Build shareholder value with human capital practices

Business analyses are increasingly researching quantifiable measures to determine a company’s current and future worth. The sudden collapses of companies like Leman Brothers, Black Rock, and Enron are instructive in predicting sustainable performance, writes Rod Waddell from Performance Path.

It has become glaringly clear that relying totally on primary financial data can impede a true analytical understanding of an organisation’s current performance and sustainability. For example:

Properties shared by all organisations in a sector may be superficial, obvious or unimportant.

Measures applicable to all organisations in an industry may ignore or understate differences between them.

Primary financial analysis may also neglect complexity and variety in organisations.

New accounting rules allow some corporations to use financial instruments (SIVs, CDSs) to improve their balance sheet.

Remembering Enron

Waddock (2002) notes that, for three years, Enron had achieved a place in the best 100 places to work in America.

In 2000, it received six environmental awards, issued a triple bottom line report, and had policies on anti-corruption, human rights and climate change.

The CEO was a speaker at ethics conferences.

Enron’s CFO was awarded CFO of the Year by CFO magazine three months before the Enron scandal was made public.

Enron appeared in many general and social investing mutual funds when it failed. In today’s turbulent marketplace we need to be able to separate the reality underlying the rhetoric. To identify sustainable companies you need better measures of lead, not lag, indicators to predict future organisational performance.

Recent research has demonstrated that a rigorous qualitative analysis of management quality and human capital practices can significantly increase share holder value. Consider the following:

You can’t make money out of analysing soft variables until they can be clearly defined. By understanding key human capital practices, we can distinguish between rhetoric and reality. Towers Watson’s Human Capital Index has confirmed that people management practices contribute up to a 47 per cent increase in market value (1999-2010).

While others like Collins and Porras (2000, 1994) report visionary companies produce sustainable long term results and are six times more successful than comparison companies, and 15 times more successful than the general market (1926-1990). They also say, “Individual leaders, no matter how charismatic or visionary, eventually die and all visionary products and services and all great ideas eventually become obsolete.”

Yet visionary companies prosper over long periods of time. Harvard Business Review, March 2010, “Roaring Out of Recession” reveals leading companies use talent management, R&D and marketing to achieve up to 37 per cent more in sales over their competitors during and up to three years after the last three recessions (1980-82, 1990-91, 2000-02).

What human capital practices provide the biggest impact on share holder value year after year? See below:

Towers Watson – 
Human Capital Index

Total rewards and accountability: 16.5 per cent

Collegiate and flexible workplace: 9 per cent

Recruiting and retention excellence: 7.9 per cent

Communications integrity: 7.1 per cent

Focused HR service technologies: 6.5 per cent

So why don’t more companies practice pay for performance. Again, people do what is best for them. Many organisations lack accurate ways to measure employee performance. One size fits all appraisals are more of an opinion poll.

Another reason is paying top performers more means less for marginal and average performers. Managers know defending “finger in the wind” appraisals is difficult if not impossible.

And finally, in order for performance to be fair, managers must have clearly established performance measures and targets. Most don’t or if they do, only look at them as the next appraisal cycle approaches. So add this up and you get unclear expectations, conflicting management practices and unrealistic goals. It is no wonder pay for performance seems too difficult. What is more difficult than implementing an effective pay for performance process, how about seeing your competition fly past you with superior performance and earnings while you limp along in the slow lane.

Look at how you can incorporate these practices into your organisation next month.

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Rod Waddell

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