You’ve heard your CEO say, “Our employees are our greatest asset.”
But if you’ve reviewed company financial statements recently, employees are not technically classified as assets — or valued that way either. In official accounting terms, people are regarded as expenses (i.e. salaries) on the income statement and appear as liabilities (i.e. pensions) on the balance sheet.
R. Paul Herman, CEO of HIP Investor, which manages money for investors seeking sustainable portfolios, disagrees with this assessment of a company’s employees. When a manager needs to boost performance, he can increase profit by reducing expenses through layoffs. Yet if people were accounted for as assets, they could be less likely to face the ax in a downturn, because managers would invest in their assets that can appreciate in value over time.
HIP Investor has uncovered a handful of companies in high-growth Asia that currently are valuing their employees as assets and reporting on them in their financial statements. HIP is seeking to re-ignite a movement to invest in people, while also upgrading corporate financial statement approaches.
I asked the HIP team to explain to me how this might actually work, because in order for human capital to be accounted for differently, standards like U.S. GAAP (Generally Accepted Accounting Principles) might need to change.
“First of all, you need to understand how the economy has shifted,” Herman said. “Tangible assets (i.e. real estate and physical equipment) are not driving performance like they once did. Intangible assets (i.e. patents and brands) and the people that create them are now the main source of value.”
In 1975, for example, tangible assets made up 83 percent of the S&P 500 market value. In 2010, this had completely flipped, and 80 percent of the S&P 500 market value was attributed to intangible assets. Inventions by people are core drivers of today’s economic engines of business — and Herman mentioned a few investment funds that focus on this theme.
Next, Herman explained that a reporting system that “fails to provide information on the core aspect — more than 80 percent of the stock price value — of a company’s ability to create value is missing the mark. People invent products (i.e. Apple’s iPad), and people serve customers (i.e. Zappos). Teams of people work with networks of suppliers (i.e. Walmart) that make goods and provide services, yet all of this value is under-accounted for because people are an ‘invisible’ asset — and one not quantified at that.” (The HIP team explains more in this Huffington Post feature.)
I fully agree. Human capital should be on the balance sheet as an asset, or at the very least reported as supplemental information in the financial statements. Intuitively, it is easy to grasp that with training and experience an employee’s value to a company does appreciate over time.
Attempts to measure human capital asset value are not new. In January 1967, more than four decades ago, the Harvard Business Review published an article titled, “Put People on Your Balance Sheet.”
The leading management journal showed how to classify human capital value as an asset. While no U.S. or European firm externally published this analysis today, several Asian firms quantify their human asset value, report it in annual reports and communicate externally about it.
Case In point: Infosys
Infosys (NASDAQ: INFY), the global technology company based in India, is using NYU Professor Baruch Lev’s model (Lev-Schwartz) to calculate the value of its human capital and has been reporting the results in its financial statements since it went public more than a dozen years ago.
Infosys includes a “human resource valuation” in its annual report. Human capital value better maps to Infosys’s market value than its traditional accounting assets.
What’s next?
I see a few opportunities to bringing this new asset definition into the 21st Century:
- A U.S. or European company could take the leap and start reporting on human capital in its financial statements — and be the first to do so.
- Sustainability-oriented and socially responsible investment firms can use this approach in their research and encourage financial analysts to ask the companies they cover to report on these metrics. HIP Investor, with the Human Capital Management Institute, is doing that with this survey, which your company can complete to benchmark itself.
- HIP Investor could lead a group of stakeholders to the Financial Accounting Standards Board (FASB), which is responsible for setting GAAP (generally accepted accounting principles).
I want to thank Paul and Tom Bowmer of the HIP Investor team for bringing this to my attention — and investors in general. While I failed my accounting class, as a recruiter I have not communicated these financial points more strongly to my clients yet.
But since employees are a company’s greatest asset, maybe I can encourage my clients to lead by doing so in the future.