As intangible assets grow to represent an increasing share of corporate value, managing human capital — a key intangible asset — becomes more important for industry groups focused on innovation.
Published: July 7, 2023
Human capital, from employee skills and creativity to intellectual property and interpersonal relationships, represents much of the intangible value in industries such as software, biotechnology and financial services.
Using S&P Global ESG Scores raw data this analysis explores whether industries built on intangible assets appear to make human capital management a priority.
Companies with better human capital management practices relative to their peers in the same industry group generate a larger share of their revenue from innovation, suggesting that good talent management gives these companies a competitive advantage.
Authors
Cornis van der Lugt | S&P Global Sustainable1, ESG Research Senior Manager
Emily Podshadley | S&P Global Sustainable1, ESG Specialist
Lukas Zimmermann | S&P Global Sustainable1, Quantitative Modeling Analyst
Matt MacFarland | S&P Global Sustainable1, Thought Leadership Editor
The COVID-19 pandemic brought about new perspectives on the future of work and workplace best practices such as remote or flexible working hours. Initiatives with significant corporate support such as the World Wellbeing Movement have increasingly pushed to establish people wellbeing as a key performance indicator.
For decades, regulators have asked companies to report metrics related to human resources. But since the early 2000s, investors, management teams, employees and regulators have grown more interested in human capital, a term that recognizes the workforce as a major component of a company’s value and a key factor in creating competitive advantage. Human capital is a key intangible asset (IA) — defined in financial accounting standards as “an identifiable non-monetary asset without physical substance”— and accounting expectations have evolved to consider resources dedicated to human capital not only as expenses but also as critical investments. In its work on sustainability-related financial disclosures, the International Sustainability Standards Board is considering human capital as a priority project, addressing employee wellbeing, diversity and inclusion and workforce investment, among other topics.
Since the early 2000s, there has also been clear evidence that the market is placing greater significance on intangible assets, from intellectual property to brand power to internal and external relationships to corporate culture and tacit knowledge. This shift is signaled by the widening gap between the book value and market value of companies — a difference that is generally considered the measure of a company’s intangible assets.
To better understand the relationship between IAs and human capital management, in this analysis we calculate the IA intensity of companies in the 22 industry groups assessed in the 2022 S&P Global Corporate Sustainability Assessment (CSA) and focus on the eight industry groups with high IA intensity. Revenue generation in these industry groups especially benefits from innovating new products and bringing them to market — activities that rely on human capital. Using S&P Global ESG Scores raw data, which is based on the CSA, we explore whether these industry groups with high IA intensity appear to make talent management a priority.
Calculating intangible asset intensity
Our approach employs stock market prices, which reflect both physical and intangible asset value, and general accounting information. We measure total asset value as the sum of market value of equity, preferred equity and debt, then deduct the book value of current assets. We calculate IAs as the difference between total assets and physical assets. To measure IA intensity, we divide the value of IAs by the value of total assets.
Using this approach, we identified seven industry groups that displayed a level of IA intensity that is higher than a threshold of 50%. We then examined the way these industry groups invest in their human capital, using company assessments from the CSA related to their employee management practices and policies.
Our approach to calculating IA intensity provides the best comparability across industry groups. However, it also results in an underestimation of IA intensity for banks and financial services companies due to the unique structure of their balance sheets. We therefore include Financial Services as the eighth industry group.
The eight high IA intensity industry groups are:
Software & Services
Pharmaceuticals, Biotechnology & Life Sciences
Healthcare Equipment & Services
Household & Personal Products
Media & Entertainment
Semiconductors & Semiconductor Equipment
Commercial & Professional Services, and
Financial Services
We use the low IA intensity industry groups (below the 50% threshold) to provide a group average for different aspects of employee management and associated benefits. These 14 industry groups are: Automobiles & Components; Capital Goods; Consumer Durables & Apparel; Consumer Services; Energy; Food Products, Beverage & Tobacco; Food Beverage, Tobacco & Staples Retailing; Materials; Real Estate; Retailing; Technology Hardware & Equipment; Telecommunication Services; Transportation; and Utilities.
We find that high IA intensity industry groups do not always outperform ones with low IA intensity on specific talent management metrics, despite the former’s reliance on the creativity and skills of their employees for the research and development (R&D) and product innovation that drive revenue. Examining the performance of peers within high-IA intensity industry groups, however, we find that companies with better human capital management scores generate a larger share of their revenue from innovation, suggesting that good talent management gives these companies a competitive advantage.
IAs broadly include brands, patents, goodwill, customer relationships, reputation, R&D and human capital, among other things. Human capital is generally considered the basis for intellectual capital and lays the foundation for social or relationship capital and structural or organizational capital.
Social relationships are both internal and external. The latter includes relations with customers, which can be valued through proxies such as survey-based customer satisfaction. Knowledge assets may be explicit in the form of intellectual property items such as patents, trademarks, and copyrights. Knowledge assets may also be tacit in the form of know-how or organizational culture. Other proxies used to value intangibles include R&D expenditure to account for the value of knowledge, advertising expenditure to account for brand value, and employee expenditure including training as part of a cost-based approach to valuing human capital.
How significant is the value of human capital compared with other intangible assets? A 2021 article published in the Journal of Financial Economics analyzed the market value of publicly traded firms in the US from 1975 to 2016 and found that labor represented 14% to 22% of market value, knowledge capital accounted for 20% to 43%, and brand capital represented 6% to 25%. Physical capital accounted for the 30% to 40%. The importance of physical capital has decreased substantially over that time, and the percentage values for intangible assets are at the upper end for high-skill industries, the authors wrote.
In the CSA, we assess human capital management through questions on labor practices, health and safety, and employee development. The CSA’s questions on talent ask whether companies offer flexible work hours, working-from-home arrangements, and long-term incentive programs, among other topics. These metrics are important value drivers for industries where R&D is decisive in giving companies a competitive advantage.
S&P Global Sustainable1 data shows that industry groups with high levels of IA intensity are also ones with more revenue generated from product innovation, which includes developing entirely new products and services or improving existing ones. Industry groups related to information technology and the internet economy, as well as those related to the provision of healthcare, biotech and life sciences have particularly high shares of revenue from product innovation. This reliance on innovation makes the quality of human capital and talent management even more important to these industry groups, which require more highly skilled or specialized labor.
Research by McKinsey has found positive correlation between investment in IAs and productivity and growth, and that firms that invest most in intangibles are outperforming their peers in revenue growth. In terms of gross value added, the researchers found that the highest-growth companies in knowledge-based sectors like financial services invest 5x to 7x more in human capital than their low-growth peers.
To delve into how investing in human capital management in particular can impact innovation, we examined peer companies within two industry groups with high IA intensity — Software & Services and Pharmaceuticals, and Biotechnology & Life Sciences — using an aggregate human capital management score based on the CSA criteria for “human capital development” and “talent attraction and retention”. Behind these scores are various questions related to training, development, incentives, support programs, employee engagement and wellbeing. We then grouped the companies in each industry group by how much of their revenue came from innovating new products and services in the most recent financial year. Group 1 reported no or less than 1% of revenue from new products; group 2 reported a percentage below the average for that industry group; and group 3 reported an above-average percentage.
In both industry groups, companies that reported at least some share of revenue from new products also have significantly higher human capital management scores. In the Software & Services industry group, the proportion of innovation-related revenue scales up with better human capital management.
While there is evidence that companies that generate more revenue by innovating new products and services within industry groups prioritize human capital management in general, the picture is more complicated for specific elements of human capital management. The 2022 CSA invited companies to report on employee support programs, listing eight options that relate to work hours and location as well as family support such as childcare facilities and parental leave. Of these, flexible working hours and work-from-home arrangements were the two options selected most frequently across all industry groups.
From the industry groups with higher IA intensity, the Household & Personal Products, Financial Services, and Commercial & Professional Services industry groups stood out as ones offering these options at higher levels. But support for flexible hours and work-from-home arrangements vary widely by industry group. For example, industry groups such as Pharmaceuticals, Biotechnology & Life Sciences and Semiconductors & Semiconductor Equipment Manufacturing run laboratories that require employees to work in-person. And significantly more companies in Financial Services offer flexible working hours and work-from-home arrangements. For an industry group facing high expectations related to risk management, information security and regulatory compliance, the challenges associated with employees working from home in hybrid arrangements remain a subject of debate.
More companies in high-IA intensity industry groups offer long-term incentive programs tied to employee performance, according to S&P Global Sustainable1 data. Companies are assessed in the CSA with special reference to employees below the senior management level, where incentive programs are less common. The CSA describes long-term incentive programs as variable compensation tied to employee performance over multiple years, including bonuses and stock options.
Among industry groups with low IAs, about 43% of companies offer these incentive programs to workers outside senior management. Every high-IA intensity industry group matched or exceeded that percentage, with the Software & Services and Household & Personal Products industry groups leading at 57%. Financial Services, which includes both banks and financial services companies, had a relatively low percentage, but the banking industry specifically stood out as the industry where the most companies reported having incentive programs based on pay-out periods of more than three years.
Turnover rates vary widely across high-IA industry groups, with some industry groups known for the war for talent displaying much higher voluntary turnover as employees seek career advancement at different firms.
Voluntary turnover across all industry groups followed a similar trajectory over the past few years due to the COVID-19 pandemic. In 2020, there was a stark drop in the percentage of employees choosing to leave their jobs, as economic uncertainty encouraged many workers to keep the jobs they had. But the pandemic experience ultimately led many employees to leave their jobs or switch careers in 2021, a global trend dubbed the Great Resignation.
While this trend held for industry groups with high and low levels of IAs alike, ones known for strenuous computer-based work showed particularly high jumps in turnover between 2020 and 2021. The Software & Services, Media & Entertainment, and Commercial & Professional Services industry groups had the highest increases in turnover over those years. While employee burnout is a risk in any industry, the pandemic exacerbated it for several of these high-IA industry groups.
A recent literature review prepared for the European Financial Reporting Advisory Group by a team of academic researchers confirmed that stronger economies and corporations rely on intangibles as major determinants of growth and value creation. However, the researchers cautioned that the more the system is grounded on intangibles, the more vulnerable it becomes since intangible assets are more uncertain and unstable. Combined with the coronavirus pandemic experience, this reality has led some, including the World Economic Forum, to call for a new human capital accounting framework that includes a calculation of total workforce value based on determinants such as price of talent, investment in development, employee skills, and increase or decrease of workforce engagement.
Refined human capital accounting approaches could be accompanied by new reporting expectations. One quickly approaching example is the Corporate Sustainability Reporting Directive (CSRD) in the European Union, under which over 50,000 large and listed small companies in the EU will annually report as of 2025 on sustainability metrics that cover companies’ workforces and workers in their value chain. As companies start reporting under CSRD requirements, they will need to report on risks and opportunities associated with their employees and refer to indicators related to matters such as development and work-life balance. The broad mandatory requirement will have wide-ranging consequences. IAs may not appear on the balance sheet, but a more balanced approach to managing and communicating about their health appears to be in the making.
