Could disclosure modernization open the door to a need for more nonfinancial reporting?
By Paul Washington and Gary Larkin
With the recent SEC proposal on human capital management (HMC) disclosure, companies have an opportunity to establish an important precedent for reporting on other non-financial areas – potentially as part of broader “integrated reporting” in the future.
In August, the SEC included principles-based HCM disclosure in its Regulation S-K disclosure modernization proposal. This action reflects the SEC’s recognition that human capital should be considered an asset, rather than just a cost, for companies. Speaking to the SEC’s Investor Advisory Committee in February, SEC Chair Jay Clayton noted that the relevant parts of Regulation S-K were adopted back when companies’ most valuable assets were plant, property and equipment, and human capital was primarily a cost. “But now, human capital and intellectual property often represent an essential resource and driver of performance for many companies,” he said.
The SEC’s action may also help open the door in the future for requiring public companies to disclose additional nonfinancial information in their SEC reports. While still nascent, there is a movement toward integrated reporting in which companies would, as part of their SEC reports, provide disclosures on the six types of “capital” relating to value creation. In addition to human capital, the others are financial, manufactured, intellectual, social and relationship, and natural capital.
The Conference Board recently published a paper with guidance for U.S. public companies considering integrated reporting. Among other recommendations, the Conference Board suggested the following:
Adopt a framework and standards specific to your company. Companies should tell their stories in plain English and tailor their disclosures to their industry and specific business – taking into account financial materiality – and not just simply adopt one of the many external reporting frameworks that are available.
Start with “bifurcated” and off-cycle reporting of financial and nonfinancial matters. Separating the cycles of required financial reporting from other nonfinancial disclosures (which would not, at the outset, be included in SEC reports) is a pragmatic step toward meeting investor expectations while addressing company concerns regarding the administrative burdens and legal concerns related to such reporting.
Given that the proposed SEC proposal on principles-based human capital management disclosure could serve as a template for future nonfinancial disclosures, companies have an important opportunity to shape future discourse on this topic. With that in mind, here’s a checklist for companies as they consider human capital management disclosures:
- In addition to ensuring that you meet regulatory requirements, provide sufficient information to address investor expectations, thereby helping to reduce the risk of additional mandates.
- Tailor human capital management disclosures to industry- and company-specific circumstances.
- Focus disclosures on those that relate to the company’s capacity to execute its business plans – i.e., whether the company has the workforce and hiring, retention, development, diversity and inclusion, and other programs to support the execution of its strategy.
Be mindful that your disclosures may serve as a template for future requirements – whether imposed by regulation or by stakeholders.
With obligations come opportunities. By providing meaningful disclosure on human capital management tailored to a company’s particular business, companies can not only provide useful information to investors, but also have a powerful impact on the future of integrated reporting.
Paul Washington is the executive director of the ESG Center at The Conference Board. Gary Larkin is a Research Associate at the Center.