I. INTRODUCTION
G
lobal markets and shorter technological life cycles impose highly dynamic conditions on companies across industries. Companies attempt to cope with these changing environments through improvements in many areas, such as investments in human capital to ensure competitiveness. The substantial investments, in this particular area, are justified by the potential of human capital to enhance firm performance and corporate valuation (Madhani, 2012). However, past attempts to quantify returns on these training investments have only shown limited success.
Due to this limited amount of literature in this area, this research paper focuses on two questions regarding investment in human capital. The first question covers whether investments in a corporation’s human capital show economic returns. The relevance of this question derives from the deficiency of adequate measurement techniques to accurately estimate the value of human capital, difficulties with respect to the credibility of disclosure and misinterpretation of training investments by the accounting discipline. For instance, commonly used accounting principles (e.g. IFRS and/or GAAP) do not have specific procedures and policies to handle human capital expenses. This a particular issue in the accounting discipline, as argued by Lev and Schwartz (1971), who state the main reason for this status quo are related to the avoidance of overstating assets and earnings. In comparison, most economists treat human capital on par with other forms of earning assets (e.g. Research and development expenditures). Consequently, the accounting approach only reflects these investments as an economic outflow to stakeholders, without showing the potential benefits of the transaction. This, in turn, may lead to erroneous conclusions and suboptimal resource allocation by all stakeholders. Potential solutions are being developed with the introduction of the TDRP (Training & Development Reporting Principles) and similar guidelines; however, the proper assessment of training expenditures is still particularly challenging. This difficulty is also reflected in the prior literature and deficiency of assessment tools for human capital development. To overcome these assessment difficulties, the research paper uses the announcement of the ATD-BEST training awards by the Association of Talent Development (ATD) as an approximation for exceptional training investments by corporations (ASTD Research, 2013). The receipt of this award will serve as a signal of “above-average” performance with respect to the development and training of employees. This signal possesses informational value which potentially, due to its novelty, results in abnormal financial returns for the organization. More formally, the first research question aims to verify whether this human capital signal possesses informational value beyond the information impounded in the stock price, following the efficient-market hypotheses under semi-strong form efficiency assumption (Basu, 1977). Further, internal management practices and specific organizational performance indicators that potentially influence the abnormal returns are analyzed. The main objective of this analysis is to provide external stakeholders with a method to proxy and visualize the economic value of human capital. More specifically, the potential provision of guidelines for various stakeholders to quantify investments into human capital and the comparison with other companies are addressed with this sub-question (Williams, 2001).
The second question focuses on the organizations’ informational advantage, with respect to managing human capital, and the respective effect on communication and disclosure. More specifically, whether the issuance of management guidance and the forecast properties of the earnings announcements are conditional on the quality of human capital related management practices. Since the employee requirements of organizations differ substantially in task complexity and skill prerequisites, organizations will require different human capital needs, HR management practices and an associated internal design structure. Particularly, the identification of the optimal internal configuration entails a combination of a proper incentive system, the management of talent and the implementation of monitoring processes. Despite the importance of this combination, the following analyses place the focus on the quality of human capital management and its subsequent effects. For instance, the author Williams (1996) examines the influence of premature management forecasts on the forecast revision process of analysts. His findings indicate that this stage-wise revision process depends on the reliability of management guidance. Particularly, the choice, which private information to provide, seems to be the driving force in this relationship. He further hints at and describes the potential private information areas that may influence the revision process. Such information areas are, for example, private information of the organizational human capital level, target setting practices and/or product development. The specific emphasis on human capital in my second research question can build on this study and potential extension, including the study by Cormier, Aerts, Ledoux and Magnan (2009).
These authors isolate the financial implications of disclosure accuracy with respect to human and social capital. In other words, they suggest that higher accuracy of quantitative disclosure, with specific attention on human and social capital, enables organizations to reduce their share price volatility, while they can increase their Tobin's Q. To further extend this stream of literature, this study will focus whether the quality of internal organizational management practices, specifically related to human capital, has an influence on the disclosure behavior and related properties of organizations.
The relevance of this research study stems from the potential to further strengthen the financial position of the entity by optimizing their investment expenditures and thereby increasing (cost) efficiency. Further, the investigation of the disclosure behavior, conditional on the internal management practices, contributes to the literature by assessing the interaction between internal management structures and the external market, while it also further adds to through the identification of a key determinant in internal structure choices and the interrelation between management practice choices. Lastly, the research study extends the financial accounting literature by identifying the informational value of human capital beyond the information impounded in the stock price.
The research paper continues with a literature review of different perspectives of disciplines that are affected by investments in human capital. Afterwards, the organizational design literature in respect to the second research question will also be assessed. Next, the paper introduces the theory and develops the underlying hypotheses for the subsequent analyses. Following this development, the methodology, research design and sample collection are explained in further detail. The study then continues with the result section and a subsequent discussion. Lastly, the research study is summarized and concluded.
II. LITERATURE REVIEW
The existing research on human capital development investigates the possibilities of economic benefits resulting from training investments. This part of the paper reviews some of the leading research on human capital development that focus on quantifying returns on training investments. Firstly, this section of the paper clarifies key terms to aid the review. Secondly, several articles and their viewpoint on human capital development are both stated and inspected. Thirdly, a closer inspection of the organizational design literature is conducted. Lastly, the literature review summarizes the important key points and findings.
Key Terms
Human capital & development
Human capital is defined as “the skills the labor force possesses and is regarded as a resource or asset” (Diebolt & Haupert, 2016). It covers the concept of investments in people (e.g. education, training and skill improvement) and that these investments increase an individual’s productivity (Diebolt & Haupert, 2016). This term is related but should not be synonymized with labor, human resource and social capital. For example, only human resource which fulfills the four criteria, specified by the resource-based view, qualifies as human capital. These criteria require resources to be rare, valuable, inimitable and non-substitutable (Wright, Dunford & Snell, 2001).
General and firm-specific human capital
Organizations and employees make an important distinction between “general” human capital (skills and abilities valued by all potential employers) and “firm-specific” human capital (knowledge and capabilities that have productive value in only one specific company/industry). Formal education produces mostly general human capital, while on-the-job training usually incorporates either more firm-specific or a balanced amount of both types of human capital. This key distinction is important with respect to the investment incentive by employees and employers. Employers are less likely to provide general skills training to their employees, due to the transferability of these skills to other firms. On the contrary, employees are less inclined to engage in firm-specific human capital without a substantial incentive (e.g. job security or reimbursements of various forms).
BEST Award
The BEST Awards are given to organizations that demonstrate enterprise-wide success with respect to employee talent development. Applicants are evaluated based on talent development on an enterprise-wide level, the importance of learning and development in the corporate culture, learning links to individual and organizational performance for increased alignment and the investments into human capital development. The main benefits of the BEST award are feedback on the efficiency of training investments, benchmarks to compare one’s investments into human capital development to competitors and improved transparency of investments to external stakeholders (ATD BEST Awards, n.d.). Further, the extensive feedback that the ATD provides can help organizations to optimize their resource allocation related to employee development.
Intangible assets
The International Accounting Standards Board (IASB) standard defines an intangible asset as: "an identifiable non-monetary asset without physical substance," (IAS 38, 2017). Further, the standard definition of an asset is also incorporated and requires a historical event that delivered the asset, that the entity controls the asset and that the entity expects future economic benefits from the asset. Thus, the defining characteristic of an intangible asset stems from the lack of physical substance and the extra requirement of “identifiability” stated by the IAS 38. This extra requirement specifies that an intangible asset can either be separable from the organization or that the intangible asset arises from a contractual or other legal right (IAS 38, 2017).
Physical capital (Tangible assets)
The physical capital (tangible assets) of a corporation includes the plant property, equipment, and other tangible investments that have a physical substance and a certain level of durability. The essential characteristic relative to intangible assets for this category is the physical nature/substance, which helps to differentiate between tangible capital and human capital (IAS 38, 2017).
Various perspectives of other disciplines
Strategy & Corporate Governance
Human capital and its potential as a strategic tool for the decision process has been investigated by scholars in various business research fields. Specifically, scholars in the strategy domain have focused on the influence of human capital on the strategic approach of the entity and the its effect on firm performance. The following section examines this relationship and proposes additional insights with respect to the importance of human capital to competitiveness and governance of an entity.
A recent study by Chatterjee (2017) focuses on human capital investments, the specific capabilities resulting from these investments and the subsequent effects on firm performance. The underlying study population of software service companies provides an optimal environment for such an investigation due to the necessity of continuous human capital development in these knowledge-driven industries. More specifically, the research paper identifies two types of key capabilities in these industries, business-domain and technological capabilities, and their effect on firm performance. The business-domain capabilities relate to skills that are rather industry-specific, while technological capabilities relate to skills and abilities of a general nature. Further, he suggests that the two capabilities can be developed through various learning mechanisms (e.g. formal and informal). However, regardless of the employed learning mechanisms, the author identifies that only the combination of both technological and business-domain capabilities enables organizations to earn abnormal returns. In other words, the primary driver of the firm performance improvement results from the interaction between general and specific skills to cope with the fast-changing environments of these organizations, while the form of education is secondary for the performance enhancement. This finding confirms that the value of human capital is considerable in service/human-driven industries and helps to justify these expenditures to external parties.
The corporate governance literature also examines human capital and its potential to differentiate an organization from its competitors. For instance, various scholars in this discipline attempt to capture the effect of human capital on decision-making and the reaction to the respective decision by external parties. More specifically, the authors Tian, Haleblian and Rajagoplan (2011) investigate the investor reactions to new CEO appointments by the board of directors. The human capital aspect in this research study was related to the varying levels of human and social capital of the respective boards. The authors define human capital by the CEO experience of the board (previous employment of board members as CEOs) and industry experience (previous employment of board members in respective industry). Likewise, social capital is defined by the co-working experience of the board (internal social capital) and the external directorship ties of the board (external social capital). Intuitively, the scholars predict more favorable reaction by the financial market, in form of positive abnormal returns, to appointments made by a board with higher levels of both human and social capital. The evidence supports this argument as indicated by the favorable reaction of stakeholders to CEO hiring decisions by boards with high human and social capital (Tian, Haleblian and Rajagoplan, 2011). Similar to the return response to CEO appointments by high board human capital, this research study attempts to value the capital market reaction to the human capital level of an organization through a training award receipt. Despite the difference in information novelty between the two human capital factors, the study argues that the reflection of ability and the future rent extraction related to the human capital level is the driver of the firm performance effect.
Human Resource Management
In the human resource management (HRM) literature, the focus generally lies on the human capital of current and/or potential employees and the resulting effects for the organizations. Recent studies analyze the role of human resource management practices (e.g. selection, development, etc.) in combination with human capital on learning within the organization and the organizational performance (Huang, Du and Lin, 2012; Kromann, Skaksen and Sørensen, 2011). This section analyzes this interaction between human capital aspects and HRM practices and its effect on the internal and external environment of the organization.
The main motivation to investigate HR practices initiates from the wide-reaching effects of a successful implementation. For instance, Lopez, Real and Valle (2011) examine the association of HRM practices with the capability to foster organizational learning and the role of human capital in this interaction. The authors find direct influence of HRM practices and human capital on organizational learning. Further, they confirm that the aforementioned former relationship also exists as a partially mediated relationship through different dimensions of human capital. These results provide additional support with respect to the value of human capital in organizations. More specifically, the continuous learning and efficient internal HRM processes might ensure future enhancement of firm performance and potential securement of competitiveness. However, similar to this research study, the difficulty lies in the deficiency to effectively signal HRM practices, current human capital levels or learning capabilities to external parties, which prohibits organizations to optimally extract potential benefits.
Previous attempts to capture these effects of disclosure with respect to human capital have provided a foundation for future research. For instance, Lin, Huang, Du and Lin (2012) analyze the reaction of the financial market to public disclosure of human capital information. They find the human capital information to be value-relevant, resulting in higher market-to-book and return on asset ratios. However, the key issue with voluntary disclosure of human capital or other information by organizations lies in the credibility of such signals. First, the organization has an incentive to communicate to the potential benefits of human capital to their external stakeholders. However, organizations certainly prefer more favorable representations to derive greater rents from the human capital investments. As a result, the absence of an independent third-party to verify the respective information is a key factor of the credibility issue. Second, the potential benefits of this disclosure need to be compared to reductions of competitiveness and performance. Immediate competitors may incorporate this detailed human capital disclosure to engage in imitation or strategy development. Consequently, the potential negative side effects may outweigh the benefits, regardless of the credibility of such signals. This research study seeks to overcome this issue by incorporating a third-party, the Association of Training and Development, to authenticate the credibility while investigating a source that limits the exposure of critical human capital information.
Financial and Management Accounting
This part of the review examines the drawbacks of traditional accounting in relation to human capital development and offers some potential new models to overcome the drawbacks. Furthermore, an analysis of the management accounting literature with respect to optimal organization design and incentive structures for efficient human capital development is provided.
Previous accounting research has revealed a significant relationship between workforce development and organizational performance, by indicating that employee development possesses the potential to generate value for the cooperation’s shareholders (Bassi, Ludwig, McMurcer & Van Buren, 2002). Nonetheless, the traditional accounting standards classify the training expenditure of employees in an organization as an expense , thus not signaling potential economic benefits of this investment to the numerous stakeholders (Carnevale, & Schulz, 1990). Moreover, most organizations do not provide their various stakeholders with this important information. Only in the last decade have organizations attempted the disclosure of human capital. For instance, various entities across industries provide a comprehensive list of training investments that shows the costs and extent of their human development strategy. Nonetheless, the necessity of a highly-skilled workforce in the modern markets requires firms to more effectively assess the value of human capital and credibly communicate it (Cappelli, 2008). Fortunately, various profit and non-profit organizations are working on potential solutions to overcome the flaws inherent in traditional accounting methods. The Center for Talent Reporting (CTR) is currently developing an additional set of accounting standards, which focuses on the transparent reporting of training and development investments (Center for Talent Reporting, n.d.). This extension to the current standards will provide a more detailed overview of performed investments, potential output measures, and performance indicators. Moreover, the transition to clearer standards and higher transparency in the training and development of personnel will enable firms to enhance their competitiveness through tailored training programs. These training programs can be especially important for organizations, which also undertake other capital-intensive investments such as the implementation of information systems.
With respect to the management accounting literature, the main factor relates to the organizational design structure, including the incentive systems, target setting and mechanisms for the retention of talent. Specifically, the incentive system, with respect to inducing specific-and general human capital development for employees and employer, has been a focal research area in the past years. Generally, employees dislike firm-specific investments in themselves due to the low likelihood of transferring this skill to other organizations and the potential long-term value for the employee. As a result, organizations need to properly encourage and safeguard employees when they require firm-specific investments. One of the first attempts by Prendergast (1993) assess the role of promotion, as an incentive, to motivate employees to engage in specific human capital investments. He finds that promotions are a mean to motivate employees to accumulate non-verifiable skills in comparison to compensate them directly via a wage increase. However, this premise only holds if employees can be assigned to different tasks rather than different job titles. More specifically, the promotion must include different task/responsibilities to ensure that the firm also has the incentive to promote the employee after the training. For instance, a clerical employee may accumulate specific skills to become more productive in his/her future position. This productivity increase may be more sensitive to skill development as it carries additional responsibility. On the contrary, for professions, such as medical staff, academics or legal consultants, the nature of tasks does not significantly vary across the ranks of the workforce. Consequently, the promotion may not provide a satisfactory incentive for the employee as the organization has no clear incentive to promote after the training. Similarly, this research study assesses the value-relevance of human capital investments and the respective internal structure requirements across industries and the contribution to firm performance.