Materiality and Human Capital

23 February, 2017

The goals of integrated reporting include both more effective communication to key stakeholders but also, and I believe more importantly, the development of integrated thinking. To make this happen, the thinking behind materiality needs to change and become more holistic. While the IIRC guidance document on materiality provides some level of transition away from the more traditional approaches I am not convinced that it is yet creating the “Ah Ha” moment for existing and potential users.

Traditional thinking has often seen human capital from a cost perspective, focusing on the fact that for many organizations the financial resources applied to paying people ranks as one of the largest expenses. If thinking needs to change, then seeing people costs as a potential area of opportunity as well as risk is an important step. Many approaches seek to minimize the cost of human capital as reduced consumption of financial capital will normally lower costs and increase profits. However the financial picture painted by this approach has at least two important and dangerous flaws. First it assumes that all labour costs are expenses that have no long term value and are therefore written off as incurred. Secondly, and as a result of the first flaw, it fails to communicate the value attributable to the work force and in to all human relationships. For many organizations – especially those engaged in the “knowledge economy” this is a very material aspect of their ability to sustain their business yet it is rarely addressed as material or as a core risk or opportunity.

There is adequate research to indicate that organizations which fully engage their workforce delivers enhanced results, not just financially but in improved customer relationships, higher innovation, lower safety issues and many other dimensions. This is a material aspect for integrated thinking and requires at least two answers. First, to what degree is the workforce actively engaged as a core aspect of business activity? Whilst many approaches to metrics exist in this area, measures such as hours of training per year per person, or number of Ph.D’s are of limited value; the Maturity Institutes research that creates the foundation of its OMINDEX rating system is founded on four key operational pillars that reflect transforming workforce effectiveness into results; through improved output, cost, quality or revenue.

Secondly, is management strategy and action sustaining, increasing or decreasing the value of the human capital? This is hard to measure but again using trends on a scale can provide an indicator. Many readers will remember the work of Steven Covey (Senior) in his book “The Seven Habits of Highly Effective People” which explored the impact of building effective relationships; he referred to an “emotional bank account” as the invisible investment that had been made in building relationships that could be “drawn against” in hard times. What integrated thinking needs is a measure for human capital that allows investors to both assess the level of organizational maturity but also whether the emotional bank account is being enhanced or depleted?

Depletions of human capital, that is more withdrawals from the account than deposits, will ultimately create an organization where the core aspects of innovation and creativity begin to fail. Goodwill and trust is lost both internally and externally; productivity sours as the foundational aspects of an effective business system – being communication, collaboration, cooperation and commitment are depleted. Initially these changes will increase costs and slow progress; ultimately these changes will create an unsustainable business system. There are always good times and bad times in business and its resilience has as much to do with how much is in its financial bank account (financial capital / cash) as how much is in its emotional bank account.