Flick through almost any annual report and you’ll find a statement that employees are the company’s most important asset. Whether you’ll find anything more enlightening is much less certain.
Employees embody a company’s skills, knowledge and culture, are central to its value creation and may be the biggest single expense. However, current corporate reporting practices don’t reflect the significance of the workforce. People issues are frequently missing from the strategy description and it’s often unclear how employees contribute to the business model. People-related metrics are also thin on the ground, other than the standard health and safety and diversity disclosures.
It’s small wonder then that the recent project on workforce-related corporate reporting from the FRC’s Financial Reporting Lab shows investors feel poorly served. As one investor quoted by the FRC noted:
“We know too much about board, not enough about the workforce.”
Why does workforce reporting matter? The FRC’s report quotes research by the London Business School, which shows that companies with high employee satisfaction levels deliver long-run shareholder returns that are 2.3% to 3.8% per year above their peers. The research also showed that employee satisfaction causes good performance, rather than good performance giving the headroom to invest in employee satisfaction.
More generally, sustainability has shot up both corporate and investor agendas in recent years. Climate change has been the major driver of this but there’s also a growing understanding that companies’ long-term success is predicated on their ability to create social value, as well as economic returns. The ways that companies invest in, motivate and manage their people are central to this. Engaged and motivated employees are more likely to generate new ideas, serve customers better, form stronger relationships with suppliers and take an active role in social and community initiatives.
Investors therefore have a legitimate interest in company’s people strategies, how those support the corporate strategy, the extent to which people are part of a company’s competitive advantage and a host of other issues, from investment in training and development to voluntary churn rates.
Ongoing disruption to the workplace also makes it critical that investors have a handle on which companies have a robust, strategic approach to managing their people. Covid-19 has had a profound impact on employees and the recovery from it may be prolonged, with people having to work in new ways. We’re likely to see more people working from home and the rejigging of supply chains to make them more resilient, with activities repatriated from lower-cost centres in Asia.
Even before the pandemic, the world of work was changing for many people, with the rise of the gig economy and the increasing use of contractors meaning many companies no longer have a clearly defined workforce. Further change is also coming, including automation, artificial intelligence and long-term demographic shifts as the population ages, as well as new immigration rules in the UK. How companies respond to these structural shifts will be a key factor in the sustainability of their returns.
It’s also true that many current and potential employees read the annual report. It’s therefore important that the report accurately portrays what you’re doing, so it’s consistent with your messages internally and demonstrates to future recruits that your organisation will value them.
Regulation is pushing for greater disclosure Given the importance of workforce reporting, it’s not surprising that recent regulations and codes have required companies to increase their disclosure. In particular:
The Companies (Miscellaneous Reporting) Regulations 2018 introduced the s172 statement and requires disclosure on CEO pay ratios and stakeholder engagement, including with employees.
The UK Corporate Governance Code 2018 included a requirement to explain the company’s approach to investing in and rewarding its workforce, introduced formal engagement mechanisms and required boards to ensure workforce policies and practices are consistent with the company’s values and support its long-term sustainable success.
The introduction of non-financial information statements in 2017 also increased the disclosure required around a range of sustainability issues, including employees, even if implementation of this regulation remains patchy. Greater disclosure outside annual reports has also come in the form of gender pay gap reporting and modern slavery statements.
Given this direction of travel and the clear interest in the topic from both investors and regulators, we can expect future rules to further increase workforce disclosures.
A framework for workforce reporting
The FRC’s report recognises that there is no single approach that will suit all companies. Instead of being prescriptive, it proposes a four-part framework for thinking about workforce issues and how to disclose them. Within each of the four elements, it then sets a list of questions for companies to consider when determining the specific disclosures that will suit them.
The four elements of the framework are as follows:
governance and management: how boards consider and assess workforce matters, including what information they see;
business model and strategy: how the workforce contributes to the success of the business model, how the workforce is invested in and what strategic changes might be needed to maximise the workforce’s value;
risk management: the workforce-related risks (and opportunities) and how the company is responding; and
metrics and targets: what is measured, monitored and managed in relation to the workforce.
You may recognise this as the framework developed by the Task Force on Climate-Related Financial Disclosures, which UK companies are beginning to adopt and which the government wants all companies to employ for climate change disclosures by 2022. The framework clearly has wider application and may become the way we think about disclosures for other material sustainability issues.
One of the advantages of this framework is that by breaking down the subjects you need to consider, it can help you to identify the gaps in your current reporting and any areas where you actually need to bolster your people-management processes.
Our experience is that while all four areas need to be addressed, business model and strategy and metrics and targets are likely to be the two areas where greatest thought is needed. As we noted above, many corporate strategies are silent on the importance of the workforce. Business models also remain a weakness in many annual reports and it is often not clear how the strategy and business model connect.
For metrics and targets, there are two main issues. First, you need to decide what metrics best explain how you manage your people and how granular that data should be. Will it go down to divisional or geographical level, for example? The focus here is partly on increasing the range of operational metrics you disclose but investors are also clear they would like more insight into the financials.
The second common issue is the quality of the underlying data. Companies that have grown rapidly, particularly through acquisition, often have piecemeal HR systems with inconsistent data and reporting. It may be that you need to complete a data capturing exercise now, with a view to starting to report in future periods. At the very least, this should be helpful for internal management purposes too.
Best practice examples of workforce reporting
The FRC’s report includes a number of disclosure examples, across all four areas of the framework. All these examples have merit and will help you to determine what will work for your organisation and what will not. As a starting point, we would encourage you to consider good examples of disclosing people elements of the strategy and linking them to KPIs and risk. Barratt Developments, Taylor Wimpey and Rentokil Initial are all strong here. Getting this right would be a big step forward for many reports.
In addition, the FRC’s report notes that investors value the more detailed disclosures found in sustainability reports. These reports often use a reporting standard such as the Global Reporting Initiative (GRI), which includes a comprehensive checklist of required disclosures to meet its standard. Even if you’re not looking to report in such a systematic way, these standards can provide insight into the metrics investors find valuable.
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