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What Are Employees Worth

February 4, 2001
Related Topics: HR Services and Administration, Workforce Planning, Featured Article
How is this possible? A company with a tiny share of a market niche, some rented office space, and a few computers goes public before it has profits, and after the IPO, it's valued in the hundreds of millions.

    The answer may lie in what the company isn't telling us. Analysts and experts agree that nearly 75 percent of the sources of value in a company are never reported and we have yet to come up with an accounting system that can record it all. The hidden value in a company is usually lumped under "intangibles," thought of as soft, rather than hard, assets. But soft is a misnomer. High-tech business is what has driven our economic boom thus far, and what's truly valuable in a biotech, software, or telecommunications company isn't the networked computer system or the new lab equipment, but the minds behind it all.

    "Value in this economy is increasingly being driven by employees and their ideas, as opposed to hard assets. So you not only have people creating a lot of value, but they are highly valued themselves, and switching jobs more frequently than ever," says Jonathan Low, a senior fellow at management and IT consulting firm Cap Gemini Ernst & Young (CGEY). Low specializes in the valuation of intangibles.

    For the last year, he and other researchers at the CGEY Center for Business Innovation have interviewed institutional investors, pension fund and money managers - those responsible for most of the stock in the economy. They discovered that 35 to 40 percent of portfolio allocation decisions are based on nonfinancial information. "This was information not provided by the company, not found in the financial reports. That's revolutionary," says Low.

    That information included things like how well a company executed its business plan, the morale of employees, corporate culture, and organizational structure. Very few companies provide information that relates to the human component of their organization; of those that do, many are European. Skandia, an international financial services company, is the one most often cited for its inclusion of human capital information in financial reports.

    Since 1994, the company has reported on what it calls "intellectual capital" - its term for intangibles. "We do it because assets such as employees, customer relationships, and product solutions have become more and more important in creating future value to companies," says Jan Hoffmeister, vice president of intellectual capital management for Skandia Group Worldwide.

    Hoffmeister says the fact that most companies are unable to account for intangibles is a huge problem. "How do you make investment decisions if you use an accounting system that doesn't really tell you very much about what creates value in the future?" he asks. Skandia provides the information about its employees through half-yearly reports that talk about compensation, training, leadership, and the like. Still, there's no line item in the report that puts a dollar value on human beings.

    That's because there simply isn't an accepted model for measuring it yet, says Margaret M. Blair, co-author of "Understanding Intangible Sources of Value," a Brookings Institution study released in November. "People talk about measuring the value of a life, but that's not what this is about. We want to know how you value the productivity and future benefit of additions to human capital, the special skills, talents, capabilities that are really embedded in the people," she says. 

    Blair defines human capital as part of a set of intangibles that a company simply cannot control. "Human capital gets on the elevator and walks out the door. The company can't directly control it. It's also things like the way employees work together, not just the sum of what an individual knows. There is a continuum of difficulty in finding ways to value this," she says. A study done by Baruch Lev at New York University has taken on that piece of the problem and Lev has released a model for valuing intangibleassets

    Blair and her co-authors did find a convincing correlation between training - aninvestment in human capital - and strong corporate performance. Researchers at CGEY had similar results. Jonathan Low says CGEY looked at IPOs of companies that had gone public from 1986 to 1997 and found that about 50 percent of them had failed to either exceed or maintain the price of their stock when they went public. "The only statistically significant difference between those that succeeded at this and those that didn't was a nonfinancial factor," he says, "whether employees' interests were aligned with corporate strategy."

    That alignment may come from giving lots of stock options to employees, heightening their stake in the company's success or failure. Another example, says Low, is more obvious. "Giving people a place where they are happy to come to work, respecting them."

    Researchers at human resources consulting firm Watson Wyatt also found that good people practices overall increase a company's value. Watson Wyatt's first Human Capital Index study, completed late in 1999, found that scoring high in 30 key areas of human capital management relates to about 30 percentage points in terms of market value or return to shareholders. The yearlong study was based on a comprehensive analysis of human resource practices at 405 publicly traded companies with at least three years of total returns to shareholders and a minimum of $100 million in revenue or market value.

    "Historically, people have thought about people practices as a fuzzy, soft area. You're not sure that if you invest a dollar, you will get more than a dollar back. This study says very concretely that there is an empirical relationship between doing things for your people and getting a financial return," says John Parkington, practice director of organization effectiveness at Watson Wyatt.

    Assessing the effectiveness of human capital is difficult, let alone trying to attach a dollar amount to it. Yet Robert Morgan, president of Spherion's Human Capital Consulting Group, says there is "absolutely a dollar amount you can put on a person. It's done in the boardroom now, not in HR."

    There is an enormous amount of work going on in this area, and various models for quantifying human capital abound . But Margaret Blair says the only way to come up with a definitive method of evaluating that capital - and consequently properly evaluate companies - is through a coordinated effort. "Information is most valuable when it is shared in some commonly understood form. It's unlikely that these efforts will ever achieve their full potential unless they are coordinated," says the Brookings Institution report.

    Blair is hopeful, though. "We are starting to ask the right questions," she says, "but we still have a long way to go."

Workforce, February 2001, Vol80, No 2, pp. 32-36  SubscribeNow!

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