As Covid upended the workplace and created burnout, some companies tried to cope by investing in the welfare of their workers – remote work, digitization, increased bonuses. Did such investments in “human capital” pay off in terms of firm value?

“Covid was a once-in-a-generation health crisis that put many workers’ health and safety at risk, with firms investing to protect them,” said Bill Mayew, the Martin L. Black Jr. Distinguished Professor of Business Administration at Duke University’s Fuqua School of Business. “But whether those efforts were fruitful was unclear in terms of improving firm value.”

In a paper published in the Journal of Management Accounting Research, Mayew and co-author Yuan Zhang, of University of Texas at Dallas investigated the relation between Covid-related “human capital” investments reported in public companies’ disclosures and company market value.

They found that investments in workers’ welfare increased firm value only when the companies had substantial cash holdings before the pandemic.

“Only firms who had sufficient financial flexibility at the pandemic onset were able to make meaningful investments in their employees that improved their market value,” Mayew said.

How a new SEC rule reveals companies’ investments on employees

As the SEC and many others consider investments in “human capital” as “important driver[s] of performance,” the researchers wanted to study this possible relationship during the pandemic.

To collect data on companies’ investments on employees welfare, they leveraged an update on public-companies’ “Form 10-K” disclosures the SEC made effective in 2020 — the first year of the pandemic — aimed at reporting on “human capital resources.”

While such disclosures offered a new and unique window into human capital investments, they came with one caveat, the authors write.  

The new standard of reporting on human capital doesn't require disclosure of the total dollar amount of investment on employees, Mayew said. According to the SEC, companies need to disclose “a description of (…) human capital resources,” when it is “material to an understanding” of a business. This requirement is “principle-based” — the authors write — with no formal definition of how to quantify the investments.

“So we can’t directly assess the dollar amount invested in human capital like we can with other investments, like when they buy a building,” he said.

The researchers studied a sample of 2,123 public companies and found that 63% of them declared material human capital investments containing the keywords “coronavirus,” “Covid” or “pandemic.”

They then measured firm value through the ratio between stock market value and total assets (the so-called “Tobin’s Q” ratio). They found that, on average, companies disclosing employee investments during Covid didn’t enjoy higher valuations than companies who didn’t.

But when they considered “cash holdings” at the beginning of the pandemic, they found a positive correlation between investments in employee welfare and firm value as the amount of available cash increased.

“If you had a lot of cash when the pandemic started, you would be able to make human capital investments that were more meaningful from a firm value standpoint,” Mayew said.

Testing the results

In order to corroborate the correlation, the researchers analyzed two possible drivers of the results: employee sentiment and productivity.

“If [market] value went up, why would investors think the company is more valuable? It has to have something to do with productivity or sentiment or both,” Mayew said.

As a measure of sentiment, they matched their sample with reviews from Glassdoor.com, a social media site where employees discuss workplace issues.

On Glassdoor, employees numerically rate how favorably they view their employers. The researchers gathered the ratings and found a positive correlation between positive reviews and firm value as financial flexibility increased.

They also measured productivity in terms of “revenue per employee,” which showed a similar pattern as the employee sentiment gleaned from the Glassdoor ratings.

“In all those tests — for firm value, sentiment and productivity — they only work when a company has enough cash,” Mayew said.

These results contribute to the conversation around the efficacy of such “qualitative” SEC human capital disclosures, Mayew said — previous research for example suggested their lack of substance.

When disclosures are “soft” and not based on objective “materiality thresholds,” he said, combining them with mandatory financial data can help them become informative.

This theme can also be extended to “Environmental, Social, and Governance” (ESG) reporting, Mayew said.

“It’s hard to compare firms when they have great latitude in what they report.  When are firms actually making investments that are large enough to make a difference?  If you can connect that information to something that's captured in dollar terms in the financial statement - like financial flexibility – that’s when meaning can emerge,” he said.

Should companies have more reserve cash for “rainy days”?

The available data doesn’t allow the identification of a causal connection between well-funded investments on employee welfare and firm value, Mayew said, especially because the disclosure rule introduced by the SEC wasn’t in force before Covid, and it is difficult to determine the “normal” level of human capital investment before 2020.

“But with Covid, some evidence is better than no evidence,” Mayew said.

This evidence of a correlation between human capital investment and higher firm value that is conditional on cash holdings, however, “definitely does not suggest that companies should hold more cash for rainy days,” he said. Extra cash turned out to be useful during Covid, he said, but this doesn’t say anything about the optimal amount of “idle cash” in normal times.

“You can imagine investors complaining about firms that hold big cash balances, because then you're not investing. Now, it turns out, if Covid hits, then you're in good shape. The rest of the 99 years when Covid doesn't hit, are you optimizing firm value or not? That's a long-standing debate,” Mayew said.