Linking Human Capital and Shareholder Value: Watson Wyatt's

Voodoo economics. Bloated balance sheets. Mickey Mouse accounting. Charges like these have often been leveled against efforts to put a value on a company's human capital. Such measurements, it is argued, are bound to be more qualitative than quantitative, more elusive than incisive. But few things are more critical than accounting for human capital. It is the chief resource and result of a knowledge-based economy. It is the source of innovation and renewal. And once it can be measured, it can be managed and exploited to increase shareholder value. That is precisely the aim of the Watson Wyatt Human Capital Index.

The WATSON WYATT HUMAN CAPITAL INDEX (HCI) shows a clear relationship between the effectiveness of a company's human capital and the creation of superior shareholder returns. It is a single, simple set of measures that quantify exactly which human resources practices and policies have the most effect on increasing - or decreasing - shareholder value.

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ABOUT THE SURVEY

Watson Wyatt surveyed more than 400 US- and Canada-based publicly traded companies with at least three years of shareholder returns and a minimum of $100 million in revenues or market value.

We asked a wide range of questions about how organizations carry out their human resources practices, including pay, developing people, communications and staffing.

After matching responses to objective financial measures, we conducted a series of sophisticated statistical analyses and found that there was a clear relationship between the effectiveness of a company's human capital - as measures by a summary score we're calling the Watson Wyatt Human Capital Index(TM) - and a shareholder value creation. This relationship we found is so clear that a significant improvement in 30 key HR practices is associated with a 30 percent increase in market value.

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SURVEY HIGHLIGHTS

Higher HCI companies create sbustantially more shareholder value. When looking at five-year TRS, the results are striking. High HCI companies have provided significantly more TRS than low HCI companies.

These practices can be grouped into five dimensions - the key links between human capital and shareholder value creation. The five key links are: Recruiting Excellence, Clear Rewards and Accountability, a Collegial and Flexible Workplace, Communications Integrity and Prudent Use of Resources.

Prevalence in an organization of the first four dimensions is associated with increased economic value. The fifth dimension is composed of certain human capital practices that are actually associated with lower market value. We call this dimension the Prudent Use of Resources because organizations must use caution when executing these programs.

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RECRUITING EXCELLENCE

Perhaps the greatest challenge facing organizations today is their ability to attract and retain talent. For those who do it well, the rewards are great: lower turnover and longer tenures among key employees. By showing a significant improvement in recruiting new talent, companies can achieve a 10.1 percent increase in market value - the largest we found among the five areas linking effective human capital practices and shareholder value creation.

CLEAR REWARDS AND ACCOUNTABILITY

This dimension examines both sides of the equation: rewards for high performance and accountability for poor performance. Significant improvement in this area is associated with a 9.2 percent increase in market value.

All of these practices reflect the importance of fairness in achieving better performance. When employees work hard and the company succeeds, they want to share in the benefits. People also want to be rewarded for superior performance. When organizations do so, they attract top performers who are confident in their abilities and who want to work where rewards are based on their own performance.

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COLLEGIAL, FLEXIBLE WORKPLACE

While it has long been assumed that corporate culture and management style have a quantifiable impact on shareholder returns, now we are confident it is so. Our data suggest that significant improvement along this dimension is associated with a 7.8 percent increase in market value.

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COMMUNICATIONS INTEGRITY

Communications integrity implies more than information flow. It assumes that communication is candid and open, and reflects a trust and respect among and between managers and employees at all levels of the organization.

PRUDENT USE OF RESOURCES

At the other end of the scale, however, some of our findings were counterintuitive. Certain practices that conventional wisdom applauds - such as developmental training and 360-degree feedback - did not add any economic value and were in fact associated with a 10 percent decrease in market value.

Why is this the case? Our hypothesis is that while there is nothing inherently wrong with these practices, many organizations implement them in misguided ways. For example, when a company emphasizes training for the next job more than learning how to succeed in the current post, it makes investments that other organizations - perhaps competitors - will recoup.

Companies must be very prudent when implementing certain human resources practices, paying special attention to appropriate execution in order to deliver the desired results.

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DISCOVERING YOUR COMPANY'S HUMAN CAPITAL INDEX

Want to learn your organization's HCI? Fill out our 36-item diagnostic, and we will analyze the results and provide you with:

• An HCI score that correlates the effectiveness of your company's human capital management with its market value.
• Your ratings on each of the key dimensions of human capital. A comparison of your HCI ratings with other company performance measures.
• A customized, easy-to-understand report that outlines your organization's strengths and opportunities for improvement.
• What-if scenarios and the return on investment models associated with selected changes. Ideas for prioritizing human capital practices to achieve results.

Please click here to contact a Watson Wyatt consultant for more information.