee engagement (including changes in the rate of discrimination claims and hotline complaints, absenteeism and voluntary turnover), talent (including assessments of the current workforce’s ability to meet new demands and whether recruiting efforts and training programs address future needs) and culture (including the identification of cultural tenets for the organization).

Several commentators and stakeholders have suggested specific sets of principles, frameworks and baseline measures that companies and their boards can adopt to comply with an expanded board oversight mandate and the new disclosure requirements. Framework approaches are gaining traction in other areas, such as sustainability, as they help to harmonize and standardize practices and promote comparability between companies in similar business sectors.[4] For additional information on sustainability frameworks and considerations, please see Corporate Sustainability: Moving Faster and Faster to the Center of Strategy and Shareholder Value in this memo.

At least some of the existing frameworks already include human capital metrics. The Sustainability Accounting Standards Board (SASB), which promulgates the SASB Standards for sustainability reporting, recently released a summary of topics and metrics related to human capital that companies can use to help structure their responses to the new SEC requirements. The metrics called out as relevant to HCM fall into three general categories:

1. Employee health and safety (e.g., amount of monetary losses resulting from legal proceedings associated with health and safety violations);
2. Employee engagement, diversity and inclusion (e.g., percentage of gender and racial/ethnic group representation in management, technical staff and other employees); and
3. Labor practices (e.g., percentage of active workers covered under collective bargaining agreements).[5]

In the same vein, the Human Capital Management Coalition (HCMC), an influential group of major pension funds and other institutional investors, published a comprehensive framework for businesses to measure and value social and human capital in an effort to improve business and investment decision-making.[6]

Finally, shareholders continue to push for standardized disclosure. In 2020, two Rule 14a-8 shareholder proposals seeking SASB-aligned human capital disclosure passed with overwhelming shareholder support,[7] and we expect future proposals to pass where the company has not adopted substantial sustainability reporting.

Formalizing the Board’s Role in HCM

Besides the adoption of HCM measures and more transparent disclosure, some boards have signaled their greater attention to HCM issues in their inclusion of HCM matters and broader employee compensation review in board committee agendas, governance charters and policies. For example, some companies have changed the name of the board committee responsible for executive compensation to reflect the committee’s supervision of HCM matters (e.g., “Human Resources and Compensation Committee”). Others have explicitly included HCM responsibilities in their committee charters.

Some companies have gone further yet and tied executive compensation to measurable HCM goals such as diversity and inclusion, talent management, retention, and pay equity. For example, in a October 14, 2020, letter to employees, Starbucks CEO Kevin Johnson announced that beginning in the 2021 fiscal year, the company will link executive compensation to diversity, equity and inclusion goals.[8] These changes could further incentivize the development of reliable and timely metrics, while signaling to investors and other stakeholders that the company’s leadership is committed to improving and investing in its workforce.[9]

Other considerations may include adding HR expertise as a factor to consider for board member qualification and explicitly calling out the management of HCM-related risks (including issues of culture that have precipitated high-profile corporate scandals and employee safety and working conditions during the COVID-19 pandemic and other health crises) in the risk committee charter.

SEC Disclosure Considerations – Principles-Based Disclosure in the Wider Landscape

On August 26, 2020, the SEC amended Regulation S-K to require public companies to include a description of their human capital resources in the Business section of their annual reports on Form 10-K to the extent material to an understanding of the business taken as a whole. Under the new rules, public companies are expected to include the human capital measures and objectives that the company focuses on in managing the business (including measures and objectives that address the development, attraction and retention of personnel).

The SEC rule was adopted partly in response to a HCMC rulemaking petition requesting mandatory disclosure requirements regarding information about companies’ human capital management policies, practices and performance.[10] The HCMC echoed broader investor views that effective human capital management is essential to long-term value creation and therefore material to evaluating a company’s prospects. The rulemaking petition argued, among other things, that prescriptive disclosure standards would lead to a more efficient allocation of capital and lower cost of capital for well-managed companies due to investors’ increased ability to compare human capital resources between companies.

The SEC rule did not adopt the prescriptive approach advocated by the HCMC and other commentators.[11] Instead, it is a principles-based rule that calls for reporting companies to make judgments about materiality under their specific circumstances.[12] The lack of specificity and guidance affords companies a significant degree of flexibility to tailor their disclosure, and to use, entirely or in part, existing frameworks – such as the SASB Standards or the HCMC Protocol – to guide material human capital resource disclosure. Because the materiality standards used by existing frameworks is often different than the standard used by the SEC, the metrics that a board uses to inform decision-making, however, will not necessarily be the same as the metrics that would be required to be disclosed under the new SEC rules.

As with other instances of mandatory disclosure, we expect the development of one or more acceptable market approaches over time as more companies file their annual reports with disclosure that is responsive to the amended rules. Trends should begin to emerge within each peer group and will continue to be shaped by SEC guidance, comment letters and evolving investor demands. A limited study of the first 50 Form 10-Ks filed after November 8, 2020 for companies with a market capitalization greater than $1 billion found significant differences in the approaches used but observed several common disclosure topics that were addressed in more than a generic manner. These topics include headcount data, diversity and inclusion, employee development and training, competitive pay and benefits, safety, culture, value and ethics, employee engagement, tenure, promotion, turnover and recruitment.[13]

Key Takeaways for Boards:

• HCM is a board-level issue with vital strategic and risk oversight implications. The COVID-19 pandemic and other events in 2020 underscored the importance of increased attention and transparency.
• New disclosure requirements and heightened investor expectations will entail the consideration and development of key HCM indicators and data. Boards should consider existing sustainability frameworks and feedback from shareholder engagement in developing these indicators.
• Boards should develop a clear approach to HCM and be ready to defend the company’s disclosure approach in shareholder engagement in light of the growing push for standardized disclosure.
• Boards should consider updating board charters, agendas and policies related to HCM to reflect expanded oversight roles and consider tying executive compensation to HCM-related metrics.

[1] See, for example, BlackRock’s 2021 Stewardship Expectations, available here, which asks investee companies, among other things, that their board and workforce diversity be consistent with local market best practice. The Stewardship Expectations also anticipate BlackRock’s increased engagement with respect to how companies “manage their impacts on people, including their employees, suppliers, customers, communities, indigenous peoples and other stakeholders.”

[2] For example, in a fall of 2019 survey of 378 U.S. public company directors, 79% of respondents said that their boards spends more time discussing talent strategy than they did five years before the survey, and 40% of the respondents said that their board discusses human capital matters at every board meeting. See EY Center for Board Matters, How the Governance of Human Capital and Talent is Shifting – Key findings from a survey of public company directors (May 19, 2020), available here.

[3] See Cleary Gottlieb, SEC Adjusts Disclosure Requirements for Public Companies (September 4, 2020), available here; SEC Release No. 33-10825 (Aug. 26, 2020), available here.

[4] Calls for standardization in environmental, social and governance (ESG) disclosure have been growing among investors and other stakeholders. For example, in his annual letter to CEOs earlier this year, BlackRock’s Chairman and Chief Executive Officer Larry Fink encouraged widespread and standardized adoption of sustainability reporting, and asked investee companies to publish disclosure in line with industry-specific SASB guidelines, including with respect to labor practices, by year-end. The request came with a warning: BlackRock “will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures.”

[5] SASB Human Capital Bulletin (November 2020), available here.

[6] Social & Human Capital Coalition, Social & Human Capital Protocol, available here. Unlike the SASB framework, the HCMC protocol does not require or assume that companies report the results of their assessments externally – it is designed to generate information for business decision-making.

[7] In April 2020, a proposal for Genuine Parts Company passed with 79.1% shareholder support (proxy statement available here). The following month a similar proposal for O’Reilly Automotive, Inc. passed with 66% shareholder support (proxy statement available here) .

[8] Starbucks role and responsibility in advancing racial and social equity, available here.

[9] For additional thoughts on the use of ESG metrics in incentive compensation, please see ESG Considerations for Incentive Compensation Programs in this memo.

[10] Rulemaking petition to require issuers to disclose information about their human capital management policies, practices and performance, File No. 4-711 (July 6, 2017), available here.

[11] Cleary Gottlieb, SEC Adjusts Disclosure Requirements for Public Companies (September 4, 2020), available here.

[12] The two Democratic SEC commissioners dissented from the adoption of the rule in large part due to its failure to adopt specific, prescriptive rules requiring comparable disclosures about human capital. Regulation S-K and ESG Disclosures: An Unsustainable Silence (Aug. 26, 2020), available here, and Statement on the “Modernization” of Regulation S-K Items 101, 103 and 105 (Aug. 26, 2020), available here. Commissioner Lee, for example, concluded that she would have supported the final rule if it had “included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity.” It remains to be seen whether the SEC under the upcoming Biden administration will favor more prescriptive-based rules with respect to human capital disclosure.

[13] FW Cook, 10-K Filings Show a Variety of Approaches to the New Human Capital Resources Disclosure Rules (November 27, 2020), available here.