Do the recently mandated human capital disclosures (HCDs) have value implications for asset prices, and if so, do they affect shareholders and debtholders in the same way?
Our recent study examines the information content of newly mandated HCDs for shareholders and debtholders. Importantly, we show that firms’ HCDs are not purely boilerplate and convey information about firms’ human capital that was previously non-public.
Despite widespread recognition that human capital is instrumental to value creation, firms were historically not required to disclose about this key intangible asset. In an attempt to remedy this disclosure vacuum, institutional investors urged the SEC to require disclosure about firms’ human capital, leading the SEC to require a description of firms’ material human capital resources in their annual reports (10-Ks) from November 9, 2020 onwards.
Notably, the new mandatory human capital disclosure requirements are principles-based and do not require disclosure of specific human capital metrics. Because of this, many commentators on the new requirement expressed concern that HCDs are uninformative for investors because firms have broad discretion on what to disclose. For example, the SEC Commissioner Allison Herren Lee expressed dissent on the SEC’s final rule, voicing concern that “the proposal leaned too heavily on principles- based disclosures…I would have supported today’s final rule if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity. But we have declined to take even these modest steps.”
On the other hand, prior research has shown that other principles-based mandatory disclosures (such as risk factor disclosures) provide multiple stakeholders with information that is relevant to firm value. Prior research has shown that such mandatory disclosures may be informative because of externalities or because they mitigate market failures, such as information asymmetry, that cannot be resolved with existing governance mechanisms. Further, HCDs may be informative because they alleviate investor uncertainty about firms’ intangible human capital-based assets or facilitate comparison with industry peers.
Even if HCDs are informative, however, it is ex ante unclear whether they affect shareholders and debtholders in the same way. Investments in human capital may increase overall firm value, so multiple stakeholders, including employees, shareholders, and creditors may all enjoy such benefits. However, investments in human capital may affect debtholders differently from shareholders. This is because debtholders primarily bear downside risk, while shareholders benefit from the upside potential of risky investments that consume existing financial resources but which may be detrimental to debtholders. Similar to other intangible investments, the future payoff to human capital investments is inherently risky and uncertain, and debtholders may respond adversely to HCDs because employee claims usually have higher priority than unsecured bonds in the bankruptcy courts. Thus, we test the joint hypothesis that the initial HCDs contain value-relevant information and that such disclosures’ value implications may differ depending upon stakeholders’ payoff functions.
We collect and read 1,636 firm HCDs in firms’ annual reports that were filed on or after November 9, 2020 (the first year for which HCDs were required), and assigned them to 13 subcategories: 1) Diversity & Inclusion; 2) Employee Development; 3) Safety & Health; 4) Compensation; 5) Engagement; 6) Tenure; 7) Culture; 8) Recruitment; 9) Pay Equity; 10) Succession Planning; 11) Employee Statistics; 12) Labor Relations, and 13) CSR. The three HCD subcategories discussed most commonly are 11) Employee Statistics, 1) Diversity & Inclusion, and 3) Safety & Health. 77.2% of the sample firms disclose between four and seven subcategories in their HCDs. On average, firms in our sample disclose 365 words in their HCDs, and firms tend to focus on topics (3) Safety & Health (mean word count = 103) and (1) Diversity & Inclusion (mean word count = 93) in their HCDs.
To test if HCDs reflect employee welfare and are not purely boilerplate, we build a mandatory HCD determinant model by first regressing the amount of qualitative HCD on existing publicly available human capital management information and other firm characteristics before the annual report filing dates. In addition, we examine whether the mandatory HCDs are associated with one specific type of non-public information—employee turnover. We show that qualitative HCDs are positively associated with publicly available human capital information, and negatively associated with employee turnover, suggesting that HCDs reflect employee welfare and are not purely boilerplate.
We examine signed equity and bond market reactions to the newly mandated HCDs to examine their information content. First, we show that greater mandatory HCD is associated with a positive abnormal equity market reaction. Further, we conduct a factor analysis and show that the equity market reacts positively to the first, second, and fifth factors. The first factor represents a combination of disclosure relating to Diversity & Inclusion, Safety & Health, Employee Development, and CSR. Employee Recruitment and Tenure represent the second, while the fifth factor represents Employee Statistics. Interestingly, the first two factors correspond well with the two facets of human capital described in prior research on voluntary disclosure, in which factor one relates to social-oriented topics and factor two to operational-oriented topics.
Next, we find that the bond market reacts negatively to the newly mandated HCDs. The negative bond market reaction shows that debtholders are concerned about the risks associated with intangible human capital investment and the potential dilution of debtholder claims outweighing the increase in firm value. This negative bond market reaction is determined by the first and third factors that are related primarily to firms’ social-oriented human capital, including Diversity & Inclusion, Safety & Health, CSR, Labor Relations, Employee Engagement, and Compensation.
Our research contributes to the emerging HCD literature and complements existing research by examining the information content of the initial mandatory HCDs and their value implications based upon the direction of short-window market reactions. In particular, we document that equity and bond investors respond in the opposite manner to socially oriented human capital disclosure topics such as Diversity & Inclusion and CSR, which highlights the contrasting value implications of human capital for shareholders and debtholders.
Salman Arif is an Assistant Professor of Accounting at the Carlson School of Management of the University of Minnesota, Twin Cities.
Yeo Sang (Johnny) Yoon is a Ph.D. candidate of Accounting at the Carlson School of Management of the University of Minnesota, Twin Cities.
Haiwen (Helen) Zhang is a Professor of Accounting at the Carlson School of Management of the University of Minnesota, Twin Cities.
This post is adapted from their paper, “The Information Content of Mandatory Human Capital Disclosures—Initial Evidence,” available on SSRN.
