The Advisors' Blog

I blogged last week about a rulemaking petition that the “Working Group on Human Capital Accounting Disclosures” submitted to the SEC – which, among other things, urged the SEC to require companies to disaggregate labor costs on their income statements. This blog from Cooley’s Cydney Posner says that the FASB also recently revived a project to disaggregate income statement expenses – including labor costs. At a late-July meeting, the FASB considered feedback on the topic from both preparers & investors. Cydney’s blog summarizes the discussion from the meeting. Here’s an excerpt:

At this point, a loose consensus appeared to form around a two-pronged hybrid approach (somewhat similar to the approach being taken by the IASB): a prescriptive component that would require disaggregation of some specific costs, including labor, depreciation and amortization and, in some cases, materials or purchases; and a principles-based component for disaggregation of other costs, which might involve management judgment or a quantitative threshold or backstop. More elusive perhaps may be a simple approach to addressing inventory and capitalized expenses.

The staff plans to perform analysis and develop alternatives for discussion at a future Board meeting. Clearly, there’s still a way to go here, but the project does appear to be moving forward. Separately, the FASB is working on a proposal to require more granularity about segments.

The attention on “labor cost” transparency follows two years of new disclosure under the principles-based human capital disclosure rules that the SEC adopted in 2020. A recent academic study (from accounting professors Demers, Wang & Wu) found that, at least in Year 1, Form 10-K HCM disclosures tended to focus on qualitative info and be phrased optimistically. If you’re preparing these disclosures, you should know that someone out there is measuring your word count and “positive tone.” Here’s more detail (cleaned up):

– The mean (median) HC disclosure consists of 501 (420) words. The length of the HC disclosure varies considerably across firms, ranging from 37 words at the 5th percentile to 1,305 words at the 95th percentile.

– In relative terms, HC disclosures represent 8.59% (5.53%) of Item 1 for an average (median) firm. The proportion of Item 1 represented by HC disclosures varies greatly across firms, however.

– “Numerical intensity” is low – just 3.87% (2.61%) for an average (median) firm in the sample – 5% of firms provide less than one number for every one hundred words in their HC disclosures,
whereas the 5% with the highest numerical intensity provide approximately one number for every 10 words.

– Firms use approximately four times as many positive words as negative words in their HC disclosures.

The professors concluded that the new disclosures lacked comparability and weren’t very informative to investors:

Our results confirm that, in the absence of detailed guidance, corporate HC disclosures are extremely heterogeneous in terms of their length, numerical intensity, tone, readability, and similarity with peer firms; they are generally not very numerically intensive, but they are very positively toned; and they inherit many of the properties of the firm’s other Item 1 disclosures.

Firms with higher levels of institutional investors have longer and more net positively-toned HC disclosures, but these disclosures are not necessarily more informative as they are not more numerically intensive nor more specific. More profitable firms tend to have more idiosyncratic disclosures, whereas firms with lower ROA tend to provide more boilerplate disclosures. Firms for which HC is strategically important, on the whole, do not appear to provide superior HC disclosures.

Finally, time trends suggest that firms have learned over the first year of the non-directive regulation to provide HC disclosures that are longer and more optimistic, but less informative (i.e., more similar or boilerplate, less specific, and less numerically intensive). Overall, our comprehensive descriptive evidence suggests that, consistent with widespread criticism, the SEC’s new principles-based rule has generated HC disclosures that are likely to be grossly insufficient for investors’ needs.

It will be interesting to see whether the new HCM disclosure that the SEC intends to put forth this fall will swing the pendulum all the way to the “prescriptive” side of the spectrum, which seems to be the direction that the tea leaves are pointing. I’m sure I’m not the only one who finds the criticisms of early disclosures a little unfair, when companies were scrambling to navigate an 11th-hour rule.

That said, now is the time to get out in front of the next round of rulemaking, because your future disclosures also will be picked apart. Our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” will provide loads of practical guidance. That includes get the very latest on what you need to be doing to prepare for new HCM disclosures that the SEC plans to require – and in the meantime, meet continuously advancing investor demands.

With so much SEC rulemaking on the horizon, our Conferences are a “can’t miss” event for anyone who is preparing SEC disclosures, engaging with shareholders, or advising compensation committees or boards. Check out the agendas – 18 fast-moving, practical sessions held virtually over 3 days – October 12th – 14th. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271. With human capital also being a very relevant topic to anyone navigating ESG issues, you can also add on our “1st Annual Practical ESG Conference” for a bundled discount! Tell your colleagues, and save even more for multi-seat registrations…

– Liz Dunshee