Corporate Governance Quality Doesn't Take a Holiday During a Recession

A looming recession coupled with accelerated inflation is something boards haven’t seen in decades. Some directors and executive managers have never experienced this combination of economic realities, which include accelerating inflation (+8.0 percent); rising interest rates (+1.25 percent); real housing prices (+20 percent); increasing prices for commodities (+25 percent-200 percent); explosive food prices (+150 percent); slowing real GDP growth (-3.5 percent); and contraction of real wages (-4 percent). The challenge is how to strategically lead organizations through this set of daunting economic conditions to sustainable success. The most direct lever organizations can use is their workforce. 

For decades, the “corporate line” has been that employees are an organization’s greatest asset, the engine of economic performance. Now more than ever before, directors and executive managers need to quantify and monitor human capital management outcomes if they truly believe that talent is the key to corporate sustainability. 

The first step is to understand how material human capital management performance is to enterprise outcomes. In our report Brave New World: Creating Long-Term Value through Human Capital Management and Disclosure, we identify a pathway to quantify the economic and material impact on corporate outcomes. 

The Conference Board suggests that organizations calculate these key fundamental human capital metrics to baseline and track performance over time, as a way to gain insights on the leveragability of human capital on sustainable performance.

1. Human Capital Return on Investment (HCROI): this measure reflects the amount of gross profit per dollar of direct human capital costs. The algorithm is: [total revenue – (operating expense – total human capital costs)] ÷ total human capital costs.
2. Human Economic Value Add (HEVA): this measure represents the economic value created per employee. It shows how much more valuable the organization has become due to investments in human capital. The algorithm is: [net operating profit after taxes – (invested capital X weighted average cost of capital)] ÷ full-time equivalent employees.
3. Human Capital Value Add (HCVA): this measure reflects the operating profit adjusted for the cost of direct human capital costs per full-time employee. The algorithm is: [total revenue – (operating expense – total human capital costs)] ÷ full-time equivalent employees.
4. Human Capital Market Value (HCMV): this measure reflects the contribution employees makes to economic value creation. The algorithm is: [market value-book value] ÷ full-time equivalent employees.
5. Employee productivity and other efficiency measures. Organizations should monitor efficiency indicators of their workforce, including productivity or revenue factor (revenue ÷ full-time equivalent employees), income factor (income ÷ full-time equivalent employees), expense factor (expense ÷ full-time equivalent employees) to monitor changes in each factor.

The next step is to understand how the metrics are trending over time and how human capital indicators like attrition, retention, engagement, mobility, remuneration, culture, etc., contribute to outcomes, as well as understand how economic conditions are affecting the workforce. For example, real wages have declined while corporate profits have soared over the last several years. Organizations should be investigating how HCROI performed over time and determine if they can afford to invest in human capital to counteract unfavorable economic conditions. Boards and executive management need to understand how to address the needs of the workforce that ultimately support corporate success.  

For more insights on how to deploy these strategies under adverse economic circumstances, see the following report written in November 2020, Brave New World: Creating Long-Term Value through Human Capital Management and Disclosure.