The Watson Wyatt Human Capital Index study found that a significant improvement in 30 key areas of human capital management is associated with a 30 percent increase in market value. The practices identified in the study were grouped into five key dimensions:
- recruiting excellence;
- clear rewards and accountability;
- a collegial, flexible workplace;
- communications integrity;
- and prudent use of resources.
The year-long 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 (TRS) and a minimum of $100 million in revenue or market value. The survey data was matched to objective financial measures of a company's value, including its market value, three- and five-year TRS, and its Tobin's Q, which measures a company's ability to create economic value beyond its physical assets. Based on this analysis, each company was given a Human Capital Index score on a scale of 1 to 100.
"At a time when virtually all companies say that people are their most important asset, this study begins the process..." says Ira Kay, Ph.D., North American director of Watson Wyatt's human capital group. "We found a clear relationship between the effectiveness of a company's human capital and shareholder value creation. Companies with a high index had high shareholder value; those with a low index had low shareholder value."
The study shows a strong relationship between human capital and shareholder value creation over both the short and long term. Over a five-year period, TRS was nearly twice as much for high-index companies (103 percent) compared to companies with a low index (53 percent). Over a recent six-month period (Jan-Jun 1999), high-index companies reported 28 percent TRS versus a negative 6 percent return for companies with a low index.
Key Dimensions for Creating Greater Shareholder Value Overall, the study showed that significantly improving 30 human capital practices within four of the major dimensions is associated with a 30 percent increase in shareholder value creation.
HCI Dimension Expected Change in Market Value Associated with a Significant Improvement in HCI Dimension Recruiting Excellence 10.1% Clear Rewards and Accountability 9.2% Collegial, Flexible Workplace 7.8% Communications Integrity 4.0%
Recruiting Excellence Recruiting excellence has the largest potential increase among the five areas. The study's data show that a significant improvement in recruiting excellence is linked to a 10 percent increase in market value. Of the six critical recruiting practices with a positive correlation to market value, the two most important ones are hiring professionals who are well equipped to perform their duties, and specifically designing recruiting efforts to support a company's business plan. Each of these practices is associated with a 2.3 percent gain in market value.
"One of the greatest challenges facing organizations today is their ability to attract and retain talent. For those companies that do it well, the rewards are great Ñ lower turnover and longer tenures among key employees, and improved ability to generate economic value," notes Bruce Pfau, Ph.D., national director of organization measurement at Watson Wyatt .
Clear Rewards and Accountability The second largest increase in market value (9.2 percent) was found among companies that have clearer rewards and accountability. The study identified three practices that are associated with a 1.8 percent gain in market value: making employees eligible for stock plans, terminating employees who perform below acceptable levels, and helping poor performing employees improve. Positive gains in market value were found among companies that pay above-market wages, link pay to their business strategy, use employee performance appraisals to set pay, and link profit-sharing plans to the company's overall success.
Collegial, Flexible Workplace The study showed that a significant improvement in operating a collegial, flexible workplace the third major area is linked to an increase market value of nearly 8 percent. Among the specific workplace practices associated with an increase in market value are offering flexible work arrangements, encouraging teamwork and cooperation, providing equal perquisites, having high employee satisfaction, and using first names between employees and top management.
Communications Integrity The fourth major area that correlates to greater shareholder value is communications integrity, associated with a 4 percent increase in a company's market value. Of the five specific communication practices identified in this area, the most relevant is the accessibility of communication technologies, primarily e-mail, which correlates with an 1.8 percent gain in shareholder value. Other practices that are associated with increased shareholder value are giving employees the opportunity to offer ideas and suggestions to senior managers, and sharing financial information with employees.
Prudent Use of Resources - Possible Negatives According to the study, certain practices that conventional wisdom applauds, such as 360-degree feedback and general training programs, are actually linked to lower market value. These counterintuitive findings are grouped together in the fifth dimension of the index called the Prudent Use of Resources. Prevalence of these programs did not correlate with added economic value but rather was associated with a 10 percent decrease in market value.
"While there is nothing inherently wrong with these practices, many companies implement them in misguided ways," says Pfau. "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, including 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.
The link between human capital and value creation is the most compelling issue human resource managers are facing today, observes Pfau. "The 30 key human capital practices we've identified in this study are what companies absolutely must focus on and get right for them to truly create a link between human capital and shareholder value creation."
Organizations that want to determine their own Human Capital Index can complete a 36-item questionnaire and receive customized results. For more information call Watson Wyatt at 1-800-388-9868.
panies that have superior human capital practices create superior returns for their shareholders. Recruiting excellence, not surprisingly, produces the highest returns. Only one area of human resource practice tends to produce negative returns, and that is under the category of "prudent use of resources". The study found that training not related to immediate job performance and 360 degree feedback can be counter-productive in some situations.