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Watson Wyatt’s HumanCapitalIndex - blindSpot

Watson wyatt sHuman capital index human capital As a Lead Indicator ofShareholder Value2001/2002 Survey capital index : human capital As a Lead Indicator of Shareholder ValueWatson wyatt WorldwideCan the way a company manages its human capital significantly affect its financial performance?Two years ago our human capital index (HCI) study confirmed that the two areclearly linked. We developed a simple set ofmeasures quantifying exactly which HR prac-tices and policies have the greatest correlationto shareholder value. Using those to assign asingle HCI score to each surveyed companyallowed us to deliver conclusive, ground-breaking results: Where there are superior HRpractices, there is higher shareholder value. Yet a crucial question remained: Do betterpeople management strategies actually createhigher market value? Or do financially success-ful companies simply have more resources toallocate to human capital initiatives?

Watson Wyatt Worldwide Human Capital Index: Human Capital As a Lead Indicator of Shareholder Value In the first HCI study, conducted in 1999, Watson Wyatt surveyed more than 400 U.S.-and Canada-based companies that were publicly traded, had at least three years of shareholder returns and had a minimum of $100 million in revenue or market value.

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Transcription of Watson Wyatt’s HumanCapitalIndex - blindSpot

1 Watson wyatt sHuman capital index human capital As a Lead Indicator ofShareholder Value2001/2002 Survey capital index : human capital As a Lead Indicator of Shareholder ValueWatson wyatt WorldwideCan the way a company manages its human capital significantly affect its financial performance?Two years ago our human capital index (HCI) study confirmed that the two areclearly linked. We developed a simple set ofmeasures quantifying exactly which HR prac-tices and policies have the greatest correlationto shareholder value. Using those to assign asingle HCI score to each surveyed companyallowed us to deliver conclusive, ground-breaking results: Where there are superior HRpractices, there is higher shareholder value. Yet a crucial question remained: Do betterpeople management strategies actually createhigher market value? Or do financially success-ful companies simply have more resources toallocate to human capital initiatives?

2 We now have powerful insight into theanswer. Our second human capital Indexstudy allowed us to compare one set of com-panies at two points in time to analyze thecorrelation. The results are in and they aredramatic. Superior human capital practicesare not only correlated with financial returns,they are, in fact, a leading indicator ofincreased shareholder value. Further, wefound that superior HR management leadsfinancial performance to a much greaterextent than financial outcomes lead goodHR. We were also able to identify certainHR practices as value drivers and throw acautionary flag in front of some conventionalpractices actually associated with a decreasein financial results of this study are more meaning-ful now than ever before. While the state ofthe economy is largely uncertain, companiescannot escape demographics. There is nodoubt that the labor shortage will continuewell into the next decade and that superiorHR practices are a key to attraction, retentionand, more and more, business outcomes.

3 It salso a certainty that executives will now, morethan ever, look to HR to justify expendituresand demonstrate the economic value of anorganization s people practices. The overriding message: If a company s goal isto improve shareholder value, a key prioritymust be its approach to human Superior human capital management is a leading rather than lagging indicator of improved financial success. This finding is more important now, during times of economic uncertainty, than in boom times. Why? Lead indicators help you get ahead of the curve. 2 Watson wyatt WorldwideHuman capital index : human capital As a Lead Indicator of Shareholder ValueIn the first HCI study, conducted in 1999, Watson wyatt surveyed more than 400 Canada-based companies that were publicly traded, had at least three years ofshareholder returns and had a minimum of$100 million in revenue or market value. We asked a wide range of questions abouthow the organizations carriedout their humanresources practices, including pay, peopledevelopment, communications and staffing.

4 Responses were matched to objective financialmeasures, including market value, three- andfive-year total returns to shareholders (TRS),and Tobin s Q, an economist s ratio that mea-sures an organization s ability to create valuebeyond its physical assets. Publicly availabledata from Standard and Poor s Compustatdatabase were used to access the financialinformation needed. To investigate the relationship between humancapital practices and value creation, a seriesof multiple regression analyses were conducted,identifying a clear relationship between theeffectiveness of a company s human capitalpractices and shareholder value key HR practices were associated with a 30 percent increase in market HCI scores were created for indi-vidual organizations so that results could beexpressed on a scale of 0 to 100. An HCIscore of 0 represents the poorest human capi-tal management, while a score of 100 is 2000, a European HCI survey was con-ducted to gain a more global perspective onthese issues.

5 More than 250 responses from 16countries were received. The survey included200 questions in six languages and coveredcompanies of all sizes and from all sectors ofthe economy more than a third of partici-pants were in the Euro 500 and more than aquarter were in the Global 500. The findingsfrom the European study were similar to theNorth American results, with improvements in 19 key HR practices associated with a 26 percent increase in market early 2001, the HCI research was con-ducted again, this time including responsesfrom more than 500 North American com-panies. In this most recent research, theparticipants reflected a broader view ofbusiness and included some larger, moreprominent firms with average annualsales of $ billion, $ billion in mar-ket value and 18,697 employees on of these companies participated inboth the 1999 and 2001 surveys. The European and new North American datawere then merged. The result is a completerespondent base of more than 750 companiesin the United States, Canada and Europe withat least three years of shareholder returns,1,000 or more employees and a minimum of$100 million in revenues or market THE SURVEY199920002001 First North American HCI StudyFirst EuropeanHCI StudySecond NorthAmerican HCI Study2001/2002 HCIS urvey ReportThe majority of the combined findings from these surveys were consistent, making it a logical anduseful tool from which to draw conclusions.

6 It is important to point out, however, that there werenotable differences in emphasis between the European and North American studies. For instance,certain questions about benefits and HR service delivery were included only in the North Americansurvey. In addition, the database is weighted nearly 2 to 1 to North American companies, so the generalized findings should be considered with that in mind. Watson wyatt will publish more aboutthe similarities and differences between the studies in the results from the 2001 HCI study are justas definitive as those from 1999: The highera company s HCI score, the higher its share-holder value. In other words, the better anorganization is doing in managing its humancapital, the better its returns for broke the companies into three groupsbased on their summary HCI scores. Thosein the low group averaged a 21 percent five-year return. The medium group aver-aged 39 percent. Those with high HCI scores returned 64 percent over five years(Figure 1).

7 In addition to providing dramatic evidencethat good human capital management mat-ters, the HCI study shows precisely whichHR practices amid the ever-increasingportfolio of options have an impact onthe bottom line. This year s study identifiesthe 49 specific HR practices that play thegreatest role in creating shareholder have divided those practices into sixdimensions (Figure 2). The research quanti-fies exactly how much an improvement ineach practice could be expected to increase a company s market value. For example, acompany that makes a significant improve-ment*in all of the practices categorizedunder Total Rewards and Accountability should see its value improve by percent(Figure 2). And a significant improvement in 43 key HR practices is associated with an increase of 47 percent in market , one dimension, Prudent Use of Resources identifies six practices thatdiminish shareholder HIGHLIGHTSR esults Link Superior human capital Practices to Higher Shareholder Return*What constitutes a significant improvement ?

8 A one standard deviationincrease. Most answers to HCI questions are on a 1 5 scale, so a significantchange is a one-scale-point movement from a 1 to a 2, a 2 to a 3, and so Rewards and , Flexible and Retention HR Service Use of change in market value associated with a significant one standard deviation (1 SD) improvement in HCI 2: Key Links Between human capital and Shareholder Value CreationPractice Impact on Market ValueLow (0-25)Medium (26-75)High(76-100)21%39%64%HCI ScoreFIGURE 1: Five-Year Total Returns to Shareholders (April 1996 April 2001)3 human capital index : human capital As a Lead Indicator of Shareholder ValueWatson wyatt WorldwideThe first HCI study confirmed that there wasa positive relationship between the quality ofa company s HR practices and its economicresults. But it did not offer resolution to thedebate that has raged for years: Do effectiveHR practices drive positive financial resultsor do positive financial results lead to betterHR practices?

9 Two years ago, we noted that the best-performing companies did not simply havebetter-funded programs, they had entirelydifferent programs than the poorly performingcompanies. The high performers employedcertain programs ( , broad-based stockoptions) that low performers did not. Theystayed away from certain programs ( ,training employees for future jobs) that lowperformers embraced. If it were true thatgood financial performance simply affordedrich companies the ability to implementelaborate HR programs, one would expect tosee the same types of programs across theboard. We did not. Yet it was still not proofthat superior HR management was causinghigh market value. The best we could offerat the time was that the relationship probablymoved both our latest study yields the missing cru-cial data. Fifty-one companies participatedin both the original and the follow-up HCI studies. We have HCI scores and financial performance information for 1999and 2001.

10 To see whichway the relationship truly runs,we simply compared two different correlations: Correlation A represents the relationship between the 1999 HCI score and 2001financial performance. Correlation B represents the relationship between 1999 financial performance and2001 HCI better financial performance is what createssuperior HR practices, Correlation B shouldbe larger. If, in fact, the way companiesmanage their human capital is what drivesfinancial success, Correlation A should be results were dramatic. Correlation A,.41, is statistically significantly larger thanCorrelation B, .19. Our analysis demon-strates that HR practices are not only associ-ated with business outcomes, but also createthem. Moreover, a careful inspection of all the data shows that for every availablecorrelation calculated over time, the relation-ship between past HR practices and futurefinancial performance is stronger than therelationship betweenpast financial outcomesand future HR practices.