THE CONCEPT OF HUMAN CAPITAL

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CHAPTER 3 HUMAN CAPITAL INTANGIBLES

INTRODUCTION

The primary aim of the previous chapter was to establish a theoretical foundation for intangible assets in general . It was pointed out that the most acceptable categorisation of intangible assets is the one that divides them down into three components as follows: Human Capital (HC), Structural Capital (SC) and Relational Capital (RC) in line with the tripartite classification from the work of Sveiby (1997). The role of intangible assets in the firm’s performance and value creation was explored. The various methods and attempts implemented by valuing and disclosing intangible assets as a whole, were highlighted.
The objective of this chapter is to create a theoretical base for human capital intangibles as a major input in creating value today. The term “capital” has been described as an institutional system which facilitates the progressive development of technology and organisational structures, the differentiation and legitimisation of organisational processes to enhance capital accumulation and development (Clegg & Dunkerley in Abeysekera, 2008:16).
In today’s new economy, intangible knowledge and intelligence that emanate from human capital are critical inputs in the value creating process (Hai-Ming & Ku-Jan, 2003:470). Human capital (HC) has also been portrayed as a significant component of intangible assets (IAs) which constitutes a major driver in the value creation process in the new economy of knowledge-intensive companies (Abhayawansa & Abeysekera, 2008:51). Therefore, it could be said that the dawn of the new economy has prompted the shift of companies’ value drivers from physical tangible assets to non-physical intangible assets.
The accounting literature portrays human capital as being significant, but greater emphasis has not been placed on human capital disclosures (HCDs) by the preparers of corporate annual reports (CARs) due to the generally agreed upon measurement problem. However, this problem should not preclude HCDs in other forms as part of the discretionary information in CARs. It should be noted that most information now being disclosed in the mandatory section of CARs originated through the discretionary information system. It was concluded that the value relevance of CARs is being undermined due to lack of adequate information on how HC drive corporate value creation (Boedker; Guthrie & Cuganesan, 2004:15).
In chapter 1, one of the research questions stated was “Why has the current reporting practice not made provision for full disclosure of human capital? This chapter therefore seeks to answer this question through a critical review of literature on human capital as one of the three main categories of intellectual capital. The chapter will also review some of the approaches to measurement and reporting of HC in the literature. This will cover approaches from the business management and the financial accounting frameworks.

THE CONCEPT OF HUMAN CAPITAL

In his book, Wealth of nations, Adams Smith (1776) first developed the idea of investing in human capital. He was of the opinion that different levels of education account for differences in the ways people work which invariably account for the differences in the returns necessary to defray or write off the costs of acquiring the skills. Comparison of the returns on investment in skills and those of investing in physical capital indicates a major limitation as employees are not owned by firms (except in a slave society) unlike physical capital which are owned by firms.
Early researchers in the field of Human Resources Accounting were of the opinion that human resources should be treated as a statement of financial position item. This means that investment in human resources should be treated as assets to be amortised over a reasonable number of years, thereby communicating the value of human resources to the users of CARs (Hermanson, 1964; Hekimian & Jones, 1967:2; Brummet et al., 1968:218). However, the problem of attaching monetary value to human resources created a setback to this approach. Although, the financial accounting model does not recognise human resource accounting, the movement created awareness which serves as a platform for an intellectual capital research agenda from the 1980s till at present (Bontis, 2003:16).
HC as distinct from economic capital is also referred to as the combination of factors owned by individual employees and the collective workforce of an organisation (Abeysekera, 2008:16). Hence, HC is made up of the intellectual skills and capabilities, knowledge obtained through education and training which consequently allow an individual to execute given tasks more effectively and productively. It is generally recognised as an intangible resource capable of creating value for organisations (Meritum, 2002:63). Human capital also includes personal traits such as intelligence; energy; attitude; reliability; commitment; ability to learn, aptitude; imagination; creativity; desire to share information, participate in a team, and focus on the goals of the firm (Fitz-enz, 2000).
The term “human capital” was coined by the economist Schultz (1961). He discovered that the yield on human capital investment through education and training in the United States was larger than that based on investment in physical capital. Bontis, Dragonelti, Jacobsen and Ross (1999:391-402), defined HC as representing the human factor in the organisation, the combined intelligence, skills and expertise that give the organisation its distinctive character. These human characteristics of the organisation are those that enable people to be capable of learning, changing, innovating and providing the creative thrust, which if properly motivated, can ensure the long-term survival of the organisation. Social accounting theorists believe that the valuation and incorporation of human capital should be viewed as part of the total assets base reflected in a firm’s statement of financial position (Stitle, 2004:313).
Some early researchers defined and explained human capital in the context of a human capital theory which states that an economic value is generated through an individual’s skills, experience and knowledge. This idea supports Sveiby’s explanation of employee competence as the stock of knowledge resident in employees. Pena (2002:182) examines three indicators namely the entrepreneur’s level of education, experience and motivation to connote human capital from the definition of HC as the accumulation of personal traits in the form of knowledge, abilities, personality and so on that enable employees to perform. Mincer (1989) refers to HC as the stock of knowledge capable of generating growth through innovation as well as the stock of skills provided through education and training.
Other researchers explain HC in terms of employee’s skills only (Flamholtz & Lacey, 1981) and in terms of the combination of knowledge, skills and abilities of people. Mackelvery (1983) and Hudsson (1993) define human capital on an individual level as the combination of an individual’s generic inheritance; education; experience and attitude towards life and business. The common factor in these definitions is that employee’s attributes are capable of creating values.
Several researchers conclude that human capital is important because it creates capital accumulation when carefully extracted and developed (O’Donnell, Tracey, Henricken, Bontis, Cleary, Kennedy & O’Reagan, 2006:112; Graham & Pizzo, 1998; Edvinsson & Sullivan, 1996:361). This shows that organisations may use HC disclosure programmes to enhance capital accumulation (Tinker in Abeysekera, 2008:18). The importance of human capital is portrayed by the competition in the human capital market for the acquisition and retention of highly skilled labour with commensurable monetary and non-monetary rewards, although it is not certain whether these rewards reflect the perspectives of both the users and providers of human capital intangibles.
However, the manner in which human capital intangibles could be reflected in the corporate annual reports is yet to be determined. The disclosure of human capital intangibles is unique in that organisations are allowed to choose what information and where such information is to be disclosed in CARs. In other words, there are no requirements backed up by laws or accounting standards to which firms are expected to comply (Abeysekera, 2008:17–18). The major reason for this is that it is difficult to measure the input of human capital visibly as its outcome is influenced by many other factors beyond the control of investors in human capital intangibles. Hence, it is not easy to associate the level of performance of firms with the quality of human capital intangibles possessed by an organisation comparative to those of others firms in the same industry (Pantzalis & Park, 2009:1610). Therefore the investors may be misinformed about the relevance of human capital intangibles in value creation as a result of a lack of harmonised corporate financial reporting.
HC has been described as the source of innovation and strategic renewal regardless of where it originates, whether it originates from arranging files and other clerical works to brainstorming, re-engineering and problem-solving. The used and the useful knowledge of an employee is the source of human capital resources. Apparently, the common assertion that people are the most important resource is both right and true.
Hall (2008) gave the following reasons why it is important to measure people and performance:
people appreciate being successful because success brings happiness and satisfaction.
it is a disservice not to measure people’s performance in that activity without feedback is not challenging.
when performance is not objectively measured, evaluation and reward will be marked subjectivity and politicking.
It is apparent that everybody makes a contribution to the success of an organisation. Therefore all employees from the CEO to the messenger need to be treated with understanding and should be encouraged to develop himself or herself to ensure competency.

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HUMAN CAPITAL AND VALUE CREATION

Between the late 1960s and early 1970s, many academics conducted research on the contribution of human capital to the growth of firms, but between the late 1970s and early 1990s, there seems to be a sharp decline in this research area. However, the dawn of the 21st century witnessed a fresh awakening to this area of research. Major evidence that attest to this is the interest shown by the Institute of Chartered Accountants for England and Wales (ICAEW) through their declaration that HC “… is the coming competitive advantage in the modern knowledge economy, and measuring and reporting human capital is essential to building sustainable economic success” (ICAEW, 2000).
Human capital has been recognised as one of the three major categories of intangible resources capable of creating value for business firms (Meritum, 2002:63). In today’s economies characterised by knowledge, human capital remains an important intangible asset necessary for achieving competitive advantage and sustainable organisational success and growth (ICAEW, 2000).
Some studies were conducted in order to explore the relationship between human capital and value creation. For instance, Edvinsson and Sullivan argue that it is the ability of an organisation to pull knowledge and not necessarily the stock of knowledge that will drive value creation (1996:358). Organisations that give serious consideration to the capability, knowledge, skills of human resources will attain value creation capacity (Wright & Snell, 2005:178). Low (2000) argues that HC is a top non-financial performance driver. This is supported by Skoog who suggests that there exists a positive correlation between disclosed HC and the long run profitability of a firm (Skoog, 2003:487). The position of Low and Skoog is further strengthened by the arguments of Mouritsen et al., (2004:53) that firms could gain the advantage of attracting valuable resources in addition to communicating the organisation’s value drivers through full disclosure of HC information. A clear cut policy on the management, measurement and disclosure of HC will ensure transparency and consequently increase the degree of confidence that the investors and other stakeholders have in the organisation (Olsson, 2001). This means that a progressive firm will convert HC capabilities to meet the increasing expectations of stakeholders (Bassi, Lev, Low, McMurrer & Siesfeld, 2000; Van der Meer-Kooistra & Zijlstra, 2001:456).
The conclusions of other researchers also suggest that many organisations have realised that HC practices and their disclosures play a significant role in the performance of firms (Boudreau 1991; Wright & McMahan 1992:303). This has resulted in a great shift by management towards the contribution of human resources in the last decade (Bassi et al., 2000). Firms who engage in pragmatic HC practices such as acquisition, development and retention of employees, incentive compensation, employee empowerment, selective staffing, job rotation, comprehensive training and team work can intensify the value creation processes (Youndt, Snell, Dean & Lepak, 1996:839).
The human capital theory is at the centre of many economic theories which seek to provide explanations for the connection between individuals’ skills, productivity and earnings (Pantzalis & Park, 2009:1610). This theory has been associated with the resource-based view of the firm by Barney(1991:102) who makes a proposition that sustainable competitive advantage is attained when the firm has a human resource pool that cannot be imitated or substituted by its rivals. The theory postulates that an individual’s skills, experience and knowledge generate economic value to an organisation and that these can be stirred-up through education and training acquired by individual employees.
Sveiby (1997:10) pioneers the tripartite framework of IA and conceptualises HC as employee competence which include explicit knowledge, skill, experience, value judgement and social network. There seems to be a consensus in the IA literature in conceptualising HC as a combination of attributes such as knowledge, skill, abilities and personality characteristics which are portrayed by individuals and corporately (Abeysekera & Guthrie, 2004:253). HC has also been defined as the accumulation of personal attributes of skills, knowledge and personality traits which allow individuals to function (Pena, 2002). In portraying the importance of HC, Becker (1964) explains that HC is the foundation for the wealth-creating capacity of an organisation. The application of HC theory to skills of the employees is continued in the works of Flamholtz and Lacey (1981). The interpretation of the theory is done by Mackelvery (1983) through the attributes of knowledge, skills and abilities of employees. Also, basing his argument on the theory, Mincer (1989) portrays HC as a stock of skills produced by education and training and also a stock of knowledge which generates growth through innovation.

Human Capital Advantage

In support of the value creation attribute, the concept of human capital advantage was developed to show the significance of human capital believed to be the source of sustainable competitive advantage for firms with a pool of employees that cannot be copied or substituted by its competitors (Boxall, 1996:8). This is also in line with the resource-based view of the firm which also emphasises retention, motivation and development of high-quality employees and provides a competitive advantage in the form of human capital. The resource-based view of the firm points to sources of human resources as an advantage in exceptional human capital and outstanding human process (Boxall, 1996:12).
The use of HC reporting was motivated by the need for management control as concluded by Grojer and Johanson (1998:496). Also, Stewart (1994) was of the opinion that IC reports were published (most especially by Scandinavian companies) as a means of reflecting IC value and as a way of managing these value drivers.
HC is an important element of IA driven value creation in the new economy, particularly in knowledge intensive companies. This is despite the importance of impact of HC on the performance or market value of a firm. There are limited empirical studies on the impact of HC on the performance or market value of a firm. Among the few studies which are focussed on the impact of HC on the value of a firm are Pena (2002:190) who found out there was a positive relation between the entrepreneur’s level of education, experience and motivation and the performance of a new venture. The departure of a company’s CEO was found to be associated with negative market reactions (Diedman & Lin, 2002:81). Successful business strategies were also discovered to be associated with personal traits of the top executive officers (Ashton, 2005:53). Investment analysts make use of corporate annual reports as a justification for making investment recommendations and forecasting earnings.
In order to further emphasise the significance of HC, the concept of human capital management (HCM) was developed. HCM is concerned with obtaining, analysing and reporting data that informs the direction of value adding, strategic, investment and operational people management decisions at corporate level and at the level of frontline management. HCM has also been defined as an integrated effort to manage and develop human capabilities to achieve significantly higher levels of performance (Chatzkel, 2004). This view is supported by Kearns (2005) because he suggests that HCM is about creating value through people.
The Chartered Institute of Personnel Management, (2003) refers to HCM as a process involving the systematic analysis, measurement and evaluation of how people policies and practices create value. HCM suggests that an organisation’s success is the product of its employees’ competence and therefore the causal link between people and performance should be made visible and available to all stakeholders.
HCM seeks to treat employees as assets which need to be measured, managed and reported on while human resources management (HRM) seeks to treat employees as significant costs that should be managed in that regard (Mayo, 2001; Kearns, 2005).
In the new economy, human capital is at the centre of value creation because knowledge-based organisations are emerging as a direct consequence of increasing forces of globalisation and technological advancement. These types of organisations recognise human capital as the dominant wealth creator and driver. This is contrary to what operated in the old economy when firms spent huge sums of money on machines and so remained bundles of tangible assets whose ownership remain with the investors who employ people for their operations.
Organisations in the new economy now spend an increasing portion of their capital on human capital intangibles and equipment needed for gathering, processing, analysing and distributing information. The new economy organisations (knowledge organisations) have intangible assets as their assets, the ownership of which cannot be easily determined. In these organisations, human capital is arguably the most important driving factor while financial risk capital is the major factor distinguishing them from the new economy organisations (Rudolf, 2004:48).
Most organisations are now aware that their competitive advantage lies in their employees and not in their machines or products and that hiring the right people with adequate support systems will cause them to be conquerors in the battle in the competition arena. This can be ascribed to the fact that competitors may copy the product, strategy and technology, but it is difficult to copy another firm’s human capital. IC has been referred to as a tree and the people as the sap that makes organisations grow. Money talks, but does not think, machines perform but cannot invent, knowledge workers through their bodies, minds and souls both think and invent (Stewart, 1998).

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HUMAN CAPITAL: MEASUREMENT AND DATA

Early researchers on human resources argued that the main purpose of measuring HC value is for effective internal management (Hekimian & Jones, 1967:107; Flamholtz, 1974:45). HC measurement is based on the data which are often in the form of numbers or quantities describing the human capital in an organisation. Examples of HC data are demographic figures on the size and composition of workforce, number of employees who resigned, absence figures, the amount of training and development programmes embarked on and the number of vacancies filled during a particular period (Baron & Armstrong, 2007:32). However, this form of data is often required for compliance with some legal and regulatory frameworks in which an organisation operates, such as employment equity in the South African environment.
Human capital data needed for decision-useful information will go beyond the raw data to their measurement, assembly and analysis so that conclusions can be reached on their value and significance. For example, the data on the number of employees who resigned during a given period can be expressed as a measure of employee turnover which is the ratio of number of employees who resigned to the number of those employed in a given period. Therefore data on human capital needs to be analysed and interpreted through measures to provide information on which evaluation, planning and decision-making could be based.
However, other researchers argue that it is impossible to arrive at an acceptable method for measuring HC. This is in view of the fact that existing financial accounting frameworks are implemented through reporting standards which only allow for recognition of items whose future economic benefits can be expressed in monetary terms in the statement of financial position (Scarpello & Theeke, 1989; IAS 38 {IASB, 2004}; IFRS 10 {IFRS Foundation, 2011}). This led to the submission by other researchers that attention should be focused on the value creating potentials of HC rather than quantifying such values in monetary terms. Hence a proposition was made for the use of “soft” accounting information instead of “hard” statements of financial position monetary values (Roslender & Dyson, 1992:312; Roslender, 1997:12). HC will require a range of measures to fully describe its character and contribution.
The Chartered Institute of Personnel Development (2003) also note that reporting human capital simply in terms of costs rather than value creation may lead to cost reduction strategies rather than more desirable value creation activities.

TABLE OF CONTENT
SONGS AND QUOTES OF PRAISE 
TABLE OF CONTENT 
LIST OF TABLES 
LIST OF FIGURES 
DEDICATION 
ACKNOWLEDGEMENTS 
DECLARATION 
ABOUT THE ACCOMPANYING CD: ADEPhD-CD 
THE THESIS HOUSE 
ABSTRACT 
CHAPTER 1: INTRODUCTION AND PROBLEM STATEMENT
1.1 BACKGROUND
1.2 PROBLEM STATEMENT
1.3 ASSUMPTION
1.4 RESEARCH QUESTIONS
1.5 OBJECTIVES OF THE STUDY
1.6 IMPORTANCE OF THE STUDY
1.7 SCOPE OF STUDY
1.8 RESEARCH METHODOLOGY
1.9 LIST OF DEFINITIONS USED
1.10 LIST OF ABBREVIATIONS AND ACRONYMS USED
1.11 DEMARCATION OF CHAPTERS
CHAPTER 2: INTANGIBLE ASSETS
2.1 INTRODUCTION
2.2 ASSETS
2.3 COMPONENTS OF INTANGIBLE ASSETS
2.4 CATEGORISATION OF INTANGIBLE ASSETS
2.5 THE ATTRIBUTES OF INTANGIBLES
2.6 INTANGIBLES AND FIRMS’ PERFORMANCE
2.7 VALUATION OF INTANGIBLE ASSETS
2.8 REPORTING OF INTANGIBLE ASSETS
2.9 SUMMARY AND CONCLUSION
CHAPTER 3: HUMAN CAPITAL INTANGIBLES
3.1 INTRODUCTION
3.2 THE CONCEPT OF HUMAN CAPITAL
3.3 HUMAN CAPITAL AND VALUE CREATION
3.4 HUMAN CAPITAL: MEASUREMENT AND DATA
3.5 REASONS FOR INTEREST IN HC MEASUREMENT AND REPORTING
3.6 REVIEW OF ANALYTICAL MODELS FOR HC REPORTING
3.7 HUMAN CAPITAL DISCLOSURES
3.8 SUMMARY AND CONCLUSION
CHAPTER 4: THEORETICAL FRAMEWORK
4.1 INTRODUCTION
4.2 FINANCIAL INFORMATION SYSTEMS
4.3 USERS OF CARs
4.4 DISCLOSURES IN CARs
4.5 DECISION-USEFULNESS APPROACH TO CORPORATE ANNUAL
REPORTING
4.6 SUMMARY AND CONCLUSION
CHAPTER 5: REGULATORY FRAMEWORK
5.1 INTRODUCTION
5.2 INTERNATIONAL REGULATIONS
5.3 LOCAL REGULATIONS
5.4 SUMMARY AND CONCLUSION
CHAPTER 6: RESEARCH DESIGN
6.1 INTRODUCTION
6.2 LITERATURE REVIEW
6.3 CONTENT ANALYSIS
6.4 THE COUNTRY (SOUTH AFRICA)
6.5 THE POPULATION (COMPANIES)
6.6 SOURCE DOCUMENTS
6.7 PROCEDURE OF CONTENT ANALYSIS
6.8 INTRODUCTION TO QUESTIONNAIRE METHOD
6.9 DATA ANALYSIS METHOD
6.10 STATISCAL PACKAGE FOR THE SOCIAL SCIENCES (SPSS)
6.11 CHARTS AND TABLES
6.12 LIMITATIONS OF THE EMPIRICAL INVESTIGATION
6.13 SUMMARY AND CONCLUSION
CHAPTER 7: RESEARCH RESULTS: CONTENT ANALYSIS OF CARs
7.1 INTRODUCTION
7.2 THE COMPANIES ANALYSED AND THE CHECKLIST ITEMS
7.3 THE SOFTWARE USED FOR CONTENT ANALYSIS OF CARS
7.4 CODING RESULTS BY FAMILIES
7.5 SUMMARY AND CONCLUSION
CHAPTER 8: RESEARCH RESULTS – QUESTIONNAIRES FOR PREPARERS GROUP 1: FINANCIAL DIRECTORS/MANAGERS
8.1 INTRODUCTION
8.2 QUESTIONNAIRE FOR THE PREPARERS GROUP 1
8.3 SUMMARY AND CONCLUSION
CHAPTER 9: RESEARCH RESULTS – QUESTIONNAIRES FOR PREPARERS GROUP 2: HUMAN RESOURCE DIRECTORS/MANAGERS
9.1 INTRODUCTION
9.2 RESEARCH RESULTS
9.3 SUMMARY AND CONCLUSION
CHAPTER 10: RESEARCH RESULTS – QUESTIONNAIRES FOR USERS GROUP 1: INVESTMENT ANALYSTS
10.1 INTRODUCTION
10.2 QUESTIONNAIRE FOR USERS GROUP 1
10.3 RESEARCH RESULTS
10.4 SUMMARY AND CONCLUSION
CHAPTER 11: RESEARCH RESULTS – QUESTIONNAIRES TO USERS GROUP 2: REGULATORS AND GOVERNMENT DEPARTMENTS
11.1 INTRODUCTION
11.2 MEETINGS
11.3 RESULTS OF COMPLETED QUESTIONNAIRES
11.4 SUMMARY AND CONCLUSION
CHAPTER 12: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
12.1 INTRODUCTION
12.2 RESEARCH PROBLEM, QUESTIONS AND FINDINGS
12.3 SUMMARY OF RESEARCH FINDINGS
12.4 SUMMARY AND CONCLUSION
12.5 RECOMMENDATIONS
12.6 CONTRIBUTIONS OF THIS STUDY TO THE SCIENCE OF ACCOUNTING
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