Regulated Human Capital Disclosures

Ethan Rouen is an Assistant Professor of Business Administration at Harvard Business School; Thomas Bourveau is an Associate Professor at Columbia University; Anthony Le and Maliha Roychowdhury are Doctoral Students at Columbia Business School . This post is based on their recent paper.

Human capital has been an increasingly important component of firms’ operations for at least the last two decades, but because firms’ investment in and management of their employees do not fall under the formal definition of an asset, there has been almost no human capital disclosure under U.S. GAAP. That changed in November 2020, when an amendment to Regulation S-K went into effect that required publicly traded firms to disclose in their 10-K filings descriptions of their human capital resources and risks.

The amendment took a principles-based approach to human capital reporting, declining to identify relevant human capital metrics or even define the term “human capital,” arguing that definitions will likely vary greatly across firms and will evolve over time.

In a new working paper, we examine what quantitative human capital disclosures look like for more than 2,000 publicly traded firms and document how they changed in response to the amendment to Reg S-K. We begin this analysis by asking whether the change in rule sated investors’ demand for these disclosures and provide evidence that there remains a need for more regulation. In the year after the passage of the amendment, the SEC requested public comment on its climate disclosure rule. Of the 656 letters sent to the SEC in response, 20 percent specifically mentioned human capital, even though the new rule had nothing to do with human capital. More than 35% of the letters requesting better human capital disclosure came from institutional investors, and 40% came from non-profit organizations, suggesting that diverse stakeholders desire this information. Almost half of the letters specifically requested additional quantitative disclosures, with letter writers pushing mostly for metrics related to diversity, equity, and inclusions, retention and turnover, and compensation.

While these findings suggest that the amendment was not sufficient in addressing the need for human capital metrics, in our main analysis we find that the format and content of human capital disclosures did increase after the changes to the rule. Prior to 2020, no firms had a section in the 10-K devoted to human capital, while 85 percent did in 2021, a level that remained constant in 2022. The percent of firms that disclosed at least one quantitative metric nearly doubled from 40 percent in 2019 to almost 80% by 2022. When looking at quantitative measures defined by the Sustainable Accounting Standards Board (SASB) as financially material (within industry), we find a similar increase, with the percent of firms disclosing at least one SASB metric increasing from 10 percent to 20 percent.

Two firm characteristics play an important role in the decision to disclose human capital metrics. First, firms with more institutional investor holdings are more likely to disclose. Second, firms with weaker accounting performance are more likely to disclose. One potential explanation for this second finding is that investments in employees mechanically reduce profits since these investments are expensed immediately. Therefore, firms are more likely to disclose this information to explain to investors the lower performance.

The large increase in quantitative disclosures after the amendment is similar across almost all industries, with Resource Transformation and Financials seeing some of the biggest increases in disclosure. Most of the newly disclosed metrics across all industries report information about DEI and turnover/recruitment, with very little increase in quantitative information related to compensation, education, health and safety, employee engagement, and other topics.

Despite the 10-K being a new venue for these disclosures, it is not the only venue. Firms were already required to disclose workforce composition metrics to the Equal Employment Opportunity Commission (their EEO-1 reports) and safety metrics to the Occupational Health and Safety Administration (OSHA). We find that metrics reported in these other venues were not reported in the 10-K at all before 2020 but that more than 30 percent of firms did so by 2022, suggesting venue shifting. In addition, less than 40 percent of firms disclosed at least one unique (i.e., not reported elsewhere) metric prior to 2020, but that more than 60% did so by 2022.

The increase in disclosure is not solely on the extensive margin. Firms that were disclosing quantitative information prior to the amendment increased their disclosures afterward. Before 2020, the average firm reported approximately one and a half quantitative metrics. By 2022, the average number of metrics was almost three. Importantly, this increase seems to be driven solely by metrics not defined by the SASB as being financially material.

Lastly, we find that this increase in quantitative information appears to make the 10-K more value relevant. We examine the absolute value to stock market returns for the three days around the release of the 10-K. Absolute returns allow us to document market movement without making judgements about whether the disclosures themselves are “good” or “bad” for investors. On average, we find strong evidence that investors respond to quantitative human capital disclosures after the amendment, but not prior to the amendment and only when human capital is most likely to be value relevant. Specifically, the positive association between absolute returns and quantitative disclosures exists only for firms in industries where human capital is most likely to be a financially material issue and only for firms disclosing metrics deemed to be financially material, where financial materiality is defined by SASB. Taken together, these results suggest that quantitative human capital disclosures are value relevant, but need a level of comparability (i.e., a large subset of firms are disclosing this information) and need to be financially material to the firm disclosing them.

Overall, our paper finds that the amendment to Regulation S-K dramatically increased the amount of quantitative human capital information firms were making available to investors and that investors reacted to this information. Still, the rule change did not result in full disclosure across all publicly traded firms, and the decision of what information to disclose remains heterogenous.

The complete paper is available for download here.

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