Human Capital Disclosure: A Principle-Based Approach
As the role of human capital has become more central to company performance, the U.S. Securities and Exchange Commission (SEC) introduced regulation in 2020 requiring human capital disclosures. The SEC adopted a principle-based approach to these filings. Essentially, this means that aside from the mandatory disclosure of the number of employees, there are no prescriptive requirements.
Publicly traded U.S. companies must disclose all human capital measures that are “material to the performance of a registrant.” Materiality is defined by what is relevant to a company’s business performance. Importantly, the SEC chose not to define “human capital,” allowing companies to decide what to disclose based on their own understanding and management priorities.
Benefits of the Principle-Based Model
This flexible approach is meant to reflect the management’s and board’s perspective on what is relevant for understanding their business. One advantage of this model is its applicability across all industries. Since the concept of human capital varies between sectors, the principle-based method avoids the need for a rigid, one-size-fits-all framework.
Additionally, by not defining human capital, the regulation remains adaptable over time. As understandings of human capital evolve, the principle-based regulation stays relevant without needing frequent revision.
Challenges of Undefined Standards
However, the lack of clear definitions and disclosure requirements can create uncertainty. Companies may struggle to identify what needs to be disclosed, leading to inconsistent and incomplete reporting across industries. This inconsistency challenges data comparability and can make it difficult for investors to evaluate human capital practices and performance effectively.
Recent Push for Reform
Over the past two years, disclosures have increased, but information often remains incomplete. In response, the “Working Group on Human Capital Accounting Disclosure” submitted a petition in June 2022 advocating for more structured and comprehensive disclosure requirements.
The petition proposes three key reforms:
- Investment Recognition – Disclosing the portion of workforce costs considered an investment in the Management Discussion and Analysis (MD&A) section of annual reports.
- Comprehensive Framework – Treating workforce costs equally with other financial metrics, including data on mean tenure, turnover, compensation (benefits, health care, training expenses), and workforce composition (full-time, part-time, contingent).
- Income Statement Disaggregation – Breaking down labor costs more clearly within income statements.
Looking Ahead: The SEC’s Response
The SEC has acknowledged the petition and is currently reviewing human capital disclosures submitted under the current principle-based approach. New regulations are expected soon, signaling that more standardized requirements could be introduced in the near future.
The Role of DEI Data in Human Capital Evaluation
The growing focus on human capital also heightens the importance of Diversity, Equity, and Inclusion (DEI) metrics. Investors increasingly demand insight into companies’ DEI performance as a key element of human capital evaluation.
Denominator addresses this need by offering the world’s largest dataset on DEI performance. By standardizing unstructured data into meaningful scores, Denominator enables companies to better understand their position within their industry and prepare for upcoming regulatory changes. This data also supports investors in making informed decisions based on standardized and comparable human capital metrics.
