July 13, 2023
The Increasing Importance of Non-Financial Data
HR leaders may have previously considered their value-add to be limited to their efforts to attract, motivate, and retain talent, while their other responsibilities — like external reporting — are important but secondary. This Equity Methods blog highlights that this mindset has been changing, and needs to change, given the increasing importance of non-financial data (especially in the proxy and sustainability report) to investors’ buy, sell, and ballot decisions.
The blog specifically highlights the importance placed on executive compensation data, pay equity and representation information and CD&A storytelling, but emphasizes that this list isn’t exclusive and investors rely on many other types of non-financial data. This data impacts the company and its equity value through say-on-pay votes, director elections, the growth of ESG funds, public and employee perception and the risk/cost of activism.
What does this mean for HR leaders? That companies need to enhance their processes and procedures around this data. Here are the suggestions from the blog:
1. Set up a system of controls. In keeping with how Sarbanes-Oxley mandated internal control procedures and an audit of the system of internal control over financial reporting, we suggest voluntarily implementing rigorous controls around all non-financial calculations taking place. This means procedure documents, control totals tests over the data, trending and fluxes to validate numerical reliability, and clear review responsibilities.
2. Leverage calculation best practices. While some non-financial calculations are black and white, others are laden with assumptions. Unfortunately, there are no rigorous standards governing calculation methodologies as we have in accounting via generally accepted accounting principles (GAAP). The limited materials made available by the Sustainability Accounting Standards Board and others do not, for example, prescribe specific approaches for complex topics.
Complex areas where we see significant divergence in methodologies include pay equity, employee engagement results, how to cut and stratify representation data, and advanced pay calculations like the new pay vs. performance disclosure in the proxy.
Our advice is to leverage your external vendors. For example, in addition to seeing a wide breadth of situations and using this experience to inform best practices, we also keep tabs of trends in litigation. Until a standard-setter gives us the equivalent of GAAP in the non-financial space, we think there’s value in monitoring what techniques do and don’t hold up in litigation.
3. Conduct at least two dry runs before going live on a new externally reported metric. In addition to working out process kinks, these dry runs also let you conduct the critical exercise of trending the results and performing root cause analysis on the variance drivers. Imagine disclosing a pay equity result that shows no gender pay gap and then a year later you disclose a 3% gap.
The first question everyone will ask is, “What changed and why?” Not only will you want readily available processes on the shelf to identify change drivers, you’ll also want some comfort that the methodology is durable and not overly sensitive to blips in the data. These offline dry runs are critical to gaining that comfort so you can begin disclosing externally.
4. Prepare and execute manager training. Once you begin disclosure, employees will see the information and have questions. These questions may be unexpected or nuanced in a way that the manager may simply not know how to reply.
We suggest drafting manager talking points and FAQs in advance of going live (internally or externally). The informational aids should address disclosures related to representation, pay equity, employee engagement, health and safety, or any other topic where an employee could express concerns or simply seek more detail.
– Meredith Ervine