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Article | Executive Pay Memo North America

Directors’ views on human capital governance and culture 

Governance Advisory Services |Executive Compensation
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By Alex Lawrie , Daisy Jin , John M. Bremen and Don Delves | November 12, 2020

Board directors around the world share their expectations on how boards influence their organizations’ culture and approach to human capital.

In our series covering non-executive directors’ perspectives on the future of the remuneration committee, we have examined directors’ views on shareholder primacy and purpose; the approach companies are taking on environmental, social and governance (ESG) issues; and how these are evolving. This article, the final in the series, is based on interviews with 170 non-executive directors in 23 countries and explores their perspectives on human capital governance (HCG) and culture.

  1. 01

    Human capital as a critical business asset

There are times when the most critical people are not in the committee’s purview. One of the things we’ve done is try to identify the high-impact people; we need to know who they are.

In our interviews, the directors revealed that companies often perceive HCG elements as a cost burden — a target or set of targets to reduce (such as employee turnover rates) — measured in much the same way as financial assets. Many directors see HCG as an opportunity for both management and the board to identify and address potential deep-rooted problems or opportunities that require effort from both management and the board. This perspective is consistent with the majority view shared by directors that employees are not simply a cost to bear but fundamental to business health and performance. Directors from all geographies typically perceive human capital as either an asset or business risk, and in most cases, a key issue for the board.

Pay used to be the primary differentiator. Now the differentiators have become pay, values and talent management.

The directors recognize that attracting, retaining and managing talent in 2020 is very different from what it was 15 to 20 years ago. The employment offerings of most companies, particularly around benefits, are less “paternalistic” than they once were. Employees today are much more mindful of an organization’s purpose — particularly younger generations, who directors believe expect more from companies. More recently, the global Diversity, Equity & Inclusion and anti-racism movements are forcing companies to examine workforce diversity and equity that goes beyond gender and ethnicity, reaching into broader areas, such as neurodiversity.

This increased focus on company purpose is leading some directors to view remuneration packages as a less significant factor in the drive to attract employees. Companies are now being challenged to consider alternative avenues through which to attract, motivate, engage and retain their talent effectively beyond pay and benefits, as the more recent generations are more likely than past generations to change jobs and switch careers.

While most directors recognize the benefits and opportunities that HCG presents, some prefer to entrust human capital management to the executive leadership, leaving the board to focus more on operational or strategic priorities rather than sustainable HCG practices. In North America, directors clearly emphasized that boards do not typically get into operational details beyond understanding the business in order to govern and exercise oversight.

  1. 02

    The board’s and the remuneration committee’s roles in human capital governance

If HCG is given attention at board level, the responsibility tends to sit with the remuneration committee, often owing to the already close ties to the HR and Reward functions.

Many directors interviewed believe that boards should play an oversight or stewardship role in HCG. While some view this as a responsibility for the whole board, others see it as being within the remit of the remuneration committee — and occasionally the nominations/governance committee.

A common observation arising from the interviews is that boards should pay more attention to HCG and ask more questions of management. For example, taken in isolation, typical HCG measures such as staff turnover may present boards with a statistical “problem,” with the root causes hidden within the organization’s human capital infrastructure and processes. Non-executive board members are inclined to raise the appropriate questions, expecting that management will execute due diligence and respond accordingly.

In the U.S., some compensation committees are changing their names and charters to reflect their expanded scope over certain human capital issues. We added leadership development to ours.

The types of human capital topics that directors are interested in vary by company and geography. In the U.S. and Western Europe, directors tend to focus on diversity alongside succession planning, talent management and leadership development. These interests are reflected particularly in the U.S. by the trend of changing committee names to incorporate these domains.

However, directors in North America emphasized that boards often do not “operationalize” their interest in HCG, generally preferring to operate in an oversight capacity. U.K. directors echoed this notion, adding that because HCG typically sits in the realm of Human Resource teams, tension between management and non-executive directors can sometimes emerge over how HCG should be best managed, as this often is the established “playground of the chief human resource officer.”

The directors noted that, as with ESG matters, shareholders will need to consider directors’ own degree of influence on HCG within businesses and carefully weigh the risks of “not doing HCG right” against not doing anything at all to encourage HCG best practices.

A final point on the board’s role in HCG: Many directors recognize that some degree of cultural change at the society level may be necessary to help organizations tackle human capital issues. HCG is about ensuring that management is empowering all employees and that the employees are maximizing their full potential. Companies’ actions, however, can be limited by social/cultural norms that may be counterproductive to their cause. While this type of cultural change would likely be very specific to an individual country, this view was shared by the directors in every market.

  1. 03

    Human capital metrics

Established HCG measures aren’t perfect.

In the context of HCG, around the world directors are asking management for more information about a company’s workforce. A common challenge for boards — most strongly articulated in Asia Pacific — is the struggle to obtain quality data relevant to HCG. Increasingly, boards utilize a set of common human capital metrics, such as safety, retention/turnover, absenteeism, succession and high-performer development. Beyond statistics, directors are keenly interested in more in-depth and qualitative data points on such factors as employee engagement and career development. Alongside more quantitative data, such measures are effective tools companies can use to help measure, develop and retain their human capital.

Another common challenge experienced by many directors is that human capital data are often difficult to capture and limited in scope. For example, data on race or ethnicity are often not collected at all or only partially so due to country rules and regulations. These data collection challenges and data privacy regulations often mean that management and boards lack the full picture needed to make informed human capital judgments.

In addition to the challenge of gathering meaningful and reliable human capital information, there is no consensus on how human capital metrics should be incorporated into executive incentive plans or whether improvements in human capital management should be measured quantitatively or qualitatively. Some directors shared that a strictly quantitative view, such as talent retention rates or workforce gender distribution, may be an oversimplification of much more complex issues as they relate to the talent market, resulting in unintended consequences for the organization. In extreme cases, a goal focused on demographic profile but lacking the right infrastructure may distort leadership succession planning. In any case, directors agree that human capital measures used in executive incentive plans must be defensible and reportable.

Notwithstanding legal reporting requirements, companies should be doing more.

Some directors suggested that legal reporting requirements related to human capital have not gone far enough. For example, in the U.K., companies that employ more than 250 people must report their gender pay gap (GPG) — a reporting requirement introduced to tackle pay fairness. Given that GPG only measures what the gap is, some directors in the U.K. felt it falls short of helping companies assess the gap over time or address the underlying causes of pay inequality. It was suggested that the GPG requirements should prompt non-executives to question management on tackling the gap and addressing underlying challenges, such as representation, particularly in leadership positions.

Our business is very much driven by where we are on the overall governance spectrum, and other individual circumstances; if companies are trying to survive, as many are during the COVID-19 crisis, then there is perhaps less interest in broadening out their HCG practices.

As boards prioritize stabilizing businesses in light of the COVID-19 pandemic and resulting social and financial disruption, human capital has attracted directors’ attention like never before. Many directors around the world shared that top priorities for them are to ensure that colleagues are safe and to retain critical talent while making the difficult decisions of rationalizing head count. This time of crisis has proven to be an accelerator for the HCG agenda, taking it to a more strategic level and, in the words of a director, a “new-normal repurposing.” For example, directors we spoke with in the U.S. shared how COVID-19 highlighted cultural issues in the context of HCG that could harm their company’s reputation. Better governance on human capital and understanding the drivers of a suboptimal culture have become priorities to turn the business around.

  1. 04

    Shaping the organizational culture

Human capital management can be a virtuous circle; when done right, it can have a long-lasting positive impact on an organization’s culture and financial results.

An observation expressed in Asia Pacific is that enhancing the management of human capital can help cultivate the desired culture; however, directors noted that some companies may pursue shareholder value creation at the expense of investing in their human capital, prospectively leading to cultural issues that may in turn damage broader financial and strategic outcomes. To avoid this pitfall, directors we spoke with suggested that boards should fulfill a custodian role related to culture, triggering rather than implementing change, with management having the greater influence. Some directors also highlighted the board’s responsibility in considering cultural compatibility when selecting senior leaders and deliberating on succession planning.

Board’s role in shaping culture is absolutely critical, in the sense that we need to choose a CEO who shares the vision of culture we want the company to have.

In North America, external drivers of cultural change that also encourage directors to play a more active role in culture include social movements, such as #MeToo and Black Lives Matter. Executives’ reactions and behaviors are under significant public scrutiny in light of these social issues, and boards recognize that mishandling these matters could detrimentally impact a company’s reputation and shareholder value. Organizational values play an increasing role in consumer behaviors as well as talent attraction and retention.

When management seeks to curate an organization’s cultural attributes or drive cultural changes, some directors stressed the importance of listening to the people. It is difficult to get to know a business, its operations, its processes and its value system without doing so. We also observed different perspectives on the role and impact of management’s leadership on culture in different countries:

  • In Japan, corporate culture is considered a pattern of behavior, and it takes a long time to build. Changing culture typically lies in changing the behaviors of middle management.
  • Similar to Japan, in Hong Kong and across much of Asia, leadership is viewed as having the most significant impact on companies’ culture (but at the CEO/C-suite level), creating trust in the organization; however, this hinges heavily upon communication, and the view that senior executives should set an example in promoting the company culture.
  • On the other hand, Indian directors noted that driving culture falls under the purview of HR and the CEO/management rather than remuneration committees.
  • In the U.S., Australia and Europe, establishing corporate culture has to start from the top. The “right” CEO needs to be recruited and, in turn, exhibit the right behaviors in order for culture to cascade down through businesses.

Throughout the COVID-19 crisis, directors noted that a conflict has emerged in some companies between culture and the concept of employees as assets, with management sacrificing employees to protect other company assets for the short- or long-term benefit of shareholders (including, in some cases, to protect the basic survival of the company). Directors understand that the manner in which companies deal with these workforce redundancies affects employees’ perception of company culture (as well as the culture itself); however, some organizations still may be tempted to operate as if the company and employees’ interests are at odds. Others recognize the value of human capital to the enterprise. One director commented that “COVID-19 has resulted in people being treated properly, at a cost to the company.”

In summary, our interviews show that globally, most directors recognize HCG as an emergent priority, especially in Europe and North America. Boards — most often remuneration committees — and management each play distinct roles in managing human capital as a critical business asset.

Directors are in general agreement that shaping culture is management’s responsibility. The board, as a custodian of shareholder assets, must ensure management is shaping a workforce culture that drives value for the company in the short, medium and long term and is aligned with the company’s purpose, which in turn sets the company apart from competition and delivers long-term sustainable value creation to shareholders.

Authors

Associate Director, Executive Compensation (London)

Senior Director, Rewards and Executive Compensation (Hong Kong)

Managing Director, Human Capital & Benefits, and Global Head of Thought Leadership and Innovation

Managing Director, Executive Compensation Practice Leader - North America (Chicago)

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