Ex-SEC members call for mandatory human capital reporting

Jun 15, 2022
Academics say change needed after ‘explosion’ in value derived from human capital

A group of 10 academics, which includes former SEC commissioners and a former general counsel at the regulator, is calling for mandatory reporting on human capital.

The Working Group on Human Capital Accounting Disclosure submitted a petition to the regulator, arguing that there has been ‘an explosion of… firms that generate value due to the knowledge, skills, competencies and attributes of their workforce’ over the last couple of decades – but that reporting requirements have failed to keep up with the changes.

‘Despite the value generated by employees, US accounting principles provide virtually no information on [company] labor,’ it adds. ‘An increasing proportion of public companies derive much of their value from intangible assets, including human capital – yet roughly only 15 percent of those firms even disclose their labor costs.’

The group argues that the practice of reporting a loss for accounting purposes makes the analysis of company operational costs – ‘the most significant of which is likely to be labor’ – more important than ever to understanding company value.

The group counts former SEC commissioners Joe Grundfest and Robert Jackson as well as former SEC general counsel John Coates among its members.

Calling on the SEC to improve transparency, the group says investors need to be able to distinguish between labor costs and investment in the workforce, saying labor needs to be treated in the same way as R&D.

Speaking to Bloomberg, Grundfest says ‘current accounting rules give us more information into the economic consequences of buying or leasing a drill press than of hiring and training a software engineer…. How much sense does that make in today’s world?’

Companies should be detailing – in the management discussion and analysis [section of their financial reporting] – what portion of labor costs they view as an investment and why, says the group: ‘This would allow investors better insight as to what portion of labor costs should be capitalized in their own models – and incentivize management to consider employees as a source of value creation.’

While it acknowledges ‘some observers’ reluctance to mandate detailed disclosure’ of the kind the group is calling for, the academics say ‘the SEC has long used the combination of qualitative and quantitative disclosure proposed here in the design of its disclosure rules’, citing the SEC’s executive-pay disclosure rules, in place since 1992.

‘Those rules have sometimes required issuers to generate information solely for the purpose of producing the data [required]. By contrast, issuers must already produce much of the information that would populate our proposed grid for purposes of tax reporting,’ the group argues.

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