HRM Delivers Shareholder Value

September 24 2002 - Call it human resource management, personnel or high performance management, the evidence for the financial benefit from good people management continues to grow. Companies using the best people management practices deliver nearly twice as much value to shareholders as their average competitors, according to a study by consultants Watson Wyatt.

This study is the fourth iteration of Watson Wyatt's highly respected Human Capital Index (HCI) research. It covers HR practices in more than 600 companies from 16 countries across Europe, combined with independent financial data. The study demonstrates a clear link between specific HR practices and financial performance. Watson Wyatt's North American and Asia-Pacific HCI studies showed similar results.

The new study showed that:

Good people management was linked to a 90% increase in shareholder value.

Companies with weak people management practices produced negative returns on equity over the past two years.

And the best companies are pulling ahead from the rest. Companies with the best people management practices gain tremendous value while the difference between average and poor performers in HR is negligible in terms of creating shareholder value.

"The perception that HR is a non-strategic business overhead still persists," says Steven Dicker, a partner at Watson Wyatt and co-author of the HCI report. "But this is wrong. Our HCI research has again demonstrated the strong link between effective human capital management and shareholder value."

Commenting on the finding that companies with the best people management deliver nearly twice as much value to their shareholders as their average competitors, Steven Dicker said: "Great people management is linked with a 90% increase in shareholder value. It is an amazing figure at first sight. As well as highlighting the gulf between the best and the rest, we believe it reflects the growing emphasis on people management within businesses as other sources of competitive advantage prove increasingly difficult to sustain.

"With the return to real-world economics after the bursting of the 'tech' bubble and unwinding of the 1990s' creative accounting, most businesses are fundamentally 'people businesses'. Increasingly, it is the quality of a company's people management that determines its real success or failure."

"However, it is not surprising that many business leaders are sceptical about the value of human resources departments when there is so much poor practice around," said Doug Ross, also a partner at Watson Wyatt and co-author of the report. "Human resources has a key role in facilitating good people management throughout the business, and our study shows this can have great value. But in too many cases human resources activity becomes an end in itself, failing to align with the business needs, failing to control costs, failing to manage risks effectively or failing to focus on its contribution to growing revenues."

Doug Ross highlights three practices that stand out in the Watson Wyatt study as undermining financial performance: using contract workers to provide 'a disposable workforce', developmental training and excessive paternalism

The disposable workforce

"The approach to using temporary workers to provide a cushion of 'disposable workers' in case of an economic slowdown or cancellation of non-core projects seems reasonable in principle," says Doug Ross. "However, our experience suggests that the temporary workers cause tensions and jealousies with permanent employees in good times because of the different terms and lack of commitment to the company, and now the 'disposals' are being implemented the permanent employees feel just as exposed as if permanent employees were being cut." According to the HCI study, companies that have avoided the 'disposable worker' approach delivered up to 5.6% more shareholder value than average performing companies.

Developmental training

"Development training appears to increase the value of the individual but not necessarily the value of the company," says Doug Ross. "This is either because the training is not well timed or good enough, or the costs of employment rise as the employee either demands more pay or moves to another employer to realise their newly enhanced value." According to the HCI study, companies that limit their use of developmental training deliver up to 5.2% more shareholder value than average companies.

Excessive paternalism

"Providing a secure working environment, coupled with effective performance management can create a high value workplace," says Doug Ross. "However, some people management practices are excessively paternalistic, such as maintaining training regardless of economic circumstances and avoiding at almost all costs the termination of employees; these undermine shareholder value." According to the Human Capital Index study, companies that were overly paternalistic lost up to 5.2% of shareholder value compared with average companies.

Watson Wyatt's global HCI is in its fourth year and has undoubtedly become the leading measure of the financial effectiveness of human capital management. The new study, the second time it has been carried out in Europe, confirms the findings of the previous European HCI, carried out when stock markets were at their heights in 2000. This year's study demonstrates that the key HR practices associated with higher value continue to show up in bear as well as bull markets. The same applies to people management practices that are linked with a reduction in shareholder value.

"The Human Capital Index brings up evidence supporting our belief that enhanced people management leads to better financial performance, rather than the other way around," said Steven Dicker. "In other words, HCI can be a leading indicator of financial performance."

Watson Wyatt examined return on equity over the past two years for the companies that participated in both 2000 and 2002 European HCI studies. High scoring companies (top quartile) in the 2000 Human Capital Index study produced returns of over 20%. Conversely, companies that scored low on HCI in 2000 showed a negative return on equity during the same period.

"For many companies, business is now tougher than ever. With no let up in sight, the need to focus on maximising real, sustainable value from their human capital has never been greater," said Steven Dicker. "The good news is that Watson Wyatt's Human Capital Index now provides a clearer, more global route map to maximising the value of human capital than ever before."