Over the past decade, ESG has morphed from a fringe concern into one of the most prominent topics in corporate governance – and a flourishing research area as well. Nevertheless, some notable blindspots remain. Based on a recent survey, the vast majority of legal ESG scholarship limits the analysis to just two ESG factors: (1) climate risk, and (2) corporate diversity. These are hugely important issues, but a close look at developments on the ground reveals that there is a lot more to ESG. As it is practiced today, ESG also covers a wide range of matters related to human constituencies, including – most notably – employees. Employee-related ESG issues have come to be known as “human capital management” (HCM), and, in short, HCM is a large part of the “S” in ESG, and an integral component of ESG viewed as a whole.
In a recent article, I analyzed the introduction of HCM matters in various aspects of U.S. corporate governance since the mid-2010s, which is best described as a human capital management movement due to its coordinated nature and rapid success. The article offers a comprehensive analytical account of the origins, impact, and normative desirability of the HCM movement with reference to the broader ESG-driven transformation of corporate governance. It also compares the novel HCM movement to historical labor-focused reform agendas in U.S. corporate law, all ultimately unsuccessful, and to institutional arrangements outside the United States, which have traditionally accorded labor a greater role in corporate governance.
Defining Human Capital Management as a Core ESG Factor
Human capital management starts from the premise that workers can be viewed as “assets” that are crucial to firm performance and that ought to be managed just as carefully as physical and financial assets. In practice, HCM encompasses various employee-related matters, including workforce training, compensation, turnover and retention, health and safety, gender pay equity, diversity and inclusion, and corporate culture.
The three primary channels through which HCM is affecting corporate governance are: (1) board-level deliberations about HCM, now viewed as a “mission-critical” matter; (2) shareholder proposals and shareholder engagement focused on HCM; and (3) HCM disclosure. Over the course of just a few years, the HCM movement has made rapid progress on all three counts, piggybacking on (and sometimes surpassing) other, more longstanding ESG initiatives.
Elements of the Human Capital Management Movement
The following developments illustrate the key aspects of the fast-growing and multi-faceted HCM movement.
Regulators and Policymakers. The SEC adopted a new rule requiring HCM disclosure in 2020, after overwhelming support from mainstream shareholder constituencies and the SEC’s Investor Advisory Committee. This marked a break with longstanding practice: For most of the SEC disclosure regime’s 88-year history, the only specific disclosure requirement pertaining to employees was the total number of employees. The SEC is expected to expand the HCM disclosure rule significantly in 2022 as part of its broader ESG disclosure program. In parallel, legislators have in recent years introduced a number of bills seeking to mandate HCM disclosure, while various stakeholder groups and standard-setting organizations have been working on HCM reporting frameworks.
Institutional Investors. Large institutional investors have consistently called for greater attention to HCM in their engagement with public companies since 2017. The same year, a group of public pension funds introduced a petition for rulemaking on HCM disclosure, which spurred the SEC’s work in this area. Shareholder proposals focused on HCM matters have been gaining ever greater support. BlackRock, an early and particularly active participant in the HCM movement, has advocated for both HCM and climate-related initiatives with equal zeal in recent years. Larry Fink’s 2022 letter to CEOs went even further and focused on HCM as the most urgent priority for corporate CEOs.
Corporate Boards. Boards increasingly treat HCM as a “mission-critical” area of oversight and are changing their practices at the urging of legal advisers, big-four accounting firms, and executive compensation consultants, among others. Board compensation committees have been expanding their remit beyond executive compensation to consider rank-and-file employee compensation and other HCM matters; the same board committees have also started to incorporate HCM metrics (alongside other ESG metrics) in executive compensation plans, which traditionally link incentive-based compensation solely to financial metrics.
Historical and Theoretical Perspectives on the HCM Movement
For all the momentum behind it, the HCM movement appears both ahistorical and undertheorized. My article seeks to fill these gaps by analyzing HCM in the context of prior labor-focused reform agendas, present-day corporate governance debates, and theoretical models of the roles of capital and labor in the firm. Some of the highlights from this analysis are summarized below.
Human Capital Management vs. Prior Labor-Focused Reform Agendas in U.S. Corporate Law. The appropriate role and status of employees in corporate governance, if any, is one of U.S. corporate law’s evergreen questions. Over the years, there have been a wide variety of labor-focused reform proposals, all largely unsuccessful, which can be grouped under three overlapping agendas. First, the worker empowerment agenda encompasses proposals to give employees various governance rights akin to rights presently enjoyed by shareholders alone (e.g., the ability to elect directors), with the expectation that this would, in turn, rebalance the allocation of the firm’s surplus between shareholders and employees. Second, the worker-shareholder agenda seeks to encourage workers to make more active use of the financial capital they hold through their savings (and the governance rights embedded in that capital) in order to advocate for labor-friendly reforms, again leading to a greater share of the firm’s surplus being allocated to workers. Finally, the stakeholder primacy agenda urges a redefinition of corporate purpose to encompass stakeholder (and, by extension, employee) interests, while holding the means of corporate governance relatively intact.
Despite sharing obvious thematic similarities with the historical labor-focused reform agendas, the HCM movement is fundamentally different (at least in its current iteration). Unlike those prior proposals, HCM initiatives change neither the means nor the ends of corporate governance. Instead, HCM spotlights the appropriate management of human capital assets, arguing that it is as important to firm performance and shareholder returns as the appropriate management of physical and financial assets. As such, workers are, at best, indirect beneficiaries of HCM-focused initiatives; by contrast, workers are the direct beneficiaries of the older reform proposals. Moreover, whereas two out of the three historical reform agendas envision an active role for workers in corporate governance (e.g., electing directors or engaging in shareholder activism), HCM initiatives treat workers as passive subjects of enhanced disclosure and board deliberations.
Workers as Assets vs. Workers as Investors of Human Capital. Some of the traditional theoretical justifications for enhancing the role of workers in governance have been premised on the notion that workers can be viewed as investors of human capital, not dissimilar from shareholders who invest financial capital in the firm. According to this argument, just as shareholders make a firm-specific investment when they purchase stock, so, too, do employees make a firm-specific investment when they enter into an employment relationship. In the case of shareholders, the firm-specific investment is induced and protected through the variety of property and control rights embedded in corporate law, and, the argument goes, some of the same rights should be extended to employees in order to induce and protect their firm-specific investment. An important yet heretofore unexamined characteristic of HCM initiatives is that they do not subscribe to this “workers as investors of human capital” model. Instead, HCM initiatives usually start by identifying workers (or workers’ human capital) as an “asset” that is key to firm success and then focus on strategies for the optimal management of this asset in the interest of shareholders. For this reason, the HCM movement currently fits with traditional shareholder-centric approaches to corporate governance.
Critiques and Recommendations
Since all available indicators suggest that HCM is here to stay, what should we make of it? The article argues that HCM is a positive and much-overdue development in U.S. corporate governance. By shining a spotlight on a key driver of firm success in the modern knowledge-based economy, corporate disclosure about HCM matters contributes to more accurate firm valuation and more informed investor decisionmaking. In addition, greater HCM oversight by boards and board committees ensures that firms focus appropriately on the management of the full range of factors contributing to firm success. Nevertheless, challenges remain.
HCM and Corporate Boards. The large public companies at the forefront of the HCM movement have been right to identify HCM as a key area of board oversight, not least because the mission-critical nature of human capital raises the specter of Caremark liability for oversight failures. Considerably more work needs to be done, however, on determining the optimal locus of expertise and control over HCM within the board and board committees, and as between the board and management. Drawing on neo-institutional theories of organizational behavior, the article discusses the dangers of firms copying HCM practices from one another under conditions of uncertainty and in a quest for legitimacy (known as mimetic isomorphism), and of actors without the requisite expertise exerting pressure or imposing mandates pertaining to HCM (known as coercive isomorphism). There is reason to believe that BlackRock in particular has become just such an actor: Whereas previously it had framed its detailed list of HCM practices as mere recommendations, it now expects compliance and admonishes boards that they would be “held accountable” for non-compliance. Moreover, BlackRock’s investment stewardship team appears under-resourced, both in absolute terms (45 or so analysts covering approximately 16,000 companies across 85 markets worldwide) and relative to comparable operations, such as proxy advisors and rating agencies.
HCM and the SEC. The SEC’s 2020 HCM rule did not list specific disclosure items, but, instead, required HCM disclosure “to the extent such disclosure is material to an understanding of the [company’s] business taken as a whole.” The SEC characterized this as a “principles-based” approach to disclosure based on a traditional understanding of materiality. The issue of materiality in the context of SEC rulemaking is complex and contested – and will likely remain so for some time to come. Based on a detailed analysis of the relevant caselaw and historical regulatory practices, I conclude that the SEC’s traditional materiality-based approach to disclosure does not preclude the SEC from requiring firms to provide qualitative and quantitative information on specific HCM topics (sometimes referred to as “line-item disclosures”). To the contrary, a proper understanding of materiality suggests that, once the SEC has identified a general subject area that is material to investors, the SEC has a responsibility to come up with detailed guidance or an information-generating framework that ensures the informational integrity of public companies’ disclosures in this area. There are several precedents for such detailed information-generating frameworks developed by the SEC, including on topics such as executive compensation, asset-backed securities, oil and gas assets, and others. The same approach is needed for HCM information. This conclusion is confirmed further by recent evidence showing that the principles-based HCM disclosure rule has failed to meet the expectations the SEC stated upon its adoption (i.e., to generate “meaningful qualitative and quantitative disclosure, including, as appropriate, disclosure of metrics that companies actually use in managing their affairs”), a point I discussed further in a June 2021 comment letter.
In light of this analysis, my article called for a second round of SEC rulemaking on HCM. Soon after his confirmation, SEC Chair Gary Gensler placed HCM back on the SEC’s agenda, alongside climate-related disclosure, and a rule proposal is expected during the first half of 2022. The new rulemaking should focus on standardization and comparability, drawing on work done by investor groups, such as the Human Capital Management Coalition, and various standard-setters, including SASB (soon to be subsumed by the ISSB). The SEC will have to contend with multiple issues during the rulemaking process, including (again) the meaning of materiality, opposition from issuers and special interest groups, and near-certain legal challenges on various grounds (e.g., statutory authority, materiality, cost-benefit analysis, First Amendment/compelled speech, and perhaps even “major questions”). As I proposed, one potential way to mitigate the risk of ESG disclosure being derailed by legal challenges could be to pursue a two-track approach: detailed mandatory rules with a delayed implementation date, coupled with comply-or-explain disclosure requirements on the same topics effective immediately, on the theory that the latter are more likely to withstand a legal challenge and would represent a valuable improvement from the status quo even if the mandatory rules are ultimately struck down.
HCM and Financial Accounting. FASB has kept a very low profile in ESG debates to date, though this position is no longer tenable given new pressures from investors and the SEC. There are some relatively easy steps FASB can take in the HCM area. FASB should require firms to break down workforce training expenses and employee compensation expenses as separate line items on the income statement. These represent the most significant human-capital-related expenses incurred by firms, but, in both instances, they are lumped together with other expenses – obscuring relevant information and making it impossible to compare firms on these important HCM dimensions.
Reflecting human capital on the income statement through expense breakdowns is considerably easier than reflecting human capital on the balance sheet – a problem that applies not only to human capital but to other intangible assets as well. Yet, approximately 90 percent of all assets held by firms in the S&P 500 today are intangible assets. The fact that the vast majority are missing from firms’ balance sheets contributes to ever-growing criticism of the utility of financial statements under current accounting rules. As noted in the article, there is a deep and extensive literature on human resource accounting dating back to the 1960s, which has developed solutions to many of the measurement and reporting challenges. Even though neither FASB, nor participants in the HCM movement, nor the SEC have engaged with this body of work to date, doing so is likely to further the goals of the HCM movement.
Why Analysis of ESG Without HCM is Incomplete
It is worth recalling HCM’s place in the larger ESG landscape. As we have seen, HCM falls firmly under the ESG umbrella, but there are also notable qualitative differences between climate-related initiatives, which have been getting the most scholarly attention, and HCM initiatives, which are often overlooked. HCM deals in large part with the productive capacity of labor as an all-important factor of production, and human capital is considered an intangible asset. By contrast, climate-related ESG matters focus on significant business risks (including risks to physical assets) and on societal externalities. Few would disagree that the management of intangible assets and the management of risks and externalities involve distinct corporate governance strategies, challenges, and legal considerations. Consequently, neither climate alone nor HCM alone can serve as a proxy for ESG – both are indispensable to ESG analysis.
 Professor Jon Macey recently observed: “Few concepts have come to dominate an academic discipline as quickly as Environmental, Social, and Governance (ESG) has come to dominate the field of corporate law.”
 In recognition of the ostensible absence of employees from the ESG acronym, the distinguished commentator and jurist Leo Strine has proposed a new term – “EESG” – with the first “E” standing for “employees.” While this intervention helpfully puts employees front and center, it also has downsides. Foremost, it may contribute to the misperception that workforce matters are not part of already-existing ESG initiatives on the ground. For this reason, it may be preferable to focus not on rebranding ESG as EESG, but on working with the existing ESG acronym, which is already ubiquitous both in the United States and globally.
 For example, workforce training expenses are part of SG&A, a catch-all line item that covers overhead expenses ranging from marketing, to professional services, to office supplies. SG&A often hides inefficiencies, and, understandably, investors view high SG&A amounts, or year-on-year increases in SG&A, as a negative signal about the firm’s current operations and future prospects (and vice versa). Currently, a firm can improve SG&A – and investor perceptions – by simply cutting workforce training expenses, a move that is quicker and easier than tackling structural business problems, but which is also likely to be detrimental to future performance.
This post comes to us from Professor George S. Georgiev at Emory University School of Law. It is based on his recent article, “The Human Capital Management Movement in U.S. Corporate Law,” available here.