The Advisors' Blog

I blogged yesterday about FASB ASU 2024-03, which will soon require public companies to include “employee compensation” and other disaggregated expense data in the notes to financials. This CLS Blue Sky blog from several b-school profs (based on their paper here) looks at how investors could use labor costs in particular to predict a company’s future performance, while noting that the required info still may not paint a full picture for analysts. Here’s an excerpt:

Measuring labor costs is hard precisely because firms do not disclose them. We use data from Revelio Labs, which standardizes millions of public employment records to estimate firm-level compensation, to build wage measures for roughly 25,000 firm-years from 2009 to 2022. The data let us split labor into three functional categories, general and administrative (G&A), sales and marketing (S&M), and research and development (R&D), a detail that no mandated financial-statement data currently provide. We validate our wage estimates against three benchmarks: voluntarily disclosed staff expense, median employee pay from proxy statements, and an industry-imputed wage measure based on voluntary disclosures. We caution that the Revelio measures are estimates, not audited figures, and are subject to selection and measurement error. Both sources of noise bias our tests toward finding smaller effects, so our estimates should be read as a conservative floor on the usefulness of audited labor-cost information.

Our first finding is that detail matters, and the useful detail is functional. Separating SG&A into aggregate wage and nonwage components yields only modest gains in predicting future performance. The larger gains arise when wages are split by function. The three components behave in economically distinct and intuitive ways: S&M wages track near-term revenue growth, R&D wages are the most informative about long-horizon revenue growth and future SG&A intensity, and G&A wages are comparatively uninformative about future fundamentals. These patterns persist when we control for the matched nonwage expense within each function, so labor is carrying information that nonlabor costs do not. Additionally, the gains are largest among firms with smaller workforces, where hiring choices map more directly onto commercialization and innovation.

The information also has capital-market consequences. Periods of high wage volatility, particularly in G&A and R&D wages, are associated with larger analyst revenue-forecast errors and with greater market illiquidity. Firms that voluntarily disclose aggregate wages attenuate some of the G&A-related uncertainty, but the effect is imprecise and does not fully resolve the forecasting errors or liquidity costs tied to more forward-looking inputs such as R&D. Taken together, the evidence is consistent with labor-cost disaggregation providing information that analysts and investors do not already have, and the usefulness of both aggregate and disaggregated labor costs.

What does this mean for the standard? The companies’ empirical premise does not hold up: Labor-cost information is useful, and the market prices its absence. More important, our evidence cuts in a second direction that the debate has largely missed. The standard requires compensation to be disclosed within the functional captions firms already present, but it does not require firms to separate R&D, S&M, and G&A on the face of the income statement, meaning that the labor-cost disaggregation our results find most useful may not be disclosed. Because the largest predictive gains come precisely from splitting labor functionally, a rule that stops at compensation-within-existing-captions is a step forward, but it can be improved by requiring firms to report R&D, S&M, and G&A in the income statement.

The professors acknowledge that they’re only considering the “investor benefit” side of the ledger here – not diving into how costly it will be for companies to collect and disclose the information. They note that a complete cost-benefit verdict will have to wait until the standard has been in force for several years.

– Liz Dunshee