Insight: careers - Invest in human capital.

What is the best way to improve shareholder returns?[QQ] The cynically minded might suggest a stripping out of unwanted assets and culling of overheads in an effort to make consistent short-term profits to reflect the transient nature of today’s investors.

However, research just published by consultants Watson Wyatt has shown one of the best ways is to invest in employees.

The Human Capital Index, European Survey Report 2000, a study of 200 firms throughout 16 European countries, shows a quantifiable link between a company’s shareholder value and the quality of its human resources. It is thought to be the first time such a link has been established.

Companies in countries ranging from Ireland to Poland, Norway to Portugal found that if they made significant improvements in key human resource practices they were rewarded with improved market value.

About half of the companies quizzed were from the UK and Ireland. The study focused on the Euro 500 as well as FTSE mid-cap firms.

On a European-wide average, improvements in working conditions or employee relations resulted in a 26% increase in market value.

The results endorsed research that Watson Wyatt completed 12 months earlier in North America, though with less dramatic results.

In Canada and the United States, some shareholders were rewarded with a 70% increase in returns because of companies’ ‘human capital management’ practices.

‘Treating employees like adults leads to grown-up financial results,’ says Steven Dicker, co-author of the study and a partner at Watson Wyatt.

‘We found a clear relationship between effectiveness of a company’s human capital and shareholder value creation. Companies with a high index had high shareholder value; with a low index had low shareholder value.’

The Human Capital Index works by applying a vast range of management information and compressing it into a single score for each organisation.

The scores expressed are on a scale of one to 100. A score of 100 represents the best practice.

Nineteen key practices were identified, which were grouped into five categories: resource management, integrated leadership practices, money, focus on the employee and a paternalistic environment.

For the first four of these categories, an increase in the practice was reflected by an increase in shareholder value.

The final category showed an increase in shareholder value only when there was a reduction in the practice considered.The study shows there is a strong relationship between human capital and shareholder value creation over both the short and long term.

Companies with high HCI scores were shown to deliver more than eight times the shareholder value (34%) over the past year compared to those with low HCI scores (4%).

Watson Wyatt found this pattern also held true over a five-year period, where total return to shareholders was nearly twice as much for high HCI companies (183%) compared with companies with a low HCI (107%).

At long last, it seems many companies are realising the importance of their employees. Investing in people is moving from theory to reality.

So what were the key ‘human capital’ issues? Using what the report calls ‘knowledge workers’ was crucial for business, reflecting a 2.3% increase in market value.

At the outset of their research, Watson Wyatt decided not to have a fixed definition of what constituted a knowledge worker.

Instead, it allowed each firm to come up with its own definition. Roughly translated it means employees who added value through understanding and knowledge as opposed to those who were just part of a process.

Doug Ross, also a partner at Watson Wyatt and the report’s other author, says knowledge workers cut right across the structure of any business and can be found at any level, among any age group, including older workers.

Effectively planned recruitment accounted for a 1.5% rise and good management/union relations where both sides worked in ‘partnership’ rather than ‘dispute’ resulted in a 1.2% increase in shareholder value. But the study was not all about enlightened management techniques.

Pay, unsurprisingly, also helped in the treatment of staff. Above average pay and benefits are associated for a 1.1% increase in market value. The survey also confirmed that the trend towards offering share ownership and incentives were associated with an increase of 2.6%.

Employee communication, the authors found, was critical. Sharing such things as business plans and financial information and encouraging feedback from employees accounted for a 2.2% increase in market value. A performance rewarded culture moved companies ‘from simply being a player to winning the game’ said the report.

Feedback can also help promote a working culture where employees are welcomed and treated as individuals.

And feedback worked both ways, from the top down and the bottom up. Senior management should keep the rest of the company informed on plans and business news – or performance could suffer.

Similarly those on the shop floor should keep their bosses informed of what’s going on.

This is particularly true of the new economy, says Ross. Customers and employees are moving about within the market much faster than ever before, increasing the need for more effective communication.

Focusing on the employee was also important. The study talks about the concept of ‘Me plc’ – where bosses allow employees to direct their own development, to test their own skills and work on projects that will boost their value in the market.

Although the benefit to an employee through such an approach is clear, Watson Wyatt claims ’empowered and highly motivated people’ also add significant value for their companies.

An increase of 1% in the market was associated with improvements in this area.

‘Integrated leadership practices’ which involves a lack of hierarchy, clear leadership and teamwork, accounted for a 3.7% rise in market value.

Dicker says ‘performance management’ is crucial in getting a company to perform better. Abolishing employment hierarchies and involving everyone in a team is central to making a company healthier.

The study also unearthed regional variations. Ireland was the country most interested in recruitment. Bucking one stereotype, Watson Wyatt found Germany has shunned hierarchical management structures.

But Europe still lags behind its North American competitors. Murray Steele, head of strategic management at the Cranfield School of Management, says he believes such practices are rooted in culture.

‘The US is a much more positive, can do, fun place to do work,’ he says.

‘The UK and Europe very much sees coming to work as a serious business. There is no place for fun.’

Steele says this is reflected in workplaces throughout Europe where initiative is still frowned upon. ‘There is a lot of lip service to words like initiative.

There are too many organisations in the UK that don’t treat employees as human beings or adults. The assumption is that they would want to use their brain too much.’

He says this is worse in countries like France rather than the UK because of the history of state involvement in the business world. This means many French companies will automatically look to the state for solutions.

Even ‘enlightened’ Scandinavian economies are affected. In February, a Swedish study of the country’s postal workers found anxiety and bullying were commonplace leading to widespread staff sickness. In the UK, sickness costs business approximately #11bn a year.

In the long run though, the research claims firms could ultimately be harming themselves through such practices.

Watson Wyatt, which itself was voted one of the UK’s best employers in the Sunday Times ’50 best companies to work for’ list published in February, has tentative plans to undertake similar research on Europe within the next two years. It has already begun to revisit North American businesses to replicate research carried out there in 1999 and is looking into doing similar work in Asia.

One conclusion to be drawn from the Watson Wyatt report is that companies now have to offer their staff more. Dicker, who used to work for PricewaterhouseCoopers, says this sellers’ market will continue.

The quid pro quo for companies looking to improve their market value, including accountancy firms, is that they will have to offer more to their staff in pay and conditions.

He says this is especially true of those within middle management, as businesses have to keep them increasingly motivated to retain them.

The days of keeping your ‘nose clean’ for a number of years in the expectation of a reward much further down the career path has long gone says Dicker.

JOB STABILITY IS BAD FOR COMPANY’S HEALTH

Watson Wyatt found that a ‘paternalistic environment’, where European culture unlike in North America, promotes ‘excessive job security, unduly low staff turnover and rigid career paths’ is still relatively widespread.

Although low staff turnover may traditionally have been seen as a good thing, this report argues a static workforce will result in poor performance.

‘Europe’s comparatively high job security and low staff turnover can lead to complacency and an undermotivated workforce, which is hurting our ability to compete with North America,’ says Doug Ross.

Watson Wyatt argues that retention programmes should be targeted at individuals who perform well and there is no room for sentimental behaviour. Poor performance should not be tolerated it warns.

‘In an environment demanding constant change and improvement, inappropriate retention may actually hold back performance,’ states the report. Prior to the research, the southern European countries were thought to be the most affected by this.

However, although the research found Spain and Portugal retained a paternalistic working culture with many people remaining in the same job for a long time, Italy did not. The Italian economy had adopted similar working practices to those in Northern Europe.

Dicker said that almost 5% can be wiped off of market value because of excessive job security.

It can also lead to companies losing their best people. The study found a hierarchical and paternalistic working culture left many of the brightest employees feeling undervalued and underused. These people were the ones most likely to try and find employment with a new company.