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Corporate Reputation Review Volume 14 Number 2

www.palgrave-journals.com/crr/

ABSTRACT In our knowledge-based economy, successful companies ’ most important assets are intangible – such as their human capital. However, few companies provide their stakeholders with de- tailed information about this resource, as they do not adequately assess the value of such re- porting. Nevertheless, against the background of the corporate social responsibility discussion, providing human capital information is becom- ing increasingly important as a key driver of corporate reputation. Human capital reporting (HCR) can also be regarded as an instrument that may affect company financial performance and ultimately increase shareholder value. Against this background, we develop a theo- retical model that illustrates the transformation of the intangible factors of HCR into tangible outcomes. Consequently, the model considers the various cause-and-effect relationships bet- ween HCR and company financial perform- ance. As with a strategy map, three dimensions with a specific number of different intangible factors should be taken into consideration. Ultimately, the model reveals the benefits of HCR. Corporate Reputation Review (2011) 14, 145 – 155. doi: 10.1057/crr.2011.11

KEYWORDS: disclosure ; human capital reporting ; human capital management ; intangi- bles ; management accounting

INTRODUCTION Human capital can be considered the most important driving force behind innovation creation ( Bontis, 1998 ; Lev, 2001 ; Zingales, 2000 ). Thus, it is a key factor for sustainable competitive advantage ( Huselid, 1995 ; Pfeffer, 1994 ; Prahalad and Hamel, 1990 ; Wright et al. , 1994 ). Furthermore, human capital is often mentioned as a company ’ s most im- portant resource (eg, Guenther and Beyer, 2003 ; Sveiby, 2001 ). Hence, human capital is highlighted by the strategic management approach against the background of the resource-based view ( Barney, 1991 ; Grant, 1996 ; Penrose, 1959 ; Prahalad and Hamel, 1990 ).

Human capital can be defi ned as a com- pany ’ s achievement potential with regard to its workforce, its labour capacity and its workforce capabilities. It includes the knowledge and capabilities of the company ’ s workforce, as well as its motivation to make use of those qualities (eg, Becker, 1983 ; Schultz, 1961 ). Accordingly, human capital reporting (HCR) can be defi ned as a com- pany ’ s reporting system, which provides in- formation about its workforce ’ s knowledge, capabilities and motivation. Comprehensive reporting enables the recipients of such information to gain better insights into hu- man capital potentials and properties. Hence, it becomes easier to assess the company ’ s

The Positive Effects of Human Capital Reporting

Ramin Gamerschlag Chair of Management Accounting and Control, Faculty of Economic Sciences, University of Goettingen , Germany

Klaus Moeller Professor for Performance Management / Controlling, Institute of Accounting, Control and Auditing, University of St. Gallen, Swizerland

The Positive Effects of Human Capital Reporting

market position and to accurately evaluate its value creation potential ( Kaplan and Norton, 2004a ; Lev, 2001 ). This can in- crease the company ’ s attractiveness and rep- utation.

Literature and practice offer a great many different concepts for measuring intangibles in general and human capital in particular (eg, Andriessen, 2004 ; Bontis et al. , 1999 ; Edvinsson and Malone, 1997 ; Fitz-enz, 2000 ; Lev, 2001 ; Neely et al. , 2002 ; Roos et al. , 2004 ; Stewart, 1999b ; Sveiby, 2007, 1997 ). Indicator-based and value-added approaches are often mentioned, specifi cally the balanced scorecard ( Kaplan and Norton, 1992, 1996 ), the strategy map ( Kaplan and Norton, 2004a, b ) and the economic value- added ( Stern et al. , 1996 ; Stewart, 1999a ). However, there has to date been no consist- ent understanding of reporting on intangi- bles or on human capital ( Wyatt et al. , 2004 ).

Although companies tend to provide members of the public with detailed infor- mation about their investments in tangible and fi nancial assets, most of them neglect to provide meaningful information about the value of their workforce (eg, Lev, 2001, 2004 ; Stewart, 1999b ). External reporting focuses almost entirely on fi nancial data, while intangible values like human capital are not adequate considered ( Lev, 2001 ). Thus, a large portion of a company ’ s re- sources does not appear on the balance sheet ( Ross et al. , 2008 ). One reason for neglect- ing to provide such information is that the potential profi t from intangible resources might not be visible ( Marr, 2006 ; Stewart, 1999b ). Nevertheless, future fi nancial suc- cess is primarily based on such intangible values ( Lev, 2001, 2004 ; Spender and Grant, 1996 ; Stewart, 1999b ; Teece, 1998 ): in a knowledge-based society, intangible values like human, structural and relational capital are the key drivers of sustainable competi- tiveness of companies and economies. Especially innovations are primarily achieved

by investments in intangibles. When these innovations are commercially successful, they are transformed into cash fl ows and increase corporate value. Hence, intangibles can be regarded as claims to future values ( Lev, 2001 ). Consequently, the non-provision of information about intangible resources can lead to a discrepancy between compa- nies ’ valuation by external parties and their real economic situations. HCR can be used to reduce this gap ( Lev, 2001 ).

Furthermore, HCR can contribute to a company ’ s reputation since reporting on human aspects is associated with other cor- porate social activities and social disclosures. Against the background of the corporate social responsibility debate, a company ’ s relationship with its employees is gaining importance and is increasingly watched by members of the public. Since reporting shows how a disclosing company deals with its employees, HCR is able to improve corporate image and reputation through targeted communication with key stake- holders – for example, customers, investors, employees and prospective employees. In addition (satisfi ed), employees might act as multipliers, and thus, can positively infl u- ence corporate reputation.

Nevertheless, few companies provide members of the public with meaningful information about their workforce. High- lighting the benefi ts of reporting activities could therefore help comprehensive HCR implementation. In this paper, the advan- tages of this will be highlighted, which should advance the discussion of HCR. Ultimately, there should be clarity about HCR benefi ts from the perspectives of both reporting companies and stakeholders.

INTERNAL EFFECTS AND THE BENEFITS OF HCR To highlight the benefi ts of HCR, there must be clarity about the underlying cause- and-effect relationships. Visualising these relationships can help one understand how

Gamerschlag and Moeller

intangible factors – such as human capital – are transformed into tangible results ( Kaplan and Norton, 2004a, b ; Marr, 2006 ; Marr et al. , 2004 ). Subsequently, it should be possible to derive the benefi ts of HCR. Against this background, we developed a theoretical model comprising a section of a company ’ s value-adding process that focuses on human capital. Similar to a strategy map ( Kaplan and Norton, 2004a, b ), the model has a cause-and-effect system that links a company ’ s human capital with its fi nancial performance, while taking three factor levels into consideration (see Figure 1 ).

It should be noted that the model also considers the indirect relationships between the different factor levels, as well as possible back couplings ( Moeller, 2009 ) and direct cost effects in the sense of a direct cost re- duction. The relationships, back couplings and effects comprise:

1. Workforce-related factors (human capital): These include the workforce ’ s capabilities as well as its motivation and commitment. Hence, it is possible to equate workforce- related factors with a company ’ s human capital. Furthermore, it is clear that all of these factors are interconnected, because they continuously infl uence one another ( Guenther and Neumann, 2005 ). Work- force-related factors thus directly infl u- ence company-internal factors.

2. Company-internal factors (structural capi tal): These include a company ’ s per- formance, its innovation ability as well

as its corporate culture. These factors describe the company ’ s internal processes and can be regarded as its core compe- tencies, which competitors fi nd diffi cult to imitate. These internal factors mostly result from workforce abilities and consti- tute one of the most important drivers of competition ( Prahalad and Hamel, 1990 ). Consequently, these competencies are often called the ‘ personality of the com- pany ’ ( Drucker, 1995 ). The internal factors therefore directly infl uence the company-external factors.

3. Company-external factors (relational capital): These are parameters outside the company that are relevant to a company ’ s success. They are refl ected in a company ’ s attractiveness and reputation, as well as in the level of need satisfaction of service provision, thus concerning particular stakeholders. These external factors have a direct infl uence on the company ’ s mar- ket value. They can be regarded as the link between a company and its environment, and enable sustained value creation. Thus, the company-external factors are directly refl ected in the fi nancial outcome.

The fi nancial outcome can be regarded as a company ’ s output quantity. In this context, either fi nancial performance or shareholder value represents this fi nancial outcome. Within the value-based view, fi nancial performance is the company ’ s main goal ( Rappaport, 1998 ). Financial outcome can, however, be infl uenced by increased

Workforce- related factors

Company- internal factors

Company- external factors

Financial outcome

direct cost effects

back couplings

Figure 1 : Cause-and-effect model of human capital

The Positive Effects of Human Capital Reporting

revenues or decreased costs. All the above- mentioned factors have a direct or indirect infl uence on fi nancial performance, either through an increase in returns or a decrease in costs.

HCR can be used to positively infl u- ence the factors on all of these levels by improving transparency, as well as a com- pany ’ s control of its objectives. Since the availability of crucial information is the main requirement for making well-founded deci- sions, HCR can improve the quality of managers ’ decision making. Consequently, the benefi ts of HCR can be directly derived from these workforce-related factors, inter- nal factors and external factors by improv- ing them. Furthermore, it is possible to identify additional HCR benefi ts between the different factor levels. Finally, HCR can positively infl uence a company ’ s fi nancial performance. In the following three sec- tions, the cause-and-effect relationships bet- ween the three factor levels and the specifi c benefi ts of reporting activities will be examined.

Workforce-Related Factors Workforce-related factors can be divided into workforce motivation, workforce capa- bility and workforce commitment, which include the resulting workforce loyalty. All these factors are directly infl uenced by the two effects of HCR: transparency and controllability. Improving these factors can be regarded as the direct benefi ts of HCR.

Increase in workforce capabilities : Workforce capabilities include individual employees ’ competence and qualifi cations, and result from their education and experience. By training its staff, a company can infl uence and improve their capabilities. By using HCR, a company can further improve its workforce ’ s capabilities due to the increased transparency, improved con- trollability ( Edvinsson and Malone, 1997 ), enhanced workforce motivation and improved workforce commitment that it provides. Against this background, the infl uences shown in Figure 2 come into effect. The results that can be derived from improved workforce capabilities are revealed in an increase in job performance ( Bartel, 1994 ; Guenther and Neumann, 2005 ; Huselid, 1995 ), as well as in an increase in the company ’ s knowledge base (owing to training activities, the employees ’ accu- mulated knowledge improves), which is positively refl ected in the internal factors.

Increase in workforce motivation : Workforce motivation examines individual employee willingness to perform to the company ’ s objectives. Together with workforce capa- bility, workforce motivation is highly sig- nifi cant for a company. In addition, by means of HCR, a company can improve workforce motivation by increasing com- pany transparency (the decisions and struc- tures become more transparent, which positively infl uences motivation), workforce

(increase in)

workforce capabilities

increase in job performance

increase in knowledge base

controllability and transparency

workforce motivation

workforce commitment

company- internal factors

unilateral effect bilateral effect (interaction)

Figure 2 : Effects and benefits of increased workforce capabilities

Gamerschlag and Moeller

capability and commitment ( Atkinson et al. , 1997 ). The results of improved work- force motivation are an increase in job performance ( Becker, 1983 ; Huselid, 1995 ), a decrease in absenteeism and improved knowledge-sharing as a result of im- proved communication between employ- ees ( Bontis and Fitz-enz, 2002 ). These effects directly influence the company-internal factors.

Increase in workforce commitment : Workforce commitment can be described as the emp- loyees ’ emotional allegiance or their identi- fi cation with their employer. It is based on their acceptance of the company ’ s goals and values. Workforce commitment normally leads to employees being highly loyal to their employer. Consequently, it is possible to regard workforce commitment and loy- alty as one entity ( Mowday et al. , 1982 ). Workforce commitment is directly infl u- enced by transparency and controllability, as well as by workforce motivation. The results that can be derived from enhanced workforce commitment are a decrease in turnover costs (fewer employees leave the company), an improved company knowl- edge base (knowledge does not leave the company as it does when employees con- tinue to leave), improved performance ( Riketta, 2002 ; Siders et al. , 2001 ) and, fi nally, an increase in customer loyalty (the ‘ one face to the customer ’ does not often leave the company).

Company-Internal Factors The internal factors include operational performance, innovation ability and organi- sational culture. These factors are directly infl uenced by transparency and controllabil- ity (enabling targeted intervention), as well as by workforce-related factors. Improve- ment in the internal factors can be consid- ered indirect benefi ts of HCR.

Increase in innovation ability : This is a compa- ny ’ s ability to continuously create innova- tions to protect or create future competitive advantages and cash fl ows. From this long- term perspective, competitiveness results from a company ’ s ability to create new knowledge and integrate it into new prod- ucts ( Johnson, 2002 ; Nonaka, 2007 ). Hence, a company ’ s innovation ability can be equat- ed with either its sustainability or its surviv- ability. Furthermore, a company ’ s innovation ability is wholly dependent on its work- force ’ s capability and motivation. Through the various benefi ts that can be derived from workforce-related factors, HCR positively infl uences innovation ability. The expected results of HCR are revealed in improved products, improvement in the product and process development, as well as in the entire company ’ s improved sustainability. Figure 3 summarises the effects and benefi ts of enhanced innovation ability.

Increase in operational performance : In this context, operational performance can be regarded as the processes ’ current capability

(increase in the) innovation

ability

increase in job performance

increase in sharing of knowledge

decrease in absenteeism

improvement in development

increase in sustainability

product improvement

company- external factors

increase in knowledge base

controllability and transparency

Figure 3 : Effects and benefits of an increased innovation ability

The Positive Effects of Human Capital Reporting

to create competitive advantages. From this short-term perspective, the company ’ s com- petitiveness results from the existing prod- ucts ’ price-performance ratio ( Prahalad and Hamel, 1990 ). Hence, it is important to focus on the effi ciency of operational sequences as an outcome of workforce- related factors. HCR can improve the operational performance by, for example, allocating human resources more effectively within a company ( Petty and Guthrie, 2000 ). The results of HCR that can be derived from improved operational performance are improved product quality, lower process costs and a reduction in the required process- ing time.

Improvement in organisational culture : The org- anisational culture includes all the values and cultural norms within the company. A good organisational culture can infl uence company members ’ actions in a positive way. Organisational culture can also be positively infl uenced by well-directed inter- nal communication and enhanced transpar- ency – a core element of a pleasant organisational culture. Increased motivation and commitment of the company ’ s work- force can also lead to an improved work atmosphere. The benefi t of an improved organisational culture (internal perspective) is an improved image and reputation of the company as a whole (external perspec- tive), which has a direct infl uence on the external factors. Furthermore, an improved organisational culture retroactively affects workforce-related factors like workforce motivation ( Neely et al. , 2002 ; Pfeffer, 1998 ) and commitment ( Atkinson et al. , 1997 ) by acting as a multiplier.

Company-External Factors The external factors consist of a company ’ s attractiveness and reputation, as well as the degree to which specifi c stakeholders ’ need satisfactions are met. The external factors are directly infl uenced by transparency and

controllability, as well as by workforce- related factors. They are indirectly infl u- enced by workforce-related factors and directly infl uenced by company-internal fac- tors. An improvement in the external factors can therefore also be regarded as indirect benefi ts of HCR.

Increase in company attractiveness and reputation : This refers to a company ’ s attractiveness and reputation to specifi c external stake- holders. According to the stakeholder approach, the company can be viewed as an instrument to satisfy different stakeholder group needs ( Berman et al. , 1999 ; Donaldson and Preston, 1995 ; Freeman, 1984 ; Frooman, 1999 ; Mitchell et al. , 1997 ; Roberts, 1992 ). In other words, each group of stakeholders evaluate the company according to their specifi c needs (which can be associated with the company ’ s objective, actions and / or outcomes). The results of HCR that can be derived from a company ’ s improved attrac- tiveness and reputation are the simplifi ed acquisition of new customers, suppliers, in- vestors, employees and new cooperation partners, as well as facilitating the obtaining of subsidies (see Figure 4 ). Consequently, an increase in the company ’ s attractiveness and reputation has a direct effect on fi nancial performance.

Increase in the degree of need satisfaction : The degree of need satisfaction describes a com- pany ’ s ability to satisfy specifi c external stakeholder needs. HCR provides these stakeholders with better information. This helps them make better decisions with ease ( Lev, 2001 ; Roos et al. , 2004 ). Thus, infor- mation asymmetry, agency costs and transac- tion costs are reduced ( Botosan, 1997 ; Eisenhardt, 1989 ; Healy and Palepu, 2001 ; Jensen and Meckling, 1976 ). HCR also takes effect indirectly through improved workforce-related factors, internal factors and the resulting benefi ts. Furthermore, due to the enhanced level of need satisfaction, HCR directly affects the company ’ s value

Gamerschlag and Moeller

through the benefi ts obtained from imp- roved satisfaction on the part of customers, suppliers and investors, as well as from co- operation partner loyalty and the facilitation of the obtaining of subsidies. As an entity, the described factors have a direct infl uence on a company ’ s fi nancial performance.

Summary – The Positive Effects of HCR By means of the developed model, it is pos- sible to identify the benefi ts of HCR by taking three levels of (intangible) factors into account: workforce-related factors, company- internal factors and company-external ones. By improving these factors, benefi ts can be derived from HCR. Additional HCR ben- efi ts are also identifi able between these fac- tor levels. Finally, it is possible to verify the impact of HCR on the company ’ s value. Thus, from the company ’ s point of view, HCR ’ s value-added lies in improving the described factors (including their results) as well as in an improved company fi nancial performance. Figure 5 summarises the described model. It shows the three factor levels (workforce-related, company-internal and company-external factors), the fi nancial outcome as well as the effects of HCR (transparency and controllability). If the reporting activities can improve all of these

factors, the company ’ s value must also in- crease.

CONCLUSIONS AND HYPOTHESES While companies tend to provide members of the public with detailed information about their investments in physical and fi nancial assets, they generally fail to provide information about their most important resources – for example, their employees. This paper considers the potential benefi ts of HCR. It describes how a company can improve its fi nancial performance with the help of these reporting activities. Consequently, we developed a model that shows the impact of HCR through various cause-and-effect relationships. The model assumes a positive relationship between workforce-related factors such as workforce capability or workforce motivation, and company fi nancial performance. Due to various cause-and-effect relationships, these workforce-related factors positively infl u- ence company-internal and company- external factors, which can lead to stronger fi nancial performance. The model seeks to show possible positive effects of HCR on fi nancial performance. This paper ’ s contri- bution lies in visualising these relations in an intuitive way and, therefore, in visualising

(increase in the) attractiveness and reputation of the company

improvement in image

decrease in process cost reduction in processing

time

improvement in product quality

product improvement

improvement in development

increase in sustainability

simplified acquisition of new investors

simplified acquisition of new partners

simplified acquisition of new suppliers

simplified obtaining of subsidies

simplified acquisition of new customers

financial performance

simplified acquisition of new employees

controllability and transparency

Figure 4 : Effects and benefits of an increased attractiveness and reputation of the company

The Positive Effects of Human Capital Reporting

all effects of human capital and HCR on the company ’ s fi nancial outcome. Indeed, almost all individual elements of the model have previously been scientifi cally consid- ered. However, according to our knowl- edge, there had been no consolidation of the individual aspects with regard to HCR.

Nevertheless, this paper also offers oppor- tunities for further research. Especially the underlying assumptions of the model must be verifi ed in detail. These assumptions could be tested empirically. The main chal- lenge lies in fi nding a way to converting the contents of HCR into measurable units that can be compared with other measures. One possible way to do this could be to apply (word-based) content analysis for extracting the amount and content of the provided information from corporate reports by focusing on various information categories (eg, Gamerschlag et al. , 2010 ; Guthrie et al. , 2004 ). Thus, this paper can be regarded as a starting point for further research by articulating hypotheses that can be tested in the future.

Since it can be assumed that – due to the voluntary nature of such disclosures – companies only provide human capital information if this information is ‘ good ’ , we posit that

H1: There is a positive relationship between the disclosure of human capital information and workforce ’ s capabilities, motivation and commitment.

These aspects could be evaluated, for example, by ongoing employee attitude surveys, the results of which could be com- pared with the information disclosed by the company. On the basis of previously defi ned questions, these surveys could be conducted on a monthly basis to get timely feedback. The relationship between HCR and company- internal factors should also be considered further, since:

H2: There is a positive relationship between the disclosure of human capital information and company-internal factors, such as organisa- tional performance or innovation ability.

These company-internal factors could be operationalised, for example, by measures such as added value per hours worked or number of implemented suggestions per employee. With regard to company-external factors, we assert that:

H3: There is a positive relationship between the disclosure of human capital information and

operational performance

controllability

transparency

Human capital reporting

increase in returns

cost reduction

attractiveness and reputation

of the company

degree of need satisfaciton

organisational culture

financial performance / value of the

company

back couplings

workforce motivation

workforce capability

workforce commitment

innovation ability

Workforce- related factors

Company- internal factors

Company- external factors

Human capital reporting

Financial outcome

direct cost effects

Figure 5 : Cause-and-effect model of reporting on human capital (full model)

Gamerschlag and Moeller

H3a: the attractiveness and reputation of a com- pany with regard to external stakeholders

H3b: the degree of external stakeholders ’ need satisfaction.

Depending on the specifi c stakeholder group, different measures could be used to verify these hypotheses. With regard to possible employees, for example, the number of (speculative) job applications could be compared with the disclosed human capital information.

If all the identified cause-and-effect relationships are proved, there must be a positive correlation between the provided human capital information and fi nancial performance measures (eg, revenues, turnover, sales or profi t ratios such as return on in- vestment). Thus, we posit that:

H4: There is a positive relationship between the disclosure of human capital information and fi nancial performance measures.

Since investors are interested in their companies ’ (future) fi nancial performance, there should also be a positive correlation between the disclosed human capital infor- mation and the capital market company valuation – for example, represented by share price or market capitalisation. Conse- quently, we assert that:

H5: There is a positive relationship between the disclosure of human capital information and the capital market valuation of a company ’ s shares.

This hypothesis can be verifi ed by using publicly available capital market data. Against this background, the provided human capi- tal information (for example, extracted from corporate reports by means of content anal- ysis) can be compared with the company ’ s capital market performance by applying various valuation models (see Barth et al. ,

2001 ). Furthermore, the value-relevance of specifi c human capital information from the perspective of investors can be evaluated.

The practical implications of this paper can be found in the detailed analysis of the internal benefi ts that can arise from compre- hensive HCR. With the help of the model, it is easier to identify HCR ’ s value-added by understanding the underlying effects. Thus, specifi c benefi ts of reporting can be identifi ed and practical conclusions can be derived. Finally, the model serves as a basis for designing instruments for strategic per- formance management with a focus on human capital. The different dimensions of the model can be operationalised by defi ning key performance indicators, which can ver- ify a company ’ s performance.

This paper ’ s contribution to literature and theory lies in advancing the indicator-based approaches of strategic performance man- agement of the described intangible factors and their interrelationships. Furthermore, this paper identifi es the relevant information that HCR must provide its recipients. This is possible by identifying the most important cause-and-effect relationships of HCR. The specific indicators that can deliver this information are also visualised in the form of different identifi ed factors with the help of the developed model.

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The Positive Effects of Human Capital Reporting

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