Human Capital in the Human Resource Management Literature...11 2.1 Introduction

‘Human Capital Analysis’

Describing the Knowledge Gap in the Financial Investment Recommendation Process Using Human Capital Analysis

Burcin Hatipoglu

Industrial Relations and Organisational Behavior

School Of Organisation and Management

The Australian School of Business

University of New South Wales

Thesis submitted in fulfillment of the requirement for the degree of Doctor of Philosophy

August 2010

Abstract

Describing the Knowledge Gap in the Financial Investment Recommendation Process Using Human Capital Analysis

After 2000 we have witnessed corporate collapses and at the same time a decrease in the trust in the financial investment industry. More than before, individuals are finding themselves investing in the financial markets directly or indirectly. Now, unsurprisingly, they tend to seek more accurate information about the reality that will aid them in decision making and at the same time build their trust in companies. This thesis seeks to examine the extent to which human capital information is reported by corporations to the public and the extent to which human capital information is analyzed by equity analysts in their investment recommendations in the Australian Equity Market. Knowledge sharing is making investors more knowledgeable through communications, which results in better decision making. The thesis examines separately the reporting of human capital in human resource management literature and finance and accounting literature. The human resource management and sustainability literatures establish a positive link with better human resource practices and financial results. Several different methods have been developed for measuring the value of human capital in human resource management. In the finance literature financial models that are used for estimating future company performance, derive data from financial statements. However, accounting standards don’t recognize human capital as an asset. Therefore, human capital specific information doesn’t exist in financial statements. Overall, both the human resource management and finance literatures point to the rising importance of intellectual capital in explaining value creation. However, there appears to be a knowledge gap between the analyst reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital. Literature survey points to a rising need for complimentary approaches to quantitative analysis (Petty and Guthrie 2000, Hooks 2002, Royal 2003). For examining the human capital reporting practices of corporations, publicly available documents for three case companies, namely BHP Billiton, National Australia Bank and Telstra Corporation were collected using library search. For answering the first research question, a disclosure index of ASX listing rules Australian Accounting Standards Board reporting requirements and corporate governance recommendations was constructed. For

ii examining the extent of human capital information used by equity analysts, equity reports by two investment banks and independent analyst reports for the case companies were collected. For evaluating the search for human capital information by the equity analysts, analyst briefing web casts and reports were collected from company websites. The thesis has findings at several levels. Studying the annual reports and variety of voluntary reports such as sustainability and environment reports by utilizing the disclosure index has shown that case companies were going beyond mandatory reporting requirements and at varying levels reported valuable human capital information. The study of the equity analyst reports and briefings has exposed that analysts seek and use qualitative information but not in a consistent and systematic way. Moreover they didn’t utilize a model to make meaning of the soft, qualitative data. By a detailed qualitative documentary analysis of the human capital data that is gathered form the library search and using the “Drivers of Sustainable Human Capital Management Systems” (Royal 2000) model, certain investment recommendations are made for the three case companies. Findings confirm to be a knowledge gap between the analyst reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital. While this gap is wider for NAB and Telstra, it is narrower for BHP. The main conclusion reached is qualitative analysis, particularly Human Capital Analysis, can draw a more comprehensive picture of the working of an organisation than what financial analysis can tell alone. Human Capital Analysis tools and techniques can become lead indicators of future financial performance and sustainability. Integrating the Human Capital Analysis into financial analysis process will provide a more complete analysis of the drivers of success and this will aid investment recommendations to become more transparent. The higher quality and quantity of Human Capital specific information will enhance the investment recommendation process. The thesis makes a significant contribution to the field of defining a knowledge gap in the investment recommendation process and suggesting a qualitative framework for narrowing this gap.

iii ‘Human Capital Analysis’ Describing the Knowledge Gap in the Financial Investment Recommendation Process Using Human Capital Analysis

Table Of Contents ABSTRACT ...... II ACKNOWLEDGEMENTS ...... VIII LIST OF ABBREVIATIONS ...... IX LIST OF TABLES AND FIGURES...... X SECTION ONE: LITERATURE AND RESEARCH DESIGN ...... 1 CHAPTER 1: INTRODUCTION...... 2 1.1 INTRODUCTION...... 2 1.2 AIM AND SCOPE ...... 6 1.3 OVERVIEW OF THE STUDY ...... 6 CHAPTER 2: HUMAN CAPITAL IN THE HUMAN RESOURCE MANAGEMENT LITERATURE...11 2.1 INTRODUCTION...... 11 2.2 HUMAN RESOURCE MANAGEMENT AND ITS CONTRIBUTION TO BUSINESS RESULTS ...... 12 2.3 THE RISE OF THE KNOWLEDGE-BASED ORGANIZATION...... 16 2.4 INTELLECTUAL CAPITAL ...... 18 2.4.1 Definition ...... 18 2.4.2 The Evolution of Intellectual Capital Management Theory ...... 18 2.4.3 Existing approaches to Measuring Intellectual Capital...... 20 2.5 HUMAN CAPITAL ...... 23 2.5. 1 The link between human capital and other intellectual capital factors...... 23 2.5. 2 The Development of Human Capital Theory...... 23 2.5.3 Human Capital Management ...... 25 2.6 KNOWLEDGE AND KNOWLEDGE MANAGEMENT ...... 26 2.7 HUMAN CAPITAL IN ORGANISATIONAL SUSTAINABILITY ...... 29 2.8 EXISTING APPROACHES FOR MEASURING HUMAN CAPITAL ...... 31 2.9 CONCLUSION...... 36 CHAPTER 3: HUMAN CAPITAL IN THE ACCOUNTING AND FINANCIAL ANALYSIS LITERATURE...... 38 3.1 INTRODUCTION ...... 38 3.2 ORGANISATIONS AS LIVING BEINGS AND OPEN SYSTEMS...... 39 3.3 SECURITY ANALYSIS FOR INVESTMENT PURPOSES...... 42 3.3.1 Financial statement analysis...... 42 3.3.2 Actors in the financial recommendation process ...... 43 3.3.3 Common equity-valuation methods...... 45 3.3.4 Pitfalls of Modern Finance Theory and Financial Ratios: Is Intellectual Capital Included in the Valuation of Stocks?...... 46 3.3.5 How accurate are security analyst recommendations?...... 48 3.3.6 Knowledge used in equity valuation. Do capital market actors seek soft information like intellectual capital? ...... 49 3.3.7 Why do they not use or seek soft data? ...... 51 3. 4 INTANGIBLE ASSET VALUATION IN ACCOUNTING...... 52 3.4.1 Has the Relevance of Financial Statement Information Declined over Time?...... 52 3.4.2 How do accounting rules treat intangible assets and intellectual capital?...... 53

iv 3.4.3 What are the difficulties of valuing intangibles in accounting?...... 55 3.4.4 What are some of the global developments in accounting for reporting on intellectual capital?...... 56 3.4.5 How are intellectual capital assets to be understood?...... 58 3.5 DISCLOSURE OF INFORMATION ABOUT INTANGIBLE ASSETS...... 59 3.5.1 Which groups have primary interest and consequently what are the consequences of not reporting intellectual capital externally?...... 59 3.5.2 What are the arguments against publishing critical data about intellectual capital? ...... 60 3.5.3 Do Capital Markets Value Disclosed Information about Intangible Assets?...... 61 3.5.4 Intellectual Reports and Triple Bottom Line Accounting. Best practices as examples...... 62 3.5.5 Triple Bottom Line and Sustainability Reporting...... 63 3.5.6 How should intellectual capital be disclosed? What kind of additional data do capital market actors seek in company disclosures? ...... 64 3.6 ETHICAL AND SOCIALLY RESPONSIBLE INVESTING...... 65 3.6.1 Comparison of Ethical Investing and Sustainable Development Investing Styles...... 66 3.6.2 How reliable are SRI Screens? ...... 66 3.6.3 Do Ethics Pay? Are SRI screens able to predict future company sustainability?...... 67 3.6.4 Guidelines for Reporting...... 68 3.6.5 Corporate Governance...... 68 3.7 CONCLUSION...... 69 3.8 DISCUSSION OF THE TWO LITERATURE REVIEWS ...... 72 CHAPTER 4: RESEARCH METHODS...... 74 4.1 INTRODUCTION...... 74 4.2 RESEARCH PURPOSE ...... 74 4.3 RESEARCH QUESTIONS...... 75 4.4 IN SEARCH OF A HUMAN CAPITAL FRAMEWORK ...... 75 4.5 THE CHOSEN FRAMEWORK: MODEL OF DRIVERS OF SUSTAINABLE PEOPLE MANAGEMENT SYSTEMS (C. ROYAL, 2000A)...... 78 1. Job Characteristics ...... 80 2. Recruitment...... 80 3. Training...... 80 4. Career Opportunities ...... 81 5. Rewards...... 81 6. Professional Identity and Culture ...... 81 4.6 RESEARCH DESIGN...... 81 4.6.1 Qualitative Research, Strengths and Limitations...... 81 4.6.2 Case Research and Sampling...... 82 4.6.3 Documentary Analysis, Strengths and Limitations ...... 83 4.6.4 Design Tests ...... 84 4.7 DATA COLLECTION ...... 86 4.8 WORKING WITH DATA AND QUALITATIVE SOFTWARE...... 90 4.9 DATA ANALYSIS ...... 91 4.10 CONCLUSION...... 97 CHAPTER 5: REPORTING OF INFORMATION BY PUBLICLY LISTED COMPANIES ...... 100 5.1 INTRODUCTION...... 100 5.2 REPORTING ENVIRONMENT FOR PUBLICLY LISTED COMPANIES IN AUSTRALIA (1999- 2004) ...... 101 5.2.1Changing Regulatory Environment...... 101 5.2.2 Periodic Disclosure...... 103 5.2.3 Continuous Disclosure...... 104 5.2.4 Industry-Specific Disclosure ...... 104 5.2.5 Reporting of Workplace Relations (for 1999-2004)...... 105 5.3 REPORTING MEDIA OF PUBLICLY LISTED COMPANIES ...... 107 5.3.1 Annual Report ...... 108 5.3.2 Company Websites ...... 109

v 5.3.3 Stand-Alone Reports...... 109 5.4 VOLUNTARY REPORTING ...... 110 5.4.1 The Audience of Voluntary Reports...... 111 5.4.2 Disclosure Content and Format...... 114 5.4.3 Voluntary Reporting in Australia...... 116 5.4.4 How to Approach Voluntary Reports ...... 119 5.5 CORPORATE-GOVERNANCE REPORTING ...... 120 5.5.1 The rising significance of Corporate Governance for Investment Recommendations ...... 120 5.5.2 Corporate Governance Reporting Practices around the World...... 122 5.5.3 The Effects of Corporate Governance Reforms on Reporting 1999-2004 ...... 123 5.5.4 Corporate-Governance Reporting and Security Market in Australia ...... 126 5.5.5 HOW SHOULD CORPORATE-GOVERNANCE REPORTING BE UNDERSTOOD?...... 129 SECTION TWO: CASE COMPANIES ...... 132 CHAPTER 6: BHP BILLITON LIMITED...... 133 6.1 INTRODUCTION...... 133 6.2 BHP BILLITON LIMITED COMPANY HISTORY ...... 133 6.3 RESEARCH QUESTION 1-A ...... 136 6.4 RESEARCH QUESTION 1-B...... 137 6.4.1 BHP BILLITON SUSTAINABLE HUMAN RESOURCE MANAGEMENT INDICATORS ...... 138 1. Job Characteristics ...... 138 2. Recruitment...... 144 3. Training...... 147 4. Career Opportunities ...... 149 5. Rewards...... 150 6. Professional Identity and Culture ...... 152 6.5 RESEARCH QUESTION 2...... 154 6.6 RESEARCH QUESTION 3...... 157 6.7 COMPANY RHETORIC VS REALITY COMPARED THROUGH SECONDARY SOURCES...... 158 6.8 HUMAN CAPITAL CLASSIFICATION PROCESS ...... 169 6.8.1 Macro Analysis of BHP’s Environment ...... 169 6.8.2 Sustainable Human Capital Practices ...... 173 6.8.3 Strengths and Weaknesses...... 177 CHAPTER 7: NATIONAL AUSTRALIA BANK LIMITED ...... 179 7.1 INTRODUCTION...... 179 7.2 NAB COMPANY HISTORY ...... 179 7.3 RESEARCH QUESTION 1-A ...... 186 7.4 RESEARCH QUESTION 1-B...... 186 NAB SUSTAINABLE HUMAN RESOURCE MANAGEMENT INDICATORS ...... 187 1. Job Characteristics ...... 187 2. Recruitment...... 190 3. Training...... 192 4. Career Opportunities ...... 194 5. Rewards...... 195 6. Professional Identity and Culture ...... 198 7.5 RESEARCH QUESTION 2...... 200 7.6 RESEARCH QUESTION 3...... 203 7.7 COMPANY RHETORIC VS REALITY COMPARED THROUGH SECONDARY SOURCES...... 204 7.8 HUMAN CAPITAL CLASSIFICATION PROCESS ...... 212 7.8.1 Macro Analysis of NAB’s Environment...... 212 7.8.2 Sustainable Human Capital Practices ...... 221 7.8.3 Strengths and Weaknesses...... 224

vi CHAPTER 8: TELSTRA LIMITED ...... 226 8.1 INTRODUCTION...... 226 8.2 TELSTRA COMPANY HISTORY ...... 226 8.3 RESEARCH QUESTION 1-A ...... 231 8.4 RESEARCH QUESTION 1-B...... 232 TELSTRA SUSTAINABLE HUMAN CAPITAL INDICATORS ...... 233 1. Job Characteristics ...... 233 2. Recruitment...... 239 3. Training...... 241 4. Career Opportunities ...... 242 5. Rewards...... 244 6. Professional Identity and Culture ...... 246 8.5 RESEARCH QUESTION 2...... 248 8.6 RESEARCH QUESTION 3...... 251 8.7 COMPANY RHETORIC VS REALITY COMPARED THROUGH SECONDARY SOURCES...... 252 8.8 HUMAN CAPITAL CLASSIFICATION PROCESS ...... 258 8.8.1 Macro Analysis of Telstra’s Environment...... 258 8.8.2 Sustainable Human Capital Practices ...... 264 8.8.3 Strengths and Weaknesses...... 268 SECTION THREE: DISCUSSION AND CONCLUSIONS...... 271 CHAPTER 9: DISCUSSION...... 272 9.1 INTRODUCTION...... 272 9.2 INFORMATION ASYMMETRY IN THE FINANCIAL MARKETS ...... 273 9.3 RESEARCH QUESTIONS REVISITED ...... 276 9.3.1 BHP Billiton (BHP)...... 277 9.3.2 National Australia Bank (NAB)...... 284 9.3.3. Telstra ...... 289 9.4 COMPANY RHETORIC VS. REALITY COMPARED THROUGH SECONDARY SOURCES...... 293 9.4.1 BHP Billiton (BHP)...... 294 9.4.2 National Australia Bank (NAB)...... 296 9.4.3 Telstra ...... 297 9.5. THE RESULTS OF THE HUMAN CAPITAL ANALYSIS PROCESS ...... 299 9.5.1 BHP Billiton (BHP)...... 299 9.5.2 National Australia Bank (NAB)...... 300 9.5.3 Telstra ...... 302 9.6. CONCLUSION...... 303 CHAPTER 10: CONCLUSION ...... 306 10.1 FINDINGS ...... 307 10. 2 IMPLICATIONS ...... 313 10.3. LIMITATIONS OF THE STUDY ...... 314 APPENDICES...... 316 APPENDIX A: DISCLOSURE INDEX ...... 316 APPENDIX B: CHECKLIST MATRIX 1...... 318 APPENDIX C: CHECKLIST MATRIX 2...... 320 APPENDIX D :CHECKLIST MATRIX 3 ...... 322 APPENDIX E: NVIVO THEME (TREE) AND SUB-TREE (NODE) LISTING...... 323 BIBLIOGRAPHY...... 325

vii Acknowledgements

Research journey is a long and lonely one. My journey has physically started in Sydney and ended in Istanbul. I need to say thank you to the ones who have stayed with me during this challenging journey.

Firstly, I would like to thank my supervisor, Dr. Carol Royal, who has patiently guided me along the way. Her clear focus and sharp mind have kept me on track from the beginning till the end.

I would also like to thank my co-supervisor, Dr. Anne Junor, who has initially guided me with the research design. Her door was always open for me.

Thank you to my husband, Samim, for encouraging me to start this long journey in the first place.

Thank you to my daughters, Nehir and Damla for their patience along the way. Special thanks for all the songs they’ve written and sang for me. Now I can start to learn how to play the piano and accompany you.

I would also like to thank my parents, who always supported me with my decisions. Thank you to you and my brother Ahmet, for taking care of my children, during times when I was in great stress.

I need to give my special thanks to my father-in law, Prof. Dr. Zeyyat Hatipoglu, for being a great role model.

Thanks to Tara Mathey for editing the final version of the thesis. And thank you all to my colleagues at University of New South Wales and Bogazici University for sharing joys, ideas and frustrations.

viii LIST OF ABBREVIATIONS

AASB Australian Accounting Standards Board ABA Australian Bankers’ Association AGM Annual General Meeting ANZ Australia and New Zealand Banking Corporation APRA Australian Prudential Regulation Authority ATM Automated Teller Machine AWA Australian Workplace Agreement ASIC Australian Securities and Investments Commission ASX Australian Stock Exchange BHP BHP Billiton BOD Board of Directors CBA Commonwealth of Australia CEO Chief Executive Officer CFO Chief Finance Officer CSP Carriage Service Provider EOWA Equal Opportunity for Women in the Workplace Agency EVA Economic Value Added FSU Finance Sector Union HR Human resource HRM Human Resource Management HC Human Capital IC Intellectual Capital ICMM The International Council on Mining and Metals M&A Mergers and Acquisitions NAB National Australia Bank P/E Ratio Price to Earnings Ratio ROA Return on Assets OECD Organization for Economic Co-operation and Development SME Small to Medium Enterprises

LIST OF TABLES AND FIGURES

Table 3.1 Comparison of Intangible Assets to Tangible Assets

Figure 4.1 The Model: Drivers of Sustainable Human Capital Management Systems

Figure 4.2. Data Collection Sources

Figure 4.3. Research Question 1.a.

Figure 4.4. Research Question 1.b.

Figure 4.5. Research Question 2

Figure 4. 6. Data Analysis Plan

Figure 4. 7. Distinguishing Company Reality from Company Rhetoric

Figure 8.1. Investment Recommendations 1

Figure 8.2. Investment Recommendations 2

x Section One: Literature and Research Design

CHAPTER 1: INTRODUCTION

1.1 Introduction

Stock markets are traditionally viewed as the centrepiece of capitalist systems. Through establishing share prices they assist in the monitoring of firms and the allocation of resources. They also provide risk capital for investment, encourage risk taking and allow managerial failure to be corrected through markets for corporate control. There are different types of investors, whose duration of interest in the market and/or in particular stock varies accordingly. For example, day traders, otherwise known as speculators, and some stockbrokers, are in and out of a stock on a daily basis. Such investors do not pay much attention to the fundamentals of a particular stock, but follow price movements, and as such they are more interested in technical analysis1. On the other hand, there are institutional investors, mutual funds, individual investors and other managed funds (pension funds, superannuation funds), which have a medium- to long-term interest in the stock. Therefore, they have a need to assess the quality and future sustainability of corporations’ performance, as they wish to select stocks that will outperform others in the future (Graham, 1972) and thus maximise their returns in the long run. In order to make better investment decisions, these groups seek the guidance of security analysts and tend to rely on the ‘buy, sell, hold’ recommendations given in the equities reports. The reports and recommendations of security analysts can have a significant effect on investment decisions (Womack, 1996). Analysts’ credibility as professional observers of capital markets is based on the accuracy of their earnings projections and recommendations. However, recently their credibility has been questioned, raising concerns over the efficient functioning of the investment recommendation process and hence efficiency in the capital markets. In order to improve the investment recommendation process there is a need for understanding such concerns. In the late 1990s, simultaneous developments in three interrelated sectors, namely telecommunications, information technologies and the Internet, resulted in high expectations for future revenues and earnings for these sectors. Based on these expectations, many start-up

1 Technical analysis endeavours to predict price levels of stocks by examining one or many past data from the market itself, the basic assumption that history repeats itself, past patterns of price behaviour in individual security will tend to recur in the future. Shifts in supply- demand balance will change the trend. The data is analysed independent and regardless of the underlying data.

2 technology companies emerged and through investment banks floated their stock on the markets. As the investment banking business was booming, analysts (sell-side analysts) working for the investment institutions that underwrote the Initial Public Offerings (IPO)2 and the subsequent offerings received financial incentives to boost investments (Opdyke, 2002). As a result, sell-side analysts gave optimistic estimates about floated stocks in order to improve returns of investment banking business. Further, in the booming market not many investors questioned the validity of the security analysts’ company valuations and recommendations and invested in the stocks based on these optimistic forecasts. However, when investors began to recognise that the estimated growths in sales would not be realised for a long time, they stopped investing in these companies and the bull market died suddenly in late 2000/early 2001. Despite investors fleeing the market, some analysts surprisingly continued to make “buy” recommendations on the stocks, which later put questions in investors’ minds. As the technology bubble burst, investors, the media and regulatory agencies began to question the credibility problems associated with security analysts’ reports. The financial media reported widely on the loss of trust in the markets. In early 2001, Fortune magazine put a picture of Morgan Stanley's internet analyst Mary Meeker on its cover, accompanied by the headline: “Can we ever trust Wall Street again?” (Serwer, 2006). Another article appeared in the Financial Times bearing the headline: “Shoot all the analysts”(Times, 2001). The marked loss of trust in equities analysts was also closely watched by the Wall Street Journal (Gasparino, 2001), (Opdyke, 2002). The media questioned issues like “research independence, the fees paid to analysts, objectivity of their research and transparency of stock ownership” (Serwer, 2006), (Times, 2001). In the US in particular, analyst independence was debated extensively; for instance, new rules proposed by the National Association of Securities Dealers in the US required all analyst research reports to include issuing firms’ percentage of “buys, holds and sells” (Barber, Lehavy, McNichols, & Trueman, 2006). Overall, there arose a need to rebuild trust in the markets and analyst recommendation process. At around the same time, in late 2001, the US capital market experienced the largest corporate bankruptcy in its history. In October 2001, Enron announced US$638 million in losses for the third quarter and revealed that it had overstated earnings by US$586 million over the past four years. The chain of events following the announcement led to Enron’s bankruptcy and Arthur Anderson, the well-known auditing firm, which had been providing

2 IPOs and subsequent offerings are offered in the primary markets raise investment capital for companies, beside debt issues. Usually investment banks buy these shares from corporations and sell them to the public with an underwriting fee. Later these shares exchange hands in the secondary markets, which provide liquidity for investors and traders.

3 consultancy and auditing services to Enron, was found responsible for falsifying the financial statements. The bankruptcy of both Enron and Arthur Anderson led to a US Securities Commission investigation and changes in the law. Both the regulators and the financial media extensively discussed “corporate governance/risk management/accountability, transparency, executive remuneration and auditors’ independence”. Then, US Congress passed the Sarbanes-Oxley Act 2002 (SOX), which had a great impact not only in the US but also around the world. The SOX legislation aimed to improve the transparency of financial reporting and reduce conflicts of interest among auditors and boards of directors. The Enron case was not an isolated incident, as other parts of the world were experiencing similar corporate scandals. Corporations were reporting higher earnings than they were actually making, they were concealing losses, and auditing firms were found to have conflicts of interest. Global accounting scandals and corporate collapses also afflicted Cendant (1998), Adelphia (2002), Peregrine Systems (2002) and WorldCom (2002) in the US; Independent Insurance (2001) and Marconi (2001) in the UK; Elan (2002) in Ireland; Kirch (2002) in Germany (J. Hill, 2005); and One.Tel and HIH Insurance in Australia. These also resulted in a loss of trust in the security markets ("The trouble with accounting: When the numbers don't add up.," 2002). In their attempts to redress “perceived governance weaknesses” (J. Hill, 2005)p.368, major stock exchanges and regulatory bodies introduced changes to “governance, disclosure, analyst independence, accounting and auditing practices”. In Australia, changes were made to the ASX Listing Rules and specifically Continuous Disclosure Requirements. In March 2003, the ASX Corporate Governance Council developed and released the Principles of Good Corporate Governance and Best Practice Recommendations for listed companies. Generally, the collapse of the technology bubble and the accounting scandals and corporate collapses that occurred soon afterward had major implications for capital markets, as well as the investment recommendation process. Firstly, there arose a need to rebuild trust in investment markets. Investors needed accurate and timely information in order to be able to assess the quality and future sustainability of corporations’ performance. The assumption that information requirements of investors were satisfied through current corporate reporting needed to be tested, and the literature indicated that investors’ information requirements were not being satisfied (Eccles, Herz, Keegan, & Phillips, 2001). The fulfilment of this need is important because knowledge transfer results in better decision making (Grant, 1996), which is highly important for the continuation and effective functioning of capital markets; conversely, lack of knowledge may result in investors’ risk perception being higher and the

4 underestimation of future earnings, leading to faulty investment decisions. Furthermore, this knowledge gap could be even higher for smaller investors with less access to information sources (Aboody & Lev, 2000). Secondly, there was a need to reconsider the investment recommendation process. The models and methods traditionally used by security analysts seemed to fall short of reporting requirements on the drivers of sustainability and performance in the new economy. Current methods and models are lagging behind the information needs of investors, and tend to report on only historical performance, while investors desire to know the leading indicators of future performance. Lastly, in comparison to traditional companies, the creation of value is vastly different in new economy companies (i.e. the knowledge economy). Large discrepancies between market capitalisation and book values have been attributed to the growing value of intangible assets in the knowledge-intensive economy not being reflected in financial statements (Amir, Lev, & Sougiannis, 2003; Baruch Lev & Zarowin, 1999);(Mayo, 2001). As the relevance of current accounting practices and the reliant financial models have decreased in the new economy, there is a need for complementary approaches that can capture the value created by intangible assets. Some recent studies attempt to explore and explain the drivers of creating value for long-term sustainability and justify the use of Human Capital Analysis together with financial analysis to explain these market value/balance-sheet differences (C. Royal & O'Donnell, 2002a). This study asserts that investors would benefit from more open communication from companies and from more accurate and timely investment recommendations. Furthermore, this study suggests that, as opposed to market-efficiency theory, capital market actors do not collect and use all the soft data available in the public information pool. It argues that this results in a knowledge gap between the more traditional investment reports written by financial analysts and the fundamental publicly available human capital information. Furthermore, if soft, qualitative data are systematically collected, analysed through theory-driven models and the results used together with traditional financial analysis and included in analyst reports, the investment recommendation process would improve. This in turn would enhance the benefits to institutional investors as well as small investors. This study ascertains that closing this knowledge gap would have the effect of increasing transparency for investors and rebuilding their trust in capital markets, which has deteriorated over the last decade.

5 1.2 Aim and Scope

This thesis aims to examine the extent to which human capital information is reported by corporations to the public and the extent to which human capital information is analysed by equity analysts in their investment recommendations in the Australian Equities Market.

1.3 Overview of the study

This thesis consists of three sections, which together seek to open up new lines of research and explanation in order to interpret the human capital paradigm in the investment process. In general, academic research to date has been limited, as it requires a multidisciplinary perspective, which spans either end of the spectrum from accounting and finance to human capital management, knowledge management, intellectual capital and organisational change fields. The study emphasises the importance of human capital as a means for examining investment reports provided by equities analysts. After considering a number of models proposed as a means of demonstrating human capital value in organisations, the Model of Drivers of Sustainable People Management Systems ((C. Royal, 2000b) (C. Royal & O'Donnell, 2002a);(C. Royal & O'Donnell, 2002c)) is chosen to examine the level of human capital reporting of publicly listed companies. This model and the suggested framework provide valuable insight into the drivers of future company success. Within the revised regulatory framework in Australia, using publicly available documents became necessary for both quantitative and qualitative analysis in financial markets. In order to replicate the regulatory environment in which analysts find themselves, archival and documentary analysis of publicly available documents is selected as the data-collection methodology. In order to meet the aims of the study, human capital- specific data on three publicly listed companies in the Australian Stock Exchange will be collected and analysed.

Section One: Literature and Research Design Considering the nature of this study, there is a need to review both Human Resources Management and Accounting and Finance Management literature on valuing and reporting human capital. The literature review begins with a chapter discussing human capital in the

6 Human Resources Management literature, with the first section addressing human resource management and its increasing importance and visibility within organisations. The second section provides rationalisation of the rising importance of intellectual capital for determining company value. Furthermore, it follows the development of intellectual capital theory and contrasts various intellectual capital measurement models. Based on the definition of intellectual capital, the following section defines human capital and its contribution to business success, as well as discussing its interaction with other intellectual capital elements. It also highlights the differences between human resource management thinking and human capital management thinking. The literature presents knowledge as inherited in human capital and explores knowledge creation within organisations. The knowledge-management section outlines the present understanding of the field and defines knowledge creation within organisations. Chapter 2 demonstrates that human capital is an intangible source of value creation and forms a part of the assets that create competitive success. It establishes that human capital should be evaluated as a part of the value of a firm. The chapter concludes with discussion of existing approaches to measuring human capital. Overall, it highlights several frameworks and points to the gaps in the literature on utilising frameworks for investment purposes The second literature review chapter, Chapter 3, examines human capital in the Accounting and Financial Analysis literature, addressing how modern finance theory and current accounting rules and regulations treat intangible assets, intellectual capital and human capital in particular. The first part of the chapter recognises organisations as complex systems, stressing the importance of inter-relationships existent in organisations and the inability of numbers (i.e. financial models) to understand these relations. In the second part of the chapter, the reliability of traditional financial models is questioned; are such models adequate in giving investment advice in today’s economy? The data-collection process, the characteristics of financial analysts and other capital market actors, data selection (e.g. omitting intellectual capital assets in valuations) and data validity are some of the factors discussed in this chapter. In the third section, the current accounting rules and regulations are discussed in regards to intangible asset valuation and human capital. In this research it is suggested that, as opposed to market-efficiency theory, capital market actors do not collect and use all the soft data available in the public information pool. The reasons for this are explored in section four of Chapter 3. Following this section, Socially Responsible Investing (SRI) style and its investment methods are discussed. The final section addresses the issue of corporate governance; the motivation for examining this issue is the

7 assumption that accountability and openness of the management of corporations may be strong indicators of future growth and sustainability. Chapter 3 establishes several important points; security analysts estimate future financial earnings using the tools provided by modern finance theory and their main sources of information are financial statements. However, current accounting rules and regulations do not recognise human capital as an asset, and as a result it is not included on balance sheets. Therefore, human capital indicators are not included in the current recommendation process. Some analysts seek soft qualitative data and attempt to use this information in their analysis but it is not done systematically using models based on theory. Comparison of the two literature chapters suggests there is a knowledge gap between what Human Capital Analysis offers and what the current financial recommendation process offers. Chapter 4, Research Methods, describes the design of this study, presenting the three research questions and discussing the suggested framework to be used. It states the nature of the study as qualitative and documentary data-collection methodology. It also specifies Sustainable Human Resource Practices as the leading framework for studying the human capital reporting practices of companies. The three case companies whose reporting practices will be explored are BHP Billiton Limited, National Australia Bank Limited and Telstra Limited. The data-collection, coding and data-analysis stages are all led by the research questions. These processes, as well as the sources for data collection, are then elaborated on. Lastly, based on the literature review, Chapter 4 highlights the need to construct a disclosure index for answering research questions 1a and 1b, which will be done through the study of the Reporting of Information by Publicly Listed Companies in the following chapter. Chapter 5 explores the current reporting environment for publicly listed companies in Australia, firstly presenting the mandatory reporting requirements for publicly listed companies on the ASX (during the sample period of 1999–2004). Following this, the chapter will present the voluntary disclosures of companies listed on the ASX, as well as the motives for voluntary disclosures, their content and their importance for making company valuations. This analysis will establish that in order to find human capital data there is a need to consult documents other than annual and sustainability reports, and will form the background study for answering Research Question 1. Lastly, the chapter will present recent developments in corporate governance reporting, discussing the relevant practices in Australia.

8 Section Two: Case Companies Following the literature review and having selected the framework of the study, the next three chapters (Chapter 6: BHP, Chapter 7: National Australia Bank, Chapter 8: Telstra) will present answers to the research questions using case companies as examples. Each chapter begins with a brief company history and then answers the research questions, which illustrate that all three companies currently report beyond mandatory reporting guidelines on human capital and each company makes publicly available good quality data. The analysis of investor briefings demonstrates that analysts’ at least seek to obtain human capital data, but do not necessarily know how to value it. Furthermore, the findings confirm that analyst reports do not report on this significant data to the investing public. Each chapter then defines how to distinguish actual practice from company rhetoric, and demonstrates the importance of closing the knowledge gap through presenting the findings of the Human Capital Classification process. This section illustrates what can be forecasted about the future financial performance of companies using human capital data that is available in the public domain, highlighting the importance of closing this gap for the benefit of the investing public.

Section Three: Discussion and Conclusions Chapter 9, Discussion, summarises the findings of the research questions and highlights the importance of Human Capital Analysis and the advised framework for understanding the knowledge-management gap in the investment recommendation process. The chapter initially presents the importance of information and knowledge for investors and describes the various forms of information asymmetry in the financial markets. Then it discusses the findings in relation to the research questions posed in this study. In answering the questions, this section utilises the data set identified through the process of documentary analysis and the data in analyst reports and company briefings. Using these findings the researcher draws comparisons between Human Capital Analysis data findings and that analyst reports reveal. The differences confirm there is a knowledge gap in the investment recommendation process. The chapter goes on to discuss how the differences between company rhetoric and actual practice can be compared through documentary analysis. This section uses data obtained through annual reports, analyst briefings, presentations, sustainability reports and websites such as company-originated documents and academic articles, books, magazine and newspaper articles, and industry reports as other resources. Further, by comparing and

9 contrasting these sources, the chapter demonstrates how Human Capital Analysis can overcome the inaccuracy and lack of reliability associated with voluntary company reports. The final conclusions and implications of the research will be drawn in Chapter 10, Conclusion. The study asserts there is a knowledge gap between traditional investment reports prepared by equities analysts and the fundamental publicly available human capital information. It is stated that closing this gap is important for the efficient functioning of investments markets. If human capital data are systematically collected and analysed through theory-driven models and the results are used together with traditional financial analysis and included in analyst reports, the investment recommendation process will improve. Having said this, adopting a human-capital perspective does not render all other lenses of analysis as unimportant or invalid, but attempts to open new lines of research and add new meaning to already existing ones.

10 CHAPTER 2: HUMAN CAPITAL IN THE HUMAN RESOURCE MANAGEMENT LITERATURE

2.1 Introduction

The broad literature review examines whether Human Capital Analysis can predict the sustainability of corporations and thus whether it can be used as a complimentary tool in traditional financial analysis. This chapter presents the topic of how human resource management literature treats intangible assets, intellectual capital and human capital in particular. Multiple disciplines, including economics, psychology and management, have contributed research addressing the value of human capital in organisational performance. While this literature review is concerned with addressing human capital as discussed in the human resource management literature, it also addresses material in other disciplines. The chapter begins with a discussion of human resource management and its increasing importance and visibility within organisations. The first section outlines the contribution of human resource management to business success. As a sub-field of human resource management, strategic human resource management and the resource-based view of the firm are discussed. The second section of this chapter rationalises the rising importance of intellectual capital for explaining company value. Furthermore, it follows the development of the intellectual capital theory and contrasts various intellectual capital measurement models. Based on the definition of intellectual capital, the following section defines human capital and its contribution to business success. It further discusses its interaction with other intellectual capital elements, highlighting the differences between human resource management thinking and human capital management thinking. This section presents knowledge as inherited in human capital and explores knowledge creation within organisations. The knowledge-management section illustrates the current understanding of the field and defines knowledge creation within organisations. The chapter concludes with a discussion of existing approaches to measuring human capital, highlighting relevant frameworks and pointing to gaps in the literature in relation to investment analysis.

11 2.2 Human Resource Management and its Contribution to Business Results

Human resource management focuses on the productive utilisation of people in achieving the organisation’s objectives and satisfying individual employee needs. Thus, the principal responsibility of human resource management is to ensure that organisations have the appropriate numbers, types and skill mixes of employees at an appropriate time and cost to meet present and future requirements. Primary human resource management activities can be stated as acquisition (recruitment, selection), development (training), reward and motivation, maintenance and departure. Over time, human resource management has evolved to encompass a broader, longer- term and more managerial definition than its previous incarnations as “industrial relations” and “personnel management” have included ((Legge, 2005; J. Storey, 1992). From a systems perspective (Bertalanfly, 1968; Kast & Rosenzweig, 1972), it can be said that economic, technological, societal and political changes have impacted organisational management, and thus the field of human resource management. In order to compete more effectively, organisations need to improve their performance through reducing costs, improving productivity and introducing new services and products. Hence, human resource management has become a partner to top management to help achieve organisational goals and improve organisational performance. Jackson and Schuler (2007) list laws and regulations, culture, politics, unions, labour markets and industry characteristics as external influences on an organisation’s human resource management at local, national and international levels (S. E. Jackson & Schuler, 2007). In Australia, some of the external factors influencing human resource management in the 1990s and 2000s were the reorganisation of the Australian economy (deregulation), tariff reductions, massive restructuring of the public sector (privatisations), changes in industrial relations practices and changes in corporate law. These external pressures are typically regarded as associated with a series of strategic responses on behalf of the organisations, including changes in the long-term plans/strategies of organisations. Porter divided all business strategies into three categories—cost leadership, product differentiation and market segment (Porter, 1980, 1985), while Storey and Sisson refined these as innovation, quality enhancement and cost-reduction strategies (Storey & Sisson, 1990). In 1993, Richard Whittington proposed four generic approaches to strategy applicable in business. According to the four quadrants formed, Whittington divides strategy into classical, evolutionary, processual, and systemic (Whittington, 1993). Mintzberg, on the

12 other hand, used plan, ploy, pattern, position and perspective (5Ps) to define the various types of strategy (Mintzberg, 1992). In his “Strategic Choice Analysis”, Child defines a continuous strategic choice process, in which through a learning process managers become aware of the opportunities and problems in the external environment. During this dynamic process they take actions that result in internal adjustments in structure, human resources or technology and aimed at the external environment, such as new products, services and new suppliers (Child, 1997). In the literature, human resource management practices have been linked to turnover (Arthur, 1994), productivity (Ichinowski, Shaw, & Prennushi, 1997)3 financial returns (F. E. Schuster, 1986)4, (Delery & Doty, 1996), survival (Welbourne & Andrews, 1996) and firm value (M. Huselid, 1995)5. Pfeffer has identified the seven best human resource practices for business success, stating that in order to be effective such practices need to exist in a bundle (J. Pfeffer, 1998; J. Pfeffer & Veiga, 1999)6. Support for a positive relationship between bundles of ‘best practices’—also known as “high-performance work practices” or “high-commitment practices”—and business results has been identified in the literature (Ichniowski, Kocha et al. 1996; Guest 1997; Hutchinson, Purcell et al. 2000). A US study conducted by multiple authors found that some human- resource policies and practices enhance organisational performance; in particular, organisations that offer profit sharing and link earnings to performance appear to perform better in all respects (Kalleberg, Knoke, Marsden, & Spaeth, 1996). There is also support for better performance when clusters of work practices exist together and interact (Kalleberg, et al., 1996)p. 120). A recent meta-analysis study shows that bundles of empowerment, motivation, and skill-enhancing result in better outcomes (retention, operating performance, financial performance, and overall performance ratings) than individual practices (Subramony, 2009). As the contribution of human resource practices has been recognised, there has been a growing need for human resource management to assume a broader role in overall corporate

3 A longitudinal study by (Ichiowski, Shaw et al. 1997) is conducted by examining a data set up of 2190 monthly observations on the productivity of steel finishing lines, at twenty six steel plants in USA. The empirical results supported the adoption of a coherent system of new HR practices produces substantially higher levels of productivity than do more traditional approaches. 4 Schuster assessed the critical contribution of human capital and profitability in 1300 of the largest industrial and non-industrials in the US. He found a statically positive relationship between the use of employee centred management practices and superior financial performance. Also, average return of those firms using one or more innovative human resource management practices was 11% higher than those firms not using any of these practices (F. E. Schuster, 1986). 5 Mark Huselid has been studying the link between the personnel policies of a company and its business performance in the US over the years. His study in 1995, collected firm-level data from 968 firms with a questionnaire mailed to the senior human relations professionals. The study examined the links between systems of High Performance Work Practices and on employee turnover, productivity and corporate financial performance 6 Jeffrey Pfeffer of Stanford University, in his book The Human Equation (1998) identifies seven practices for a high performance management system. (HPO) They are employment security, selective hiring, self-managed teams and decentralisation, extensive training, reduction of status and differences, sharing information and high-contingent compensation (J. Pfeffer, 1998).

13 strategy, causing managers to merge organisational strategies and human resource management activities. In 1992, Dave Ullrich reminded executives to integrate strategic initiatives with human resources to gain a competitive advantage (Ulrich, 1992). Consequently, a transformation from human resource management to strategic human resource management has occurred. Strategic human resource management ideally “has a longer-term focus, possesses fully integrated linkage, where human resource management exerts influence on both strategy formulation and implementation” (Martell & Carroll, 1995), is “consistent with the organisation strategies and objectives[,]...is responsive to the changing nature of the organisation’s external environment” (O'Reilly & Pfeffer, 2000)p. 157), and aims to provide the firm with “a distinctive competitive advantage’ (J.C. Collins & Porras, 1996). Overall, the strategic human resource management literature stressed the importance of an ‘alignment’ or ‘fit’ between business and human resource management strategies and the contribution of human resource management to business for achieving a competitive advantage. To understand the means by which an organisation can support human resource management in gaining competitive advantage, strategic human resource management focuses on the issues of vertical and horizontal fit. Horizontal fit refers to the alignment of HR practices into a coherent system of practices that support one another, while vertical fit refers to the alignment of HR practices within a specific organisational context. Ichniowski provides relatively strong evidence of the synergistic effects found in tightly coupled systems of practices (Ichinowski, et al., 1997). A joint study by O’Reilly and Pfeffer (2000) in the US examined how seven companies achieved sustainable success. In their book “Hidden value: How Great Companies Achieve Extraordinary Results with Ordinary People”, they asserted that the hidden value of companies resides in the intellectual and emotional capital of the firm (O'Reilly & Pfeffer, 2000), p. 8). Moreover, successful organisations have a clear, well- articulated set of values that are widely shared and there is alignment and consistency in the people-centred practices that express their core values (O'Reilly & Pfeffer, 2000)p. 232). Despite the fact that in the literature the universalistic approach of "best practices"/“high-performance work practices” and the contingency approach of "best fit"/strategic human resource management seem to be in conflict, they may be used in concert to achieve balance. Becker and Gerhart (1996) argued that the two approaches may be complementary if one understands that "best practices" exist at different levels (B. Becker & Gerhart, 1996). Further, best human resource management practices can be appropriate for different circumstances identified by the “best fit” approach.

14 In explaining the significance of strategic human resource management to firm performance, the majority of prior research has adopted the resource-based view of the firm. Economist Edith Penrose described the importance of resources in her book “Growth of the Firm” as early as 1959, stating that “a firm is basically a collection of resources” (Penrose, 1959). Building upon Penrose’s work, Wernerfelt suggested that a firm can achieve a competitive advantage by making better use of its resources (Wernerfelt, 1984). Barney proposed that an organisation can gain a competitive advantage from the resources it possesses if they are rare, valuable, inimitable and non-substitutable (Barney, 1991); further, a competitive advantage results in positive returns (Peteraf, 1993). Grant differentiated between resources as inputs into the production process and capabilities, which is what an organisation can achieve as a result of teams of resources working together (Grant, 1991). While the human resource management practices of a firm can lead to competitive advantage through developing a unique and valuable human capital pool (Barney & Wright, 1998), they may also lead to competitive advantage as a portion of organisational capital by providing firms with increased fit and flexibility. Barney (1991) argued that ‘sustained competitive advantage’ is achieved not through an analysis of a firm's external market position but through a careful analysis of its skills and capabilities—characteristics that competitors find themselves unable to imitate. Similarly, Prahalad and Hamel described the core competencies behind a firm’s competitiveness. In examining the resource base of a firm in a sample of engineering consultancies, Boxall and Steeneveld (1999) noted that firms need certain kinds of similar human resources simply to become and remain viable in their competitive sector (Boxall & Steeneveld, 1999). While some scholars (Boxall & Purcell, 2000; Peteraf & Barney, 2003) have argued that resource based view of the firm is too general and under conflicting theoretical influences, they agreed that it is worthy of examination and honing of its academic precision. As Becker and Huselid (1998) have reminded us, the importance placed on human resource management increases as “traditional sources of competitive advantage; quality, technology, economies of scale became easier to imitate” (B.E. Becker & Huselid, 1998). As a result, there is a greater need to understand human resource management and its contribution to firm performance. Overall, the resource-based view of the firm has shifted the focus of strategic human resource management from the external environment to the internal resources of the firm, and from the simple human resource management practices to the actual human resources of a firm. Moreover, as Boxal and Purcell noted, the trends in the resource-based literature have

15 encouraged studies towards “intellectual capital, learning processes and organizational adaptability” ((Boxall & Purcell, 2000) p. 200). This section has pointed to the changing role of human resource management from one of basic operational work to a broader and more long-term focus within an organisation. It has presented empirical evidence illustrating the contribution of human resource management processes to business results. The focus of studies on human resource management has been on to justify the existence of the human resource function within the organisation and to show how it contributes to or can contribute to business results. It has identified specific human resource activities and processes, as well as bundles of activities as contributing to firm performance. However, within this literature there is virtually no focus on investigating or empirically demonstrating human capital and its contribution to firm performance. Hence, there arises a need to explore human capital within intellectual capital management literature.

2.3 The Rise of the Knowledge-Based Organization

During the second half of the twentieth century, Western nations moved out of the age of capital and into the age of knowledge. The structural changes that shaped the new economies were the shift of economic activities from the manufacturing to the services sector, upskilling of labour across all economic sectors, and strong growth of exports of high- tech manufacturers. The move from manufacturing sectors to services shifted the emphasis from tangible to intangible assets (Stittle, 2004) and, with capital easily available, the critical production factor shifted to people. However, it did not shift to simple labour; instead, knowledge displaced capital as the scarce production factor—the key to corporate success. Those who had knowledge and knew how to apply it would be the wealthiest members of society: technical specialists, investment bankers, creative artists and facilitators of new understanding. Drucker stated, “Increasingly there is less and less return on the traditional resources, labor, land and (money) capital. The only—or at least the main—producers of wealth are information and knowledge” (Drucker, 1993)p. 166–167). Geus explained the new role of people as distributors and evaluators of inventions and knowledge (De Geus, 1999)p. 24). According to Organisation for Economic Co-operation and Development (OECD) data, the service economy has come to account for on average more than 60% of the

16 economic activity in the OECD countries (OECD, 2000). Amongst these, knowledge- intensive sectors such as finance, insurance, real estate and business services have grown the most. In Australia, approximately two-thirds of all business activity is conducted in the services sector, which also accounts for about 70% of all jobs (Austrade, 2008). This activity takes place in the financial services, media, telecommunications, law, consulting and tourism sectors. For further development of knowledge economies, the need for investments in human capital worldwide became evident. The Australian Government was the first to recognise the need for investment in people for the new knowledge economy (OECD, 2000). In 2004, the Australian Government established the “Australian Government Consultative Committee on Knowledge Capital”. The OECD Deputy Secretary-General Berglind Asgeirsdottir confirmed the need for knowledge investments, stating that “development of knowledge economy is dependent on innovation, new technologies, human capital and enterprise dynamics” (Asgeirsdottir, 2005). There are differences in work practices and the way in which value is created at knowledge-based organisations in comparison to traditional organisations. Edvinsson and Sullivan (1996) noted that knowledge-based companies derive their profits from the commercialisation of the knowledge created by their people (L. Edvinsson & Sullivan, 1996). According to Guthrie they are different since their strategic management focus is directed towards the knowledge-based intangibles of the organisation (J. Guthrie, Petty, Ferrier, & Wells, 1999). Hence, the way they view their employees is also different. According to Drucker, in the knowledge economy employees are no longer regarded as labour but as capital (Drucker, 2002). The development of a knowledge-based economy and firms does not necessarily imply that all firms are becoming knowledge intensive and all workers have become knowledge workers. Basic workers can also perform knowledge-intensive work, such as “a machining centre operator that is operating on a high technology part in which hundreds of thousands of dollars have been invested” (Wiig, 2004) 7). According to the architectural view of human capital, Lepak and Snell consider knowledge workers within a firm constituting only a portion of the workforce, with the size of the portion depending on the firm (Lepak & Snell, 2003) 335). According to their view, employees may contribute in different ways to a firm’s competitive advantage; some with knowledge, some with jobs they perform and some with both.

17 This section presented the rising importance of intangible assets as a part of the knowledge economy. Knowledge is viewed as a critical but not sole element of intangible assets.

2.4 Intellectual Capital

Prior to this section the literature has pointed to the changing knowledge economy and the rise of knowledge workers. The following section will explore intellectual capital, and human capital as one of its components.

2.4.1 Definition

Intellectual Capital (IC) was first used as a term by economist John Kenneth Galbraith in the 1960s (Stewart, 1991). Thomas Stewart, in his seminal 1991 Fortune magazine article, introduced the term to the business world. He defined IC as “intellectual material knowledge, information, intellectual property, and experience—that can be put to use to create wealth” (Stewart, 1997). One of the many definitions of intellectual capital is offered by OECD, which describes intellectual capital as “the economic value of two categories of intangible assets of a company (1) organisational (‘structural’) capital; and (2) human capital” (OECD, 1999). The organisational capital includes the intangible aspects of an organisation such as processes, culture, relationships and intellectual property and human capital refers to a combination of factors processed by individuals and the workforce of an organisation. In this definition, OECD has defined intellectual capital as a subset of intangible assets. Williams and Bukowitz consider that intellectual capital embraces all forms of knowledge, ranging from abstract (culture, norms, values, group dynamics and individual knowledge) to concrete (presentations, documents and blueprints) (Bukowitz & Williams, 2001).

2.4.2 The Evolution of Intellectual Capital Management Theory

Throughout the late 1980s and early 1990s, interest in the topic of intellectual capital increased in parallel to the realisation of the growing importance of information and knowledge. Citing data collected by the Brookings Institute and a study by Lev, Kaplan and Norton note the trend of the declining market value of firms that can be attributed to tangible assets (representing 62% of a company's market value on average in 1982, 38% by 1992 and around 10–15% in 2000) and the increasing trend in market value that can be attributed to intangible assets (R.S. Kaplan & Norton, 2001)p. 2). Scholars have attributed the differences between company book values and market values to the values of intellectual

18 capital assets that are not recognised and measured in company balance sheets (L. Bassi, Lev, Low, McMurrer, & Siesfeld, 2000). The concept of viewing organisations as a broader set of resources dates back to the work of economist Edith Penrose, who recognised “the value of human resources to a firm” (Penrose, 1959)p. 24) that later influenced scholars to develop a resource-based view of the firm. Another study conducted by Hiroyuki Itami (1980) studied the effect of invisible assets on the management of Japanese corporations (Sullivan, 2000). Karl-Erik Sveiby, a practitioner in Sweden, addressed knowledge management in organisations in his early books and discussed the human capital dimension of intellectual capital in the late 1980s; he published the results of The Konrad Working Group in the book “The Invisible Balance Sheet” (The Konrad Group, 1990). In this book he proposed a theory for measuring knowledge capital by dividing it into three “families”: customer capital, individual capital, and structural capital. The approach was adopted by a large number of Swedish-listed companies including Skandia and, in 1993, the Swedish Council of Service Industries adopted it as their standard recommendation for annual reports, the first ever standard in this field (The Konrad Group, 1990). Sveiby later developed an “Intangible Asset Monitor” for a consultancy company called Celemi (Celemi, 1999), which, although privately held, has published information about its intangible assets since 1995. In the revised version of the model, the value of a company is presented as the sum of tangible assets and intangible assets, of which internal value, external value and competence are the three major components. Sveiby stated that all tangible and intangible assets of a firm are the result of human action and noted that people can create value by directing their energy outwards in working with customers and suppliers (external structure) or inwards in maintaining/building the organisation (internal structure) (K-E. Sveiby, 2001). In 1992, in a year-long research project comprising 12 companies at the leading edge of performance management, Kaplan and Norton developed a ‘balance scorecard’, a new performance-measurement system that pushed senior managers to get involved in the measurement of performance (R.S. Kaplan & Norton, 1998). The balance scorecard defined performance measures as consisting of a customer perspective, internal perspective, innovation and learning perspective and financial perspective. The balance scorecard made strategy and vision central and assumed that people will adopt whatever behaviours and take whatever actions are necessary to arrive at those goals. Leif Edvinsson, a director of Intellectual Capital at Swedish financial services company Skandia, adopted Sveiby's concepts and produced Skandia's first annual report

19 supplement on intellectual capital in 1995. He adapted the balanced scorecard from Kaplan and Norton to form the “Skandia Navigator”, placing people at the centre as the driver of four outcomes, with five sets of measures. In his book Intellectual Capital (1997) he lists 32 measures for “renewal and development” and 23 for the ‘human’ focus (L. Edvinsson & Malone, 1997). In the same year he formed a company called Intellectual Capital Sweden AB and developed a tool named IC Rating. The rating evaluates data collected from internal as well as external interest groups related to the company (Intellectual Capital Sweden, 2003). Hubert St. Onge refined the Skandia intellectual capital model, identifying customer capital as a separate category equivalent to human capital and structural capital. The St. Onge model proposes that long-term profits are created at the confluence between human, structural, and customer capital. In summary, earlier studies such as (Hall, 1989), (Itami, 1991) and (Stewart, 1997) discussed the existence and value of intellectual capital in organisations. By definition, OECD and Sveiby defined intellectual capital as a subset of intangible assets, while the Skandia study situated intangible assets as a subset of intellectual capital. The studies by Sveiby, Edvinsson and Malone, Kaplan and Norton suggest models and indicators for measuring intellectual capital, while Edvinsson discussed transformations between and within resources that could provide sustainable earnings potential (L Edvinsson, 2000). Further, Roos and Roos (1997) linked intellectual capital to corporate strategy and the production of measurement tools. Over time, scholars have come to agree that intellectual capital includes three components—human capital, external capital and internal capital—and emphasis its importance in creating value and the need to measure and report it. This section presented the definition of intellectual capital and defined the development of intellectual capital management theory, as well as establishing the value of intellectual capital as part of a firm’s intangible assets. Furthermore, it demonstrated that human capital is not the only asset but is one of the assets that contribute to the competitiveness of a firm.

2.4.3 Existing approaches to Measuring Intellectual Capital

The traditional way in which management regards employees is according to the three factors of land, labour and capital. Under this short-term view, labour is classified as an expense and is not expected to provide benefits beyond an accounting period. However, in the knowledge-based economy, as the contribution of human capital for value creation

20 becomes apparent, employees are viewed as an asset rather than a cost; they have potential future value. Under this view it is important to build intellectual capital, foster learning and retain knowledge. Intellectual capital must be measured in a way that is useful for decision making. Kaplan and Norton notes that tools for measuring tangible assets are meaningless for measuring intangible assets (R.S. Kaplan & Norton, 2001)p. 67). Unlike tangible assets, intangible assets do not have market value but possess potential value. The need for management is for both internal and external purposes. Research to date (Guthrie et al., 1999; Brennan, 1999) shows that companies are slow to report on their intellectual capital and, when they do, it is usually in the form of qualitative statements (Guthrie et al., 1999; Brennan, 1999). Some of these underestimate the importance of intellectual capital assets and choose not to disclose them. Guthrie and Petty conducted a content analysis of the annual reports of the 20 largest Australian listed companies (by market capitalisation) and found that key components of IC are not reported with a consistent framework (J. Guthrie & Petty, 2000). On the other hand, the reporting of data could be crucial for valuing the intellectual capital of a firm. In terms of defence of the organisation, it can be argued that there are no mandatory standards for reporting intellectual capital; information disclosed voluntarily will also become available to competitors, and competitive advantages can quickly disappear. These arguments will be further discussed in chapters 3 and 5 within the context of voluntary disclosures. From 1990–2010, numerous approaches have been suggested for measuring the value of intellectual capital in organisations; recently Sveiby identified 42 methods. He divided the existing measurement approaches into four categories (K.-E. Sveiby, 2010). Of these methods, Direct Intellectual Capital, Return on Assets (ROA) and Market Capitalisation were developed based on accounting and financial methods, while Scorecard Methods have used Kaplan & Norton’s balanced scorecard approach. Explanations and examples of these are as follows.

1) Direct Intellectual Capital (DIC): Estimate the $ value of intangible assets by identifying the various components. Once these components are identified, they can be directly evaluated, either individually or as an aggregated coefficient. Some examples are Intellectual Asset Valuation by Sullivan (2000) and Total Value Creation, TVC™ by Anderson and McLean (2000), The Invisible Balance Sheet by the Sveiby–Konrad Group (1989), and Human Resource Costing and Accounting by Flamholtz (1985).

21 2) Market Capitalisation (MCM): Calculate the difference between a company's market capitalisation and its stockholders' equity as the value of its intellectual capital or intangible assets. Some examples are Investor-Assigned Market Value (IAMV™) by Standfield (1998) and Calculated Intangible Value by Stewart (1997), as well as Tobin’s q by James Tobin.

3) Return on Assets (ROA): The average pre-tax earnings of a company for a period of time are divided by the average tangible assets of the company. Economic Value Added (EVA™) by Stern & Stewart (1997).

4) Scorecard Methods: The various components of intangible assets or intellectual capital are identified and indicators and indices are generated and reported in scorecards or as graphs. Some examples are Meritum Guidelines by the European Commission, the Value Chain Scoreboard™ by Baruch Lev (2002), IC Rating™ by Edvinsson (2002), the Value Creation Index (VCI) by Baum, Ittner, Larcker, Low, Siesfeld, and Malone (2000), Intangible Asset Monitor by Sveiby (1997), and the IC-Index™ by Roos, Roos, Dragonetti & Edvinsson (1997).

The above review of intellectual capital models highlights several important points. Firstly, some methods only measure the value of intellectual capital at an organisational level, without identifying the components that constitute intellectual capital. EVA, Market to Book Value and Tobin’s q are some examples of such measures. Secondly, all three methods (DIC, MCM, ROA), which base their principles on accounting and finance, have attempted to value intellectual capital in terms of dollar value. On the other hand, the Scorecard Methods attempt to provide more specific, comprehensive and rich data at an organisational level. Thirdly, while market capitalisation methods may utilise publicly available data and are suited for external users, balanced scorecard methods require internal data that can be accessed by management. The study of the intellectual capital models point to a need for models/frameworks that can be used by external parties such as investors and equity analysts using publicly available data. Research on intellectual capital either examines the aggregate effect of intellectual capital on business results or takes a sum-of-the-parts approach. The studies do not discuss specific drivers of human capital performance or test the direct effect of human capital on business results. Hence, there arises a need to view human capital within the human capital- management and knowledge-management literature.

22 2.5 Human Capital

This section will present the foundations of human capital theory and define the present understanding of its application at the firm level.

2.5. 1 The link between human capital and other intellectual capital factors

A review of intellectual capital models illustrates that intellectual capital refers to three types of capital; external, structural and human capital. Sveiby called human capital “competence” and categorised it as an intangible asset. Further, value creation for Skandia Monitor exists along five areas; financial, customer, renewal and development, process, and human focus, whereby human capital is central to the organisation, facilitating knowledge creation (L. Edvinsson & Malone, 1997). Whether human capital is viewed separately under intellectual capital or as the central concept, the intellectual capital elements have “complementary capacities, which work jointly and in a complementary way” (Erikson & Nerdrum, 2001). Hubert Saint-Onge noted that the relationship between human and structural capital is a “double-arrow” dynamic and that “human capital is what builds structural capital, but the better your structural capital, the better your human capital [is]”( Hubert Saint-Onge in (L. Edvinsson & Malone, 1997)p. 35). Bontis and Fitz-Enz also stressed the interaction between different intellectual capital elements (Bontis & Fitz-enz, 2002) Through these interactions among different elements of intellectual capital, the resources of the firm are transformed to create value.

2.5. 2 The Development of Human Capital Theory The foundations of human capital theory can be traced to the field of economics and capital theory. In 1906, Fisher's capital theory highlighted that all types of stocks would be considered capital when yielding services, and even explicitly included human beings as capital (Nerdrum & Erikson, 2001). Both Schultz and Mincer built upon Fisher’s capital theory and listed human capital as an independent capital category (F. E. Schuster, 1986). Mincer's article “Investment in human capital and Personal Income Distribution” (1958) was highly significant, with concepts and tools developed as a part of capital theory applied to human capital. The development of human capital theory accelerated after the 1960s, when economists concerned with explaining income distribution, growth and differences between

23 regions and nations helped to develop human capital theory. The studies of Becker and Chiswick were highly controversial but influential in the development of the theory. Becker’s seminal book Human Capital (1964), linked human capital with a physical means of production. He asserted that, similar to investments in physical resources, investments in human capital provide positive returns, and that as human capital embodied in human beings increases, the owners of human capital will benefit from increased productivity. Becker used formal education and training as examples of investments in human capital (G. S. Becker, 1964). He conducted empirical analysis on the rates of returns from college education, asserting that able persons invest more in themselves and firms would prefer to invest in firm-specific skills rather than in general skills (G. S. Becker, 1964)p. 79). Chiswick’s Expanded Human Capital Model identified an individual’s income as a function of years of schooling, experience and level of employment (Chiswick, 1974). His study was aimed at explaining interstate differences in the US and Canada. In line with the human capital theory, Hudson defined human capital as a combination of genetic inheritance, education, experience, and attitudes about life and business (Hudson, 1993). Human capital was discussed in the management literature much later than Becker’s work, mostly in the beginning only as a part of the intellectual capital in the early 1990s. It was named “individual capital” by Sveiby (The Konrad Group, 1990), “human centered assets” by Brooking (1996), “cultural capital” by Thompson (Thompson, 1999) and “human capital” by (Liebowitz & Wright, 1999). Following the development of the theory, a large body of literature has examined the returns on investment made in human capital from individual, societal and organisational perspectives. Annie Brooking defined human-centred assets as “the expertise, creative and problem solving capability, leadership, entrepreneurial and managerial skill embodied in employees (Brooking, 1996)p. 15). She stated that such assets are important because they are expensive (to train, hire and sustain), have rights (to leave employment, be sick) and possess knowledge important to the firm. Edvinsson and Malone (1997) made the distinction between human capital and structural capital, combining “knowledge, skill, innovativeness and ability of the company’s individual employees” with the “company’s values, culture and philosophy” to define human capital, while “hardware, software, organisational structure, patents and trademarks” constituted structural capital (L. Edvinsson & Malone, 1997)p. 11). In 1997, Roos emphasised the need for individuals’ to use their knowledge and skills for the benefit of the organisation (J. Roos, Roos, Dragonetti, & Edvinsson, 1997). Consequently, definitions of human capital have come to include attributes like willingness

24 and capacity to act. Fitz-Enz defined human capital as (1) knowledge, information and data; (2) skills and technical ability; (3) personal traits such as intelligence, energy, attitude, reliability, commitment; (4) ability to learn; and (5) desire to share information, participate in a team and focus on the goals of the organisation (Fitz-Enz, 2000). More recent examples have further refined the definition of human capital to include innovation capacity and more contemporary concerns such as “diversity” and “workplace quality”. Boedker, Guthrie et al. (2005), through refining Petty and Guthrie’s (2000) definition of human capital, stated it comprises 1) innovation; 2) knowledge; 3) EEO/diversity; 4) education, training; 5) learning and development; 6) employee demographics; and 7) work-related competencies (Boedker, Guthrie, & Cuganesan, 2005) (Petty & Guthrie, 2000).

2.5.3 Human Capital Management In the previous sections, the literature demonstrated that people are regarded as “value creators” of the organisation and provide the organisation with its competitive advantage. An important assumption of the human capital theory is that firms do not own human capital, but rather individuals own it and choose to use it for the benefit of the organisation. If human capital is an important asset to a firm, then investments, valuation and better management of this asset should be critical to a firm and its stakeholders. Several studies indicated the significance of investments in human capital. Bontis and Fitz-Enz (2002) measured the antecedents and consequences of effective human capital management practices. The antecedents of effective human capital management include management's ability to continue to invest in human capital while defending the organisation from human capital depletion (Bontis & Fitz-Enz, 2002). Investments in human capital create effectiveness (Bontis & Fitz-Enz, 2002), capital accumulation and profitability for firms (L. Edvinsson & Sullivan, 1996) (Aldana, 2001), future financial returns (L.J. Bassi, Ludwig, McMurrer, & Van Buren, 2002) as well higher stock valuations. A study supported by multiple authors working on intellectual capital and human capital valuations has shown that financial analysts place higher value on the stock of firms that seem to possess talented employees (L. Bassi, Lev, Low, McMurrer, & Siesfeld, 2000). While working at the American Society of Training and Development, Bassi researched the connection between training and business performance, looking at data collected from thousands of companies. Bassi concluded that training was the single most powerful predictor of stock returns (Ingham, 2007), p. 324).

25 In their joint study, Collins and Porras set out to identify the historical development of a set of visionary companies (J.C. Collins & Porras, 1994) p.18). They defined the visionary companies as premier institutions in their industries, widely admired by their peers and having a long track record of making a significant impact on the world around them. They found that visionary firms invested more heavily in management practices and human capital, put a greater percentage of the year’s earnings back into the company and were the early adopters or innovators in their industry. All these patterns of behaviour were reflected in the stock returns of visionary firms. From 1926–1990, visionary companies were 15 times more successful than the general market and 6 times more than the comparison companies. A study supported by multiple authors attempted to establish the direct effects of human capital on firm performance by examining law firms in the US and measuring human capital’s effects on service and geographic diversification. They found that leveraging human capital had a positive effect on firm performance (Hitt, Bierman, Shimizu, & Kochhar, 2001). A review of the literature suggests there are differences between human resource management and human capital thinking. According to Schuster (1986) human-resource management views people as resources that can be deployed at any required time to serve organisational tasks. In contrast, human-capital management recognises that people are investors of their own human capital, and as such are investments rather than costs (F. E. Schuster, 1986). Becker and Huselid announced the change in understanding as “Toward human capital management” in their 1997 article and noted that a firm’s human resources and human-resource management system are more than a cost to be minimised (Brian E Becker, Huselid, Pickus, & Spratt, 1997). According to (Lepak & Snell, 2003) human-capital management is about focusing on how human capital contributes to a firm’s core competencies, thus leveraging the knowledge base of employees. This section has presented the differences in thinking between human-resource management and human-capital management. It has shown the critical differences between the two approaches, regarding how they view human capital and how they utilise this critical asset. It has highlighted knowledge and learning as important components of human capital. The next section will explore the links between human capital and knowledge management.

2.6 Knowledge and Knowledge Management

Knowledge has become a critical ingredient for gaining a competitive advantage in the knowledge economy (Grant, 1996), which is dependent on replicating knowledge

26 resources grounded in the expertise and experience of people (Teece, 1998). Sveiby distinguished knowledge from data and information, describing it as “a capacity to act” (K-E. Sveiby, 2001; K. E. Sveiby, 1997). Royal and O’ Donnell view knowledge as a subset of intellectual capital, which is a subset of human capital (C. Royal & O'Donnell, 2008a) In simple terms, knowledge management can be described as how an organisation makes use of its intellectual capital. This requires an understanding of the different types of knowledge that reside in the organisation. Nonaka distinguished between explicit information, information that is verbalised, written down and communicated and transferred and tacit knowledge, which is knowledge that comes from personal experience and is often described as reaction (Nonaka, 1991; Nonaka, 1994). In particular, tacit knowledge is embodied in the individual and is not easily transferable, being based on intuition, emotion and belief. Therefore, the concern for management is to explore how to overcome the fragile transmission of knowledge between individuals in the organisation ((von Krogh, Roos, & Slocum, 1994) cited in (Nonaka, von Krogh, & Voelpel, 2006)). For the transmission of knowledge, there needs to be “the conversion of tacit into explicit knowledge (and vice versa)” (Nonaka, 1994) and access to collaboration, expert networks or communities of practice within the organisation (Brown & Duguid, 1991), ((Wiig, 2004) 9). Knowledge-management behaviours include a four-stage conversion process: socialisation, the sharing of tacit knowledge into explicit concepts; externalisation, the articulation of tacit knowledge into explicit concepts; combination, combining different entities of explicit knowledge; internalisation, embodying explicit knowledge into tacit knowledge’s three primary activities: knowledge generation, which describes the way employees improvise and organisations innovate; knowledge integration, which describes how employees transform their tacit knowledge into explicit knowledge by codifying their ideas into the systems of the organisation; and knowledge sharing, which describes the socialisation process through which employees share knowledge with one another (Nonaka & Takeuchi, 1995). As opposed to merely transferring knowledge, Grant (1996) emphasised the need to devise mechanisms for integrating individuals’ specialised knowledge (Grant, 1996). Rules and directives, sequencing, routines, group problem solving and decision making are suggested strategies for the integration of knowledge (Grant, 1996). In the literature, organisational knowledge creation and organisational learning have been examined together and are regarded as central to one another (Grant, 1996), where the learning environment within the organisation can become a facilitator for knowledge

27 creation. Nonaka emphasised the enabling environment as making unique differences in organisational knowledge creation (Nonaka, et al., 2006). The enabling environment includes items like “firms’ repertoire of enabling conditions, organisational members’ irreplaceable experiences, the organisational dialogue area, concrete objectives during knowledge creation, middle managers’ leadership, top leaders’ activism, the dynamics of the firm’s project system layer, business system layer and knowledge system layer” (2006, p. 1191). Emphasising the importance of the learning environment, a case examination of two companies studied the multiple learning processes and found that a high volume of information was collected and creative learning strategies were enhanced as a result of greater input and the cross communication of ideas generated in a consultative way. The research has shown that participants were able to share and obtain new knowledge that helped them learn and contribute to value-adding processes (Becket & Murray, 2000). A case study in a leading Indian infotech company showed that organisations can move individuals to a more value-added position by giving them greater opportunities for knowledge sharing and capture, rewarding initiative, sharing and innovation as well as learning. Moreover, top management visibility and support as well as increased leader involvement and guidance can also increase feelings of belonging and importance, as well as improving performance, thus improving the human capital knowledge value added (Gopika & Akhilesh, 2002). Bontis and Fitz-Enz studied the antecedents and consequences of human capital, their model outlining the importance of coupling knowledge-management activities with general human resource policy. In their research, knowledge-management activities encompassed three constructs: knowledge generation, knowledge integration, and knowledge sharing (Bontis & Fitz-Enz, 2002). The study shows that knowledge-management initiatives can decrease turnover rates and support business performance when coupled with human- resource policies. Describing the evolving stages of knowledge management, Sveiby states that after 2001 we entered the fourth stage, in which there is realisation that the key to unlocking the value of knowledge is people. At this stage the concerns relate to how to maximise the ability of an organisation’s people to create new knowledge and how to build environments conducive to the sharing of knowledge (K-E. Sveiby, 2001). In summary, using the knowledge-based view of a firm, firms are seen as “dynamic repositories of different sets of knowledge that are critically dependent upon the individual and collective human capital of the organisation” (Ranft & Lord, 2000); knowledge is

28 embodied in human capital and not easily communicated and the goal for knowledge management is to generate, capture and use knowledge to gain business performance.

2.7 Human Capital in Organisational Sustainability

Sustainable Development was defined as “meet[ing] the needs of the present without compromising the ability of future generations to meet their own needs” by the Brundtland Commission, headed by the Norwegian Prime Minister Gro Harlem Brundtland in 1987 (Brundtland Report, 1987). Since then, the concept of sustainability has been used extensively in the management field, among others, for understanding the contribution of organisations to society and the environment. One way of interpreting organisational sustainability is corporate longevity and survival; the human capital characteristics of those companies that are long-lived and strong performers should be studied. Arie de Geus and colleagues examined the question of corporate longevity at Royal Dutch/Shell Group of companies in 1983. They found four factors in common (De Geus, 1999), p. 12):

1. Long-lived companies were sensitive to their environment. Sensitivity to the environment represents a company’s ability to learn and adapt. 2. Long-lived companies were cohesive, with a strong sense of identity. Cohesion and identity are aspects of a company’s innate ability to build a community and persona for itself. 3. Long-lived companies were tolerant. Tolerance and its corollary, decentralisation, are both symptoms of a company’s awareness of ecology: its ability to build constructive relationships with other entities, within and outside itself. 4. Long-lived companies were conservative in financing. Conservative financing shows an ability to govern its own growth and evolution effectively.

De Geus’s long-lived companies, such as Shell, value human capital and seek to integrate the development of human capabilities into their long-term strategic approach. Organisational sustainability can also be interpreted as an organisation’s sustainable practices, which contribute to the greater society and the environment. In such a definition, human capital practices must be studied to explore how human capital becomes a partner to the strategy-setting and implementation phases of organisational sustainability. Dexter Dunphy takes human sustainability as “building human capability and skills for sustainable high level organisational performance and for community and societal well being”(D. Dunphy & Benveniste, 2000).

29 Sustainability consists of both ecological and human sustainability. In Dunphy’s view of becoming a sustainable organisation, organisations need to display properties other than meeting social obligations. For proper analysis it is critical to understand and take into account these high-order practices (D. Dunphy, Griffiths, & Suzanne, 2003). According to Dunphy’s “Sustainability Phase Model”, organisations move in steps in becoming totally sustainable. Companies developing sustainability go through the following stages:

1. Rejection. Employees and subcontractors are regarded as resources to be exploited. The environment is regarded as a “free good” to be exploited. 2. Non-responsiveness. Financial and technological factors dominate business strategies. The ecological environment is not considered to be a relevant factor in strategic or operational decisions. 3. Compliance. The emphasis is on compliance with the legal requirements of industrial relations, safety, and workplace safety. Seek to comply with environmental laws and minimise legal fees. 4. Efficiency. Systematic attempt to integrate human resource practices functions to reduce costs and increase efficiency. Management of environmental costs. 5. Strategic pro-activity. Intellectual and social capital are used to develop strategic advantage. Innovation, work/life balance, diversity, flexibility. Contribution to the community, pro-active environmental strategies. 6. The sustaining corporation. Accepts responsibility for contributing to the process of renewing and upgrading human knowledge and skill formation in greater society. Active promoter of ecological sustainability.

In this model for achieving successful strategic sustainability, companies should move from efficiency to strategy, develop human capital, achieve effective use of new technology, engage in valuable strategies and develop new organisational structures and cultures. Waddock (2004) points to the external pressures on organisations to engage in responsible practice. The study lists the pressures coming from 1) primary stakeholders (owners, employees, customers, and suppliers) 2) secondary stakeholders (NGOs and activists, local communities, and governments) and 3) general institutional or societal pressures, as external forces that are shaping organisations’ responsible behaviours in relation to employees, society and the environment (Waddock, Bodwell, & Graves, 2002). Based on these pressures, it is observed that from 2000–2004 there was increasing corporate social responsibility and sustainability reporting around the globe, particularly in Australia. Organisations were trying to justify that they were behaving responsibly. One example of best practice in terms of responsible behaviour and organisational sustainability is the Insurance Australia Group (IAG) in Australia, whose practices in human

30 capital management are highly distinctive. Benn, Wilson and Low (2007) conducted interviews with company officials and studied secondary documents to discover the mechanisms of governance for sustainability. IAG has installed a clear definition of sustainability from the top down, starting with vision and mission and flowing through to the board, executive, corporate and operational levels. The company assesses capability through financial performance, people-management performance, community interest, customer outcomes and values. The reporting systems also include human and environmental performance, openly showing how IAG leverages human capital towards achieving the company goals. IAG won a Special Award for Corporate Governance in 2005, and was rated AA for Social Responsibility by RepuTex (Benn, Wilson, & Low, 2007).

2.8 Existing Approaches for Measuring Human Capital

Firms may decide to measure and report the value of human capital either for internal purposes such as better management and control of assets, and/or for external purposes, such as compliance with the law or for the use of shareholders and other stakeholders. Mayo, in his book The Human Value of the Enterprise, reminds us of some of the internal purposes for measuring human capital. He records “balancing the cost numbers with value numbers, recognising the intrinsic diversity in the worth of people, measuring the value that is added to each stakeholder by each individual, estimate future returns from intangible and people- related investments, measure the drivers and outcomes of performance, valuations during mergers and acquisitions” (Mayo, 2001)as internal reasons. The items he lists coincide with an old and popular management saying: “You can’t manage what you don’t measure.” However, it is also true that “you can’t report what you don’t measure”, therefore for satisfying the needs of external stakeholders, as Mayo suggests, human capital needs to be measured internally. A wide variety of studies measures and links human capital to the parameters of business success, including a mix of studies developed by academicians and practitioners/consultant companies. The models differentiate their approaches as a result of how they view human capital, either as assets to be maximised or liabilities/costs to be minimised. Some, like “Human Capital Value Metric” by Bukowitz, Williams and Mactas (2004), are only intended for internal use, while models like “Human Capital Index” by Watson Wyatt (2002) can be shared with and used by investors. All models except “ Model of the Drivers of Sustainable People Management Systems” (2000) by Royal require data that can be accessed only by management. In addition to the intellectual capital models described

31 in the previous sections, some of the existing human capital measurement models are discussed below. HR Scorecard. Dave Ulrich (1997) reviewed the link between human-resource management and business results, suggesting the use of a balanced scorecard approach for the measurement of HR activities. Working on the model of balanced scorecard, Ulrich, Becker and Huselid developed the HR Scorecard (B.E. Becker, Huselid, & Ulrich, 2001). The study suggests that a well-developed scorecard allows HR managers to do a better job of managing HR as a strategic asset, as well as better demonstrating HR’s contribution to the firm’s financial success. It consists of four components:

1. HR deliverables, such as talent, stability, optimal staffing levels, people-related outcomes necessary for business success. 2. High-performance work system—a set of systems and processes designed to achieve the deliverables 3. HR system alignment measures—alignment of HR system with drivers of the firm’s strategy-implementation process 4. HR efficiency measures—measures for HR’s function in assessing its own productivity and efficiency. Leading and lagging indicators are separated.

The scorecard tries to capture both human capital-value creation and HR costs as value drivers of firm performance. The study offers many different measures for the four components, but adds that HR deliverable metrics that cannot be directly tied to the firm’s strategy map should not be included in the HR scorecard. Each firm should use specific measures and alignment suitable for its own case. Workforce Scorecard. In 2005 Huselid and Ulrich developed a complementary method to the HR Scorecard (M. A. Huselid, Becker, & Beatty, 2005), asserting that firms need a business strategy, a workforce strategy and a strategy for the HR function. The Workforce Scorecard aims to enable managers to measure and manage the contribution of employees rather than the contribution of the HR function to success. It consists of four areas:

1. Workforce success 2. Workforce competencies 3. Workforce mind-set and culture 4. Leadership and workforce behaviours

Human Capital Index (HCI). A global consulting firm, Watson Wyatt, developed the Human Capital Index, attempting to link human-resource practices with market value.

32 The first HCI study was conducted in 1999, surveying more than 400 US and Canada-based companies. They associated thirty key HR practices with a 30% increase in market value. In 2000, a European HCI survey was conducted with more than 250 companies. The findings from this study were similar to the North American results, with improvements in 19 key HR practices associated with a 26% increase in market value. In 2001, the survey was conducted again, including responses from 500 North American companies, identifying 49 HR practices. Later, the North American and European surveys were merged (WatsonWyattWorldwideResearch, 2002). The total results indicated companies with low HCI scores averaged a 21% five-year return, the medium HCI scores group averaged a 39% five-year return and high HCI scores averaged a 64% five-year return. In addition to proving a positive link between effective human resource practices and an increase in market value, the survey also addressed the debate of “Do effective human- resource practices drive positive results or do positive financial results lead to better human- resource practices?” An examination of two different correlations of the 51 companies that participated in both the 1999 and 2001 surveys showed that human-resource practices are the leading rather than the lagging indicators. HCI works through quantifying a company’s people-management policies and practices. Human Capital Monitor. Mayo in The Human Value of the Enterprise introduces the Human Capital Monitor, which is designed to link the intrinsic worth of individual human capital available with the working environment, including the systems and processes that guide and condition people’s behaviour and the value they create (Mayo, 2001). The suggested monitor measures people’s contribution to added value as a sum of the human asset worth of each individual and the success of the working environment. The method operates through the following steps:

1. Human Asset Worth is measured by multiplying employment costs and Individual Asset Multiplier (IAM) and dividing by 1000. IAM is measured as a function of the capability, potential, contribution and values alignment of every individual. Human capital is maximised through acquisition, retention and growth. According to the way Mayo measures human capital, he aims to obtain a ‘balance sheet’ effect, where some people are looked upon as assets and some as liabilities. 2. Working environment is measured as leadership effectiveness, practical support in the workplace, the nature of the workgroup, the culture of learning and development and the systems of rewards and recognition, which in return all contribute to people’s motivation and commitment to the organisation.

33 3. Each individual’s contribution is linked with a measure of the specific areas of value their role is designed to add to the current and future value for stakeholders.

HCM Value Matrix. Jon Ingham suggests the use of a three-tiered HCM Value Triangle for describing the level of value associated with business and people-management activities and the outputs of these processes. At the top of the value triangle is HCM, which creates value by creating capabilities for the future and driving and accelerating business strategy. He described the HCM Value chain in an organisation as follows (Ingham, 2007)p. 176):

1. Input: organisation effectiveness, leadership capability, mental models, management time, HR function capability, funding, resources 2. Activity: organisation, resourcing, development, performance management, career development, engagement, talent management 3. Output: tangible resources, intangible capability 4. Impact: employer of choice, operations, customers, financial

Ingham built upon the HCM Value Triangle and HCM Value Chain to form a Human Capital Value Matrix. The matrix shows the unidirectional causal relationships within an organisation while value is being created (Ingham, 2007). Human Capital Value Metric. Bukowitz, Williams and Mactas in their 2004 study developed the Human Capital Value Metric. Their aim was to provide a tool for operating and functional managers to estimate the economic contribution of human capital for use in business planning and monitoring systems (W. R. Bukowitz, Williams, & Mactas, 2004). Their model calculated each individual’s contribution to profits. Model of the Drivers of Sustainable People Management Systems. Studies carried out by Royal (C. Royal, 2000a; C. Royal & Althauser, 2002) in the investment banking industry determined key indicators and drivers of performance, and developed the Model of the Drivers of Sustainable People Management Systems. The Model illustrates the important role of human capital analysis in understanding the drivers of the firm. The drivers of sustainable people-management systems include changing internal and external pressures and managerial beliefs and perceptions, all of which interact and shape management strategy, ultimately resulting in the adoption of internalised labour market structures that are appropriate to a company and within its industry (C. Royal & O'Donnell, 2002a, 2002c). The process of human capital analysis refers to the search for patterns of human-resource

34 management practices and systems, which are likely to be sustainable over time (Carol Royal, Daneshgar, & O'Donnell, 2003) (C. Royal & O'Donnell, 2003). Royal defines sustainable people-management practices as enduring, timeless and stressing the importance of long-term employment and organisational membership. They are internally consistent and consistent with the broader context in which the firm operates. Practices encourage recruitment and retention, skill acquisition, internal career mobility and advancement, creating strong ties between the organisation, and employees will perform better with regard to financial performance (C. Royal & O'Donnell, 2002a). Royal suggests that by considering a company’s development over time it would be possible to identify emerging patterns in human capital that ultimately affect financial performance and market valuation. In this context, Royal and O’Donnell developed the Human Capital Classification Process. Human Capital Classification Process. This process provides insights into patterns of human-capital practices in an organisation, within its industry, in order to better anticipate future events within that organisation. The Human Capital Classification Process gathers a wide range of publicly available information on a company-by-company basis and involves an analysis of the Drivers of Sustainable People Management Systems (C. Royal & O'Donnell, 2002a). A comparison is made between the strategic “rhetoric” regarding a company’s sustainable human resource practices versus the “reality”. Sustainable human resource practices are defined as job characteristics, recruitment, training, careers, rewards, and professional/identity/culture (C. Royal & O'Donnell, 2003). The Australian Stock Exchange Top 50 publicly listed companies were rated on a five-star Human Capital Classification Process system, which indicated the firms’ relative positions on human capital, at a particular point in time (C. Royal & O'Donnell, 2003). In September 2002, the authors were able to pick early warning signs in AMP, a large Australian life insurance company, by using the Human Capital Classification Process system, 18 months before financial problems at the company were revealed (p. 24). Between November 2004 and February 2005, Royal conducted action research in the finance industry, feeding analysts Human Capital Analysis information. Traders indicated they benefited from the timeliness of human capital information and analysts benefited from a framework that enhances sales dialogue and investment recommendations (C. Royal & O'Donnell, 2008a). Overall, there are multiple approaches to measuring human capital in the literature. Models that put a dollar value on human capital assets can only measure what resides in the firm at the relevant time. In other words, as they can only show the lagging indicators of

35 performance, they are useful for cost-control purposes and making comparisons with similar firms. From an investment perspective, there is a need for models that show the leading indicators of performance, models that can demonstrate the value human capital will provide in the future, for example, the potential for change, expansion, growth and innovation. There is also a need to offer a qualitative context for knowledge transfer of this significant information. As Norton reminds us, there is a need for context in describing the steps involved in value creation (Daum, 2001), which can be offered through qualitative analysis. Models such as the HR Scorecard and HCM Value Matrix are comprehensive but use information that can only be accessed by management. The Human Capital Classification Process stands out as a comprehensive intangible analysis framework that can be used by external evaluators for appraising the value-creation process. The literature review suggests that this framework should be further tested to demonstrate whether it can provide a knowledge transfer of human capital intangibles value of the organisation to the financial markets.

2.9 Conclusion

This chapter has reviewed a wide range of literature on human-resource management, intellectual capital, human capital, knowledge management, organisational learning, organisational sustainability and measurement systems and models regarding intellectual capital and human capital. The literature has highlighted several important points regarding human capital:

x Human Resource Management has come to include a strategic role within the organisation in addition to its functional role. x There is an established link between good human resource practices and business results. It is essential to include human resource systems as a part of the value of the firm. x Increasing importance is placed on intellectual capital for explaining value in organisations. There are established methods for measuring intellectual capital’s contribution to value creation. x Intellectual Capital is comprised of structural capital (internal), relational capital (external) and human capital. They are all significant in creating value for the company.

36 x The fact that human capital is an intangible source for value creation and forms part of the assets that create competitive success is established in the literature. x While Human Resource Management literature regards human capital as a resource to be deployed when needed and examines the links between human resource practices and business results, human-capital management literature considers leveraging the knowledge base of human capital and observes how it directly contributes to a firm’s core competencies. There is a need to consider human capital when valuing a firm. The literature suggests there is a further need to develop and test human capital models during investment analysis. x Knowledge is embodied in the individual and human capital theory asserts that organisations do not own it. Therefore, there is a need for knowledge management within organisations that will generate, capture and use knowledge to improve business performance. x There are links between human capital and improved sustainability performance on social, economic, environmental and financial results. There are examples of firms that have engaged people to develop and implement principles of sustainability. There is a further need for studies showing how engaging people in sustainable practices adds value to the firm and which indicators investors can use to select these firms. x There are already several approaches for measuring human capital described in the literature. Depending on the purpose of the evaluator, an existing framework can be used to judge the contribution of human capital to value creation in an organisation. These frameworks need to be further tested.

This chapter presented human capital as a part of the human resource management literature. It has shown the existence of established models and frameworks for valuing human capital and pointed to a need to utilise a systematic approach in evaluating the human capital intangibles of a firm. The next chapter will discuss the value of human capital in the Accounting and Financial Management field.

37 Chapter 3: Human Capital in the Accounting and Financial Analysis Literature

3.1 Introduction

The aim of the broad literature review is to examine if a knowledge gap exists between how the human-resource management field and finance and accounting fields view and treat human capital. Previously, Chapter 2 demonstrated that human capital is an intangible source of value creation and forms part of the assets that create competitive success. Moreover, there are links between human capital and improved sustainability performance in terms of social, economic, environmental and financial results. Consequently, human capital should be evaluated as part of the value of the firm. Chapter 2 also indicated the existence of established models and frameworks for valuing human capital in the literature. Following these results, this chapter will explore how modern finance theory and current accounting rules and regulations treat intangible assets, intellectual capital and human capital in particular. Stock markets are traditionally viewed as the centrepiece of capitalist systems. Through establishing share prices they assist in the monitoring of firms and allocation of resources; they provide risk capital for investment; they encourage risk taking; and they allow managerial failure to be corrected through markets for corporate control (B. S. Black & Gilson, 1998; Mayer, 1994)p180). Recently, the media, investing public and policymakers have become increasingly concerned with the credibility problems associated with the independence and objectivity of brokerage houses and security analysts’ (sell-side) research product (C. Royal & O'Donnell, 2002a). Due to these developments there arose a need to reconsider traditional financial valuation models and seek the reasons for the markets’ failure. The first part of this research recognises organisations as complex systems. When looking for ways to understand the mechanism of organisations and trying to reach conclusions about the real value of organisations, one should understand how the system works. This research stresses the importance of inter-relationships existent in organisations and the inability of the numbers (financial models) to understand these relations. In the second part of this research the reliability of traditional financial models is questioned. Are the models adequate in giving investment advice in today’s economy? What are the factors contributing to failure? The data-collection process, characteristics of financial

38 analysts and other capital-market actors, data selection (e.g. omitting intellectual capital assets in valuations) and data validity are some of the factors questioned in this chapter. Financial models use accounting information as their input (data reliability); therefore, in section three the current accounting practices are discussed in regards to intangible asset valuation. How do current accounting rules and regulations treat Intellectual Capital, particularly human capital? Can the true value of a company be measured when using only lagging indicators such as accounting information? Is there a need for change in the regulations? Is there evidence that the capital market actors and the investors would benefit from such changes and disclosure of information about value drivers of future success? At the end of section three, to conclude the above discussion, the disentangling of intangible assets is discussed. Would intangible assets survive, grow and produce if disentangled from other entities? Would analysts be able to understand and asses the value of these assets if they treated them separately from the tangible assets? In this research it is suggested that, as opposed to market efficiency theory, capital- market actors do not collect and use all the soft data available in the public information pool, the reasons for which are explored in section four (Disclosure of Information); however, investors would certainly benefit from more open communication with companies. There is a niche in investments that has grown substantially over the last decade. In general, the Socially Responsible Investing (SRI) style takes into account ethical issues and the drivers of sustainable growth. This research questions whether this style of investing can unveil the general paradox of “What are the real value drivers of sustainable growth?” Does this kind of investing really measure long-term success? Is it rooted in theory and is there room for development? In the final section, this research addresses the issue of corporate governance, which has dominated the agenda of regulators, the media and the business environment in general. The motivation behind looking at this issue is the assumption that accountability and openness in the management of corporations could be strong indicators of future growth and sustainability. Finally, the chapter concludes with the findings of this section and a brief overview of the general topic.

3.2 Organisations as living beings and open systems

Organisations are dynamic beings that encompass numerous dimensions, which are constantly changing. The interplay of environmental, technological, economic, structural, social and human factors affects the characteristics of organisations and influences their

39 behaviour and performance. In this section of the literature review it is argued that the complexity of the organisational system requires additional measures to be added to current financial methods. This will result in better evaluation methods of the long-term performance of sustainable corporations. This research suggests that the systems view of organisations can be used to examine and analyse intricate relationships and behaviour that are existent in today’s organisations. Viewing organisations as socio-technical systems7 rather than machine parts, as suggested by early management theories (classical management theory and the scientific management school), has led organisation theory to examine biology by developing the idea that employees are people with complex needs that must be satisfied if they are to lead healthy lives and perform effectively in the workplace. The open systems view was derived from the metaphor of organisations resembling living organisms, first developed by a theoretical biologist named Ludwig von Bertanffly as a biological metaphor. As opposed to the classical management theorists, who treated organisations as a closed mechanical system that could be designed using clearly defined structures or parts, the open systems view treated organisation as being engaged with their environments. The ideas of survival, adaptability, development, growth, flexibility and stability were also introduced by Ludwig von Bertanffly and were developed by management scientists8 to achieve a better understanding of organisations. Using the metaphor of organisations as living organisms improves understanding of how organisations import energy (input) from outside by self-regulating (homeostasis), their needs for survival, and how they process, correct (feedback), grow (output) and adapt to the changing environment. This view draws attention to the needs of the various members of the organisation and state that different species of organisations exist. In addition, the emphasis is shifted away from the process, where the observation is taken not only of the internal operations of an organisation but of the organisation itself as systems persisting over time (sustainability). Therefore, organisations that are adopting, changing (Scott, 1992), regenerating (C. Royal & O'Donnell, 2002a), self- renewing and being resilient (Hamel, 2002) will have a higher probability of sustaining over

7 Elton Mayo (Hawthorne Studies), Maslow (theories of motivation) Chris Argyris, Frederick Herzberg, Douglas McGregor, Eric Trist and Ken Bamford (the Tavistock studies) all in some way or another identified the importance of social needs in the organization. 8 Tom Burns and G.M.Stalker: the distinction between “mechanistic” and “organic” approaches to organizations, the need for open and flexible organizations when there is change in the environment (Burns & Stalker, 1961) The Contingency Theory recognized that there is no best way of organizing, and different approaches to management may be necessary to perform different tasks and achieve a “good fit”. Lawrence and Lorsch noted that in some environmental circumstances some organizations are better to survive than others (P. Lawrence & Lorsch, 1967). Henry Mintzberg and his colleagues showed that an effective organization depended on developing a cohesive set of relations between structural design and the age, size and technology of the firm and the conditions of the industry . Population Ecology view built on the idea of the environment making a selection and the survival of the fittest. It highlighted the importance of resources and innovation.

40 time. For third parties, like security analysts trying to predict the sustainability of an entity, there is a need for better understanding and evaluation of these elements existing in an organisation. Consequently, quantitative methods would be inadequate to catch these capabilities within an organisation. Modern systems approaches have come to regard the organisation as a complex and highly interlinked network of parts exhibiting synergistic properties (Flood & Jackson, 1991). In this approach, the whole is greater than sum of its parts, and the emphasis is on the environment, the interrelation among the subsystems and the alignment between different systems. The organisation derives “material, energy and information” from its environment (Buckley, 1967), evolves with it (Morgan, 1997) and is in an interactive relationship with the society (Gebert & Boerner, 1999). Despite much evidence showing the benefits of an open organisation, Gebert and Boerner (1999) find that there is a cyclical nature of openness and closeness in organisations. As the organisation’s objective innovativeness tends to suggest a policy of decentralisation, critical awareness, and the emphasis on the possibility of learning (opening), the other cluster of objectives tends to require technical regulations and standards and control strategies (closeness). According to the mechanistic view of things, order naturally and inevitably crumbles into disorder in the absence of external intervention, and therefore managers intervene with quantitative measures (closure). However, quantitative measures (like scorecards) are one-dimensional and as such can only depict cause-and-effect relationships. Johnson and Broms (2000) in their book Profit Beyond Measure also use the metaphor of organisations as living organisms (Johnson & Broms, 2000). They argue that quantity is good to report on the current status and external features of an organisation but that organisations have many dimensions, similar to nature, and quantity cannot explain the internal operations of a living system. They give examples of two successful companies, Toyota and Skandia. These companies have constant feedback mechanisms that interrelate all parts of a living system, working harmoniously between internal and external customers and the environment, and provide variety. In their organisations, order and disorder coexist. As discussed in the cases of Toyota and Skandia, there is a self-organisation/emergence in organisations, in which local interaction between parts of an organisation produces emergent patterns of behaviour of a coherent kind in the whole, all in the absence of a blueprint (Stacey, Griffiths, & Shaw, 2000) (Johnson & Broms, 2000; Senge, 2000). As organisations become more complex, we observe increased interdependencies (work units become increasingly dependent on each other and the information flow). The nonlinearity of the

41 interactions, the increase in environmental uncertainties (shifting suppliers, technological breakthroughs, competitors tactics, inflation or recession, international disturbances) (Smith, Percy, & Richardson, 2001), the rise in the complexity of the system and the increased interdependencies require a better understanding of the system. The capabilities of the companies lie in the relationships (Johnson & Broms, 2000) and none of these capabilities are measured in traditional financial analysis by security analysts (C. Royal & O'Donnell, 2002a). Overall, organisations are not mechanical but rather organic forms and are more than the sum of their parts. For that reason, complex systems like organisations cannot be understood by an analysis that attempts to decompose the system into its individual parts in order to examine each part and relationship in turn. One of the founders of the general systems theory, Ashby, argues that if we take a complex system to pieces we will find that we cannot reassemble it (Ashby, 1956). Therefore, in trying to predict the performance of a firm, it would not be possible to catch these patterns of behaviour with traditional financial models. Qualitative measures would be better suited to catch these patterns of behaviour (J C Collins, 2001). This section has viewed organisations as open systems and highlighted the importance of interrelationships existent in organisations and the inability of mere numbers (financial models/quantitative analysis) to understand these relations. It also emphasised how it would be misguided to value an organisation simply by adding the sum of its parts. This points to a gap in what quantitative analysis can measure and the true value of the complex relationships and networks of an organisation. The next section will discuss the actors and tools used in the financial investment process.

3.3 Security analysis for investment purposes

3.3.1 Financial statement analysis

The origins of financial statement analysis can be traced to two historical developments. The first is the separation of management and ownership and the second is the credit borrowing of the corporations. As a result of these developments, both investors and lenders began systematically analysing corporate financial data and using financial ratios. The major objective of financial statement analysis and financial ratios is to provide decision- makers with firm-related data required in the process of decision making. As there could be various end users of this data, security (equity/financial) analysts in particular utilise it for

42 valuing publicly listed companies, reaching dependable conclusions and ultimately giving investment recommendations. However, as Graham, Dodd, Cottle and Tatham observe, “in applying analysis to the field of securities we encounter the obstacle that investment is by nature not an exact science just like medicine and law and the individual skill, art and chance are determinant factors” (Graham, Dodd, Cottle, & Tatham, 1962)17). Therefore, examining the process of security analysis and the capital market actors in detail may unveil the paradoxes involved in the industry.

3.3.2 Actors in the financial recommendation process

Capital markets started as a means of raising capital for corporations from the general public, in addition to banks and similar institutions. Over time, the roles and relationships between actors became more and more complex as the number of investment tools offered increased. Nevertheless, the amount invested in the capital markets increased, as well as the number of households investing. For example, in the US as of 1999, 48.2% of households (78.7 million individuals) owned stock in some form (L. E. Mitchell, 2001). In Australia, total investment funds have recorded a compound annual growth rate of 11% between 1989–2008 and exceeded A$1.3 trillion as of March 2008 (Austrade, 2008). Of these funds, superannuation fund assets (including Australia’s life insurance office fund assets) exceeded 70%. There are different types of investors, for whom the duration of interest in the market and in particular stock varies. Day traders, otherwise known as speculators, and some stockbrokers, who are in and out of a stock daily, do not pay regard to the fundamentals of a particular stock, and instead follow the price movements, and as such they are more interested in technical analysis9. On the other hand, institutional investors, mutual funds, individual investors and other managed funds (pension funds, superannuation funds) can have medium- to long-term interest in the stock and therefore need to know the future sustainability of corporations, and thus they seek the guidance of security analysts. Security analysis is the process of estimating return (dividends, change in the capital invested) and risk (uncertainty in the probability distribution of returns) for individual securities. Security analysts usually have a degree in finance, business (C. Royal & O'Donnell, 2002a) and are employed by the investment banks, brokerage houses or

9 Technical analysis endeavours to predict price levels of stocks by examining one or many past data from the market itself, the basic assumption that history repeats itself, past patterns of price behaviour in individual securities will tend to recur in the future. Shifts in supply-demand balance will change the trend. The data is analysed independent and regardless of the underlying data.

43 independent research services for covering individual stocks and industries. Their earnings forecasts have become widely used by investors/fund managers as a basis for the design of portfolios and investment strategies. Graham, et al., (1962) define the three functions of equity analysts as the “Descriptive Function”, where they collect information, use established valuation models to analyse the data, predict the future value of the company, compare it with current value at the stock market and reach conclusions; the “Selective Function”, where they advise others on their purchase, sale, retention or exchange of the security; and the “Critical Function”, where they directly or indirectly guide the investments, and consequently the funding opportunities, of the companies they report on (Graham, et al., 1962) p. 18). In his book Common Stocks, Uncommon Profit, Fisher remembers what security analysis meant in the 1920s (Fisher, 1996). Security analysts, who were called ‘statisticians” during those times, showed off their strength and sophistication by covering the stocks or bonds that the investment banks were selling to their customers. He reminds us that over a century later not much has changed in the industry. Today, security analysts are being accused of serving more than one party by the media (Mayer, 1994) . With the investment banking business booming during the late 1990s and early 2000s, only a few questioned the validity of security analysts’ company valuations and recommendations. However, when the technology bubble burst and the bull market withered— even as analysts continued to pump out exceedingly bullish exhortations to buy—investors, the media and the regulatory agencies started questioning the credibility problems associated with the security analysts’ reports. The concerns were twofold. First, problems arose because the analysts who wrote these reports worked for the investment institutions that underwrote the Initial Public Offerings (IPO)10 and the subsequent offerings and were receiving financial incentives to help in getting more investment banking business (Opdyke, 2002). These conflicts most typically surface in "sell-side" firms, where stockbrokers propose securities to investors. Much of the research bill at the sell-side firms is supported by investment-banking departments. This is in contrast to "buy-side" research, which is produced by analysts at mutual-fund firms, hedge funds and investment-trust departments, mostly for internal use. On the other hand, there are “independent firms” that don't offer investment-banking services and typically sell their research to professional investors; however, some, like Value Line Inc. and Morningstar Inc., are best known for selling reports to individual investors (Sidel & Craig, 2002). For the

10 IPOs and the subsequent offerings are offered in the primary markets and raise investment capital for companies, beside debt issues. Normally investment banks buy these shares from the corporations and sell it to the public with an underwriting fee. Later these shares exchange hands in the secondary markets, which provide liquidity for the investors and the traders.

44 independent firms, research is typically sold via "soft dollar" arrangements—a common practice in which investors get analysis in return for placing their trades through the firm's brokerage desk (Opdyke, 2002). Many segments of the investment community have grown increasingly suspicious in recent years regarding the value of sell-side analysts' stock recommendations. There is a belief that security analysts are focused on attracting and retaining clients, rather than on writing research reports that accurately reflect their opinions of the companies they are covering. The regulators and some investment banks are trying to find solutions to rebuild trust. For instance, new rules proposed by the National Association of Securities Dealers in the US require all analyst research reports to include the issuing firms’ percentage of “buys, holds and sells” (Barber, et al., 2006). At the same time, state and federal regulators in the US proposed creating an independent panel, funded by Wall Street firms, that would provide unbiased investment advice in addition to the advice doled out by brokerage firms, and they have also required recommendations to be disclosed (Bogle, 2002). US scrutiny of allegedly misleading stock research by Wall Street brokerage firms has led regulators in other parts of the world to take a closer look at potential conflicts of interest, such as in Germany, Britain, France and Japan (Portanger & Sims, 2002). The second problem arises in relation to the methods security analysts use to value companies, especially intangible assets. This point will be further discussed in the section Pitfalls of Modern Finance Theory and Financial Ratios. This section has presented security analysts as an important actor in the investment recommendation process, as their recommendations can have a substantial effect on investment decisions. Their credibility is based on the accuracy of their earnings projections and recommendations. However, their credibility has recently been questioned and there is a need to rebuild trust. The next section will address the methods utilised by security analysts.

3.3.3 Common equity-valuation methods

Current valuation methods have roots going back to the beginning of the century. Traditionally, the performance of companies and their businesses were measured by financial indicators such as Return on Investment (ROI), earnings per share (EPS) and net profits. In the 1930s, in The Theory of Investment Value, John Burr Williams wrote that the price of a stock should equal the present value of the stream of future dividend payments expected from that stock. At that time, Williams suggested that looking at dividends was a far

45 more potent indicator of value for investors than earnings (L. E. Mitchell, 2001). Thus, the “dividend discount model” projects the amount of cash the company will produce and discounts it to the present value using the time value of money and element of risk associated with that particular company. In 1934, two finance professors David Dodd and Benjamin Graham introduced the “scientific analysis” method, which required an analysis of factors such as economic influences, industry factors and pertinent company information such as product demand, earnings, dividends and management, in order to calculate an intrinsic value for the firm’s securities. Using this method, the investment decision is given by comparing this value with the current market price of the security (Graham, et al., 1962); (Fischer & Jordan, 1983). Both the dividend method and the scientific model are known as fundamental analysis. In the 1950s, Harry Markowitz stated that investors are risk-averse characters and that they are reluctant to assume additional risk unless they can anticipate a commensurate increase in their expected rewards (Markowitz, 1952). These two concepts (risk and return) introduced by the “portfolio theory” now form the foundation of an increasing variety of valuation models. One widely used model as of today is the “Capital assets pricing model” (CAPM), derived from the portfolio theory. This valuation model asks the analyst to provide an estimate of the future earnings (cash flow) or dividends and then combine that estimate with the information provided by the price of the stock and some measurement of risk (beta) to arrive at a judgment as to whether the stock is appropriately valued. Another valuation method evolved in the 1970s; the “efficient market theory” stated that the stock market is efficient, so that at any given time the price of a corporation’s share price reflects a company’s past and publicly available information (the theory is largely associated with Eugene Fama). The only way to beat the market in this scenario is to have insider information. However, in time security regulations increasingly have become more strict punishing both the information providers and users. 11

3.3.4 Pitfalls of Modern Finance Theory and Financial Ratios: Is Intellectual Capital Included in the Valuation of Stocks?

Modern finance theory is the main conceptual reference point for fund management and provides formal insights into valuing stocks and constructing an optimum portfolio. It centres on an attempt to predict stock-price movements by fine-tuning near-term earnings

11 For instance Sarbanes-Oxley Act 2002: New SEC rules about selective disclosure, insider training and breach of family relationship causing insider training.

46 estimates. Accurate earnings estimates12 are also essential for most contemporary stock- valuation models such as the intrinsic value theory of stocks and the growth and momentum schools of investing. There are problems with financial models associated with estimating future earnings, as these estimates are based on data taken from past financial statements that do not reflect important parts of the intellectual capital existent in the company. Virtually none of the indicators in financial statements are capable of representing human capital and the value created by human capital in the organisation. Unfortunately, the performance of people and all the activities related to them are represented in financial and accounting statements as costs only. Chapter 2 discussed external capital, internal capital and human capital as three components of intellectual capital, and scholars identify important attributes of human capital as 1) knowledge, information and data; (2) education, skills and technical ability (work-related competencies); (3) personal traits such as intelligence, energy, attitude, reliability, commitment; (4) ability to learn; (5) desire to share information, participate in a team and focus on the goals of the organisation; 6) employee demographics; 7) innovation; 8) EEO/diversity. Holland refers to the weaknesses of modern finance theory, asserting that it does not reveal how analysts should forecast the future (returns, risk, liquidity) and that it is weak in identifying relevant information sources and how to do this on a consistent basis (J. Holland, 2003). Another major problem in estimating future earnings is the relevant information gathering. Evidently, until the recent changes in the regulations, the most highly valued analysts and fund managers have been the ones that have good connections with the companies and obtain selective information. A study examining the information needs of telecommunications analysts interviewed 25 analysts and recorded that they ranked “direct contact with company representatives” and “financial statements” as the most significant sources (Glaum & Friedrich, 2006). While analysts have previously used direct contact intensively (G. Breton & Taffler, 1995; G. Breton & Taffler, 2001), henceforth this will be limited, as many countries, including Australia, have restricted selective disclosures to equity analysts. What happens to their estimates when they have to rely solely on public information? How will they stay ahead? Some analysts have migrated to the basics of fundamental analysis,

12 Fisher lists the methods for earnings estimates as follows: ROI method (return on investments), Market Share-Profit Margin Approach (forecasting of the industry), Scientific method (Benjamin Graham), Regression Analysis (examining of two simple variables like any internal or external company variable in the case of simple linear regression), Trend Analysis (examining the behaviour of an economic series over time), Decision-Trend analysis (addition of probabilities on the occurrence of projected estimates) and Simulation (projection of a distribution of occurrences) (Fischer & Jordan, 1983).

47 such as examining customer relations and so forth, utilising information that is publicly available. Holland blames modern finance theory for focusing analysts’ attention only on numbers and not on any soft data (J. Holland, 2003). Basing his research on the Swedish markets, Norberg defines the characteristics of security analysts and why they do not tend to consider soft measures like intellectual capital. He notes that high proficiency and materialism are important for analysts and they are goal oriented, with less room for inner values. They tend to value numbers and their values and mentality govern their behaviour, which is difficult to change (Norberg 2001cited in (Johanson, 2003). Traditional financial ratios (ROI, EPS) appear to be successful in the short term but do not aid in predicting long-term profitability (e.g. neglecting employee training). For example, the negative earnings of dotcoms made it impossible to use EPS models and without any substantial models and skills, analysts wrongly estimated the future sustainability of these companies. Moreover, with the multiples currently being relied upon, accountants and accountancy methods vary from company to company and across borders, making global comparisons difficult. Furthermore, cases like Enron have demonstrated how wrong it is to rely on a company’s own calculation of its earnings. Some financial advisors report that investors are concentrating on valuation methods that concentrate on hard cash and the dividend yield, rather than the growth prospects (Gascoigne, 2003). This section has questioned whether intellectual capital assets are considered in modern finance theory. The study of the theory suggests that it recognises neither intellectual capital nor human capital for inclusion in calculations of future earnings estimates. Further, it makes no suggestions for soft data collection. The next section will discuss the accuracy of analyst recommendations using current valuation methods.

3.3.5 How accurate are security analyst recommendations?

Numerous studies conducted during the 1960s and 1970s comparing management’s and analysts’ earnings forecasts to the realised earnings, found significant deviations (Bart A. Basi, Carey, & Twark, April 1976; Bidwell, Winter 1977; Copeland & Mariani, October 1972; Green & Segall, January 1967; Groth, Lewellen, & Schlarbaum, Jan/Feb 1979; McDonald, 1973; M. R. Richards, Benjamin, & Strawser, Fall 1977). A later study compared 66,100 (1974–1991) consensus estimates of Wall Street analysts to reported earnings of a large sample of NYSE, Amex, and OTC companies. The study found that errors are larger

48 than one might expect; that they were increasing over time; and that analysts were optimistic on average. Forecasting errors also appeared to be large across industries and through various stages of the business cycle (Dreman & Michael, 1995). Johanson lists the reasons for this as follows: “possible biases, time constraints facing the analysts, use of technical analysis in place of deep fundamental analysis, security analyst’s inability to incorporate information on intangibles and considering voluntary information disclosure as less reliable” (Johanson, 2003). This is not to say that analysts’ recommendations have no value. A study examining US sell-side analysts’ stock recommendations for the 1986–1996 period found that the first portfolio of "strong buys" and "buys" earned an average annual return of 18.8%, beating a broad US stock market index (the Wilshire 5000), which turned in 14.5%, while the last portfolio of "sells" averaged only 5.8% (Barber, Lehavy, McNichols, & Trueman, 2001). This section presented studies examining the accuracy of security analyst recommendations. Although there are mix results depending on the samples, time periods and methodology used, there is sufficient evidence to suggest there is room for improvement. The field will seek new ways of depicting value in firms.

3.3.6 Knowledge used in equity valuation. Do capital market actors seek soft information like intellectual capital?

There is a continuous stream of primary and secondary information flowing from many directions into the public domain information pool. The most important primary data are annual company reports (quarterly/half yearly) sent to stock exchanges, stockholders and the press. In most cases these reports contain hard financial data. Research indicates that most capital market actors seek additional data to get ahead of the competition. However, their methods are not systematic and do not arise from theory built on empirical or other research. Until recently, inside information coming directly from managers of companies to better connected analysts and fund managers was an easy way of getting ahead. However, there are other sources of publicly available information for analysts that want to make the effort. These include reports to commissions other than stock exchanges. In various countries, railroads, public utilities, banks, insurance companies, pipe lines, express companies, interstate trucking companies and freight forwarders are required to report to the relevant commissions. Even though not all such reports can be made available to the public, some are reproduced in newspapers, and so forth. The market also consists of many other primary and secondary information processors, users and producers, credit-raters, auditors, investment

49 bankers, and information specialists such as Bloomberg and Reuters. Supplementary information in the form of economic statistics, which relate to the business or the industry, industry surveys and publications and government publications are additional ways of collecting soft data. Other possible information sources are further discussed in Chapter 5 in the section Reporting Media of Publicly Listed Companies. Some analysts collect information from suppliers and customers either through direct interviews and/or through observations. However, unlike the financial reports, the soft data collection process is unsystematic and dependent on the ability/time limits of individual analysts. The capability of understanding the role of intangibles in the firm’s value-creation process not only differs between firms but also among different capital markets actors. The discussion of Human Capital Management in Chapter 2 illustrated that investments in human capital are highly important and need to be monitored over time. Royal suggests that by considering a company’s development over time, it would be possible to identify emerging patterns in human capital that ultimately affect financial performance and market valuation (C. Royal & O'Donnell, 2003). There are contrary findings regarding the usage of intellectual capital information by capital market actors. Several studies found that fund managers consider information on intangibles when making portfolio-management decisions (J. Holland, 2002; J. Holland & Doran, 1998; A. Rylander, K. Jacobsen, & G. Roos, 2000). Mavrinac and Boyle (1996) propose that analysts consider non-financial indicators when publishing prospects but other studies like Eccles and Mavrinac (1995) demonstrate there is a lack of interest in intangibles (Eccles & Mavrinac, 1995; Mavrinac & Boyle, 1996). However, in a study of 275 portfolio managers aiming to evaluate critically the influence of non-financial data in the performance evaluation and investment context, Mavrinac and Siesfield (1997) found that 35% of the investment decision was influenced by non-financial data on average, even though it did not explain which non financial data specifically (Mavrinac & Siesfeld, 1997). Other studies specifically show that, regarding human capital information, the focus is on management quality or brand-management skills rather than human capital (J. Holland, 2002; J. Holland & Doran, 1998) or ethics (Mavrinac and Siesfeld 1997). On the other hand, these are only a few components of human capital. A close examination of human capital intangibles in Chapter 2 noted that it is not only management quality that is important but also workforce quality/education/skills/knowledge/capacity to innovate/diversity and the supporting human resource practices and systems.

50 When Glaum and Friedrich (2006) asked telecommunications analysts which variable is most important to them among non-financial information, 48% chose quality of management, but explained that these “soft facts” played a role in company valuation only “implicitly”. Similarly, Amir and Lev’s study show that even if analysts seek more intellectual capital-related information, it does not fully account for intellectual capital’s contribution to future profitability (Amir, Lev, & Sougiannis, 2003). This section addressed the data-collection process of security analysts. The review suggests that in general analysts value information that will give them an edge in the process, but their methods of soft-data collection are not systematic. Moreover, they are not aware of the extensive information sources available in the public domain other than annual reports. The next section will address the reasons for this gap in the data-collection process.

3.3.7 Why do they not use or seek soft data?

There are numerous reasons why financial analysts/capital market actors do not seek or use soft data or data about intellectual capital. Johanson discusses how sell-side analysts face in-house and external barriers to using corporate information relating to human capital, listed as follows (Johanson, 2003):

1. They may not understand how human capital contributes to the corporate value chain process (knowledge problem). 2. They face issues of validity and reliability concerning voluntary intellectual capital information (uncertainty problem). 3. The investment firm may not own individual competence; the risk of losing competence can be important (ownership problem). 4. Analysts may not know if the measures really matter in the firm’s management control process—are they embedded in strategy and execution? 5. Mentality of financial analyst and fund managers. 6. Collection and evaluation of soft data requires a substantial amount of time, which may limit them.

The knowledge absence about the value of human capital to a firm’s value indicates a gap in the investment recommendation process. This gap in the literature suggests a need for developing and demonstrating the potential value of Human Capital Analysis for the valuation of firms. The section on Security Analysis for Investment Purposes discussed the ability of modern finance theory in understanding the drivers of value and success in today’s economy. This research suggests that soft data such as information relating to intellectual capital and

51 specifically human capital would aid in understanding the complex organisations of today. Even though the markets value some of the soft data available, there is no evidence of a systematic collection of data and the inclusion of this significantly important data in company valuations. Overall, the literature review of the financial analysis techniques, models, data and reports point to a gap in the use of intellectual capital assets data, in particular human capital. The next section will discuss accounting information as the major source of data the valuation models use.

3. 4 Intangible Asset Valuation in Accounting

3.4.1 Has the Relevance of Financial Statement Information Declined over Time?

Over the years there has been ongoing debate regarding the ability of financial statements to truly reflect the real value of companies. The debate has gained momentum due to the discrepancy between market capitalisation to book values in the 1990s and 2000s, especially with technology firms and the argument that the growing value of intangible assets in the knowledge-intensive economy is not reflected in the financial statements. Well known scholars in the field, such as Steven Wallman (Wallman, 1995) and Baruch Lev (Lev 1997; Lev and Zarowin 1999), assert that intangibles play an increasingly important role in the economy. They argue that the relevance of these statements has declined over time because financial statements do not adequately reflect information regarding these assets, and are unable to provide executives with information essential for managing knowledge-based processes and intangible resources, as well as for investors to better understand the true value of a company. Several studies have addressed this question but the results are mixed, with no clear evidence of a decline in the value relevance of financial statement information, even for high- technology firms (S. Brown & Lo, 1999; Chang, 1999; D. W. Collins, Maydew, & Weiss, 1997; Core, Guay, & Van Buskirk, 2003; Francis & Schipper, 1999). Lev and Zarowin (1999) identified a systematic decline in the usefulness of financial information to investors (B. Lev & Zarowin, 1999) and another study by Lev in the US found that the ability of financial information to explain stock prices and returns fell to 11% in the period 1999–2000 (Amir, et al., 2003). The mixed results do not prove that intellectual capital has a deserved place in financial statements and actively plays a role in investment decisions. Information disclosure to capital

52 markets thus far is based on and revolves around accounting-based financial information. Thus, there are two schools of thought regarding the issue of accounting for intellectual capital. Proponents such as Sveiby (1997) argue that one cannot measure the new with the old, and therefore they suggest new Intellectual Capital Models should be used and intellectual capital supplements should be published in addition to classical financial statements. Others, like (Rennie 1998), believe we can extend or adopt the accounting system, which will be discussed in the following section. Reporting will be further addressed in the section on Disclosure of Intangibles.

3.4.2 How do accounting rules treat intangible assets and intellectual capital?

In accounting, notions of knowledge and reputation as capital are found in two contexts: human resource accounting and accounting for intangibles. Human capital is approached in the context of “human resource accounting”, an idea that formed in the 1960s and was experimented with in the 1970s and 1980s, but has now been abandoned. During that time researchers attempted to measure the value of people to a firm and to account for investments in human resources in the annual account. Flamholtz (1973) developed a model by investigating the variables that influence the services an individual contributes to a company during his or her time within that company, examining both the characteristics of the individual and the organisational characteristics (Flamholtz, 1973, 1974). Accounting for intangibles: According to the International Accounting Standards Committee (IASC) literature, an asset is a resource controlled by an enterprise as a result of past events and from which future economic benefits flow to the company. An intangible asset is a claim to the future benefits that does not have a physical or financial (a stock or a bond) embodiment. In accounting the physical or tangible asset classification often combines capital and land without distinguishing between them. The focus is more on physical and financial assets (balance sheet) as well as transactions (profit and loss statement). There is little reflection of the true value and impact of intangibles in the financial reports (Cordon, 1998). Lev (2001) notes that even though managerial information systems (cost accounting) are geared toward physical and labour inputs, intangible inputs are considered period expenses and are not allocated to product costs (B. Lev, 2001). Most intangible assets are expensed in financial reports and hence remain absent from balance sheets (i.e. they are not capitalised).

53 Meer Kooistra and Zijlstra note that including intellectual capital information in annual reports would be difficult because accounting standards based on principles of “matching, objectivity, consistency, precaution principle and the realisation principle” do not leave room for the subjectivity of intangible assets (van der Meer-Kooistra & Zijlstra, 2001). For example, according to International Accounting Standard IAS 38, an intangible asset is recognised on the balance sheet if the asset’s cost can be reliably measured and all future benefits specifically attributable to the asset will flow to the enterprise. All other costs incurred for non-monetary intangible items should be expensed. The intangible asset is reported on the balance sheet at its cost less any accumulated amortisation and any impairment costs. In the US, both accounting and securities regulators have favoured strict adherence to historic cost measurement and the proscribed capitalisation of internally developed assets with only a few exceptions (e.g. software). For example, R&D expenditures must be disclosed separately but both the acquired in-process R&D and internally developed ones should be fully expensed in the acquiring company’s financial report. In contrast, even though Australian GAAP appears to be dominated by an emphasis on reliable measurement, it gives corporate managers wide discretion to capitalise intangible assets irrespective of whether the assets are acquired or generated internally. Therefore, there exists a wide diversity in accounting policies for intangibles assets in Australia. In a study conducted from 1993–1997 for a diverse pooled sample of 1,366 Australian firms, 51% of the companies capitalised intangible assets (Wyatt, 2002). Many defend the immediate expensing of intangibles because it is biased, inaccurate and produces serious distortions in reported earnings. Expensing is only conservative when outlays on intangible investments exceed their revenues, which usually occurs early in a company's life. Later, as investment in intangibles subsides while revenues from intangibles increase, reported profitability is often overstated. Lev observes that so far proposals to capitalise intangible assets have generally been opposed by managers, financial analysts, and accountants on the grounds that intangibles are too uncertain (risky) to be considered assets; amortisation of capitalised values is subjective and could be misused to manipulate financial reports; and the failure of intangible projects presented on balance sheets as assets may expose managers and auditors to frivolous shareholder litigation (B. Lev, 2001).

54 3.4.3 What are the difficulties of valuing intangibles in accounting?

The characteristics of intangible assets cause serious measurement and valuation problems in accounting. These characteristics make it difficult for intangible assets to meet normal asset recognition criteria. The value of human capital is dependent upon infrastructure, corporate culture, social and technological networks and communication structures, which in turn simultaneously enable human capital. Thus, the amount of leverage human capital has depends on its application within an organisational context. Accounting is unable to solve these problems.

Table 3.1 makes comparisons between the attributes of tangible and intangible assets.

Table 3.1: Comparison of Intangible Assets to Tangible Assets

Some of the Characteristics of: Tangible Assets Intangible Assets Physical Not physical, Embedded in physical assets Predictable time of return on investment Time delays (1) Zero sum Not zero-sum (2) Value can be quantified Some of it can be quantified, Subjective value Measured in financial terms Both financial terms and other (3) Diminishing returns, reduction of value Increasing or decreasing returns, no technical value (4) Saleable Many not saleable, difficult to have market value, few liquid organised markets (5) Comparable Not comparable with similar assets due to lack of markets Well defined property rights Few property rights, less control (6) Perception of lower risk Perception of higher-risk investments Ex post perspective Ex ante perspective Concerned with internal elements Both internal and external elements (7) Cost can be chased Costs cannot be chased (8) Inventory Inventory calculation is hard (9) Depreciation rate predetermined Depreciation/appreciation rate hard to find (10) (Bornemann & Leittner, 2002) (Lambert, 1998; (B. Lev, 2001); Romer, 1998; G Roos, Roos, Dragonetti, & Edvinsson, 1998). Notes: 1) The flow of investment in a particular aspect of IC can take time to have its intended effects, e.g. investment in training. 2) Small investments can have an enormous impact and large investment may fail.

55 3) Other measurements such as numbers, hours, and ratios. 4) Intangible assets can increase their value over time, but are equally likely to devalue overnight. 5) Many intangibles like customer loyalty are not separate and saleable assets—their value can be measured only as part of the residual value of the firm. 6) Exclusion of others from enjoying the benefits of these assets often do not extend to intangibles, e.g. economic developments have considerably weakened firms’ control over human resources. There are inevitable spillovers, e.g. competition and society benefiting from the training, unless it is company specific. 7) Customer relations is an example for external elements. Network effects. 8) The costs of intangibles (the basis of capitalisation) bear no relationship to their real value in light of future benefits. 9) For reporting, this means that the value of intangible assets can increase or decrease without any transaction occurring. 10) Because of the contradicting effects of the half-life time cycles of knowledge and learning effects, the depreciation/appreciation rate of an intangible asset is hard to define.

3.4.4 What are some of the global developments in accounting for reporting on intellectual capital?

Several accounting organisations and standard-setting bodies have initiated projects to explore the possibility of modifying or adapting the accounting system in order to be able to incorporate intellectual capital and intangible assets. Some of the developments around the globe are as follows. The issue had been on the agenda of The International Accounting Standards Committee’s (IASC) since 1987, but only in 1997 they did publish an Exposure Draft, which was approved in 1998. IAS 38 declared intangibles should be recognised on the balance sheet only when their cost can be realised reliably; internally developed ones are not to be recognised, and revalued only if there is an active market, and the useful life is not to exceed 20 years (Alfredson, 2001), (Carey, 1997) adopted the general concept that an identifiable asset must be recognised when it is probable that the future economic benefits attributable to the assets will flow to the enterprise and the asset can be measured reliably. In 1997, the Accounting Standard Board of the UK (ASB) issued Financial Reporting Standard 10—Goodwill and Intangible Assets (FRS 10), which recognised that goodwill and identifiable intangibles may have indefinite lives. In 1999, the Beyond Budgeting Round Table (BBRT) was formed, with some 45 companies supporting its research on intellectual capital (Mayo, 2001). As of 2003, a new government task force has looked at ways to elevate “human capital management” to the top of the transparency agenda in the UK (Bolton, 2003).

56 In 1996, the US Financial Accounting Standards Board (FASB) added to its agenda fundamental issues relating to methods of accounting for business combinations, accounting for goodwill and purchased intangibles. Two consecutive FASB exposure drafts (1999 and 2001) proposed an impairment test for goodwill and other intangible assets with indefinite lives. They were finalised in 2001 as SFAS 141 (Business and Combinations) and SFAS 142 (Goodwill and other Intangible Assets) (Alfredson, 2001). Besides the impairment test and the business combinations, the new rules required the acquired intangible assets to be recognised separately and those with definite lives to be capitalised. Moreover, in 2002, FASB added a project to its technical agenda entitled “Disclosure of Information about Intangible Assets Not Recognised in Financial Statements”. In the same country, the securities board SEC appointed a task force to find ways to encourage companies to provide more information regarding intellectual assets through traditional accounting (F. Norris, 2001). In 2000, in a follow-up study on SEC’s work the Brookings Institution announced two reports on intellectual capital (Unseen Wealth: Report of Brookings Task Force on Understanding Intangible Sources of Value and Intangibles: Management, Measurement and Reporting). As of 2002, SEC issued The Sarbanes-Oxley Act13 and as of 2003, SEC issued guidelines for public companies to disclose off-balance- sheet transactions and to reconcile pro-forma reports with GAAP, which will make it difficult for companies to understate their assets and liabilities (Millman, 2003). The Canadian Institute of Chartered Accountants had been working on a new economy project since 1994 with a number of elements, such as integrated performance reporting, intellectual capital management, shareholder value creation, environmental performance measurement and reporting and total value creation (Upton, 2001). Then in 2001, it issued guidance for disclosure principles for the Management Discussion and Analysis section of financial reports (Millman, 2003). In 1998, the Danish Agency for Development of Trade and Industry published a study of Intellectual Capital Accounts, which categorised intellectual capital into human resources, customers, technology and process accounts. In 1999, the Netherlands Ministry of Economic Affairs asked four accounting firms for feedback on intellectual reporting, resulting in the publication of “Intangible Assets, Balancing Accounts with Knowledge”. In the same year the OECD sponsored a Symposium on Measuring and Reporting IC: Experience, Issues, and Prospects” (Upton, 2001).

13 This rules on selective disclosure, insider trading and breach of family relationships causing insider trading.

57 In 1989, the Australian Accounting Research Foundation issued ED 49, which proposed standards for the recognition of identifiable intangible assets, purchased and internally developed, their subsequent amortisation and the associated disclosures in financial reports (Alfredson, 2001). In 1998, accounting for intangibles came to the attention of the Australian Securities Investment Commission (ASIC) and there was much disagreement over the adoption of ISC policies.14 Australia committed all entities that report under Australian Accounting Standards (AAS) to switch to international financial reporting standards (IFRS) by 2005. This deadline coincided with the operative date for the European Union's requirement that listed companies prepare their consolidated accounts in accordance with IFRS (international financial reporting standards). As a result, 29 Australian Accounting Standards changed and three new standards were introduced. Summarising the findings above, there is general recognition of the new economy around the globe, whereby regulators have started working with accounting groups, have founded committees to investigate accounting for intangibles and intellectual assets, and have to a certain degree encouraged companies to make voluntary disclosures.

3.4.5 How are intellectual capital assets to be understood?

Previously, Chapter 2 presented various models suggested by researchers to measure and report on intellectual capital. Edvinsson and Malone (1997) have suggested that to understand the true value of the firm it is necessary to supplement the financial value of the firm, with the value of the firm’s intellectual capital (L. Edvinsson & Malone, 1997). The firm’s market value is the sum of financial and intellectual capital or, as in the Eustace model (Eustace 2001), the value is the sum of recognised conventional assets, recognised intangibles and non-recognised competencies. These models treat the issue from an accounting perspective as a collection of items of separable assets. However, finance theory treats the issue differently, regarding it as the net present value of the firm’s cash flows. Gu and Lev value intangibles on this basis but their model, just like any other valuation model, is very much dependent on future earnings (Gu & Lev, 2001). As the systems view of the organisation has suggested, treating intangible assets as tangible assets will prevent the true value that resides in human capital, social networks and systems from being included in valuation. Rather than these accounting-based conceptions of

14 In 2000, the Group 100 jointly with Australian Ins. of Company Directors, the Business Council of Australia and CPA Australia declared that they thought it would be inappropriate for the AASB to adopt an approach that harmonises with IAS 38 until it is adopted for cross- border purposes.

58 valuing intangible assets, there is a need for models that can capture the potential value of these assets. Human Capital Analysis (C. Royal & O'Donnell, 2003) suggests that through a search for patterns of human resource management practices and systems, it is possible to identify the patterns that lead to higher financial performance and market valuation. The Human Capital Classification Process gives insight into these patterns. Section one of this chapter has discussed organisations as complex systems and how it is difficult to define the inner mechanisms of a system; even if we were to recognise the assets, they may not convey any meaning, because meaning is not carried in the inscription of the intangible asset itself. Therefore, the capital markets need to understand, recognise these issues and look for better ways to include soft data and qualitative analysis in their valuation models, without disentangling the system. Sections two and three of this chapter have discussed intangible asset valuation in modern finance theory and accounting literature, mentioning the differing views on valuing intangible assets together with tangible assets or separately. The chapter has further provided examples from alternative practices around the world, pointing to gaps in the understanding of human capital as a value creator and its inclusion in the valuation process. The next section will discuss intellectual capital disclosures and their suggested value for the investment process.

3.5 Disclosure of Information about Intangible Assets

3.5.1 Which groups have primary interest and consequently what are the consequences of not reporting intellectual capital externally?

Why should a company reveal more information than it is required to by law? From a strategic point of view, publishing mission-critical material adds substantially to a firm’s internal and external credibility. Thus, the original motivation to publish data concerning intangible assets was partially derived from the efficient market hypothesis, which suggests that lower financing costs will result from a greater transparency of business activities and increased credibility. Theories explaining the possible motives will be discussed further in Chapter 5: The Audience of Voluntary Reports. The primary groups that should be interested in disclosure are as follows: 1. Corporate managers and their shareholders. Intangible investments are associated with excessive cost of capital, which in return hinders investment and growth (C. Botosan, 1997; C. A. Botosan, 1997; Sengupta, 1998). Therefore, corporate

59 managers and their shareholders should be interested in alleviating the excess cost of capital. Moreover, low market values may lead to hostile takeovers (B. Lev, 2001), ( B. Lev, Sarath, & al., 2000); (van der Meer-Kooistra & Zijlstra, 2001).

2. Society. The Dutch Ministry of Economic Affairs stated that the slow growth of companies and erosion of the competitive advantage due to the excessive cost of capital will have an adverse effect on society in general. Moreover, companies that invest consistently in intangibles tend to have an inflation-related high cost of capital imposed on them by capital markets. They will be constantly punished, which in turn will stop these kinds of investments (e.g. training, R&D).

3. Investors and capital market regulators. Research documents the existence of above-average information asymmetry (differences in information about firm fundamentals between corporate insiders and outsiders) in intangible-intensive companies (B. Lev, 2001). This will cause an increasing bid–ask spread and thin liquidity (Aboody & Lev, 1998; Boone & Raman, 2001; Glosten & Milgrom, 1985).

4. Accounting standard setters, corporate boards. Empirical evidence indicates that deficient accounting for intangibles facilitates the release of biased financial reports (B. Lev, 2001).

5. Policymakers. Information from corporate accounts is a major input into the national accounts and policy deliberations, e.g. the assessment of fiscal policy, protection of intellectual property rights (B. Lev, 2001).

6. Investors. The failure to identify, measure, report the value of relevant IC components externally is that investors lack information on the development of a company’s intangible resources due to which investors’ risk perception will be higher, as a lack of information about investments in IC could lead to an underestimation of future earnings (van der Meer-Kooistra & Zijlstra, 2001). Information asymmetry increases the opportunities of insider gains (Aboody & Lev, 2000), causing significant losses for small investors.

7. Employees. Publishing strategy, goals, code of conduct, relations with key stakeholders, performance targets, achievement of targets, and sustainability indicators help employee orientation, reduce internal information asymmetries, and increase an organisation’s attraction as an employer of first choice (Bornemann & Leittner, 2002).

8. Corporate managers. Offering more information on intellectual capital is interpreted by the financial analysts as a sign of strength compared to competitors, and also as a sign of commitment of a company’s management to realising their goals (van der Meer-Kooistra & Zijlstra, 2001).

3.5.2 What are the arguments against publishing critical data about intellectual capital?

The foremost concern of management in critical information disclosure is competitors gaining insights into the chosen strategy. If a resource-based view of the firm is taken, this

60 concern is not valid as it would not be possible to gain a competitive advantage by imitating the strategy illustrated in an intellectual capital/sustainability report. Van der Meer-Kooistra and Zijlstra (2001) list several other reasons for companies not voluntarily disclosing intellectual capital data:

1. There could be manipulation opportunities within the reports on intellectual capital where only the good news is presented and bad news is concealed 2. Increases costs by means of new rules and bureaucracy in the organisation 3. Creates tax consequences if included on the balance sheet 4. Decreases degrees of freedom for management 5. Creates high expectations

Other management concerns include the potential of poor performance, which may lead to increased demand for management explanations, liability and potential lawsuits. Furthermore, there is still little direct evidence of the benefits and costs of intellectual capital disclosures. As there are many arguments for not disclosing intellectual capital information, there are also sound reasons for disclosure, as will be further discussed in Chapter 5. If research findings state that financial analysts look for soft data, why wouldn’t they push for more disclosure? There is a belief that to date well-connected analysts have relied on insider information from companies, and felt this was sufficient for their research. Furthermore, some analysts do not want to change their research habits. Lev records that America Online (AOL) in the US had to abandon capitalising when analysts blamed it for manipulating earnings (B. Lev, 2001) p. 83).

3.5.3 Do Capital Markets Value Disclosed Information about Intangible Assets?

There are numerous studies suggesting that intellectual capital information is relevant for capital market actors. Scholars have linked the value investors attribute to capitalised and amortised R&D and advertising expenditures (B. Lev & Sougiannis, 1996), brand values (Barth, Clement, & al., 1998), customer satisfaction (Ittner & Larcker, 1998), non-financial indicators of growth and customers (E. Amir & Lev, 1996), software development costs (Aboody & Lev, 1998), R&D intangibles (Ahmed & Falk, 2006), (Abrahams & Sidhu, 1998; Ahmed & Falk, 2000; Smith, et al., 2001), royalty income (Gu & Lev, 2001) and capitalised purchased goodwill (Godfrey & Koh, 2001).

61 Overall, value relevance studies find that while information about intangibles is associated with equity prices and is value relevant to investors, the coefficients are often smaller than those recognised assets.

3.5.4 Intellectual Reports and Triple Bottom Line Accounting. Best practices as examples.

Intellectual capital reporting represents an approach that can be used to measure intangible assets and to describe the results of a company’s knowledge-based activities. This kind of reporting emerged in the nineties, primarily in Scandinavia, when firms started to implement and publish intellectual capital reports, often as a supplement to the annual report. In the meantime, virtually worldwide, other firms have started to experiment with new forms of disclosure and the valuing of intangible assets. There are some organisation-specific models of intellectual capital reporting that have been developed and used in Scandinavian companies (L. Edvinsson & Malone, 1997; Johanson, 2003). Although best practices are applied in this field, the research indicates their application is not yet widespread. For instance, Guthrie and Petty studied the 19 largest listed Australian companies and best practice, read annual reports and conducted content analysis looking for reporting of 24 separate intellectual capital attributes. They concluded that despite a general consciousness about the importance of intellectual capital, companies poorly understand the relevant of intellectual capital components and therefore are not able adequately to identify, measure and report on intellectual capital within a consistent framework (J. Guthrie, et al., 1999). Further, in the US, an examination of the financial reports of 40 large public companies indicated, that, without exception, there were no disclosures of relevant, quantitative information concerning human capital other than: “Our employees are our most important asset” (L. Bassi, et al., 2000) p. 335). Despite the above findings, there are also some best practices being applied, initially in Scandinavia. For example, Skandia AFS published an annual report on intellectual capital for the first time in 1993. The Danish Ministry of Science, Technology and Innovation in cooperation with Mouritsen, Bukh et al. (2000) published Intellectual Capital reporting guidelines. Between then and 2002, over 100 Danish organisations participated in preparing intellectual capital reports as a part of a pilot study (J. Mouritsen, Bukh, Flagstad, & Thorbjørnsen, 2003). Based on this pilot study, the Intellectual Capital Statements Guideline was released, encouraging other companies to commit. Millman (2003) cites another example from India, Infosys Technologies, whose annual reports present detailed results according to

62 both the Indian and US GAAP. Another in the US, Herman Miller, the second-largest office maker, reports both according to GAAP rules and EVA methods, and capitalises certain expenses related to the creation of intangible assets (Millman, 2003). In Austria, the European Research Technology Organisation and the Austrian Research Centre, began reporting on intellectual capital in 1999–2000 (Bornemann & Leittner, 2002).

3.5.5 Triple Bottom Line and Sustainability Reporting

There are three pillars of sustainable development; economic growth, ecological balance and social progress. With the increasing importance placed on economic growth, ecological balance and social progress, companies around the globe started to correct their strategies and publish information about these three pillars of sustainable development, which is called triple bottom line accounting. Even though it is still in its infancy, there are some best practices. On 8 February, 2001, a Financial Times article reported the results of the Global Reporters Survey, the first international benchmark study of companies' efforts to address the triple bottom line in their reporting. Sustainability reporting was most prevalent in the oil and pharmaceutical industries and least prevalent in the automotive and chemical industries. Sustainability reporting by North American companies lagged behind other parts of the world. The study concluded that, despite some encouraging trends, only a small fraction of major multinational corporations seriously report on sustainability issues. The second Global Reporters survey, published on 18 November, 2002, addressed trends and best practices in eight business sectors as well as current issues facing companies and users of sustainability reports. According to Australian Government research, less than 25% of very large companies were producing annual or sustainability reports in 2003/2004 (CAER, 2004). A survey conducted by Corporate Social Responsibility of 100 of the world's largest businesses found that 21% of financial services companies included environmental and social reports in their annual reports (Investment Adviser, July 2, 2001). This compares to 7% for the previous year. The results of KPMG's International Survey of Corporate Sustainability Reporting 2002 showed that 45% of the top 250 companies of the global Fortune 500 and 28% of the top 100 companies in 19 countries issued environmental, social, or sustainability reports, compared to 35% and 24%, respectively, in 1999. As of March 2003, the GRI's website listed 206 companies issuing sustainability reports under the Guidelines, compared to 160 as of December 200l. This number had reached over 900 in 2006 and over 1500 in 2009.

63 This section presents the recent developments in the reporting of intellectual capital, environmental and social performance of companies. Trends indicate that since 2000 there has been rapid increase in the number of companies reporting on their sustainability performance, frequently using Global Reporting Guidelines. This suggests that, independent of its quality, there will be more sources of data other than annual reports. The next section will discuss how these data should be disclosed in order to be valuable for external users.

3.5.6 How should intellectual capital be disclosed? What kind of additional data do capital market actors seek in company disclosures?

There is general agreement that companies are better off identifying and reporting company-specific metrics and demonstrating management’s understanding of strategy and value creation in their own way (Stock, 2003) (Bukh, 2003). Based on several different studies (Rylander, Jacobsen, & Roos, 2000), (Floyd Norris, 2001), (Mavrinac & Siesfeld, 1997), (van der Meer-Kooistra & Zijlstra, 2001)common requests by financial analysts for intellectual capital reporting are as follows:

o Intellectual capital information that is deeply rooted in strategy, quantified, comparable, user-friendly, standardised, externally audited and that gives a transparent view of the company. o Size of the available market for the products, the competitive strengths and weaknesses of the company o Information on the variables that cause changes in intellectual capital resources o Information on the embeddedness of intellectual capital in the management process o Knowledge and experience embodied in people, either formalised or tacit o Organisational systems and processes supporting intellectual capital creation o Knowledge on innovation and technology o Business relationships o Drivers of long-term performance

Some scholars suggest there should be mandated universal regulations for non-financial information disclosure but investors and analysts find universally applied principles to be ineffectual (Mavrinac & Siesfeld, 1997). Baruch Lev, who has been studying intangible assets and intellectual capital reporting for many years, suggests disclosing information about the value chain of companies (B. Lev, 2001). Although Lev’s “value chain scorecard” is a very good recommendation on disclosure issues, all the examples given relate to innovation. The model does not include all the human capital intangibles discussed in Chapter 2; thus, leaving the arena open to further discussion. There is need for the disclosure of more specific human

64 capital-related information. For instance, Royal and O’Donnell (2003) define Sustainable Human Resource Practices as job characteristics/knowledge competencies/skills, recruitment, training, careers, rewards, professional/identity/culture. Companies that wish to communicate the value created by human capital should consider reporting more on these variables.

3.6 Ethical and Socially Responsible Investing

Companies are increasingly being evaluated on social as well as financial performance criteria, by institutional and social investors, environmental, human rights and labour activists, consumers, academics and the media. Furthermore, large corporations in the US, Canada, UK and to a lesser extent Australia are now annually evaluated by social research firms like Kinder (US), Lydenberg (US), Domini (US), by large pension funds like CalPERS, by religiously affiliated investor groups like IRRC (US), by indexes like FTSE4Good (US) and DJSI (US) and Repudex (Australia). SRI is defined by the UK Social Investment Forum as “the integration of an individual’s investment objectives with his/her commitment to social concerns such as social justice, economic development and a healthy environment”(UKSIF, 2004). In the same country there is a legislation requiring greater openness in the way companies are run and an obligation on pension funds to make a statement of their ethical principles in their investment strategy ("Ethical investment: Morality plays," 2000). The roots of socially responsible investment (SRI) can be traced to the political climate of the 1960s, which attracted increasing attention due to the apartheid problems of South Africa, environmental problems of the Exxon oil spill, and Chernobyl. The investment amount in SRI funds grew after the 1990s as investors’ interest in corporate practices increased. Currently in Europe there are over 100 SRI funds managing green and ethical investments. In the UK alone, in the ten years to 2010, the amount managed in these types of funds grew from £1.5 billion to £7.5 billion (EIRIS, 2010). Initially the SRI investment industry in Australia has lagged behind that of many overseas markets. However, managed SRI funds reached A$3.3 billion growing 41% between 2003 and 2004 (D. Greene, 2004) and there were 95 such funds in 2005 (S. Jones, van der Laan, Frost, & Loftus, 2008). Recent demand for SRI coincided with the increased exposure of many Australians to the share market through compulsory superannuation as well as direct investment in newly floated companies (Hayes, 2000).

65 3.6.1 Comparison of Ethical Investing and Sustainable Development Investing Styles

Even if sustainable development and ethical investment styles may seem identical, there are certain differences in how each styles executes investment decisions. Schofield and Feltmore (2003) explain the main difference between the two investment styles as follows: while sustainable development portfolio management focuses primarily on enhancing performance, ethical investing focuses on ensuring that the social values of investors are aligned with investment decisions (Schofield & Feltmore, 2003). Sustainable development investing uses positive screening15 to identify companies appropriate for inclusion in portfolios, in contrast to negative screens used by ethical investing to identify companies not appropriate for inclusion in portfolios. The authors remind us that even if a company may pass the negative screening process associated with ethical investing, it may still be operating poorly environmentally, economically and/or socially, such as some technology, mining or hospitality companies. Assessing the corporate practices for SRI involves examining how companies treat primary and secondary stakeholders and requires a “multiple bottom lines” approach, rather than the traditional single bottom line approach associated with financial reporting. In addition to using positive screening for selecting stocks, a sustainable investment style may also try to influence corporate decisions for better sustainable management through shareholder dialogue and pressure (shareholder advocacy) or forward investments to projects that benefit specific communities (community investing) (D. Greene, 2004).

3.6.2 How reliable are SRI Screens?

Indices of performance have been developed by firms such as Kinder, Lydenberg, Domini Co, (Domini Index, US), FTSE4Good(US), Dow Jones Sustainability Index –DJSI (US), Corporate Responsibility Index (UK) and SIRIS, Repudex (Australia), as well as such firms as the Ethical Investor magazine in Australia; 88% of these firms report that they use at least three screens (EIRIS data). But reliability of these screens and their performance as predictors of future sustainability is arguable. Firstly, there are different screening techniques used globally that inevitably produce some contradictory findings16. Where a company may perform well on one criterion that is central to the concerns of one group of investors, it may not perform well on other criteria

15 Screening is the process of examining a company with a view of including in or excluding from an investment portfolio on the basis of passing or failing a particular hurdle, for example, if the company has interests in uranium mining. 16 Vanguard Calvert Social Index Fund, The Domini Social Fund and the citizens Index Fund all use several of the same criteria, they often come with different results.

66 (Karen, 2000). Secondly, there is concern about the actual reliability and validity of data that are the basis for the rating; data are collected by questionnaires sent to companies, and even when companies do not have the capacity to respond to a question, conclusions are drawn from it. A third concern is the lack of systematic theory to guide the practice of research. The establishment of screens did not result from empirical research, but rather is intuitive or derived from market research among investors who are deemed socially conscious (Hopkins, 1999). Lastly, most of the screens do not involve a detailed historical analysis of human capital.

3.6.3 Do Ethics Pay? Are SRI screens able to predict future company sustainability?

A key reason for the relatively low take-up of SRI, especially in Australia, has been the perceived poor performance of screened investments. Secondly, it is very difficult to prove that by adopting eco-efficiency measures, companies can improve both environmental performance and financial results. Issues such as waste management and energy conservation can be relatively easy to quantify; issues such as improved community involvement are more difficult. While fostering good community relations is presumed to be good for business, it is impossible to measure and therefore difficult to prove as a business case. There are mixed results both in the international and Australian literature regarding the returns in socially screened and unscreened entities. Guerard (1997) found no statistically significant difference between the average returns of a socially screened and an unscreened universe from 1987–1996 in the US, while Feldman et al. (1997) found that companies adopting a more environmentally pro-active approach reduce operating costs and have a favourable impact on the perceived riskiness to investors and, accordingly, the cost of equity capital and value in the market(Feldman, Soyka, & al., 1997). Another study conducted by the Institute of Business Ethics compared two groups of companies in the FTSE 350—those with a demonstrable commitment to ethical behaviour through having published codes of business ethics, and those without. Their performances were measured over five years from 1997 to 2001 (Webley & More, 2003), revealing that companies with codes performed significantly better on two of the measures; economic value-added and market value-added. Thus, the study openly supported the view that applying codes of business ethics does pay off.

67 The Domini Social 400 Index (renamed the KLD Social Index 400) was the first to use multiple social screens and has outperformed the S&P500 on a total-return and risk- adjusted basis since inception in 1990 (KLD Indexes, 2010). In contrast, a recent comprehensive study examined the returns on performance of 89 ethical funds in Australia over the period 1986–2005 and found that ethical funds significantly underperformed the market in Australia, particularly during 2000–2005 (S. Jones, et al., 2008).

3.6.4 Guidelines for Reporting

FTSE4Good (US), –DJSI (US), Corporate Responsibility Index (UK) and Repudex (Australia) are well-known indices that offer criteria for inclusion but no detailed guidance for company managers. Fortunately, different guidelines are applicable to different sectors and companies. For instance, food retailers may find that the Ethical Trading Initiative is more applicable, while multinationals may wish to sign the UN Global Compact. A company's choice of guidelines often depends on where the pressure for change is coming from; some are employee led, some supply-chain led and some investor led. Recently developed and prolific guidelines are the GRI Sustainability Reporting Guidelines. Despite their increasing popularity these guidelines have not improved the reporting of human capital-related information. The current emphasis of social indicators is on community contributions and occupational health and safety. There is a gap in the reporting of human capital-related information in the sustainability reports prepared under these guidelines and what Human Capital Analysis requires. While they represent a good starting point, Human Capital Analysis is not complete unless human capital-related information is obtained from alternative sources. These sources are further discussed in Chapters 4 and 5.

3.6.5 Corporate Governance

The way in which managers are made responsible to the board of directors and in turn to shareholders is an important aspect of the functioning of a free-enterprise economy. Ultimately, decision makers are accountable for their decision, and in both the British and the US systems, it is quite clear that accountability is to the shareholders as owners of the company (neoclassical economic model). However, in principle managers in the past have enjoyed a measure of discretion to pursue their own objectives without the need to consider seriously the

68 interests of shareholders. Now that the need for accountability of decision makers is being emphasised as a means of achieving good company performance, there is a strong case for reviving the traditional system of corporate governance in the form of clearer responsibility of boards and managers to shareholders. When managers use company resources for their own personal needs, this indicates they do not act in the best interests of the company, they will deplete company resources, and as a result the future financial performance of the company will suffer. In today’s economy, companies gain from accumulated knowledge, and when top executives change jobs frequently for their own interests, companies suffer. For example, CEO tenure has gone from eight years in 1980 to four years in 2000 (Funk, 2003), and it is doubtful as to whether company profits have kept up with the rise in CEO payouts. In Australia, when Suncorp- Metway’s CEO left in 2002 with a $36 million payout, investor sentiment suffered dramatically. Firstly, investors were unaware of the stock options the CEO held, and secondly his redemption payment was unreasonably high. As a result, transparency has become a significant indicator shaping investment decisions.

3.7 Conclusion

This chapter discussed how modern finance theory and current accounting rules and regulations treat intangible assets, intellectual capital and human capital, in particular. The first section suggested viewing organisations as organic forms and asserted that they are more than the sum of their parts. This view implies that complex systems like organisations cannot be understood by an analysis that attempts to decompose the system into its individual parts in order to examine each part and relationship in turn. This view pointed to a need for a renewed approach to assess the true value of the complex relationships and networks of an organisation. The second section reviewed the process of security analysis and the capital market actors in detail and unveiled the paradoxes involved in the industry. Security analysts have a significant role in the investment recommendation process and collect information, use established valuation models to analyse the data, predict the future value of the company, compare it with current value on the stock market and advise others on their purchase, sale, retention decisions. Analysts are typically from a business background and tend to use the tools of modern finance theory for valuations. However, there are several problems with their valuation methods. Firstly, future earnings estimates are based on data taken from past financial statements and do not reflect important parts of companies’ intellectual capital.

69 Secondly, methods for forecasting the future (returns, risk, liquidity) are not specified in the models, and relevant information sources and how forecast on a consistent basis is not identified. While analysts value the “management quality of a firm”, they possess neither the skills nor the resources to include this element in their analysis. The most highly valued analysts and fund managers are those that have good connections with companies and obtain selective information. However, it is not clear how they will stay ahead using their current methods after the recent changes in regulations. Despite their given role in the industry, the review found that in recent years many segments of the investment community have grown increasingly suspicious of analysts’ stock recommendations. Studies examining the accuracy of security analyst recommendations have shown that despite a mix of results, there is room for improvement. Financial analysts firstly use annual reports and personal contacts for data collection but the review found there is more data available in the public domain. Some analysts value and collect soft data but unlike with financial reports the data-collection process is unsystematic and dependent on the ability/time limits of the individual analysts. These findings demonstrate a knowledge gap in the data-collection process and the use of soft data during the data-analysis process. The next section discussed current accounting practices in regards to intangible asset valuation. The review suggested that the ability of financial information to explain stock prices and returns decreased in recent years. This has been partially attributed to accounting principles that do not record intellectual capital. Despite previous efforts to account for human capital, current accounting theory does not recognise human capital on balance sheets. Scholars differ regarding whether to change the current accounting rules or to record intangible assets on separate reports and recent initiatives by accountants and governments have addressed this important issue. The number of companies reporting their intellectual capital assets and social and environmental performance is increasing. There are multiple reasons for firms not disclosing intellectual capital information. However, after corporate collapses in the 2000s it has become highly important to build trust in the markets. Further, in addition to investors/shareholders, other stakeholders may also benefit from greater transparency. The review of the literature suggests that investors value human capital information, therefore disclosing it would benefit investors. The need for disclosure regarding the environmental, social and governance performance of firms is particularly high for the socially responsible investment community. Yet despite the rising interest in SRI funds, the reliability and validity of their positive

70 screens is arguable. These findings also point to a knowledge gap in the inclusion of human capital in SRI models and as such there is a need for developing and testing theory-based models for this niche investment market. Trends indicate that independent of the quality, the quantity of information available will increase in the near future. There are certain guidelines and codes developed by national and international organisations for reporting on environmental and social performance but they do not fully disclose human capital information. The review of the literature in Chapter 2 found that human capital relates to:

1) knowledge, information and data; 2) education, skills and technical ability (work-related competencies 3) personal traits such as intelligence, energy, attitude, reliability, commitment; 4) ability to learn; 5) desire to share information, participate in a team and focus on the goals of the organisation; 6) employee demographics; 7) innovation; 8) EEO/diversity.

Security analysts estimate future financial earnings using the tools provided by modern finance theory and their main information sources of information are financial statements. However, current accounting rules and regulations do not recognise human capital as an asset, and as a result it is not included in balance sheets. Therefore, human capital indicators are not included in the current recommendation process. While some analysts seek soft qualitative data and attempt to use this information, it is not done systematically using models based on theory. The literature review has shown that investors value information regarding intellectual capital. Moreover, Chapter 2 illustrated how human resource practices are linked to lower turnover, higher productivity, higher financial returns, survival and higher firm value. Studies have also shown that human capital intangibles have an increasing role in value creation and that including potential value created by human capital in company valuations and the investment recommendation process and closing this knowledge gap is highly significant to achieve an efficient capital markets system.

71 3.8 Discussion of the two literature reviews

The general intention of the literature review was to examine whether Human Capital Analysis can be used to predict the sustainability of corporations and thus used as a complementary tool to traditional financial analysis. This topic was examined in two chapters. The first background chapter (Chapter 2) addressed the broad issue of intellectual capital and human capital in the school of Human Resource Management. It presented different models for measuring intellectual capital. Specifically, it sought for support in the literature indicating that Human Capital Analysis can be used in addition to traditional quantitative analysis. It asked the questions: “Can Human Capital Analysis measure or predict future financial performance of corporations?” and “Can the general public benefit from such additional analysis?” The second review addressed how modern finance theory and current accounting rules and regulations treat intangible assets, intellectual capital and human capital, in particular. It sought support in the literature for the view that current financial theory is inadequate in explaining the value drivers of corporations in today’s economy, and alternative methods are needed to supplement this kind of analysis. The comparison of the two chapters show that there appears to be a knowledge gap between the analyst reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital. As early as 1962 Graham and Dodd stated that “quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise” (Graham, et al., 1962)p. 17) . Around that time Rukeyser reminded us that “no valuable analysis of investments can be made without appraising the human factor which is an intangible ingredient in corporate success or failure” ((Rukeyser, 1954) p. 19). This chapter concludes that there is a lack of systematic approach to soft data collection and modelling in the capital markets and there is room for further research and testing in this field. This thesis aims to fill this gap through using an existing framework, which will be further described in the Chapter 4. Until recently, one the most preferred information sources for security analysts besides annual reports was direct contact with company officials. However, after changes to continuous disclosure laws in many nations including Australia, this preferential access was stopped. Using information in the public domain and basing both quantitative and qualitative

72 analysis on it was then inevitable. Chapter 5 will address the mandatory and voluntary disclosures of publicly listed companies.

73 Chapter 4: Research Methods

4.1 Introduction

This thesis seeks to open up new lines of research for and interpretation of the human capital paradigm in the investment process. Chapters 2 and 3 have outlined the literature and theoretical background used to develop the research questions for this thesis. The literature review indicated the need to embrace a multidisciplinary perspective for studying the human capital reporting of companies. The understanding is shaped by a range of disciplines, which spans the spectrum of accounting and finance to human capital management, knowledge management, intellectual capital and organisational change fields. The purpose of this chapter is to present the research questions, the research framework and to describe the steps taken to identify, analyse and select the research methods of this study. The data collected and analysed using the selected framework will enable these research questions to be addressed. The aim of this study is to examine the extent to which human capital information is reported by corporations to the public and the extent to which human capital information is analysed by equities analysts in their investment recommendations in the Australian Equities Market. The process for selection of a framework is described and the Model of Drivers of Sustainable People Management Systems is presented. Next, the nature of the study as qualitative and using documentary analysis will be established. In this section, the three case companies and the reasons for choosing them as samples of the reporting practices of listed companies will be discussed. Lastly, the data collection, coding and data analysis stages, which are led by the research questions, are presented. The qualitative methods employed in this study will permit the issues to be studied in depth and detail (Glaser & Strauss, 1967). The focus of the study will help explain phenomena of human capital reporting and will be of interest to the school of Human Resource Management. Further, improved explanations of “reporting”, “value creation” and “sustainability” within organisations will be of interest to the Schools of Management, Accounting, Finance and Environmental Studies.

4.2 Research Purpose

This thesis seeks to examine the extent to which human capital information is reported by corporations to the public and the extent to which human capital information is analysed

74 by equities analysts in making investment recommendations in the Australian Equities Market.

4.3 Research Questions

This thesis examines the following three questions:

1. a. Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable Human Resource Practices?

1. b. How much more than the mandatory regulations do these companies report or make available to the general public?

2. Is there a knowledge gap between the equities analyst reports and reporting of Sustainable Human Resource Practices by companies?

3. How important is it for analysts to be able to bridge the knowledge gap, within the financial regulatory services framework, when making forecasts about the future financial performance of ASX-listed companies?

4.4 In search of a Human Capital Framework

The literature review chapters (Chapters 2 and 3) established that there appears to be a knowledge gap between analyst reports and their understanding of companies from a human capital perspective and what is understood in the field of human capital. Chapter 2 has recognised human capital as an intangible source of value creation and asserted that it should be evaluated as a part of the value of the firm. It also displayed the existing models for this process. Chapter 3 ascertained that the current investment recommendation process does not systematically include human capital as part of company valuations and human capital is not discussed in any detail in financial quantitative fields, as it is a separate field of study and expertise and the links between these disparate fields are not very strong. The first section of Chapter 3 examines organisations with mechanistic, linear constructions of the world versus organic system constructions. The examination addresses concerns about definitions of closed systems versus open systems and the implications of such boundary definitions for research, theory and practice in understanding organisations. Taken from the literature review:

75 Modern systems approach regards the organisation as a complex and highly interlinked network of parts exhibiting synergistic properties, where whole is greater than sum of its parts and that interact forming highly organised feedback loops, existing in an environment, from which it draws inputs and to which it dispenses outputs by (Flood & Jackson, 1991).

Organisations are not mechanical but rather organic forms and they are more than the sum of their parts. For that reason, complex systems like organisations can’t be understood by an analysis that attempts to decompose the system into its individual parts in order to examine each part and relationship in turn. One of the founders of the general systems theory Ashby argues that if we take a complex system to pieces we will find that we cannot reassemble it (Ashby, 1956).

Holistic thinking is central to a systems perspective, as it assumes that the whole is understood as a complex system that is greater than the sum of its parts. It also assumes that describing and understanding a person’s social environment or an organisation’s political context is essential for overall understanding of what is observed. A systems approach requires “synthetic thinking” rather than “analysis”, which takes the system apart. Under such a method the organisation is first approached as a whole, then the containing whole will be explained, and finally the understanding of the containing whole is disaggregated to explain its parts, through revealing their role or function in that whole. This method will reveal why a system works the way it does. Another point made in the literature review was that order and disorder co-exist in organisations. Johnson and Broms in their book called “Profit Beyond Measure” give examples from two successful companies Toyota and Skandia. These companies have constant feedback mechanisms of a sort that interrelate all parts of a living system working harmoniously between internal and external customers and the environment and they still provide variety. In their organisations order and disorder coexist (Johnson & Broms, 2000). This section of the literature viewed organisations as open systems and highlighted the importance of interrelationships existent in organisations. Therefore, in trying to estimate the future performance of a firm it would not be possible to catch these patterns of behaviour using traditional financial models and pure quantitative analysis. This pointed to a gap in what quantitative analysis can measure and the true value of the complex relationships and networks of an organisation. In this research it is asserted that qualitative measures would be better suited to catch these patterns of behaviour. The literature also emphasised how it would be wrong to value organisations by adding the sum of their parts. There arose a need to identify a human capital framework that views an organisation as a system rather than the sum of its parts.

76 Until recently, one of the most preferred information sources besides annual reports for security analysts was their direct contact with company officials. However, the literature review illustrated that following changes to continuous disclosure laws and requirements throughout the world, including Australia, this preferential access was stopped. Thus, using information available in the public domain and basing both quantitative and qualitative analysis on this became inevitable. Therefore, there arose a need for a human capital framework that can be used by external parties without breaching regulatory boundaries. This type of examination requires the use of documents made publicly available. Overall, two distinct criteria were identified for measuring the human capital intangibles of a company. One was the need for a qualitative human capital method/framework that views organisations as systems and accounts for the interrelationships that exist in organisations. In that case, a model that views human capital as a “relative movement” over time would be more appropriate for measuring something this complex rather than an “absolute measure”. The second was for a framework that can be utilised through publicly available documents. In seeking a human capital framework, based on these criteria, the current frameworks identified in the literature review were examined. The literature review suggested a mix of studies developed by academics and practitioners/consultant companies. The models were differentiated in their approach based on how they viewed human capital—as assets to be maximised or liabilities/costs to be minimised. The first set was the measurement methods developed for intellectual capital. Among those models, EVA, Market to Book Value and Tobin’s q only measured the value of intellectual capital at the organisational level, without identifying the components that constitute intellectual capital (such as human capital). Models like Market Capitalisation, Return on Assets and Direct Intellectual Capital based their principles on accounting and finance and attempted to value intellectual capital in terms of dollar value. On the other hand, Scorecard methods attempted to provide more specific, comprehensive and rich data at the organisational level, but require internal data that can only be accessed by management. Studies on intellectual capital examined either the aggregate effect of intellectual capital on business results or took the sum of the parts approach. They did not discuss specific drivers of human capital performance or suggest the direct effects of human capital on business results. The second set consisted of models that considered human capital measurement. Among these models, Workforce Scorecard (M. A. Huselid, et al., 2005) and Human Capital

77 Value Metric (W. R. Bukowitz, Williams, & Mactas, 2004) measured human capital for operational use rather than value creation for the future of the organisation. Human Capital Monitor (Mayo, 2001) measured people’s contribution to added value as a sum of the human asset worth of each individual and the success of the working environment. The HR Scorecard by (B.E. Becker, et al., 2001) and the Human Capital Index by Watson Wyatt are useful and can be shared with and used by investors but once again they require internal data that can only be accessed by management. The Model of Drivers of Sustainable People Management Systems (C. Royal, 2000a) and Human Capital Classification Process (C. Royal & L. O'Donnell, 2002; Carol Royal & Loretta O'Donnell, 2002a) were identified through the literature review process as suitable frameworks for understanding the human capital value of a company. The model and the suggested framework provide valuable insights into the drivers of future company success. The reporting of human capital-specific knowledge can be traced without breaching regulatory boundaries using the indicators of the specified model.

4.5 The Chosen Framework: Model of Drivers of Sustainable People Management Systems (C. Royal, 2000a).

Studies carried out by Royal (C. Royal, 2000b; C. Royal & Althauser, 2002) on the investment banking industry determined key indicators and drivers of performance, and led to the development of the Model of the Drivers of Sustainable People Management Systems (Figure 4.1). The model indicates the important role of Human Capital Analysis in understanding the drivers of a firm. The Drivers of Sustainable People Management Systems include changing internal and external pressures and managerial beliefs and perceptions, all of which interact and shape management strategy, ultimately resulting in the adoption of internalised labour-market structures that are appropriate to a company and within its industry. The process of Human Capital Analysis refers to the search for patterns of human resource management practices and systems, which are likely to be sustainable over time (C. Royal & O'Donnell, 2002a); (C. Royal & O'Donnell, 2002b)). Sustainable People Management Practices are defined as enduring and timeless and stress the importance of long-term employment and organisational membership. They are internally consistent and are also consistent with the broader context in which the firm is operating. Practices encouraging recruitment and retention, skill acquisition, internal career

78 mobility and advancement create strong ties within the organisation and its employees will perform better with regard to financial performance (C. Royal & O'Donnell, 2002a). Figure 4.1

The Model: Drivers of Sustainable Human Capital Management Systems (Royal 2000)

EXTERNAL INFLUENCES Historical Trends Market Economic environment Valuation Resources Supply& demand for skilled labour Institutional factors, Product/Market Technological Change Performance Cross Cultural Factors Financial Costs Human Search Organisational Environmental Historical Recruitment Context Salaries Exogenous Variables

INTERNAL INFLUENCES Managerial Managerial Sustainable Employment relations Beliefs & Strategy people management Future Cultural Integration Perceptions practices Anticipated Corporate Governance Trends Costs Training & development Career systems Performance management and reward systems General overhead costs Workforce skills Need to secure commitment Workforce values Insider-Outsider Relations

Royal (2000) suggests that by considering a company’s development over time it is possible to identify emerging patterns in human capital that ultimately affect financial performance and market valuation. In this context Royal and O’Donnell developed the Human Capital Classification Process, which process provides insights into patterns of human capital practices within an organisation and its industry, in order to better anticipate future events within that organisation. The Human Capital Classification Process involves gathering a wide range of publicly available information on a company and conducting an analysis of the Drivers of Sustainable People Management Systems and interrelated variables affecting the value of a firm (C. Royal & O'Donnell, 2003). A comparison is made between the strategic “rhetoric” regarding a company’s Sustainable Human Resource practices versus the company’s actual

79 practices. The model states that Sustainable Human Resource practices fall into three typologies; 1. Professionalism: practices that encourage recruitment and career progression at all levels. Employees associate themselves more with profession and less with the organisation.

2. Individualism: practices that support short-term, external subcontract market arrangements, with little security.

3. Traditionalism: practices that encourage a long-term employment relationship, security and career progression based on junior entry and career movement within a firm.

Sustainable Human Resource Practices are defined as Job Characteristics, Recruitment, Training, Careers, Rewards, and Professional/Identity/Culture (C. Royal & O'Donnell, 2002c)b. Brief definitions of these six indicators are as follows:

1. Job Characteristics a. Competencies: Knowledge competencies, Skills competencies, Creativity competencies. b. Management Control: The extent to which employee participation and discretion are evident. c. Co-Worker Relations/ Work Organisation/ Teamwork/ Communication: The extent to which companies that maintain communication, co-worker interdependency and team-based structures. d. Power/Decision Making/Leadership: The extent to which consent relationship, decision making and leadership are participative and employee-oriented.

2. Recruitment Defined on the basis of criteria and selection process (at the bottom, at the top, or both). For instance, the “Professionalism” set of human resource practices encourages an employment relationship where recruitment and career progression occur across all levels of the firm.

3. Training Defined by main source and nature of training. For instance, those organisations classified under “Professionalism” tend to adopt an internal/external training philosophy. In these organisations the nature of the internal training is on-the-job, from colleagues and peers and external training is acquired from a tertiary or professional institution, providing a formal degree or diploma.

80 4. Career Opportunities Defined by internal/external careers and employment security. For instance, opportunities for both internal and external careers occur in organisations that have “Occupational Specialist” positions.

5. Rewards Defined by fixed or variable pay criteria for pay increases. The template indicates that in organisations in which employees are “Occupational Specialists” and dual career ladders exist, a highly variable and performance-related pay structure exists.

6. Professional Identity and Culture The template specifies that organisations in which employees identify more with the organisation rather than with the profession are those in which there is a strong dominant culture and where networks are structured top down.

4.6 Research Design

4.6.1 Qualitative Research, Strengths and Limitations

The literature review established that in attempting to forecast the future financial performance of a firm it is not possible to catch the human capital value and patterns of behaviour existing in an organisation with traditional financial models and pure quantitative analysis. The review supported the idea that financial data are historical and incapable of explaining the value drivers of success and sustainability. This points to a gap in what quantitative analysis can measure and the true value of the complex relationships and networks within an organisation. Therefore, qualitative techniques are suggested to be more appropriate in this study for understanding patterns of behaviour. Guthrie and Petty state that it is the researcher’s task to convince others of the usefulness of qualitative measures and to demonstrate a meaningful interplay between hard quantitative measures of performance and softer qualitative performance indicators. They add that from a strategic perspective often the qualitative measures are more telling and more important (Petty & Guthrie, 2000). Royal and O’Donnell (2003) state that qualitative data can explain individuality, complexity and variety in organisations. Further, although quantitative financial primary data are objective, soft data used in a systematic manner will add value to financial analysis. Miles and Huberman (1994) alert researchers to the drawbacks of using qualitative data, among which are the labour intensiveness of data collection, frequent data overload, the possibility of researcher bias and the time demands of processing and coding data. All of

81 these concerns are important and they will be discussed in the Design Tests (Section 4) in terms of reliability and validity.

4.6.2 Case Research and Sampling

In this study, the need to achieve a holistic understanding of the value drivers of an organisation and human resource practices requires a research design that can deal with the complex relations within an organisation as well as its interaction with the wider environment. The holistic nature of case research has been emphasised by Goode and Hatt (1952): “It is a way of organising social data so as to preserve the unitary character of the social object being studied” ((Goode & Hatt, 1952)331). In studying the reporting practices of publicly listed companies, case research will enable the researcher to “investigate the contemporary phenomenon within its real-life context; when the boundaries between phenomenon and context are not clearly evident and in which multiple sources of evidence are used” (Yin, 1989)23). Furthermore, as the researcher has little control over reporting practices and analyst coverage, a case study approach will offer more explanatory results (Yin, 1989) and will allow for any reporting differences to be traced over time. The selection of case study companies is done through “theoretical sampling”, as this type of sampling helps identify important new differences by maximising or minimising certain differences and similarities between cases. (Glaser & Strauss, 1967), p. 45) described “theoretical sampling” as

the process of data collection for generating theory whereby the analyst jointly collects, codes and analyses his data and decides what data to collect next and where to find them, in order to develop his theory as it emerges.

While the theories and models tested in this research can be applied to all publicly listed organisations, the broad sample-pool is all the companies trading on the ASX. Among them BHP Billiton, National Australia Bank (NAB) and Telstra are selected, under the belief that large companies would be more “progressive and innovative” (James Guthrie, Petty, &

82 Ricceri, 2006) in their disclosure of soft data. All three companies are in the ASX 20 list and are the largest in their industries 17. A brief summary of each company follows:

BHP Billiton is the largest diversified resources group globally, engaged in the discovery, development, conversion and marketing of petroleum, aluminium, base metals, carbon steel materials, diamonds, coal and stainless-steel materials.

National Australia Bank is an international banking group that operates in Australia, New Zealand, the UK, Asia and the USA. Through its subsidiaries and branches, NAB offers services to its retail, corporate and institutional customer base, which amounts to more than 10 million customers globally.

Telstra is the leading telecommunications company in Australia. It offers a full range of services throughout Australia, providing more than 10.3 million fixed lines and 6.5 million mobile services and network services that include Internet, pay TV and multimedia. The company was previously state owned.

The study of publicly available data will involve the period from 1999–2004 (5 consecutive years), as this period coincides with great changes in the reporting environment of publicly listed companies. This period also witnessed the boom and bust of technology stocks, both bull and bear markets, accounting scandals and major corporate collapses and the subsequent changes to corporate law, disclosure requirements of the ASX and voluntary reporting practices of publicly listed companies. Therefore, it is assumed that a study spanning this period will demonstrate the variety in reporting practices and coverage of analyst reports.

4.6.3 Documentary Analysis, Strengths and Limitations

This thesis will use documentary and archival data-collection methodologies with the aim of exposing the reporting practices of companies and equity analysts over a certain period of time in history. There are several reasons the selected data-collection methodology is appropriate for this study.

17 Yin (1984) argues that in multiple case analysis each case should be selected so that it “either a)predicts similar results or b) produces contrary results but for presictable reasons (Yin, 1984)p 48-49). The same author also argues that in multiple case study the researcher should be concerned about “unwanted variations in data collection procedures from case to case” (Yin, 2003)p 54). The ideal case size is recommended as 4-6 cases (Yin, 2003). However the number of case replications is dependent upon the “certainity wanted to be achieved”and the “richness of underlying theoretical prepositions”. The author warns that if the empirical case do not work as predicted modifications must be made to theory (Yin, 1994).

83 Documentary and archival analysis are common forms of research methods in history and political science disciplines. They allow the researcher to study documents from earlier time periods. The Drivers of Sustainable Human Capital Management Systems model (Royal, 2000) suggests that by considering a company’s development over time it is possible to identify emerging patterns in human capital that ultimately affect financial performance and market valuation. The literature review indicated that changes in continuous disclosure laws and requirements in many nations, including Australia, halted the preferential access of security analysts to company officials. Hence, using information available in the public domain and basing both quantitative and qualitative analysis on this became inevitable. As a result, in order to obtain company-specific data, it is essential for security analysts to follow the reporting practices of companies within the regulatory framework. In order to replicate the regulatory environment in which analysts now find themselves, archival and documentary analysis of publicly available documents is an appropriate data-collection methodology. Following data collection, it will also be possible to apply comparative historical analysis, which emphasises “processes over time” and has the power to make use of “systematic and contextualised comparison” (Mahoney & Rueschemeyer, 2002)p. 10). This type of analysis will make it possible to compare company and analyst reporting practices as well as explaining how institutions change over time (Thelen, 2002) p. 360). A wide range of publicly available information gathered on a company basis using the Human Capital Classification Process (C. Royal & O'Donnell, 2002a) can also be compared applying this analysis method. The next section will explain design tests used in this study.

4.6.4 Design Tests

The question of how well the case study techniques fare in the context of the research design criteria depends on how well the research itself fits the criteria. Criteria used in quantitative research, such as Measurement Validity, Internal Validity, External Validity and Reliability, are also found to be applicable to qualitative research by some researchers, like Yin (Yin, 1989). However, a second position is taken by some writers like (Lincoln & Guba, 1985), who suggest trustworthiness and authenticity be used as applicable criteria. Elements of trustworthiness (credibility, transferability, dependability, conformability) do have equivalents in Yin’s criteria.

84 This research will overcome the biases of case study analysis as follows:

a. Measurement Validity: In order to establish correct operational measures for the concepts being studied, reporting evidence for the case studies will be collected from multiple sources. These sources will include documents, archival records, interviews appearing in documents and direct observations when applicable (more detail will be provided in the data- collection section). The use of multiple sources of evidence will enable this research to address a broader range of historical, attitudinal and observational issues. Such data triangulation will increase the validity of the research. Further, a case study database, as suggested by (Yin, 1989), will be formed. This database will comprise a formal assembly of evidence distinct from the final case study reports and will establish a chain of evidence. The case study notes, which are computerised, will be divided into major subjects of study (i.e. Sustainable Human Practices indicators: job characteristics, recruitment, training, careers, rewards, professional/identity/culture).

b. Internal validity (credibility): Linking data to propositions and establishing a casual relationship will be done through pattern matching, a promising approach described by Campbell (1975). Under this approach, several pieces of information from the same case may be related to a theoretical proposition. In this case the empirically collected data will be compared to the pattern established by Royal (C. Royal, 2000a).

c. External validity (transferability): To establish the domain to which this study’s findings can be generalised, a multiple cases variety will be used. The need for replication of results requires more than one case to be selected, hence the use of three case study companies in this study. It is expected that each case will produce similar results (i.e. a literal replication). If the cases are in some way contradictory, the initial propositions will be revised and retested using another set of cases. If some of the empirical cases do not have the predicted outcomes, the theory will be modified. The method of generalisation will be analytic generalisation as opposed to “statistical generalisation”, in which a previously developed theory is used as a template with which to compare the empirical results of the case study. If two or more cases are shown to support the same theory, replication can be claimed.

85 e. Reliability (dependability): To ensure this study, for example, the data-collection procedures, can be repeated with the similar results, a case study protocol will be followed. The methods of data collection will provide a guide for future use and will address the issues of transferability and dependability. Another aspect of social research is that it should be value free and objective. As Turnbull (P. Turnbull, 1973)p. 13) stated, “the reader is entitled to know something of its aims, expectations, hopes and attitudes that the writer brought to the field with him, for these will surely influence not only how he sees things but even what he sees.” While care will be taken not to impose the researcher’s personal beliefs on the study, it is beneficial to state that the selection of the research area and the formulation of the research question are very much influenced by the researcher’s past work experience in the field.

4.7 Data Collection

The collection of soft qualitative human capital data is guided by the research questions, as follows.

Research Question 1. a. Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable Human Resource Practices?

To answer this research question, firstly a “disclosure index” will be constructed. For construction of a disclosure index there is a need to know the current mandatory reporting requirements of publicly listed companies in Australia. Moreover, where applicable, industry- specific reporting requirements will be added to this index. These reporting requirements will be explored in the following chapter, Chapter 5: Reporting of Information by Publicly Listed Companies. The disclosure index will include only the qualitative aspects of mandatory reporting requirements (see Appendix for the checklist matrix). Secondly, the annual reports of the three case companies will be collected for the period 1999–2004 using the annual report collection of the Connect-4 database. Annual reports are the most comprehensive documents available to the public and are therefore the “main disclosure vehicle” for publicly listed companies (Marston & Shrives, 1991). The literature review has shown that security analysts primarily use annual reports and personal contacts for data collection. The importance of the annual report as a vehicle for discharging accountability will be further discussed in Chapter 5.

86 Research Question 1. b. How much more than the mandatory regulations do these companies report or make available to the general public?

To answer this research question, the sustainability reports (HSEC, CSR, Triple Bottom line) of the three case companies will be collected for the period 1999–2004 using company websites in the first instance. The literature review in Chapter 3 has discussed sustainability/triple bottom line reporting and the GRI Sustainability Reporting Guidelines used for reporting environmental and social performance. It indicated that the current emphasis of social indicators was on community contributions and occupational health and safety rather than more specific human capital-related information. This points to a gap in the reporting of human capital-related information in sustainability reports prepared under these guidelines and what Human Capital Analysis requires. There arises a need to seek data in other publicly available documents. Yin identifies six sources of collecting evidence for case studies (Yin, 1989) (Yin, 2003). These are documents, archival reports, interviews, direct observations, participant observations and physical artefacts. Royal and O’Donnell (2003) give the following examples of qualitative data- collection techniques to be used in a regulated environment:

Structured interviews (designated company officers permitted under the regulatory environment) Semi-structured interviews (designated company officers permitted under the regulatory environment) Industry performance analysis Archival Analysis Media Analysis Oral Histories (designated company officers permitted under the regulatory environment) Corporate ownership analysis Participant observation through site visits (keeping within regulatory framework) Historical Analysis of each company Academic Data Sources

Neither structured nor semi-structured interviews are used in this study, as the questions asked by analysts are more quantitative in nature. The Disclosure Index constructed from the ASX Listing Rules and Australian Accounting Standards displays the mandatory reporting requirements of publicly listed entities in Australia (Included in the Appendices). This Index shows there are only a few human capital-related disclosures required by law. For instance, ASX Listing Rules “4.10.3:

87 Corporate Governance” and “4.10.17 Review of Operations” and AASB “1034.5.1.d Number of Employees” require very general information to be disclosed18 (AASB, 2004b; ASX, 2004). Further, the reporting of Sustainable People Management indicators such as “recruitment, training and rewards” is only required at the executive level; these requirements are ASX Listing Rule “10.17: Payments to Directors”, AASB “1034.6.1. Executive Remuneration” and “1046 Executive Disclosure”. The other qualitative data-collection techniques such as industry performance analysis, archival analysis, media analysis, oral histories, participant observation through site visits (conducted by other parties and documented) are among the techniques used in this research. A summary of the data-collection sources and the documents expected to be found are presented in Figure 4.2. The documents in this research will be collected through a vigorous process of library search and online electronic search. The timeframe for this search will not be restricted to 1999–2004, but will include recent company history as well. While “all data in the public domain” is the chosen framework for data collection, this is too extensive for a single study. Accordingly, the data will be categorised into subsets, based on their sources. A selection of data will be chosen from each subset, which will be called “company originated” (websites, CEO presentations, reports) and “other” (media, newspapers, dissertations, books). It is expected that after analysing the first set (year 1999/2000) the researcher will gain insights into which data sources give richer and more valuable information about the specific human capital indicators (e.g. union websites, government sources, academic articles). This approach is in between a very loose structure and what Miles and Huberman describe as a “ well-delineated and tight construct” (Miles & Huberman, 1994). Data saturation will be reached when there is sufficient data for each indicator, or the researcher stops the data search when a sufficiently wide variety of documents has been searched. As case company-specific data are collected, the framework provided by Sustainable People Management Human Capital Practices will be utilised. The six indicators of the framework (Job Characteristics, Recruitment, Training, Careers, Rewards, Professional/Identity/Culture) will be used as keywords in searching for human capital reporting of companies.

18 ASX Listing Rules 4.10.3: A statement disclosing the extent to which the entity has followed the best practice recommendations set by the 4ASX Corporate Governance Council during the reporting period. Amended 1/1/2003. ASX Listing Rule 4.10.17: A review of operations and activities for the reporting period. AASB 1034.5.1.d The entity must disclose the following, either the number of employees at the reporting date or the average of employees during the reporting period.

88 Figure 4.2. Data Collection Sources

Sources Documents

1.Company Website Annual reports (1, 4), Sustainability Reports (1), Investor Briefings, Presentations, Annual General Meeting Notes,

Web casts, Pod casts (1) 2. Stock Exchange Website

3. Library Sources Company Media Releases and ASX Announcements (1, 2)

4. Electronic

Databases Job openings (1)

5. Academic Sources Books and Reports written by scholars (5) (3) 6. Australian Historical company newsletters, reports, pamphlets (3) Government and Local Regulatory Websites Newspaper and magazine articles Scholarly Articles, Reviews, Dissertations, Participant 7. Industry Org. Observations written by scholars (5) and Employer Org. Electronic Books (4) Websites

8. Union Websites Union reports, Announcements Employee concerns (8, 10) 9. International Organisation Websites Industry publications, industry analysis (2, 3, 6,7,9)

10. Activist Websites Community concerns, blogs (10,11)

11. Local

Community

Websites

89 Research Question 2. Is there a knowledge gap between equities analyst reports and reporting of Sustainable Human Resource Practices by companies?

To answer this research question the security analyst reports covering the three case companies over the time period of 1999–2004 will be collected. Reports from two investment banks and one independent research company will be used. During sampling, priority will be given to reports written following major events for the case companies. Major events will be considered as “annual general meetings, announcement of annual reports (half yearly and quarterly), leadership changes, mergers and acquisitions and other major changes” concerning investors. The narrative sections of these reports will be analysed once again using the six indicators of Sustainable People Management Practices in searching for human capital reporting of companies. Secondly, transcripts of investor briefings and web-casts of these briefings will be collected from company websites.

Research Question 3. How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making forecasts about the future financial performance of ASX-listed companies?

The data-collection process will be completed after answering Research Question 2. However, to answer Research Question 3 there may be a need to go back and forth between literature, annual reports, other reports and analyst reports to make comparisons.

4.8 Working with Data and Qualitative Software

Considering Miles and Huberman’s warning regarding the drawbacks of using qualitative data (Miles & Huberman, 1994)p. 2), a systematic method will be applied to data collection, data sorting and data display. The qualitative software program NVIVO will be used to code and categorise data in the study. The use of a qualitative software program will provide “consistency, speed, representation and consolidation” to this research (Weizman & Details, 2000) 808). Through coding, data will be broken into component parts, according to their sources and reporting of Sustainable People Management Human Capital indicators. Using this program will enable the researcher to categorise vast amounts of data and code and recode data as subcategories of indicators emerge during coding (T. Richards & Richards, 1994). A list of themes and sub- themes (i.e. trees and sub-trees) of coding is provided in the Appendix E of this thesis.

90 After coding and categorising data under themes and sub-themes, the data will be displayed in what Miles and Huberman call a “Checklist Matrix” (Miles & Huberman, 1994)p. 108). They suggest a “Checklist Matrix” is good to make “data collection more systematic, enable verification, encourage comparability, and permit simple quantification” (Miles & Huberman, 1994) 109). Samples of Checklist Matrices constructed for this research are provided in the Appendices B, C and D. For research questions 1a, 1b and 2, different Checklist Matrices will be constructed during the data display stage.

4.9 Data Analysis

The data analysis will be conducted in the order of the research questions. The steps are as follows.

Research Question 1. a. Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable Human Resource Practices?

During this stage the narrative sections of the annual reports (1999–2004) for each case company will be reviewed, searching for items on the Disclosure Index. The results will be displayed on Checklist Matrix 1. After confirming compliance with the mandatory guidelines, the data found in this question will be used to answer the next question. In an environment where both government and security regulators have the power to enforce compliance, it is not surprising to find that companies are in compliance, especially when the sample companies are among the largest market-capitalised companies in the market. Moreover, any incompliance with the pre and post ASX Listing Rules will result in delisting of the company. Figure 4.3 shows the first step of the analysis process.

Figure 4.3: Research Question 1.a.

Disclosure Index

Australian Accounting Annual Reports Compliance ASX Listing Rules 1999-2004 with BHP mandatory NAB regulations Telstra

91 Research Question 1. b. How much more than the mandatory regulations do these companies report or make available to the general public?

During this stage, the narrative sections of the annual reports (1999–2004), “other company initiated documents” and “other documents” for each case company will be reviewed, searching for Sustainable People Management Indicators. Figure 4.4 illustrates the process. The results will be displayed on Checklist 2 and the study of this matrix will reveal the amount of specific Human Capital data in the public domain that is within the reach of analysts.

Figure 4.4 Research Question 1.b.

Sustainable People Documents Results Management Practices Indicators

Annual Reports Job (1999–2004) Characteristics BHP, NAB, Telstra

Recruitment Company Initiated Reports The extent of Sustainability Reports Training Human Company websites Capital Briefings, presentations Reporting by Media ancmnts. case EEOA Reports Careers companies

Other Reports Rewards Industry reports Media Analysis Books, reports Scholarly articles Professional/ Union Websites Identity

92 Research Question 2. Is there a knowledge gap between equities analyst reports and reporting of Sustainable Human Resource Practices by companies?

During this stage the narrative sections of security analyst reports (1999–2004) and analyst briefings for each case company will be reviewed, searching for Sustainable People Management Indicators. An examination of investor briefings will give insights into the types of questions asked of company officials by security analysts. The results will be shown on Checklist 3 and the study of this matrix will reveal the amount of specific human capital data reported in equities reports. Figure 4.5 shows the process.

Figure 4.5 Research Question 2

Sustainable People Documents Management Practices Indicators

Job Characteristics

Recruitment Analyst Reports (1999-2004) BHP NAB The extent of Training Telstra Human Capital Reporting of Analyst Careers Reports Investor Briefings 1999-2004 Rewards BHP NAB Telstra Professional/ Identity

Next a comparison of the answers to Research Questions 1 and 2 will be conducted. This comparison will reveal differences in the reporting of Sustainable Human Resource Practices by companies and analysts. Figure 4.6 portrays the sequential data analysis process.

93 Figure 4. 6 Data Analysis Plan

Mandatory Sustainable PM Model Rules and Regulations (Royal 2000) for Reporting

Disclosure Index SHR Indicators

Annual Reports All Other Analyst Reports Analyst Qualitative Briefings

Documents

Research Question Research Question 1.a 1.b Research Question 2

Differences in reporting

KNOWLEDGE GAP Research Question 3

94 Research Question 3. How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making forecasts about the future financial performance of ASX-listed companies?

Demonstrating the importance of the knowledge gap will be the next step of the analysis and will be done in two stages. Firstly, actual company practice will be distinguished from company rhetoric. The Human Capital Classification Process necessitates a comparison be made between the strategic “rhetoric” regarding a company’s Sustainable Human Resource practices versus actual practice (C. Royal & O'Donnell, 2003). In this study this will be done using the qualitative data found in the public domain. The data found in “company originated documents” will be compared with data found using “other sources”. Once again, the aim is to replicate the regulatory environment in which analysts find themselves and to demonstrate why company rhetoric should not be accepted unequivocally but should be verified in terms of whether promises leaders make and change programs affect the future financial performance of the company. This process promises to improve transparency for investors. In 2003, three Australian organisations collaborated on the Corp Rate project, assessing corporate governance, social and environmental performance of Australia's top 50 listed companies. In assessing social performance, Oxfam Community Aid Abroad (Oxfam) focused on the existence of policy framework as well as commitment to implementation and accountability of companies. This understanding will be used in monitoring companies’ commitment to sustainability and improving organisational performance. A comparison of “company reality” vs. “company rhetoric” will be conducted in three subsections.

1. Policy Framework: Commitment to sustainable development by the development of internal policies, business conduct, management standards, performance targets and code of ethics, initiating and committing to voluntary industry codes, showing capacity to renew policies. 2. Implementation of Policy Framework: The approach of how policies are implemented (top/down, bottom/up), the internalisation of values and standards at management level and employees, the follow up of targets and other evidence for implementation. 3. Public Accountability: Consultation and Dialogue with stakeholders, transparency, reporting of significant information, external auditing.

95 The literature review indicated that accountability and openness of the management of corporations can be strong indicators of future growth and sustainability. Further, companies should be firstly accountable and open to primary stakeholders such as shareholders (corporate governance), employees, society through environmental and local communities, customers and suppliers/partners. Based on this understanding, throughout this process the case companies’ commitment to establishing policy framework for sustainability and stakeholder management, implementation of the policy framework and transparency will be examined. During this process the company rhetoric contained in company originated documents will be compared to company reality constructed from other documents. Figure 4.7 shows this process. Following the process of distinguishing “reality” from “rhetoric”, the human capital- specific data collected in this research will be used in the Human Capital Classification Process. This process involves discussion of the historical analysis, strengths and weaknesses of sustainable human resource practices and macro analysis of the case companies. This analysis will reveal the kinds of insights human capital-based analysis can provide to a careful eye and ascertain the importance of the knowledge gap between the human capital- based understanding and security analysts’ understanding of human capital.

96 Figure 4. 7 Distinguishing Company Reality from Company Rhetoric Management for Documents Sustainability

Annual Reports Policy (1999-2004) Framework BHP, NAB, Telstra Company Rhetoric Company Initiated Implementation Reports of Policy Sustainability Reports Framework Company websites Briefings, presentations Media announcements EEOA Reports

Public Accountability Other Reports Industry reports Company Media Analysis Reality Books, reports Scholarly articles Union Websites Activist websites

4.10 Conclusion

This chapter presented the diverse methodological approach for this study, which is qualitative in nature and relies on the triangulation of publicly available data sources. It also identifies through a multidisciplinary approach that human capital theory and practice is a leading conceptual framework for exploring the research questions that have been highlighted in this chapter. The data collection, coding and data analysis stages are all led by the research questions. Lastly, this chapter highlights the need for constructing a disclosure index to answer research questions 1a and 1b. This will be done through an examination of the Reporting of Information by Publicly Listed Companies in the following chapter. Using documentary data-collection methodologies has certain limitations that may influence the results of this study. In this study, it is the assumption that by choosing large, dual-listed companies there will be more valuable qualitative data in the public domain. In Guthrie’s words these

97 companies would be more “progressive and innovative” in their reporting practices (James Guthrie, et al., 2006). However, it may well be that this is not the case, as managers may regard such human capital indicator information as particularly sensitive and be unlikely to disclose this information (“Reporting Gap” as specified by Eccles) or may regard such information as unimportant and not disclose it (“Understanding Gap” as specified by Eccles; (Eccles, et al., 2001). Further, there might be more data for some indicators and less for others, or in some cases companies may disclose more than others. As this study uses a paradigm that to a large extent replicates the regulatory environment in which analysts operate—in other words, a very regulated environment where company access is quite limited—the study will be restricted to publicly available data. This will prevent the researcher from contacting the case companies to request information about missing human capital indicators. The researcher can only improve the quantity and quality of human capital information by increasing the number of data sources and improving his/her data search techniques, which will still be limited to the extent that it is reported to the public by the case company. Some parts of this research will utilise voluntary disclosures of companies in order to reach conclusions, yet these reports can be unreliable, biased, missing important data and report mostly good news. In this research, it is the assumption that through triangulation of data, the measurement validity of the data collection will be improved. However, this limits the researcher, as he/she needs to rely on others’ (e.g. other scholars) views and analysis of the company. This research will examine human capital reporting practices of three case companies and it is the assumption that this will improve the external validity of the research. Conversely, reporting laws and regulations, ownership structure and other factors may influence the reporting practices of companies, restricting the opportunity to generalise the findings of this study to other countries. The same can be said about generalising the results for smaller companies. Having stated some of the limitations of this study, it is also important to state what it offers for future research. As human capital has become an important part of company value, failure to disclose human capital information may cause investors to misjudge company value, leading to mispricing of stocks and eventually create inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access (John Holland, 2001) and the firm’s cost of capital could increase as assets are undervalued (B. Lev, 2001). Therefore, reporting of this information as a part of the investment

98 recommendation process will help to rebuild trust in capital markets, as well as enhance the efficiency of markets as a result of increased transparency. It may also encourage companies to report more human capital-related information and may remind regulators of the type of human capital indicator reporting that needs to be made mandatory. Overall, this study aims to identify additional techniques for analysing publicly listed companies for investment purposes.

99 Chapter 5: Reporting of information by publicly listed companies

5.1 Introduction

In the previous literature review chapters (Chapters 2 and 3) it was identified that there appears to be a knowledge gap between the analyst reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital. Chapter 2 recognised human capital as an intangible source of value creation and asserted that it should be evaluated as a part of the value of the firm, as well as illustrating the existing models for this process. Chapter 3 ascertained that the current investment recommendation process does not systematically include human capital in company valuations. Even though both literature reviews agreed on the importance of human capital for value creation, there existed a gap between their approaches, which differed mainly in relation to soft data collection and the use of models based on theory. The global accounting scandals and corporate collapses, including those of Cendant (1998), Enron (2001), Adelphia (2002), Peregrine Systems (2002) and WorldCom (2002) in the US, Independent Insurance (2001) and Marconi (2001) in the UK, Elan (2002) in Ireland, Kirch (2002) in Germany (J. Hill, 2005) and One.Tel and HIH Insurance in Australia, damaged investors’ trust in investment markets. In attempting to understand what caused the collapses, investors and regulators questioned the role and structure of internal and external auditors, the reliability of accounting rules, the role of the board of directors and executive remuneration. As the auditing profession came under scrutiny, accountants began considering reforms in accounting standards("The trouble with accounting: When the numbers don't add up.," 2002). In their attempts to improve “perceived governance weaknesses” (J. Hill, 2005), p. 368), major stock exchanges and regulatory bodies introduced changes to governance, disclosure, analyst independence, accounting and auditing practices. This chapter will firstly present the mandatory reporting requirements for publicly listed companies at the Australian Stock Exchange (during the sample period of 1999–2004). The examination includes the ASX listing rules, the applicable accounting rules and regulations and other applicable disclosure requirements. This section will form the background for answering questions like whether publicly listed Australian companies report on human capital intangibles.

100 The reviews in Chapters 2 and 3 noted that new laws and regulations in many countries, including Australia, have halted the practice of companies giving preferred access to information through direct contact with security analysts and fund managers. The chapters also stressed the importance of including and analysing human capital-specific data during the investment recommendation process. Thus, to collect human capital information a study of documents available in the public domain will be necessary. Companies not only report to fulfil their mandatory judiciary duties but also to disclose other selective information. Following an examination of mandatory reporting requirements, this chapter will present the voluntary disclosures of listed companies at the ASX, during which the motives for voluntary disclosures, their content and importance for evaluating company valuations will be discussed. The examination of mandatory and voluntary reporting practices of publicly listed companies will display the reporting media that can be used for collecting company-specific data for Human Capital Analysis. This examination will form the background study for answering research questions like whether potential human capital-related data are in the public domain on which to base Human Capital Analysis. The section will conclude with a brief overview of voluntary reporting. Lastly, the chapter will present the recent developments in corporate governance reporting and discuss the relevant practices in Australia, the basis for which is the assumption that accountability and openness of the management of corporations could be strong indicators of future growth and sustainability. The discussion will identify the best governance practices and which criteria to use when evaluating reporting performance.

5.2 Reporting Environment for Publicly Listed Companies in Australia (1999-2004)

This section will present the mandatory reporting requirements for publicly listed companies at the ASX. In addition to the recent changes in the rules and regulations, it will also define the controlling agencies in the system.

5.2.1Changing Regulatory Environment

This section will review recent changes in the corporate regulatory environment in Australia. In March 1997, the Australian Federal Government embarked on a program of

101 corporate law reform, known as the Corporate Law Economic Reform Program (CLERP). CLERP was a comprehensive initiative to improve Australia’s business and company regulation (ASIC, 2004). The CLERP 9 Discussion Paper19, Ramsay Report on the Independence of Australian Company Auditors, HIH Royal Commission Recommendations20 and the Government’s Response to the Recommendations of the HIH Royal Commission21 have been influential in shaping the reform. It was a long and extensive process but, ultimately, The CLERP 9 Act (Audit Reform & Corporate Disclosure) was enacted in June 200422. The CLERP 9 Act (The Act) contained several significant reforms to the existing corporate governance provisions in the Corporations Act 200123. The revisions included changes to continuous disclosure, financial reporting, executive remuneration and shareholder participation. The Act also contained new provisions relevant to auditor independence, licensing obligations for financial services licensees, analyst independence and amendments to the fundraising provisions. The new continuous disclosure provisions introduced by the Act gave Australian Securities and Investments Commission24 (ASIC) more power to impose transparency. The changes increased the penalties for impeachment, added individual liability for involvement in a contravention and let ASIC impose penalties without a need for court action. Consequent to the reforms taking place in Australian Corporations Law, the ASX25 established the ASX Corporate Governance Council in 200226. The Council developed and released the “Principles of Good Corporate Governance and Best Practice Recommendations” for the listed companies in March 2003. Amendments to the ASX's Listing Rules on enhanced disclosure and corporate governance followed the recommendations27(ASIC, 2004).

19 Commonwealth of Australia, Corporate Disclosure - Strengthening the financial reporting framework, September 2002. www.treasury.gov.au/documents/403/PDF/Clerp9.pdf retrieved on 2005. 202003, Commonwealth of Australia, Report of the HIH Royal Commission, www.hihroyalcom.gov.au/finalreport/index.htm. It is the final report written by HIH Royal Commission in response to the collapse of HIH Insurance in 2001. HIH’s failure is defined as the “largest corporate failure Australia experienced to date”. 21 Press Release by Treasurer of Commonwealth of Australia Peter Costello, April 2003, retrieved May 2005. www.treasurer.gov.au/DisplayDocs.aspx?pageID=&doc=pressreleases/2003/082.htm&min=phc#response 22 Press Release by Treasurer of Commonwealth of Australia (Peter Costello), 2003: 103, CLERP (Audit Reform and Corporate Disclosure) Bill introduced Dec 2003, retrieved on May 2005 www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2003/103.htm&page ID=003&min =phc&Year=2003&DocType=0 Australian Securities and Exchange Commission, CLERP 9 Corporate reporting and disclosure laws . www.asic.gov.au/asic/ASIC.NSF/byHeadline/The%20laws%20ASIC%20administers. Retrieved on 2005. 23 Australian Government, Attorney-General’s Department www.comlaw.gov.au/ComLaw/Management.nsf/current/bytitle/ 3B11B1FDA7FE3EF3CA256F7100071C8F?OpenDocument&VIEW=compilations 24 ASIC is an independent Commonwealth Government body that regulates Australian corporations, markets and financial services organisations (including ASX). Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 are among the legislation it administers. www.asic.gov.au/asic/ASIC.NSF/byHeadline/The%20laws%20ASIC%20administers. Retrieved on 2005. 25 ASX operates the primary national stock exchange in Australia. ASX is a regulated commercial organisation that monitors specific aspects of the businesses of other organisations (e.g. the governance of listed companies and on-exchange or on-market trade execution by brokers 26 Australian Securities Exchange: the Australian Corporate Governance Council, 2002. Retrieved May 2005. www.asx.com.au/about/corporate_governance/corporate_governance_council.htm 27 Australian Securities Exchange: Corporate Governance and Listing Rules, 2003. www.asx.com.au/about/corporate_governance/corporate_governance_listing_rules.htm

102 Other significant changes in the Australian regulatory environment during the sample period were the adoption of International Financial Reporting Standards and acceptance of the Basel II Capital Accord.

5.2.2 Periodic Disclosure

The ASX is the operator of Australian financial market facilities and services. Through the enforcement of Listing, Market and Clearing and Settlement Rules, ASX maintains its objective of providing “fair, orderly and transparent markets”28. While ASX does not have the responsibility and power to regulate listed entities’ compliance with the law, it may refer misconduct to ASIC for further investigation or prosecution. However, as a market operator “it governs the admission of entities (trusts and companies) to the official list as well as the quotation of security, suspension and removal of entities from the official list and disclosure and some aspects of a listed entity’s conduct”29. Based on a contractual relationship with ASX, entities’ compliance with the ASX Listing Rules is a requirement for admission and remaining on the official securities list. The pre-listing rules of ASX necessitate the submission of financial accounts for the three full financial years and pro-forma balance sheets30. To remain listed, companies are required to send a full set of primary financial statements 31 to the ASX on a periodic basis 32. It is also a requirement to send this information in an annual report the shareholders (ASX listing rule: 4.6). These reports are to be reviewed by a registered company auditor or an independent accountant. To receive the auditor report, the financial statements must be prepared in accordance with the Australian Accounting Standards and the Urgent Issues Group Consensus Views33. The Australian Accounting Standards Board (AASB) and ASIC enforce these standards, which are backed by the Corporations Act 2001, section 334.

28 Australian Securities Exchange, ASX Position Paper, 2008, retrieved on 2009. www.asx.com.au/supervision/pdf/asx_role_financial_regulatory_framework.pdf 29 Australian Securities Exchange, Listing Rules (2004) 30 Australian Securities Exchange, Listing rule; Profit test 1.2.3.a, 1.2.3.c or Asset test 1.3.5.a, 1.3.5.c (2004) 31 A complete financial report normally includes a balance sheet, an income statement, a statement of cash flows and a statement of changes in equity, and those notes and other statements and explanatory material that are an integral part of the financial report. Australian Accounting Standards Board: AASB101: Presentation of Financial Statements. www.aasb.com.au. 32 Australian Securities Exchange, Listing rule 4.3-4.7 (2004). Quarterly, half year and end of year. 33 The UIG was established in 1995 and is a self-regulatory mechanism of the Australian accounting profession under the auspices of the Australian Accounting Research Foundation. Releases of the UIG must not be in conflict with accounting standards issued by the Australian Accounting Standards Board. The contents of the abstracts released by the UIG have mandatory status by way of a revised release of APS 1 Conformity with Accounting Standards and UIG Consensus Views. APS 1 is released jointly by The Institute of Chartered Accountants in Australia, and the Australian Society of Certified Practicing Accountants and shall be followed by members of these bodies. (Deegan & Rankin, 1996)

103 5.2.3 Continuous Disclosure

Besides periodic disclosures, listed entities are required to report specific information to the ASX on a continuous basis. The continuous disclosure policy34 was introduced earlier in 1996 but the changes made to the Corporations Act and consequently to the listing rules have increased the reporting requirements for companies. Continuous disclosure is defined as the “timely advising of information to keep market informed of events and development as they occur”35. The Listing Rules demand the information be released to the media and investors at the same time by ASX and the company. Simultaneous media announcements of the ASX and the company present important information to the public through company and ASX websites and media.

5.2.4 Industry-Specific Disclosure

There are special acts or industry-specific organisations that govern industries, which bring additional reporting requirements for listed companies. Some of these extra requirements are included in the company annual reports. The banking sector must comply with the Banking Act 1959, the Financial Sector Reform Act 2001 and the revised Code of Banking Practice of the Australian Bankers Association 2003. Accounting Standards like AASB 1032 Specific Disclosures by Financial Institutions36 specify the additional financial reporting required for financial institutions in annual reports. Furthermore, the Australian Prudential Regulation Authority (APRA) has responsibility for the prudential and regulatory supervision of Australian deposit takers and requires banks to provide regular reports covering a broad range of information, including financial and statistical data relating to their financial position and prudential matters37. Similar to the banking industry, the telecommunications industry is highly regulated in Australia. The Communications Minister and the Department of Communications, Information Technology and the Arts are primarily responsible for telecommunications industry policy and legislation. There are regulatory controls over “consumer information, competition, network functionality, technical aspects, quality of service, network coverage, retail price and

34 Australian Securities Exchange, Listing rule 3.1 Introduced 1/7/96, Amended 1/7/00 and 1/1/2003. 35 Australian Securities Exchange, Listing Rule 3.1s (2004), Corporations Act 2001 chpt 6CA, 674-678. 36 Australian Accounting Standards Board, Disclosures in the Financial Statements of Banks and Similar Financial Institutions (2004). AASB 130 superseded AASB 1032 after 2004. 37 NAB Annual Report (2003), Regulation of Financial Services System pg13. www.nabgroup.com/vgnmedia/downld/NABFullFi2003NoSigWCovers.pdf

104 commercial information”, of which only some apply to Telstra. The telecom companies often report on their compliance with these regulations. In the same way, for companies that are involved with minerals and mining exploration activities, accounting standards like AASB 103938 and ASX Listing Rules39 bring additional reporting requirements.

5.2.5 Reporting of Workplace Relations (for 1999-2004)

The current laws and initiatives relevant to Australian employee relations are as follows. Workplace Relations: The Workplace Relations Act 1996, which came to operation after 1 January 1997, is the major Act legislating Australia’s industrial relations (effective during the sample period of this thesis)40. The most important provisions of the Act are the introduction of Australian Workplace Agreements (AWAs), expansion of the use of enterprise bargaining agreements; a reduction of the allowable matters in Federal Awards to 20; restrictions on union activity; and outlawing closed shops. AWAs that are made for a maximum of five years are approved, promoted and registered by the Workplace Authority. It is a requirement that when offering AWAs the company is responsible for ensuring that no individual suffers any net disadvantage compared to the relevant collective agreement. Occupational Health and Safety: Certain jobs, by nature, are more dangerous than others. Historically, the mining industry has been the sector with the highest injury rates. US mining data indicate that the mining sector has the highest fatality rate (25.6%), with agriculture, forestry, fishing and hunting having the second-highest (Mine Safety And Health Administration, 2005). Hazard exposure, injuries, illnesses and fatalities are the most common safety issues in the mining and energy sectors. Increasing numbers of nations are establishing stricter regulations and asking for transparency of information. In the US a separate government agency, Mine Safety and Health Administration, enforces compliance with mandatory safety and health standards of the country. In Australia, the Workplace Relations Ministers’ Council (WRMC) is responsible for workplace relation matters. OH&S laws and workers’ compensation arrangements operate separately in each of the Commonwealth, State and Territory jurisdictions and are

38Australian Accounting Standards Board, AASB 1039, Concise Financial Reports: Disclosure of additional information by mining companies in relation to exploration and evaluation expenditure and decommissioning costs. 39 Australian Securities Exchange, Listing Rules Chapter 5: Additional Reporting on Mining and Exploration Activities (2004). 40 Fair Work Australia is the new national workplace relations tribunal, established in 2009.

105 administered by the jurisdictions’ OH&S authorities. In 2002, the WRMC endorsed The National OHS Strategy for 2002–2012. The Strategy was developed by the members of the National Occupational Health and Safety Commission (NOHSC) and established a national OHS vision as “Australian workplaces free from death, injury and disease”. Having replaced the NOHSC, the Australian Safety and Compensation Council (ASCC) provides policy advice to the WRMC on national OHS and workers' compensation arrangements. The National Standards and Codes of Practice declared by the ASCC are advisory only, and require separate legislative action by Commonwealth, State and Territory governments to implement the standards and codes within their jurisdiction. The laws are slightly different in each jurisdiction, and there are different laws affecting the mining industry. For example, in the state of New South Wales, the Occupational Health and Safety Act 2000 and the supporting Occupational Health and Safety Regulation 2001 regulate OHS for all workplaces. The Coal Mine Health and Safety Act 2002 and the Mine Health and Safety Act 2004 legislate additional requirements for the mining industry (WRMC, 2004) (Australasian Legal Information Institute, 2005). An international standard, Occupational Health and Safety OHSAS 18001 was developed to facilitate the integration of quality, environmental and occupational health and safety management systems by organisations. It was designed to be compatible with the ISO 9001 (Quality) and ISO 14001 (Environmental) management systems standards. Discrimination: The Australian Human Rights Commission41 is responsible for administering the Racial Discrimination Act 1975, Sex Discrimination Act 1984, Human Rights and Equal Opportunity Commission Act 1986, Disability Discrimination Act 1992 and Age Discrimination Act 2004. The Commission makes recommendations regarding laws and government policies and programs that involve human rights issues. Employees can make complaints about human rights breaches and certain acts of discrimination in employment under the Human Rights and Equal Opportunity Commission Act 1986. In addition to their reporting duties to the ASX and shareholders, corporations are required to report on their compliance with specific statutes or industry-specific regulations. In Australia, the Equal Opportunity for the Women in the Workplace Agency (EOWA) is the leading authority in managing equal opportunity for women. It administers the Equal Opportunity for Women in the Workplace Act 1999 (Commonwealth)42, which came into effect on 1 January 2000. The new and updated Act requires private-sector companies with

41 Legally known as the Human Rights and Equal Opportunity Commission. 42 It replaced the Affirmative Action Act 1986.

106 100 or more staff to establish a workplace program to remove barriers to women entering and advancing in their organisation and report annually to EOWA on the program and its effectiveness. These reports can be accessed through the EOWA website from 2001 onwards. Human Rights: On December 10, 1948 the General Assembly of the United Nations adopted and proclaimed the Universal Declaration of Human Rights. It lists thirty basic principles that are considered essential to human dignity. The UN Global Compact is a voluntary UN initiative, which offers a framework for businesses that are committed to aligning their operations and strategies with ten universally accepted principles in the areas of human rights, labour, the environment and anti-corruption (www.un.org). Companies that join the initiative report on their progress in line with the ten principles. The representatives from the US Department of State and the UK in consultation with oil, mining and energy industries set US–UK Voluntary Principles on Security and Human Rights 2001. The principles set the basis of a global standard for the mining sector. This section of the chapter presented the reporting environment for publicly listed companies in Australia. Accounting rules and regulations, security listing rules as well as industry-specific regulations determine the mandatory disclosures of publicly listed companies. The following section will present the common reporting media for publicly listed companies.

5.3 Reporting Media of Publicly Listed Companies

An examination of the reporting requirements for publicly listed companies in Australia has shown that annual reports and company websites are the two types of media that companies use to fulfil their regulatory reporting requirements. The review in Chapter 3 indicated that security analysts use financial statements found in yearly/half yearly/quarterly reports to value stocks, as annual reports include not only financial information but also soft information on company operations presented voluntarily. Corporate governance reports, sustainability reports and environmental reports that come as supplements to annual reports and/or published on websites also present valuable soft information. This section will briefly explain their uses and the information that can be found in each type of company communication.

107 5.3.1 Annual Report

The approach of this study is to view the annual report as a means by which a listed corporation fulfils its regulatory duties to stockholders and the stock exchange. The AASB explains the annual report as addressing “present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public use financial reports in order to satisfy some of their different needs for information” (AASB, 2004a). Annual reports are defined by researchers as bringing meaning to a company’s performance and activities, despite continuing disagreements on their “objectives, audience, and credibility” (Thomas, 1997; White, 2000). Wiseman stated that it “is widely recognised as the principal means for corporate communication of activities and intentions to shareholders and has been the source for virtually all previous corporate disclosure research” (Wiseman, 1982)p. 55). Hence, the annual report is found to be “the most publicised and visible document produced by publicly owned companies” (Henriques & Sadorsky, 1999) and is a vital source in responding to “mandatory corporate reporting requirements” (Stanton & Stanton, 2002) (AASB, 2004a) and in discharging public accountability to multiple stakeholders (Boyne & Law, 1991) (Tooley & Guthrie, 2007) (Yuthas & Rogers, 2002). In fulfilling the regulatory requirements of an annual report, companies present narrative information in addition to financial data. For instance, they are obliged to give information about operations (Corporations Act s299), a review of its operations and activities (ASX listing rule 4.10.17, revised in 2003), describe any events affecting the financial position after the reporting period (AASB 1002), list the payments made to related parties (AASB 1017) and executives (AASB 1034:6) and benefits given to employees (AASB 1028) and include a statement disclosing compliance with best practice recommendations set by the ASX Corporate Governance Council (ASX listing rule 4.10.3, from 2003). The narrative portions are found in the footnotes of financial statements and subsections such as the Chairman’s Review, Chief Executive Officer's Report, Director’s Report, Business Review, Remuneration Report and Corporate Governance Statement. The reporting of a Corporate Governance Statement has been a requirement of the ASX Listing Rules since 1996 and is normally a sub-section of the annual report. However, over time, the content and length of corporate governance statements have changed. It is common to find that companies publish a corporate statement separate from the annual report.

108 5.3.2 Company Websites

The use of company websites has become a common means of communicating not only with shareholders/investors but also with multiple-stakeholders. In addition to annual reports, companies choose to publish sustainability reports, environmental reports, and corporate governance statements through their websites. It is also possible to get access to media announcements, investor briefings and company presentations through multiple formats. Webcasts and podcasts have also become a common format to disseminate presentations on websites.

5.3.3 Stand-Alone Reports

Many companies voluntarily choose to report on a range of indicators that are of interest to multiple stakeholders. Increasingly, companies prefer to prepare separate reports for these lengthy explanations. Depending on the chosen indicators and the standards, they are known as Citizenship Report, Environment Report, Environment and Social Report, Health and Safety Report, Intellectual Capital Report or Sustainability Report. They are either published through company websites and/or sent to shareholders as supplements to the annual report. The format and content of such reports generally depend on the chosen indicators. Intellectual capital reports include narratives about the company vision, management changes and actions, a set of indicators and initiatives. Sustainability reports tend to integrate environmental, societal and governance issues into a single report. The content analysis of the 33 sustainability reports published by the Fortune Global 250 companies in 2001 shows that among the social topics addressed, community involvement/philanthropy, health and safety and equal opportunity/workplace diversity scored the highest (Kolk, 2003). The same study revealed that “truly societal external indicators” are not used frequently, as only two companies reported the “distribution of values added over different stakeholders” ((Kolk 2003, 281). Quantifiable environmental and societal performance data tend to include numbers like community spending, accident/injury frequency, number of fatalities, employee numbers/operation/country, women on staff, gas emission numbers and so on (CAER, 2005). Conversely, qualitative, soft data tend to include policies on environment/climate change,

109 corporate governance/board practices, employee matters/recruitment practices and training and mentoring programs, information on supplier chains and customer relations (KPMG, 2005). The following section will further discuss the voluntary reporting practices of companies and discuss how to utilise these reports to collect data for Human Capital Analysis.

5.4 Voluntary Reporting

Besides fulfilling the mandatory reporting requirements, listed companies may choose to voluntarily communicate43 non-financial information to stakeholders. These types of disclosures provide important soft data that can be used for qualitative analysis. Keeping in mind that the literature review (Chapter 2 and 3) suggested using documentary analysis, the availability of rich data found in voluntary reports plays a critical role in answering the research questions. Therefore, in addition to mandatory disclosures, the data-collection process will benefit from the voluntary disclosures of listed companies. Lev and Zarowin have documented a systematic decline in the usefulness of financial information to investors over the past 20 years (B. Lev & Zarowin, 1999) linking the decline to the financial reporting system’s inability to reflect the impact of change on firms' operations and economic conditions. Unless there is a reform in accounting rules and/or financial reports, companies that wish to communicate their intellectual assets/capital and environmental, social, ethics and corporate governance performance (ESG) need to use a format other than a typical annual report. Voluntary reporting fills this gap between traditional reporting and the external communication needs of listed companies. Voluntary reporting is not a new concept, especially in some countries. For example, US Steel in the US and BHP in Australia reported on their social performances in annual reports as early as the beginning of the twentieth century (Hogner, 1982) (J. Guthrie & Parker, 1989). Elkington defines voluntary disclosers as either confidential (to banks, insurers, customers) and non-confidential (social reporting within annual reports, self-standing reports, eco-audits, eco-labelling) (SustainAbility, 1993,cited in (Elkington, 1994). Many companies report on a range of indicators of interest to multiple stakeholders and do so for various reasons. In an extensive review of the reasons for such disclosures, Deegan points out that “there could be several motivations simultaneously driving organisations to

43 Any disclosure of information which exceeds the limits of mandatory disclosure in terms of content or amount as voluntary disclosure (Agca & Önder, 2007).

110 report social and environmental information” (Deegan, 2002)p. 291). For the purpose of this research, determining the audience of these disclosures might aid us in clarifying the motives behind management’s decision to voluntarily disclose information, and most importantly to explain the differences among the case companies.

5.4.1 The Audience of Voluntary Reports

In a review of corporate social reporting (CSR), Gray et al. state that in the literature there are two approaches to understanding this concept (R. Gray, Kouhy, & Lavers, 1995). The first treats the financial community as the primary users of this information and assesses it through the rules of “mainstream accounting”. However, this “decision usefulness of accounting information” approach does not explain much about CSR, as “interest in CSR is not motivated predominantly by a concern with the needs, wants and whims of financial participants” (R. Gray, et al., 1995). The second approach to understanding CSR is to view the audience of this information through an “organisation–society dialogue” (R. Gray, et al., 1995). This approach assumes society is the main user of corporate social disclosures, as opposed to the financial community being the only user. Under this approach, the most researched and accepted theories are gathered around two sub-topics; the first is economic theory studies, otherwise referred to as positive accounting theory or agency theory; and the second is social and political theory studies. In economic theory studies, similar to ownership theory, the audience of CSR is selected as the shareholders. Watts and Zimmerman, who first proposed the positive theory of accounting, explored the relation between the choice of accounting and other variables (size and leverage) (Watts & Zimmerman, 1978) (Watts & Zimmerman, 1990). This theory proposed that particular voluntary disclosures of companies are made in an attempt to reduce the political costs of these entities. It explains CSR as management’s attempt to “mediate, suppress, mystify and transform social conflict” through choice of accounting information (Tinker & Neimark, 1987). Fama (1980) stated there is a contradiction between what management wants and what shareholders ask. While management wants to increase the size of the firm (remuneration, power, job security and status), shareholders want to maximise their returns through improved efficiency of the firm (Fama 1980 cited in (C. W. L. Hill & Jones, 1992).

111 Building upon this idea, agency theory states that managers will disclose information only “if the benefits of the disclosures outweigh the associated agency costs” (Ness & Mirza, 1991) p. 212). Agency costs occur when managers, as the agents of the principals (shareholders), act to the financial detriment of the principal. In their longitudinal study of General Motors’ annual reports over sixty years, Tinker and Niemark noted that corporate reports are not passive descriptors of an "objective reality” but are used to monitor the evolution of managerial ideology (Tinker & Neimark, 1987) p. 72). In their study of the oil industry, Ness and Mirza (1991) argued that social information is disclosed to increase the welfare of management (Ness & Mirza, 1991). Although there are many studies observing CSR through the lens of economic theory (i.e. normative in nature), it is more widely accepted that the audience should be wider than just the shareholders (i.e. more descriptive). Moreover, the “management serving the shareowners” theory is found to be “morally untenable” (T. Donaldson & Preston, 1995) and “highly offensive” (R. Gray, et al., 1995) by these advocates. As opposed to the economic theory-based studies discussed above, social and political theory studies extend the focus to a wider group than the shareholders, in studying “organisation–society dialogue”. An ethical explanation of the CSR is given by Matthews in the social contract of business with society (Mathews, 1995). Social contract theory assumes that business and society are separable entities with conflicting interests and, as described by Shocker and Sethi (1974), the survival of this contract is dependent on:

1) The delivery of socially desirable results to society 2) The distribution of economic, social or political benefits to groups from which it derives its power.

An institution must constantly meet the twin tests of legitimacy and relevance by demonstrating that society requires its services and that the groups benefiting from its rewards have society’s approval (Shocker & Sethi, 1974) p. 67 cited in (Patten, 1992) (Mathews, 1995). This theory implies that disclosures are made to ensure the continuity of the social contract. Similar to the social contract theory, the legitimacy theory connects disclosures to the approval needs of the organisation and the public pressures placed on the organisation (Lindblom, 1994) (Patten, 1990, 1992) (R. Gray, et al., 1995). Preston and Post explain these disclosures as a method of responding to the changing perceptions of a corporation's relevant

112 public (Preston & Post, 1975) in (Patten, 1992)). Dowling and Pfeffer explain legitimacy as a condition which exists when an entity’s value system is congruent with the value system of the larger social system (Dowling & Pfeffer, 1975)p. 122). Lindblom defines four strategies that organisations may choose to legitimise their actions, of which a combination might be used through the public disclosure of information through various media (Lindblom 1994 cited in (R. Gray, et al., 1995). There are numerous prior empirical studies explaining CSR through the legitimacy effect. One of the earlier studies is by Hogner. After examining the annual reports of US steel from 1902–1980 he suggested CSR disclosures were motivated by and indicative of corporate needs for legitimacy (Hogner, 1982). However, a similar longitudinal study by Guthrie failed to confirm legitimacy theory as an explanation of BHP’s social disclosures, (J. Guthrie & Parker, 1989). Two later studies that tested the mentioned pressures before and after the 1989 Exxon Valdez oil spill were confirming legitimacy reasons for environmental disclosures, (Patten, 1992)p. 475). Both the social contract theory and legitimacy theory accept that an organisation is a “component of the larger social environment within which it exists” (Gray, Owen, & Adams, 1996). Stakeholder theory adds to this “organisation–society dialogue” the expectations of stakeholders, “those groups without whose support the organisation would cease to exist" (Stanford Research Institute cited in (Freeman, 1984)). Stakeholder theory prescribes that the “information asymmetry between managers and stakeholders” should be reduced for the sake of fairness (C. W. L. Hill & Jones, 1992). All three theories discussed under social and political theory studies posit that CSR is intended for parties other than the shareholders and investors (R. Gray, et al., 1995). Recent empirical research has questioned the drivers behind voluntary reports and the findings confirm the above assertion; CSR is made for parties other than shareholders and investors. Mouritsen studied the drivers behind intellectual capital reports in Denmark, noting that as an external communication device, intellectual capital statements are propositions that demonstrate the importance given to employees, innovation and knowledge (J. Mouritsen, Bukh, & Marr, 2004). According to a report titled “The State of Sustainability Reporting in Australia 2005”, the target audiences for sustainability reports are employees (87%), customers (79%), shareholders (74%), local community (67%), institutional investors (54%), suppliers (59%), analysts (51%), and governments and NGOs (28%) (CAER, 2005). The sustainability rating services, socially responsible funds and awards given for social responsibility certainly encourage the companies to make more disclosures. For instance, in

113 Australia the Financial Services Reform Act 2001 requires fund managers to take environmental, social or ethical considerations into account in investment decision making. This section has presented the theoretical explanations for voluntary disclosures. The next section will present various disclosure formats for intangible assets.

5.4.2 Disclosure Content and Format

Prior empirical studies have been conducted categorising types of disclosure; some have tried to measure the factors causing differences in disclosure, with variations in disclosure content and volume being attributed to size, multi-nationality, stock market influence, competition with other multinationals, competition for funds, national differences, industry, leverage, profitability and international listing status. Among others, company size was found to be the strongest factor influencing voluntary disclosure (Watts & Zimmerman, 1978) Trotman and Bradley 1981; Mathews, 1993; (Gray, et al., 1996; Meek, Roberts, & Gray, 1995). Country/region, international listing status and industry are also cited as relevant in determining the disclosure of companies (Gray, et al., 1996) (S. J. Gray, Meek, & Roberts, 1995) (Ness & Mirza, 1991). The content and format of disclosures have evolved considerably over the years. Voluntary disclosures included in the annual report have become standalone reports and have begun to appear on company websites. Similarly, the earlier trend of environmental reporting has been replaced by triple bottom line reporting (TBL), intellectual capital reporting and sustainability reporting (R. Gray & Milne, 2002). An examination of Fortune Global 250 reporting practices indicates that the percentage of pure environmental reports declined by 70% from 1998–2001 (Kolk, 2003) and that 60% of reports used TBL for reporting in 2001. TBL, first mentioned by (Elkington, 1994), asked corporations to focus on the environmental and social value in addition to the economic value they add to society, thus demanding the disclosure of three kinds of reports in one. Intellectual capital reporting requires corporations to present a strategy for knowledge management and to report on knowledge-management activities (Jan Mouritsen, Thorbjørnsen, Bukh, & Johansen, 2004). The types of measurement and reporting guidelines used in intellectual capital reporting were discussed in Section 3.5.4 of Chapter 3, Intellectual Capital Reporting.

114 The term sustainability reporting (or sustainable development reporting) is often used interchangeably with TBL. Based on the definition of sustainability development44, Gray asserts that sustainability reporting has a broader responsibility than TBL (R. Gray & Milne, 2002) 5). Sustainability reporting requires a much more “complex analysis” in explaining “the extent to which organisations have contributed and diminished the sustainability of the planet” (R. Gray & Milne, 2002) 5). One framework commonly used for sustainability reporting is the Sustainability Balanced Scorecard (SBSC) developed by Robert Kaplan and David Norton. It extends the original Balanced Scorecard approach to environmentally and socially responsible strategies applied to all organisational levels. Sustainability reporting has become highly popular following the 2002 UN World Summit on Sustainable Development and the release of the second version of the GRI Guidelines. According to KPMG, almost 70% of Global 250 company reports are published as sustainability reports, whereas in 2002 they were environment, health and safety reports (KPMG, 2005). The GRI framework displays the principles and indicators organisations can use to measure and report their economic and ESG performance. The Sustainability Reporting Guidelines are updated regularly45 and include sector supplements (Global Reporting Initiative, 2006). The number of companies reporting on non-financial information is growing. Fortune Global 250 firms providing social and environmental reports increased from 35% to 45% from 1998–2001 and to 52% in 2005 (Kolk, 2003) (KPMG, 2005). Among the Fortune Global 250 firms, UK (71%)46 and Japan (80%) lead the way in standalone CSR reports (KPMG, 2005). The emerging voluntary standards and guidelines have effectively improved and guided disclosures, and differ in the kinds and level of information they recommend. For instance, in Europe, the Meritum Project (1998–2001) and the following E* Know Net, which were both sponsored by EU and OECD, developed and released guidelines on intellectual capital (G. Roos, Pike, & Fernström, 2005). In Japan, the government requested environmental accounting and released indicators for reporting (Kolk, 2003) 285). Among

44 Sustainable Development: to meet the needs of the present without compromising the ability of future generations to meet their own needs. Brundtland Commission,UN. 45 The GRI was launched in 1997 as a joint initiative of the US non-governmental organisation Coalition for Environmentally Responsible Economies (CERES) and the United Nations Environment Programme (UNEP) with the goal of enhancing the quality, rigour, and utility of sustainability reporting, through the publication of sustainability reporting guidelines. The initiative is defined as “a large multi-stakeholder network of thousands of experts in dozens of countries worldwide, who participate in GRI’s working groups and governance bodies, use the GRI Guidelines to report, access information in GRI-based reports, or contribute to develop the Reporting Framework in other ways – both formally and informally”. Exposure drafts of GRI guidelines were released in 1999, the first official guideline was released in 2000 and revisions were done in 2002, 2006. Industry supplements were released for Telecommunications in 2003, Metals and Mining and Financial Services in 2004 (Global Reporting Initiative, 2006). 46 In the UK, over 80% of FTSE 100 companies produced some form of non-financial information in 2005. (Henriques & Sadorsky, 1999)

115 others, the GRI Guidelines that began as a UNEP initiative have been the most influential guidelines globally (Global Reporting Initiative, 2006). This section on voluntary reporting discussed the motives of disclosures and the format of reports. The review suggests that unless there is a reform in accounting rules and/ or financial reports, companies that want to communicate their environmental, social, ethical and corporate governance performance (ESG) and intellectual assets will use forms other than a typical annual report. The literature review suggests that there could be several motivations simultaneously driving organisations to report social and environmental information. Agency theory, legitimacy theory and stakeholder theory are frequently used to explain these motives. All three theories discussed under social and political theory studies (social contract, legitimacy and stakeholder) posit that reporting is done for parties other than shareholders and investors. Recent empirical studies indicate the primary target audiences for sustainability reports are employees, customers and shareholders. The review also suggests the number of companies reporting on non-financial information is increasing.

5.4.3 Voluntary Reporting in Australia

Voluntary reporting appears to increase with regulations demanding mandatory disclosures. For instance, environmental reporting was required since 1996 in Denmark and since 1999 in Norway and Sweden (Kolk, 2003) 285). However, since 2000 regulators have begun to ask for broader reporting than pure environmental impact reporting, for instance, French law has required companies to report on both environmental and societal issues since 2002 (Kolk, 2003) 285). In Australia, unlike some other countries, intellectual capital and sustainability reporting is not mandatory. However, environmental reporting legislation does exist. In 1995, the Urgent Issues Group (UIG) published the “Disclosure of Accounting Policies for Restoration Obligations in the Extractive Industries”, which requires that reporting entities in the extractive industries shall disclose information about the extent of restoration obligations recognised as a liability in their financial reports, and the accounting methods adopted in determining the liability for restoration (Deegan & Rankin, 1996). Corporations Law legislated general requirements for all companies in 1998.

116 x Section 299 (1f) was introduced into Corporations Law by the Company Law Review Act 1998. The section required companies to provide details about their performance against significant environmental legislation in their director’s report. Later, CLERP 9 (2004) extended this to operations and financial position of the entity and its business strategies and prospects (Section 99A(1)). And Environment Australia47 and ASIC have provided guidance on environmental reporting. x Section s1013 (A) to (F) of the Corporations Act 2001 requires providers of financial products with an investment component to disclose the extent to which labour standards or environmental, social or ethical considerations are taken into account in investment decision making48.

The reporting legislation has increased the environmental reporting of listed companies from 1999, but in comparison to some other countries, intellectual capital and sustainability reporting in Australia was low (Karen Bubna-Litic, 2007; K Bubna-Litic, Leeuw, & Willamson, 2001). Guthrie and Petty conducted a content analysis of the annual reports of the 20 largest Australian listed companies (by market capitalisation) and found that key components of intellectual capital are not reported with a consistent framework (J. Guthrie & Petty, 2000). In 2002, according to a KPMG survey, only 23% of the top 100 publicly listed companies in Australia published CSR reports (KPMG, 2005). Similarly, the Australian Conservation Foundation found that only nine out of fifty Australian listed companies issued standalone environmental and sustainability reports in 2002 ("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004). However, between 2002–2005 the number of companies providing voluntary reports increased, even though Australia still lagged behind the other developed nations. The KPMG International Survey of Corporate Responsibility Reporting 2005, when comparing the sustainability reporting rate of the top 100 publicly listed companies from 16 countries, ranked Australia fourteenth (KPMG, 2005). In 2005, 18% of the S&P /ASX 300 companies offered sustainability reporting (KPMG, 2005). Some industry sectors report on voluntary indicators more than others, for instance, minerals and mining companies49 tend to report more on their environmental performance. In examining the reporting practices of the top 500 companies by market capitalisation (1994), Tilt found that mining companies disclosed rehabilitation costs more than the rest of the sample. The author linked their disclosure of rehabilitation costs to mining companies’

47 Environment Australia : the Public Environmental Reporting Framework (2000) provides an eight-step process that companies can follow in preparing an environmental report (www.environment.gov.au). 48 These changes were brought about under the Financial Services Reform Act 2001, No 122, 2001 www.comlaw.gov.au/ComLaw/Legislation/Act1.nsf/framelodgmentattachments/D5B29DAB4036EBF2CA25742E000AA3A0 49 In 1996, Minerals Council of Australia has launched the Australian Minerals Industry Code for Environmental Management. In developing this code minerals industry wished to demonstrate its commitment to managing the environmental aspects of its operations. BHP was among the first companies to sign the Code. The Code underwent a review in 1999 to ensure that it remained relevant to the needs of the stakeholders.

117 legitimisation needs (Tilt, 2001) 194). In Australia, mining companies receive tax benefits for rehabilitation costs. Further, in 2004, Bubna-Litic linked the production of standalone Sustainability Reports by three resource companies (BHP, WMC, Rio Tinto) to their commitment to the Australian Minerals Industry Code (Bubna-Litic, 2007) 78). The quality and comparability of voluntary disclosure is of concern for users of the reports, as voluntary reports tend to display positive information more than negative information (Karen Bubna-Litic & Willamson, 2004; Deegan & Rankin, 1996; UNEP & Ltd, 1996), tend to be biased (Deegan & Gordon, 1996) and are incomplete (C. A. Adams, 2004). Despite recorded increases in voluntary reports, the 2004 assessment indicates that only “40 percent of the companies are reporting information, which is more meaningful to their stakeholders” (Bubna-Litic, 2007) 75). It is expected that the quality and comparability will improve as more companies adopt common guidelines such as the GRI Sustainability Reporting Guidelines. A study assessed the environmental reporting practices of 24 ASX- listed companies in the resources sector relative to a standard set by the (GRI) Sustainability Reporting Guidelines and found that even the largest and highest-scoring firm fell short of the standard set by the GRI Guidelines (Overell, Chapple, & Clarkson, 2008). Scholars also believe that despite their increasing popularity, the guidelines have not yet improved disclosure content; Stittle notes that even the revised G3 GRI guidelines are unable to illustrate how important indicators such as human capital (HC) provisions relate to the long- term development of reporting HC (Stittle, 2004). Examination of the GRI indicators reveals that while they include many indicators for environmental and social performance (community relations), there is little on human capital intangibles. Another major concern for users of voluntary reports is their accuracy and completeness, as reporting conducted using guidelines can be simply ticking boxes and not conforming to socially responsible or high corporate-governance behaviour. On the other hand, it is also probable that measuring performance may in time change behaviour, but there is little evidence of this effect. A report on accountability found that sustainability reporting has not had much effect on corporate decision making (Monaghan, 2003) in (Bubna-Litic, 2007)). In studying one corporation’s reporting behaviour over time, Adams observed that increased sustainability reporting does not necessarily mean improved accountability (C. A. Adams, 2004). In addition to voluntary reporting, companies engage in other types of behaviour to display accountability, like getting listed on other stock exchanges with stricter regulations for control; for example, non-US firms are increasingly being listed on US exchanges. Hertig

118 states one reason for such a demand is to obtain access to US capital markets, but adds that a US listing also provides credibility for companies, showing their willingness to comply with stringent US disclosure standards (Hertig, 2004)334). Another trend is to obtain the external verification of voluntary reports, where private companies provide external validation services using standards; for instance, Social Accountability 8000 (SA8000) was launched by Social Accountability International as a voluntary standard based on ILO and UN conventions (Stittle, 2004). In 1999, the Institute of Social and Ethical Accountability in the UK published the AA1000 Assurance Standard for social and sustainability reporting. In Australia, the Australian auditing standards AUS102.44 50 and AUS 502 can be used to audit sustainability reports (CAER, 2005) 12) and Standards Australia has published the Standard DR0342251 as guidance for verifying sustainability reports. Kolk (2003) found that verification of sustainability reports among the Fortune Global 250 increased from 18% in 1998 to 31% in 2001 and in Australia, 40 of the 119 companies producing a sustainability report/section in 2004 had their report independently verified (CAER, 2005).

5.4.4 How to Approach Voluntary Reports

An examination of the voluntary reporting practices of companies illustrated several important points for this research. Over the years the number of companies reporting on their environmental, social, and corporate-governance performance has increased and the content has changed and enlarged to include more social performance. As the drivers of voluntary reporting vary among companies, there are numerous formats for reporting; there are also newly developed national/international guidelines and standards, and some nations have introduced regulations. Although the guidelines have caused an uptick in the quantity of disclosure, the quality of reports is not consistently high, as they can be incomplete, biased and not reflect reality. Some sectors, such as the resources sector, report more than others. Australia lags behind the rest of the developed world in sustainability reporting, but trends indicate

50 AUS102.44 states that “Australian Auditing and Assurance Standards, while developed primarily in the context of financial report audits, are to be applied, adapted as necessary, to all audits of financial and non-financial information, to all other assurance engagements, and to all audit related services” AUS 502 can help in designing audit programs. Others that can be used are :AUS 108: Assurance engagements, AUS 402: Risk assessments and internal controls, AUS 512: Analytical procedures, and AUS 514: Audit sampling and other selective testing procedures. 51 Standard DR03422: General Guidelines on the Verification, Validation and Assurance of Environmental and Sustainability Reports. It was revised to AS/NZS 5911 in 2005.

119 increasing numbers of companies will be reporting on their ESG performance. GRI Sustainability Guidelines set out a good format for reporting sustainable performance and have the capacity to make comparisons possible. Quantifiable environmental and societal performance data such as community spending, accident/injury frequency, number of fatalities, employee numbers, operation, and country are positive inclusions, but under these guidelines the reporting of human capital- related information that is qualitative in nature is very limited. Information on policies for developing human capital, knowledge management, work organisation, training and mentoring programs and culture-change programs is scarce. Overall, the literature review suggests that while intellectual capital is reported to some extent, there is no consistent framework for reporting human capital data. Overall, even if the voluntary reports hold the potential of providing rich soft data they need to be approached with caution and the analysis needs to be enhanced with other types of documentary analysis. This necessitates the use of other publicly available documents when conducting the data search for Human Capital Analysis. The next section will discuss corporate-governance reporting.

5.5 Corporate-Governance Reporting

5.5.1 The rising significance of Corporate Governance for Investment Recommendations

Corporate governance has become increasingly important over the past two decades, for reasons outlined in a survey paper prepared for the European Corporate Governance Institution: The worldwide wave of privatisation, pension fund reform and the growth of private savings; the takeover wave of the 1980s; deregulation and the integration of capital markets; the 1998 East Asia crisis and a series of US scandals and corporate failures were found to be influential in this increasing level of attention (Becht, Bolton, & Röell, 2002)p. 7). As nations with good corporate governance systems attract and retain investments in their countries, good corporate systems provide the opportunity for capital markets to develop and increase funds available for borrowing, thus fostering company growth. At a company

120 level, good corporate governance practices can lower failure risk, which is an important criterion for investors (Van Den Berghe & Levran, 2003). However, despite its recognised importance, the contribution of good corporate practices to company performance is yet to be proven. For example, in the literature correlations between some attributes of boards (e.g. age of directors, duality) and increased performance have been recognised, but it has not been possible to establish a causal link (Lockhart, 2006)p. 32). Equally, there have been mixed results for the contribution of independent non-executive directors to firms’ performance. For instance, a study in the US from 1985–1995 examining 934 firms found that firms with more independent board members do not necessarily perform better than other firms (Bhagat & Black, 2002). Similarly, a study examining large Australian companies found no consistent evidence that independent directors on the board either add or subtract value (J. J. Lawrence & Stapledon, 1999). Van den Berghe and Levran (2003) report that when making investment decisions investors consider corporate governance in addition to financial measures, and may pay even higher prices for high governance standards. Thus, there is increasing pressure on listed companies to display high corporate-governance practices. For instance, OECD has recognised that corporate governance is important “in improving economic efficiency and growth as well as enhancing investor confidence” (OECD, 2004b). The United Nations Principles for Responsible Investment project (UNPRI) asks signatories to integrate environmental, social and corporate principles (ESG) to their investment decision making and ownership practices. Royal and O’Donnell (2008) in their study of Human Capital Analysis used corporate governance as one of the indicators of the Human Capital Wheel (C. Royal & O'Donnell, 2008b). Evaluating the contribution of corporate governance for investment decisions is not an easy task, especially when there is such a wide variety of practices among companies. Based on prior studies of emerging markets, Van den Berghe and Levran (2003) report that “variation in a firm’s corporate governance behaviour can have a huge effect on its market value in weak corporate governance systems” (B. Black, 2001; Klapper & Love, 2002) (Durnev & Han, 2002). Relying on this conclusion, it can be assumed that investors may place differing values on high-level practices of corporate governance depending on the governance systems. Thus, in order to use corporate governance as an indicator for company valuations, it is important to understand the differences in corporate-governance systems. Furthermore, for evaluating the disclosures of dual-listed companies such as BHP, Telstra and NAB, it is essential to be aware of the disclosure requirements of the other stock markets.

121 5.5.2 Corporate Governance Reporting Practices around the World

There are historical differences in the development of corporate-governance models52 among various nations (Van Den Berghe, 2002)p. 7), which have affected reporting practices accordingly. In two consecutive studies across a large cross-section of countries, La Porta et al (1997; 1998) explored the reasons for these differences, attributing them to the structure of laws and their enforcement. Based on the literature review, van den Berghe identified four governance systems with similar properties, the first two being the major systems (Van Den Berghe, 2002). 8). In the Anglo-American system (mainly the UK and US) there is an active securities market (i.e. financing through equity) with “dispersed shareholdings” (Dignam & Galanis, 2004), which are highly protected by the legal system (Shleifer & Vishny, 1997). These companies give utmost importance to the “maximisation of shareholder value” and there are higher levels of transparency (also known as the outsider system of ownership, market oriented or shareholder centred) (Van Den Berghe, 2002), p. 8). In the Rhineland system (Germany, Netherlands) there exists concentrated shareholdings such as “banks, families, non-financial corporations and the state” (where financing occurs through long-term debt finance) and these are more directly involved in the control of the companies than are shareholders (Van Den Berghe, 2002)p. 8; (Dignam & Galanis, 2004)p. 1). In this system, companies attribute added importance to stakeholders and have a greater role in society (also known as the insider system or stakeholder-centred system) (Van Den Berghe, 2002)p. 11). The Japanese system has similarities to the Rhineland system, while the Latin system (France, Italy, Spain and Belgium) differs from the Rhineland system due to “the presence and control of a reference shareholder” (Van Den Berghe, 2002)p. 8). The rising rate of globalisation, increasing numbers of multinationals, cross shareholdings and the dual listing of corporations creates homogeneity among corporations and difficulty in determining a single “best governance system” in order to attract external investment in corporations (Rubach & Sebora, 1997). It is difficult to identify the

52 p: 7: Corporate Governance Model is defined as specific corporate governance structures and processes that are embodied in a country’s legal , institutional and cultural context. : Corporate Governance System is defined as national models that are tied together by similarities in some major corporate governance dimensions.

122 characteristics that define a single superior system when there are still differences in ownership structure, securities markets and governance mechanisms among nations. There is a consensus among the scholars that there is an emerging convergence of the two major corporate-governance systems, but there remains debate regarding the direction of the convergence (Rubach & Sebora, 1997). Van der Berghe (2002) found there are three main schools of thought on the possible direction: convergence toward the shareholder model(Hansmann & Kraakman, 2001), convergence towards a hybrid corporate-governance model (Rubach & Sebora, 1997), (Lane, 2003)and maintaining the right balance for each company (Van Den Berghe, 2002)p. 150). Gilson, when examining convergence, concluded that it is difficult to predict the future mode of convergence due to the diversity of circumstances of nation states (Gilson, 2004)p. 158). Nonetheless, evidence suggests that at minimum there is convergence on increased disclosure by companies. A study examining the corporate-governance practices of the world’s 75 largest trans-national firms in two periods (1995 and 2002) revealed convergence towards greater disclosures and increase of independent directors on boards regardless of national governance regimes (Parbonetti, Markarian, & Previts, 2007). The simultaneous corporate failures that occurred in the US and in nations like the UK, Ireland, Germany and Australia from 2000–2003 show that no legal system is perfect and point to an urgent need to regain the lost trust in the institutions protecting the owner’s rights. This has even accelerated with the global financial crisis in 2008/2009. Shareholders, regulators and various other stakeholders continue to pressure for greater accountability from management and boards of directors. Particularly after the recent global financial crisis the debate between self-regulation vs overregulation seems to heat up both in the media and academia. The corporate governance reforms that have been globally influential during 1999- 2004 will be discussed in the following section.

5.5.3 The Effects of Corporate Governance Reforms on Reporting 1999-2004

OECD: In 1999, the Organisation for Economic Co-operation and Development (OECD) accepted the OECD Principles of Corporate Governance, which became a declaration of the minimum acceptable standards for listed companies and investors around the world (OECD Principles of Corporate Governance). These principles were revised in

123 2004 and OECD recognised that “one size does not fit all” and the principles should be adapted and updated (OECD, 2004b). The OECD Principles emphasise the equitable treatment of all the shareholders (majority and minority) ( Principle III) (p. 20). The Principles also recognised the importance of the stakeholders: Principle IV states that “The corporate governance framework should recognise the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises ” (p. 21). The recommendations suggested that reporting should be done not only for shareholders but also to benefit other stakeholders. Europe: Nations in Europe have “diverse cultures, financing traditions, ownership structures and legal origins”, and as such their governance systems show great variety (Gregory & Simmelkjaer, 2002). The European response to the corporate collapses was more about self-regulation through codes rather than legislative reform (Becht, et al., 2002)p. 72). As Cuervo and Aguilera (2004) explained, “Codes are voluntary guidelines with different levels of enforcement depending on the country where they are issued” (Cuervo-Cazurra & V.Aguilera, 2004) 343). According to a survey paper prepared for the European Corporate Governance Institution, codes played a greater role in Europe than the rest of the world (Becht, et al., 2002)p. 72) and were prescribed by a broad array of groups (Gregory & Simmelkjaer, 2002) 2; (European Association of Securities Dealers, 2000; European Shareholders Group, 2000), (European Shareholders Group, 2000). After 2000, the European Union showed an interest in developing corporate governance and corporate law in several consecutive commission reports. Firstly, the European Commission (EC) set up the High Level Group of Company Law Experts in 2001, (High Level of Company Law Experts, 2002) and the “Action Plan on the Modernisation of Company Law and Corporate Governance” was initiated to receive views about the High Level Group recommendations. The responses underlined the urgency to improve certain corporate-governance practices across EU 53 (EC, 2003). European Corporate Governance Forum was formed in 2004 in order to understand the needs of coordination and convergence among EU states. The Forum concluded that the “comply or explain” approach suited the EU best, considering the differences among organisations and national legal and governance frameworks (European Corporate Governance Forum, 2004).

53 Some of the urgent action s to be taken were promoting the role of non-executive or supervisory directors (nomination, remuneration and audit committees) and directors' remuneration.

124 National corporate-governance codes in Europe set out recommendations that are not mandatory but provide that reporting is based on a “comply or explain” approach. The inclusion of stakeholders in corporate-governance decisions is also common. United States of America (US): The US has a well-developed securities market with highly dispersed shareholders. It is typically described as having an insider governance system. Reports of the Blue Ribbon Commission, Principles of Corporate Governance by the Business Roundtable and Principles of Corporate Governance: Analysis & Recommendations by the American Law Institute addressed the importance of corporate governance and made suggestions for improving governance practices in the US. US Congress passed the Sarbanes-Oxley Act 2002 (SOX), following the corporate and accounting scandal of Enron. SOX had a great impact not only in the US but also all around the world. SOX legislation aimed to improve the transparency of financial reporting by increasing penalties for misreporting of earnings. It also aimed to reduce conflicts of interest among auditors and boards of directors. Some of the corporate-governance provisions of the Act include: x Independence of the external auditor (sections 208) x An independent audit committee (sections 301–2) x The principal executive officer and the principal financial officer of the company to sign a statement that they have reviewed the report and have sufficient internal controls in place to ensure that the financial statements do not contain any material misstatement. The CEO and CFO are responsible from establishing disclosure controls and procedures54. Following SOX, the New York Stock Exchange (NYSE) revised its listing rules and NYSE Corporate Governance Rules were passed in 2003. For example, it requires listed companies to have a majority of independent directors55 (NYSE, 2004) (The Library of Congress, 2004) and they must appoint audit committees with at least three independent members, of which at least one member has financial expertise. United Kingdom (UK): The UK has also a well-developed securities market with dispersed shareholdings consisting of shareholders, institutional investors and financial institutions. However, in comparison to the US, institutional investors play a greater role in the UK.

54 The “disclosure controls and procedures” term signifies the “controls and procedures designed to ensure that financial and non-financial information is fully and accurately disclosed on a timely basis”. 55 It also exists at Sarbanes-Oxley, Rel 4/04. NYSE Listing Rules (section 302-2 and 404).

125 The Cadbury Report and the Code of Best Practice 1992 have set a benchmark for corporate-governance codes in the UK and around the world (Cadbury Committee, 1992) (Becht, et al., 2002) p. 39). The Code aimed at increasing control and accountability, recommending separating the roles of the Chair and the CEO, appointing three non-executive directors and having board committees for audit and remuneration. It also introduced the soft “comply or explain” principle56. However, the Cadbury Report was criticised for “risking enterprise activity” in favour of increased accountability (Keasey, Short, & Wright, 2005)p. 21). Later, the Hampel Report (1998) and the first Combined Code (1998), in response to criticism of the Cadbury Report, had taken an approach based on principles rather than prescription57 (Keasey, et al., 2005)p. 22; (Hampel Committee, 1998) (N. Turnbull, 1999) (Greenbury Committee, 1995). Between the first Combined Code (1998) and the second Combined Code (2003), the developments in UK corporate policy displayed the changing beliefs about self-regulation’s ability to deliver accountability (Keasey, et al., 2005)p. 35). The report by the Higgs Committee (2003), on which the second UK Combined Code on Corporate Governance (UK Combined Code, 2003) was built, was very prescriptive in nature (Higgs, 2003) (Keasey, et al., 2005) 38). This coincided with the corporate collapses around the world and the changes made to corporate governance in the US. Highly influential in nature, the Higgs Report was heavily criticised by business leaders. The revised UK Combined Code toned down some of the recommendations of the Higgs Report and came into effect in 200358 (Financial Reporting Council, 2003) (Keasey, et al., 2005)p. 39). All companies incorporated in the UK and listed on the Main Market of the London Stock Exchange are required, under the Listing Rules, to report on how they have applied the Combined Code in their annual report and accounts (two-part report). The adoption and reporting of corporate governance continued to rely on the “comply or explain” principle (Financial Reporting Council, 2003).

5.5.4 Corporate-Governance Reporting and Security Market in Australia

Australia’s corporate-governance model mostly follows the Anglo-Saxon model. Some describe it as an outsider system that is associated with dispersed shareholdings and an active

56 A company should comply with the code but if it cannot comply with a particular principle that it should explain why it is unable to do so. 57 Other reports and recommendations that were influential were the Greenbury Report (1995),) and the Turnbull Report (1999) 58 The number of code provision was reduced to 48, reclassified Higgs code provisions into supporting principles.

126 security market (Campbell, 2002), but the Australian corporate-governance model has a number of differences from the UK and US models, displaying features of both insider and outsider systems. Lamba and Sonnenfeld examined the ownership structure of 240 publicly listed companies in Australia and found that publicly listed companies make up a smaller portion of the 500 largest companies in Australia compared to the UK and US. Moreover, controlling blockholders are more common, which is a feature of an insider system. Dignam and Galanis showed the socialist political system and the ownership structure as evidence for a mixed corporate-governance system in Australia. In addition, unlike the outsider system, institutional investors have chosen to remain outside the Australian listed market, with blockholders exerting control and a small amount of hostile takeover activity (Dignam & Galanis, 2004). Australia has a long history of security markets, dating back to the nineteenth century. The ASX is among the world’s top ten listed exchange groups, yet is relatively young 59. It was formed after a federal reform process in 1987 by the amalgamation of six independent stock exchanges that formerly operated in the state capital cities (ASX, 2008). Hence, the reforms that took place in the late 1980s not only established the ASX but also formed a national securities regulator, ASIC, and a single corporate statute, the Corporations Act 2001 (Dignam & Galanis, 2004)p. 638). (For ASIC see 4.1.1.) The Australian security system was still highly fragmented in the 1990s, despite the above revisions. The report of the HIH Royal Commission addressed the problems in the corporate collapse of HIH Insurance in 2001, partly attributing the failure to fragmented insurance and securities regulation (Dignam & Galanis, 2004). Security market regulation has been weaker in Australia in comparison to the UK and US (Dignam & Galanis, 2004). For example, since 1996 ASX listing rules have included a continuous disclosure requirement60 and a requirement to disclose certain corporate-governance practices in the annual report61. However, the rules were not found to be as effective as those in the US and UK and were criticised by institutional investors for lacking “regulatory teeth” (J. Hill, 2005)p. 377). Regulatory control that was to be provided by ASIC has also been weak. For example, ASIC took a rather “hands-off approach” in relation to routine offences (such as disclosure of information) by public companies (Helen Bird et al. 2003 cited in (Dignam & Galanis, 2004).

59 As measured by its market capitalisation. It was formed in 1987 by the amalgamation of six independent stock exchanges that formerly operated in the state capital cities. 60 Australian Securities Exchange, Listing Rules Chapter 3, 3.1 (2004) 61 Australian Securities Exchange, Listing Rules Chapter 4, 4.10.3 (2004)

127 In Australia, simultaneous reports and initiatives have aimed at developing corporate- governance practices. Cuervo and Aguilera note that “codes are developed in order to improve a country’s corporate governance system to promote investment and growth” (Cuervo-Cazurra & V.Aguilera, 2004) 343). The release of the first Bosch Report in 1991 even preceded the UK’s Cadbury Report and aimed to “improve the performance and reputation of Australian business by encouraging and assisting the general adoption of the highest standards of corporate conduct” (Plessis, McConvill, & Bagaric, 2005) 92). The following Bosch Reports in 1993 and 1995 were prepared under the influence of the UK’s Cadbury Report and stressed the importance of good corporate governance for publicly listed firms. However, Plessis and McConvill note that in the late 1990s certain directors saw corporate governance as a burden on Australian businesses. During this time corporate- governance reporting was not accorded much importance and merely occupied a half-page summary in some annual reports. Nonetheless, the importance placed on corporate governance in Australia has changed, particularly after the corporate collapses of telecommunications company One.Tel and HIH Insurance in 2001. The two corporate collapses have pointed to the need for improvement. During this time (2000–2004) there was an increase in the number of reports, recommendations and codes 62 . Finally, the CLERP 9 Act was enacted on June 200463 and contained several significant reforms to the existing corporate provisions in the Corporations Act 2001. The new continuous disclosure provisions introduced by the Act gave ASIC64 more power to impose transparency. Consequently, the ASX also strengthened its regulations and adopted “a more stringent approach” to corporate governance (J. Hill, 2005) 378). In 2002, the ASX established the Corporate Governance Council with the purpose of “promot[ing] investor confidence and to assist companies [in meeting] stakeholder expectations” (ASX Corporate Governance Council, 2003). The Council produced a report outlining the Principles of Good Corporate Governance and Best Practice Recommendations in March 2003. The report identified ten principles of good corporate governance, as follows:

62 Among all, the Hilmer Report, Ramsey Report on Auditor Independence, Rebuilding Public Confidence in Financial Reporting: An International Perspective, HIH Royal Commission Report, Horwath Corporate Governance Report and Corporate Governance: A guide for fund managers and corporations (The Australian Investment & Financial Services Association , 2002) have made recommendations on different aspects of corporate governance. 63 Press Release by Treasurer of Commonwealth of Australia (Peter Costello), 2003: 103, CLERP (Audit Reform and Corporate Disclosure) Bill introduced Dec 2003, retrieved on May 2005 www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2003/103.htm&pageID=003&min=phc&Year=2003&DocType=0 Australian Securities and Exchange Commission, CLERP 9 Corporate reporting and disclosure laws www.asic.gov.au/asic/asic.nsf/byheadline/CLERP+9?openDocument. Retrieved on 2005. 64 ASIC is an independent Commonwealth Government body that regulates Australian corporations, markets and financial services organisations (Including ASX). Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 are among the legislation it administers. www.asic.gov.au/asic/ASIC.NSF/byHeadline/The%20laws%20ASIC%20administers Retrieved on 2005.

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1. The respective roles and responsibilities of the board and management to be clearly documented 2. Board members to be able to contribute to the discharge of the board’s responsibilities and duties 3. Decision-making to be ethical and responsible 4. The integrity of financial reporting to be safeguarded and independently verified 5. Information to be disclosed in a timely manner 6. The rights of shareholders to be respected 7. Risks to be managed 8. Performance to be encouraged 9. Remuneration to be fair and responsible 10. Interests of stakeholders to be recognised

Starting in 2004, listed companies had to report their adherence to the principles under ASX Listing Rule 4.10.3, which requires that listed companies must provide “[a] statement disclosing the extent to which the entity has followed the best practice recommendations”. If the entity has failed to follow one or more of the recommendations, a disclosure must be made outlining the reasons why the company has failed to comply.

5.5.5 How should Corporate-Governance Reporting be Understood?

Corporate responsibility and sustainability are closely linked to corporate governance. Chartered Secretaries Australia Limited stated that corporate responsibility “sits at the heart of good governance” (CSA, 2005; Marinac, 2005). Reporting of CSR and sustainability performance have the potential to reveal high corporate-governance practices. The implications of a board’s failure to perform are extensive for stakeholders, and as such it is important to understand what contributes to good corporate-governance practices. Assessing board effectiveness and corporate governance based solely on compliance with the guidelines and linking this compliance to a higher company value is not possible. Despite the convergence in corporate-governance systems there is no “one-size-fits all” structure (Denis & McConnell, 2003). Even OECD acknowledges that the OECD Principles of Corporate Governance need to be revised periodically and are not binding, as their implementation depends on the legal, economic and cultural circumstances (OECD, 2004a). Ratings services like Governance Metric International (GMI), Institutional Shareholder Services (ISS), the Corporate Library and S&P have developed methodologies

129 for assessing good corporate governance (Psaros & Seamer, 2002). However, the success of their models is yet to be proven. Yale professor and corporate-governance expert Jerry Sonnenfeld argues that the metrics used by ratings agencies like GMI and ISS are not supported by scientific research (Sonnenfeld, 2004), citing the above-average rating of some companies65 directly prior to corporate-governance crises occurring in their boardrooms. He argues that ‘good governance’ should not only be defined in terms of structural factors such as board independence or ownership concentration but also how boards work together. He adds that “the human dynamics of boards as social systems” will differentiate a firm's governance and suggests that individual characteristics like leadership, values, decision making, conflict management and strategic thinking processes of members should also be taken into account for evaluation. Stakeholder groups are concerned that their voices are not heard on company boards, yet guidelines and most reporting practices take virtually no notice of stakeholder concerns. The ASX Corporate Guidelines recognise “accountability to key stakeholders” as an important part of ensuring their continued support (ASX Corporate Governance Council, 2003): Principle 10), but they do not state whether stakeholders should be represented on the board or how their rights should be upheld. It recommends codes of conduct to address the board’s legal obligations to stakeholders. The guidelines also fall short of recognising the importance of the culture mix or the “human element” of directors. In their book titled “Corporate Boards that Create Value”, Carver and Oliver state that boards should be comprised of diverse members, with each director providing expert advice, useful connections and acting as a safeguard for the investors to add value to the corporation (Carver & Oliver, 2002). Overall, ASX Corporate Guidelines set out a common road map for directors and executives. Compliance with these guidelines and reporting demonstrate that the company is committed to functioning in line with prescribed practices. In this research, the ASX Guidelines will serve as a basis to evaluate the high corporate-governance practices of a listed entity. However, for companies that go beyond the guidelines, the strength of the reported policy framework, committees that support the board in company strategies, the human capital of the board and diligent reporting practices will add value to understanding corporate-governance practices.

65 HealthSouth, Boeing, AMR, Merrill Lynch, Bristol-Myers, Delta, EDS, Citigroup, and Xerox

130 This section discussing corporate governance emphasised the increasing importance of corporate governance in investment decisions and demonstrated the pressures on boards of directors to assume greater accountability. As the field is relatively new, the results of studies examining the contribution of good corporate-governance practices to performance and perceived value are yet to be proven. There are indications that in addition to financial performance, investors consider corporate governance when making investment decisions. A major problem associated with the concept of corporate governance is in assessing what those best practices are, as practices vary among companies. There are historical differences in corporate-governance models and reporting practices worldwide, yet despite differing views regarding the convergence of models, there is a high degree of consensus regarding transparency. Recent reforms around the world demonstrate the importance attributed to corporate governance by regulators and investors, with codes of best practices and “comply or explain” principles now common forms of corporate governance. Following two high- profile corporate collapses in Australia, corporate-governance reporting became more important and Principles of Good Corporate Governance and Best Practice Recommendations were implemented in March 2003. This chapter illustrated the reporting environment of publicly listed companies in Australia, then went on to present the mandatory and voluntary reporting practices of publicly listed companies. The study of those practices highlighted the reporting media used for collecting company-specific data for Human Capital Analysis. Generally, the chapter aimed to form the background for answering Research Questions 1a and 1b. The following data chapters will present human capital data and answer the research questions using the Human Capital Analysis process.

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Section Two: Case Companies

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Chapter 6: BHP Billiton Limited

6.1 Introduction

BHP Billiton Limited (BHP) is the first case company used in this study to answer the research questions. This chapter will begin by giving a general company history, will answer the research questions, and will then apply the Human Capital Analysis tools to the data collected from the public domain.

6.2 BHP Billiton Limited Company History

BHP is the largest diversified resources group globally and is engaged in exploration, development, conversion and marketing of petroleum, aluminium, base metals, carbon steel materials, diamonds, coal and stainless steel materials. Its products are used as input material for a great variety of consumer goods such as cars, computers, microwave ovens and super- fast trains (BHP Annual Report 2004), (Barta, 2006). BHP Billiton was created through the Dual Listed Companies (DLC) merger of BHP Limited (now BHP Billiton Limited) and Billiton Plc (now BHP Billiton Plc), concluded on 29 June 2001. BHP Billiton Limited and BHP Billiton Plc continued to exist as separate companies, but operate on a combined basis as BHP Billiton. BHP Billiton has primary listing on the Australian Stock Exchange (BHP Billiton Limited) and London Stock Exchange (BHP Billiton Plc) and secondary listing on the Johannesburg Stock Exchange and American Depository Listing on the New York Stock Exchange. The headquarters of BHP Billiton Limited and the global headquarters of the combined BHP Billiton Group are located in Melbourne, Australia and BHP Billiton Plc is headquartered in London, UK. Both companies have an identical boards of directors and are run by a unified management team. Billiton was incorporated in 1860 in the Netherlands and engaged in tin and lead smelting. In 1970, Royal Dutch/Shell acquired Billiton, which accelerated its growth. Initial joint-venture discussions with BHP occurred in 1977. Billiton Plc was listed on the FTSE 100 index in 1997. Before the merger it possessed an aggressive growth strategy and was becoming a leader in mining and metals and had a growing portfolio of copper. Initially a mining company founded in 1885, BHP mined silver, lead and zinc in Broken Hill in New South Wales, Australia, and comprised three main operating businesses—minerals, petroleum and steel (www.bhpbilliton.com). For most of the twentieth

133 century BHP was Australia’s “largest industrial organization” (Fagan & Webber, 1994) and a “growth stock” that put Australians through university and made its nation proud by representing it internationally. In 1997–1998, BHP suffered a financial crisis (Hanson & Stuart, 2001) when, for the second time in its long history, it recorded a loss66. From 1996 to 1999 the company value decreased by $5 billion (net) and almost halved in market capitalisation (Phaceas, 2000). BHP came under the scrutiny of shareholders and the general public. The chairman attributed the results to the “combined effects of lower commodity prices and the impact of the financial situation in Asia” (BHP Annual Report 1998). However, the failure was partially a result of internal reasons. The Company was careless and quick to buy new mines in other parts of the world for the sake of growth. Magma Copper in the US, development of the Beenup mineral sands, and Hartley platinum operations in Western Australia and Zimbabwe proved to be disastrous investments that had to be written off (Phaceas, 2000) (Barta, 2006). The company also lost its licence to operate due to environmental and safety concerns. An oil spillage in Bass Strait, the death of 11 people at Moura Mine, negligence in the grounding of vessel Iron Baron off Tasmania, environmental hazards posed by the Ekati Diamond Mines in Canada and the copper mine (OK Tedi) in Papua New Guinea caused great concern among various stakeholders (Economist, 1995), www.bhpbilliton.com). Despite the severity of the situation, BHP demonstrated its capacity to change and quickly transformed itself. It repositioned itself as a “global company that discovers, develops and converts natural resources”(BHP Billiton, 2001a) . BHP had lost many experienced managers and executives and the new strategy and market positioning called for the recruitment of a new CEO and other executive managers with international resources and markets experience67. The new strategy held that a true global company had to be close to its markets and able to respond to customer needs. The organisation was centred around seven Customer Sector Groups, with a portfolio approach and decentralisation of the decision- making process. The first phase of the reformation was to lower costs by closing down unprofitable businesses (non-core assets) and streamlining employees, which simplified the hierarchy and fit the new customer-driven strategy. The cost savings and rising commodity prices produced immediate financial results in 200068. At that time BHP defined its major challenges as:

66 US$1.4 billion loss in 1998 and US$2.3 billion loss in 1999. 67 Paul Anderson: CEO from Dec 1998 to 2001, Managing Director of the new Group from 2001–2002, extensive background in natural resources and energy. 68 US$ 1.6 billion profit in 2000.

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1) Effectively manage portfolios and assets; 2) Attain high performance by employees; 3) Provide high-quality service to all stakeholders.

The company recognised that “maximising returns to shareholders” could not be realised in the long run without the cooperation of employees and recognition of other stakeholder interests. Thus, the Charter was rewritten, complementing the new value-driven structure and communicating what was expected from all employees: “safety and environment, integrity, high performance, win–win relationships, courage to change and respect to each other”(BHP, 2000) , as well as leadership skills and technical knowledge. Increased worker autonomy, quality improvement in teams and workers’ access to co- workers, managers, and supporting professionals signalled the transition toward a high- performing work culture. By 2001, the company was ready for a new growth opportunity, with indications the industry would undergo vertical integration and consolidation. BHP had already closed some unprofitable businesses and planned to spin-off its steel assets69. A merger with Billiton seemed a good opportunity to become a powerful international company. Despite much opposition from shareholders, Paul Anderson convinced the board and shareholders to agree to the merger, which transformed the new company into a strong diversified multinational. How a merger is managed is critical for its success or failure (Marks & Mirvis, 1992); creating a common culture and managing the human side of the merger plays an important role (Robbins, 2002). Even though the two companies were culturally different, the integration was completed smoothly and the cost savings exceeded the target of $270m. Its presence in Europe made it easier to emerge as a global resources company with a more focused marketing approach. The group also confirmed its capability to change and adapt. Post merger, commodity prices continued to rise and BHP Billiton continued to grow. The company that recorded a loss in 1998 had a record profit of US$ 7.5 billion in 2004. The market capitalisation of BHP Billiton, which was US$28 billion in 2001, reached US$35 billion in June 2003 and US$58 billion in June 2004 (BHP Annual Report 2004, p. 2). The company was able to distribute US$ 0.26 per share in dividends (up from US$0.145 in 2003) and in 2004 the share price outperformed the ASX200 by 75%.

69 BHP closed down Newcastle Steelworks in 1999, spun-off half of its long-steel business in 2000 (later named One Steel Limited) and flat steel producer BHP Steel in 2002 (later named BlueScope Steel Limited).

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The above history briefly summarises the background of a BHP. In the following section the research questions will be addressed using publicly available data on BHP.

6.3 Research Question 1-A: Do publicly listed Australian companies go beyond the mandatory regulations in reporting their sustainable HR practices?

A disclosure index was constructed using the ASX Listing Rules and AASB Accounting Standards for this study. The disclosure index included the qualitative Human Capital related reporting requirements for the publicly listed companies in the ASX (a sample of the disclosure index is included in the Appendices). Analysis of annual reports of BHP, using the mandatory disclosure index, indicates that that the company complies with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999-2004 and goes beyond these mandatory requirements. However, despite a very careful text search, reporting of “number of employees” for years 2003 and 2004 (AASB 1034.5.1.d) and “auditor remuneration” (AASB 1034.5.3)70 for 2001 were not found in the annual reports. Even though these few items were found to be missing, BHP’s reports were systematically prepared. Even more, the company reported on the existence of an Audit Committee71 (ASX, 2004) before it became a requirement to report and it also fulfilled the requirements of the “Additional Reporting on Mining and Exploration Activities”72 (ASX, 2004). Compliance with laws and regulations is important; as it reduces the risk of both economical and social sanctions. A very costly sanction for publicly listed companies is delisting from the stock exchange, while non-compliance with specific standards such as labour laws, OH&S and environmental regulations can result in fines, high legal costs and interrupted operations. Besides the economical implications, companies also run the risk of increased scrutiny from various stakeholders such as shareholders, community, government, and activist groups. On the other hand, judging the future performance of an organisation

70 AASB 1034.5.3 became operative in 2001. The company reported on this item starting 2002. 71 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year. 72 ASX Listing Rules 5.1.1 and 5.2: Details of mining production and development activities of the entity or group relating to mining and related operations and a summary of the expenditure incurred on these activities. A summary of the exploration activities and results.

136 based solely on compliance with laws and standards and ignoring other valuable indicators such as Human Capital is inadequate in explaining the differences between potential success and failure. Royal warns that some positive screens applied by specialised research providers fall into this trap by using only compliance as an indicator for sustainability (Royal, 2002). It is essential to value what is reported beyond mandatory regulations, in order to distinguish rhetoric from reality and include this in Human Capital analysis.

6.4 Research Question 1-B

How much more than the mandatory regulations do these companies report or make available to the general public? For answering this research question annual reports of BHP, other company originated data (sustainability reports, website..) and other data obtained from secondary sources (academic articles, books…) were collected and analyzed separately. The study of the annual reports and HSEC (sustainability) reports have shown that they can be good sources for gathering information about BHP’s “corporate strategy,” “corporate governance mechanisms”, “community and environmental performance”, “occupational health and safety” as well as “economic performance”. However besides “executive and directors’ remuneration” (required by mandatory regulations) there was not much Human Capital data in the reports. As suggested by the literature review and confirmed by the data collection there appeared a need for collecting information from secondary sources. The search for Human Capital data in the public domain other than the annual reports has revealed that there was plenty of qualitative data for BHP in the public domain. The data found in the narrative sections of the annual reports and sustainability reports was combined with other data found from the secondary sources and a Human Capital database for BHP was constructed. This data was sorted using the six indicators of the “Drivers of Sustainable People Management Systems” (Royal, 2000) and presented in a checklist matrix displaying the available Human Capital data in the public domain, otherwise within the reach of the security analysts (A sample of the checklist matrix is included in the Appendices). Next section will present the results within the framework of the model by Royal (2000).

137 6.4.1 BHP Billiton Sustainable Human Resource Management Indicators

According to Royal and O'Donnell (2002) organisations that adopt sustainable human resource strategies attract and retain employees, provide internal career ladders, invest in training and development, align these practices with the strategy and as a result attain higher degrees of organisational performance (C. Royal & O'Donnell, 2002a). Organisations with greater consistency among their policies and practices display higher levels of sustainability. It is assumed that when organisations develop and implement highly sustainable practices, they choose to be accountable to their stakeholders and transparent in reporting practices. Understanding the future organisational performance, hence sustainability, of organisations is possible after analysing the sustainable human resource practices of organisations and their progress in sustainability development. Using the constructed Human Capital database these practices are explained below.

1. Job Characteristics a. Competencies: The Royal Template classifies organisations with high-order contextual and theoretical knowledge, occupational specialist positions and high levels of creativity as professional organisations.

Knowledge Competencies: In terms of knowledge competencies, companies with high-order contextual and theoretical knowledge are considered to be professional organisations. Scholarly research suggests over the past twenty years BHP has transformed from a bureaucratic organisation to a learning organisation. It understands the value of knowledge capital and is becoming an industry leader in establishing new systems to develop and capture knowledge. Liyanage and Greenfield define a firm’s knowledge capital as a function of its R&D effort, technology acquisition, experiential learning, organisational learning and network knowledge capacity (S. Liyanage, Greenfield, & Don, 1999). In describing BHP’s R&D processes, the company shows signs of going through what the study defines as a “third generation model” to the more advanced “fourth generation R&D model” after 1999. In this phase BHP actively managed information flows, communication patterns, networks and linkages among internal and external knowledge-generation processes, as evidenced by the internal organisation-wide "Knowledge Management Program”, the appointment of a

138 Knowledge Officer and active support for Communities of Practice (CoPs). The strategic alliance with the Chinese Academy of Science for joint R&D and BHP’s research sponsorship in over twenty local and international universities confirm the active management of external resources (BHP Billiton, 2005). Conversely, the decline in R&D expenditures of the industry and BHP73 raises concerns about future innovation capacity. Upstill and Halla warn this is particularly the case for step-change processes, in which large initial expenditures are needed (Upstill & Halla, 2006). In terms of technology acquisition and adoption BHP was an industry leader. While adopting EDI and later Internet-based e-commerce, BHP subsidiary BHP Steel74 led and managed change within both the industry and the organisation. During 2005/06 BHP was an industry leader in the mining industry in terms of the development and application of e- learning training (Australian Government: Department of Education Science & Training, 2006). Its “technological knowledge competencies” (Royal 2002) are evident in its training and application of new technologies. This capacity was also well received in Asian countries, where BHP was named one of “Asia’s Most Admired Knowledge Enterprises” in 2003 (Yao, Kam, & Chan, 2007). BHP has integrated experiential and organisational learning into its daily operations. In new projects the handover of new equipment and plant and the continuity of maintenance functions is critical for the long-term success of the project (Meredith & Mantel, 2006). BHP has an initiative entitled “Knowledge, Communications and Learning Program” that involves employees at every stage of a project’s handover and has been successfully applied at the Escondida Chile Oxide Project (Duggan & Blayden, 2001). A template developed from past experiences evidences BHP’s capacity to capture knowledge created by individuals. Indeed, Knowledge Management (KM) has been integrated into its overall business improvement/operating excellence functions (L.L.Lee, 2000). In terms of BHP’s capability to capture knowledge, the web-based KM system at Illawarra Coal is a good example. Capturing and storing "inconsistent, dispersed and isolated" data is one of the many challenges in KM for BHP (BHP Coal Pty Ltd, 2003). The

73 The BHP R&D budget fell from A$221million in 1998/99 to A$60 million in 2002/03 and to A$43 million in 2004/05 (Upstill & Halla, 2006) 74 BHP Steel, one of the major subsidiaries of BHP at the time, started using electronic data interchange with its trading partners as early as 80s. At that time the use of EDI led the company to collect and share information with its trading partners and gained the reputation of being an "easy to trade with" supplier. In early 90s, BHP Steel was a pioneer in initiating the centralisation of EDI in the industry. Chan and Swatman noted that the Company demonstrated its technical capability to pull together “multi-disciplinary, inter-departmental -and cross- industry initiatives” through this process (Chan & Swatman, 2000): pg5

139 new web-based system enables explicit yet dispersed data to be collected in the centralised decision systems to deliver a global reporting capability. For knowledge sharing, BHP has systems to maintain or channel information flow. Krogh notes that knowledge connection and the externalisation of the tacit knowledge are the challenges of knowledge sharing (Krogh, Roos, & Slocum, 1994). BHP encourages and supports the development of both informal CoPs and formal networks (L.L.Lee, Parslow, & Julien, 2002). CoPs are regarded as a primary vehicle for knowledge sharing across large and disparate organisations (L.L.Lee, 2000) and existed within BHP, as Steel Iron-Making Practices Network, as early as WWII. These informal communities became especially helpful in knowledge sharing among employees during globalisation. There were 200 CoPs during the sample period, with over 2,500 members within BHP. Formal networks such as the Global Maintenance Network share best practices within the organisation (L.L.Lee, 2000). The BHP Corporate Knowledge Sharing Program encourages more networks in the areas of mine planning, operation, processing and supply. The tools developed by this program provide basic functions of electronic discussions, document sharing, news broadcasting, requests for help and a directory of members over the intranet. The collection of statistics and the development of metrics ensure the continuity of these networks and knowledge sharing. Overall, the existence of networks ensures the exchange of tacit knowledge and builds social capital. In relation to skills competencies, companies that have occupational specialist positions as opposed to well-defined routine positions are considered professional organisations. These organisations find innovative ways to perform work and skills development. BHP has occupational specialist positions as well as flexible work arrangements, as they vary across seven customer sector groups. BHP’s human resource management systems display the capacity to manage a large core workforce together with an even larger contractor workforce. BHP is facing what researchers call a “duality” (Zheng, Rolfe, Milia, & Bretherton, 2007); managing a flexible workforce while trying to attract and retain skilled labour. BHP has formed a very large peripheral workforce in parallel to the changes in the industrial relations environment in Australia75. At the same time, the broadening in the classification of jobs, such as in the coal industry, resulted in a crossing of occupational boundaries and makes multi-skilling essential (Zheng, et al., 2007). However, at some worksites it has become

75 Through the late 1980s and 1990s, the mining sector underwent changes in job categorisation. The changes in the industrial relations system in Australia with the introduction AWAs have fastened this shift and gave way to increased flexibility.

140 difficult to establish a multi-skilled workforce. Moreover, the changes in the company structure and major downsizing during 1997–2001 reduced the skills pool both at operational and management levels. According to an employee survey, BHP has studied and identified critical knowledge loss risk areas (Lee 2000) and evidence indicates that training systems were introduced to close this gap. Other challenges for BHP are competency assessment and skills improvement for employees working in remote sites. BHP uses innovative ways to overcome this impracticability. The Goal-Oriented Learning System at Bayside Aluminium (Mozambique) tracks the progress of candidates during their five-month training. BHP has a leadership role in e-learning for safety training for operational personnel in these regions (Australian Government: Department of Education Science & Training, 2006). BHP worksites cooperate with local governments and universities in identifying skills profiles and shortages in local labour markets (Yellow River, Canada) and BHP continues to intake highly trained graduates. In terms of creativity competencies, the Royal model considers companies that encourage new idea generation as professional organisations. On a continuum ranging from low to high, BHP is found at the lower end, demonstrating a commitment to continuous improvement and change. The merger of BHP and Billiton was very challenging in terms of integration and delivering results. As the organisation exceeded expectations in delivering the expected results of the merger, BHP’s capability to lead change was also confirmed. On the other hand, prior to the merger, the BHP Board announced that the merged company would benefit from Billiton’s entrepreneurship. However, shortly after the merger, Billiton’s Gilbertson was terminated as CEO. Investors and media viewed this event as an indication of BHP’s intolerance of his entrepreneurial mentality (Lancher, 2004). Even if BHP claims “open mindedness to innovation” as an essential capability for employment, the evidence does not suggest BHP is actively seeking creativity in its employees. Rather, a commitment to the Charter principles, teamwork and health and safety rules are more commonly required and supported by the HR systems. The most creative solutions are evidenced in social responsibility projects and improvements in health and safety (L.L.Lee, et al., 2002).

b. Management Control: Companies with low levels of management control and high levels of employee discretion and control are at the higher end of the continuum for

141 professionalism. At BHP, low levels of control are maintained through high levels of managers’ accountability for achieving performance targets.

BHP’s organisational structure is consistent with the Charter, written by former CEO Anderson (1998), with an emphasis on maintaining shareholder value (Phaceas 2000), (www.bhpbilliton.com). The highly decentralised company is organised around seven Customer Sector Groups, which were further brought under three broadly related business areas of Non-Ferrous Materials, Carbon Steel Materials and Energy (BHP Billiton, 2004). The portfolio approach to organisational structure and accounting and finance systems aim to maximise returns from each sector group in delivering expected shareholder value. A unified management team and board run BHP from Melbourne and London, with the Charter acting as a big umbrella over the geographically dispersed company. As guidelines flowing from the Charter do not determine individual behaviour, policy implementation is left to individual managerial discretion (L. D. Black, 2006). Past project failures have prompted BHP to strengthen its decision-making system and compliance with standards, whereby new projects are reviewed according to a set of strict standards for acceptance by the Capital Projects Review Committee (Sykes, 2005). BHP established a detailed audit protocol based on HSEC Management Standards, forming internal audit teams of HSEC professionals and line managers. Yearly self-assessments and external audits every three years aid BHP in controlling compliance and management system effectiveness (Poltorzycki, 2002), (BHP Billiton, 2002b), (Gilbertson, 2002). Overall, BHP has well-developed policies, standards, performance targets and auditing systems that lessen the need for high levels of management control. However, performance targets are closely measured, and there is pressure on managers and teams to achieve such targets.

c. Co-worker Relations/ Work Organisation/ Teamwork/ Communication: In the Royal (2000) model companies that maintain high levels of vertical and horizontal communication, co-worker interdependency and team-based structures with flatter hierarchy are viewed as being on the higher end of the continuum for professionalism. BHP was found to be closer to the higher end of the continuum. BHP was an early adopter of Total Quality Control systems and team-based structures (1986) (Prescott & McLeod, 1990). In the late 1980s BHP had already begun initiatives for better quality, higher levels of consultation, employee participation and teamwork such as the

142 “Business Improvement Through Employee Involvement” at BHP Whyalla (Davis & Lansbury, 1996). BHP’s consistent efforts to improve quality led to its being named an “excellent quality organisation” (Samson, 1997). Evidence in the public domain suggests team-based structures are widely used at BHP and the company has linked significant increases in performance to teamwork. For example, when BHP acquired Tintaya Copper, it immediately changed the structure to team-based work groups and installed principles to empower the workforce (Browne & Montaya-Nelson, 1997). Teams that take on projects (Duggan & Blayden, 2001) or teams that collaborate on specific business targets/work practice improvements such as decreasing the accident frequency rate at Mozal II (Mozambique) have resulted in sustained project success (Salamon, 2003). Despite the wide use of teams across operations, Black (2006) notes that it mostly comprises semi-autonomous teamwork structures, and strategic decisions are made at managerial levels (L. D. Black, 2006). It can be said that BHP teams are operational rather than strategic. Maintaining open vertical and horizontal communication in global organisations is challenging. Various methods and channels are required to ensure the flow of information among headquarters and a diverse workforce of over 35,000 employees and a similar number of contractors at BHP. Black has observed that the company uses multiple methods for maintaining information flow. For downward communication of company objectives and values, BHP uses centralised communications resource systems and at the customer-sector level each operation is responsible for disseminating relevant information. Other human resource functions complement this structure. A 'best practice' Intranet for values learning and performance bonuses communicates company objectives and values to the employees (L. D. Black, 2006). Horizontal communication occurs through formal networks and informal groups (CoPs), as well as a network of 'thought leaders', who push and pull information through the firm. BHP states that upward communication is maintained through regular performance surveys, employee surveys, direct communications with immediate supervision, site-based and corporate newsletters, intranet, site-based and HSEC reports (www.bhpbilliton.com). d. Power/Decision Making/Leadership: Royal’s (2000) model describes an ‘active consent relationship’ in which decision making and leadership are participative and employee oriented. In this kind of a relationship, employees internalise company goals and receive intrinsic rewards from active participation in decision making. Using the publicly available

143 information, BHP was found to be in the transitional stage, moving from an autocratic relationship to a direction of active consent. For multinational companies, the higher the need for responsiveness to local conditions, the greater the need to decentralise decision making (Daniels, Radebaugh, & Sullivan, 2004). The mining and energy sector requires higher levels of local responsiveness in the countries in which business is conducted. Hence, the data suggest that BHP has flattened the former hierarchical business structure and is highly decentralised, with controls assured through increased accountability and performance targets. The customer-sector groups allow each site to develop its own methods for achieving company objectives, while at the top, a flatter team structure exists. During 2002–2007, CEO Goodyear reduced the office of the chief executive from twelve members to eight, decreased the number of executives with a direct reporting responsibility from seven to four, and created a collaborative team working environment with the top hundred managers (Howarth 2004; Durie 2004). This structure enables responsibility to be layered, increasing manager accountability. Despite the change in structure, participative management at BHP is limited to certain aspects of business and not yet fully employee oriented. BHP encourages employee participation in continuous improvement and change programs but the employee contribution in vision setting and policy development is limited. Poltorzyki notes that in a sustainable development working group that included business unit representatives, policy development was "still somewhat top down" (Poltorzycki, 2002). On the other hand, the acceptance and practice of Charter values by top management encourage employees to internalise the culture, as demonstrated by many examples of vertical and horizontal communication networks. Pre- and post-merger leadership styles at BHP show variation. During the sample time period, Anderson (1998–2002), Gilbertson (2002) and Goodyear (2002–2007) served as CEOs. Gilbertson’s (Billiton) leadership style was found to be “arrogant” and “unapproachable” (Durie 2003) yet “intelligent, enthusiastic, energetic” (Bachelard 2002), while the approachable, “down to earth” leadership style of Anderson and Goodyear was a better match for BHP’s culture (Durie 2003; Trounson 2000; Kavanagh 1999).

2. Recruitment The Royal (2000) model suggests the human resource practices indicating professionalism are those that encourage an employment relationship where recruitment and

144 career progression occur across all levels of the firm. This is exemplified in organisations in which positions are filled through both internal and external resources and qualifications and experience are the major criteria for selection. In terms of recruitment practices, BHP has moved from a structure that displays attributes of traditionalism to one of professionalism. Since its establishment, BHP has been known to recruit and develop managers internally. However, this trend began to change as BHP underwent globalisation (1980s). Global operations and new markets required international management experience, which did not exist within the BHP skills pool. After this period, intake of external recruits increased and leadership skills as well as international markets experience were required for management positions. While there remains a strong emphasis on internal recruitment, external recruitment occurs at junior levels and to some extent at higher levels. Internal advertising is conducted for all positions and all internal applicants are interviewed (BHP Billiton Iron Ore Pty Ltd, 2002; HBI Operations BHP, 2001). Internal resources are particularly significant for positions in which there are skill shortages, such as the trades and tertiary-qualified levels of mining (www.humanresourcesmagazine.com.au/articles 2006). BHP is a keen employer of graduates, with the advanced graduate recruitment program capturing potential employees with degrees in Engineering (Electrical, Geo- technical, Mechanical, Mining), Metallurgy and Business ("A Champion of Corporate Governance," 2004). Among the vast array of competencies required from these candidates are “leadership capability, technical knowledge, a dedicated work ethic and the ability to work well with others”. Vacation employment programs help to identify potential candidates and the “graduate competency model” helps to select and advance new graduates. BHP uses lengthy but solid methodologies like assessments, interviews and behavioural testing in place of basic technical testing ((BHP Billiton, 2004); Browne and Montaya-Nelson 1997). BHP is classified as a preferred employer in the regions in which it operates (Browne and Montaya-Nelson 1997; Jenish and Woodward 2001; ("National Australia to buy MLC ", 2000)) and in Canada is on the top 100 employers list ("CSR: The Road ahead," 2002). Careers at BHP are presented as “global careers”, representing the diversified trans-national nature of the company. Working for a global company and the possibility of international experience naturally make the posts desirable for candidates. The Charter values are communicated to the candidates early on through the company website, with adherence to the Charter values listed as the most important selection criterion. Capabilities such as teamwork, leadership, technical knowledge and ethics are important at

145 lower levels, while at a senior management level industry experience and commercial skills replace technical skills. The historic gender imbalance in the mining sector continues, with a male-dominated workforce and a small percentage of women in administrative roles. Reports filed at the Equal Opportunity for Women in the Workplace Agency detail each work site in Australia, indicating that women are not equally represented in BHP’s operations. There are differences among continents76, which could be attributed to socio-economic factors and local laws, but generally BHP lags behind industry averages. For example, the EEOA Workplace Profile 2001 at BHP’s HBI Iron Plant noted that women comprised 13.3% of the total workforce, below the ANZSIC Metal Ore Mining average figure of 14.1% (HBI Operations BHP, 2001). The reports also indicated that various BHP worksites did not have sufficient policies to attract a more diverse workforce for non-traditional roles. Similarly, career progression was found to be different for women (BHP Billiton Cannington, 2001; HBI Operations BHP, 2001) . During the sample period, BHP had begun to reverse the trend by advancing human resource practices (BHP Coal Pty Ltd, 2003). It instituted recruitment and career progression based on “merit principles” and increased the number of female vacation students in the technical and engineering areas to encourage more women to apply for graduate positions (BHP Billiton, 2001b). Despite these efforts, from 2000–2004 there was no increase in overall participation or improvement in salary differentials. Overall, the data suggested change would be slow. However, there was an increase in women’s participation in professional positions (Petroleum Pty Ltd BHP Billiton, 2003), which continued with a woman joining the CEO’s executive office later in 2005, a first in BHP’s history, and another woman joining the board. This put BHP among the 8.7% of ASX 200 companies with a woman on the board and 12% of companies with a woman in an executive position (EOWA, 2006). In addition to gender equality, BHP needs to consider other minority groups represented in the communities in which BHP operates; as of 2004, 45% of BHP’s 35,000 employees resided in South Africa. Employment equity programs in South Africa, indigenous employment programs in the Pilbara region of Australia, programs aimed at improving minority group representation in the Northwest Territories in Canada (EKATI) and New Mexico in the US (New Mexico Coal) are some examples that demonstrate BHP’s improved

76 33 percent female employees in Europe, 18 percent in North America and 12 percent in Australia, 2002 figures

146 practices. At remote sites BHP makes an extra effort to serve the community and employee needs. This not only helps attract local employees but also assists BHP in gaining acceptance by local communities. For example, at Ekati employees take computer and special education courses, and voluntary adult-education classes are offered during work hours.

3. Training According to the Royal template, organisations classified under professionalism tend to adopt an internal/external training philosophy, whereby the nature of internal training is on- the-job, from colleagues and peers, and external training is acquired from a tertiary or professional institution, providing a formal degree or diploma. In terms of training, BHP has a structure consistent with professionalism. From its establishment until the 1980s, BHP offered a wide range of training activities to all levels of employees, often with little lasting effect and at great cost (Webster, Dockery et al. 2001). After the 1980s, BHP became more committed to training and started to offer more effective programs. Lately, the company showed its commitment to training by identifying it as one of the seven value drivers of the company. BHP uses both internal and external modes, and thus fits the occupational specialist category. Although the total training budget is not listed, evidence suggests BHP invests heavily in both internal and external programs. Traditionally, learning in the mining and steel-working industries occurred through apprenticeships for unskilled workers. Apprentice training programs included various teaching methods like practical exercises, trade tests and lectures. On-the-job training was common for the semi-skilled and skilled workforce and advanced with experiential skill acquisition. As early as 1927, there were formal internal staff training programs (C. Wright, 1995) but following the 1980s reliance on internal training lessened and external training became common. This change was attributed to multiple internal and external reasons, such as the nationwide trend for more broadly based and nationally consistent standards in training, moves to skill-related career paths, adoption of TQM principles, new technology and realisation of the importance of individual competencies in management. With the introduction of TQM principles, the complex job classifications were simplified77 and job rotation gained importance; as a consequence multi-skilling of workers became significant (Kelly & Underhill, 1997). With the introduction of AWAs in 1998 the wage schedules changed from "by job tenure" to "by training and skill acquisition" (Webster,

77 For examples it was reduced from thirty to nine job classifications in BOS Department

147 Dockery, Bainger, & Kelly, 2001). Moreover, in stages, the internal market, which was centred on seniority, gave way to competency-based job structures; the continuous introduction of new technology made on-the-job training inadequate; and internal training was supported by technical knowledge that was acquired externally. External training is administered both through universities and other training facilities. BHP works closely with local and international universities (London School of Economics, Carnegie Mellon, Cambridge) to support in-house programs (Edwards 1996; www.dest.gov.au/archive 1996; Durie 2004). BHP also finds innovative ways to provide competency assessment and skills improvement in remote areas, having established an off- site training facility near Port Kembla Mill, with external training providers to assist in external accreditation of training courses for ironworkers (Kelly & Underhill, 1997). The Internet is also used for many short technical courses for staff in remote locations (e-learning) (Australian Government: Department of Education Science & Training, 2006). Internally, specific technical skills training and HSEC training are managed within the businesses, supplemented by workshops, formal training programs and through intranet services like the Australian Training Register Intranet (Petroleum Pty Ltd BHP Billiton, 2003). Learning in supervision, teamwork and leadership skills is also available for operational staff (HBI Operations BHP, 2001). For example, the Global series of Leadership and Development Programs (GLP) is designed for staff in management and advisory roles through to senior and executive roles (BHP Billiton Illawarra Coal, 2002),(BHP Coal Pty Ltd, 2003). From 1992, a strong coaching and mentoring system has also been available at various levels (site mentor, functional mentor, and graduate) for all employees (MacGregor 2000). In terms of scope, training programs are targeted to the needs of the businesses and complement the teamwork structures. For instance, the BHP Billiton Mitsubishi Alliance (BMA) has invested $50 million in a new program (Skills for Growth) to develop employees in line with planned growth in the company’s export coal business sector (www.bhpbilliton.com), (C. Donaldson, 2006). The industry need for higher levels of technology management and generic management capabilities is integrated into the two-year graduate training program (Shantha Liyanage & Poon, 2003), (www.bhpbilliton.com), with learning supplemented by job rotation among mine sites, processing plants and regional business centres (Illawarra Coal).

148 4. Career Opportunities Internal career ladders offer opportunities for career advancement and employment security, as well as opportunities for both internal and external careers through occupational specialists. According to the Royal model, recruitment occurs both at the bottom and higher levels, with training essentially external through degree courses supplemented by internal on- the-job learning. Historically, “The Big Australian” was known for its strong internal career ladders. As early as the 1920s, each individual’s career path was recorded (Sawer 1985) and training programs were established to ensure steady career progression, such as the Residential Management Course, the first internal management development program in 1964 (Stace, 1996). There was also a clear distinction between workers (unionised) and staff members (un- unionised), preventing career change from one to the other. After the 1980s, career paths have been skill-related rather than based on seniority. Public data suggest there is a dual career structure at BHP, with career opportunities presenting internally and externally experienced people joining higher up. There is clear development at BHP, with new graduates undergoing job rotation experience and development programs. Graduates are then assessed for executive potential as part of an eight-year development program. Those assessed as potential leaders are offered experience in three jobs in three different commodities and countries78 (Durie, 2004). Potential leaders receive intense mentoring from business leaders and are assessed annually before advancing (Durie, 2004). The career path for operational staff also involves on-the-job training undertaken in stages with regular assessments (BHP Billiton Iron Ore Pty Ltd, 2002). Career mobility through development is possible both vertically and horizontally79, with BHP’s Employment Centre playing an active role in helping employees manage their careers internally and after leaving the company. Employees who leave the organisation as a result of redundancy are provided with access to specialised career management and transition support, as occurred in Newcastle Steel and other closing plants (Petroleum Pty Ltd BHP Billiton, 2003). It is also possible for external applicants to enter BHP at a higher level, with the rate of experienced employees joining HBP increasing following the 1997/1998 period. During that time, the globalisation, M&A activities and restructuring were pushing BHP toward

78 For example, Brian Kruger, Chief Financial Officer of BlueScope (BHP Steel)had joined the Company in 1983 after graduation and he had worked in a series of positions before becoming CFO (James, 2004) 79 For example; an employee during his 13 years at BHP moved from a fitter, to a turner apprentice, coke ovens and a level three operator in the reconditioning yard (Milsom 2000)

149 change and exposed a skills and experience gap in the organisation. Although both investors and media were sceptical about BHP hiring foreign executives, senior managers with international experience helped to turn the company around. CEO Anderson successfully oversaw positive changes and Goodyear, at a very young age, successfully completed the transformation post merger (Robinson, 1998). Seniority gave way to international experience, M&A knowledge and leadership capacity as important criteria for selecting executives ("CSR: The Road ahead," 2002). The strength of BHP’s career management system (talent management and succession planning) was demonstrated through the speedy replacement of CEO Gilberston and other executives who had resigned. Annual Talent Management Reviews provide input for promotions based on merit and specific job requirements (www.bhpbilliton.com) and identify potential successors for key roles, with nominated successors rated on readiness and suitability (HBI Operations BHP, 2001). Despite a smooth management transition during the merger, the departure of four of the five Billiton executives only after six months alarmed the media and was regarded as an HR failure (Sykes 2004; Bachelard 2003; Durie 2003; Joffe 2003). However, Chip Goodyear, who was CFO at the time, proved to be a superb leader. The many changes in the executive ranks pre and post merger made it clear that working at BHP was no longer “a life-long career” (Durie 2004).

5. Rewards The Royal template indicates that in organisations in which employees are occupational specialists and dual career ladders exist, highly variable and performance- related remuneration exists. The data confirm that at BHP the reward structure combines fixed and variable pay, which are characteristics of Royal’s professional organisation. In setting salaries, BHP reports that while the market rate is considered, pay is determined by qualifications, skills, experience and performance of employees. The performance- management system takes a stakeholder view, linking it to value creation for shareholders as well as integrating HSEC policy and management standards into its system (www.bhpbilliton.com, 2003). Internal award programs recognise employees’ and contractors’ leadership in ESG and support the communication of these values (Poltorzycki, 2002). BHP had traded its traditional base pay system for skill-based pay in the 90s. The new skills-based reward system complemented the team-based environment by motivating individuals to learn multiple skills and provided horizontal/multiple job opportunities

150 (Lawler, 1996; J. R. Schuster & Zingheim, 1992). BHP supplemented the new system with training programs and technical support. After re-structuring, the performance appraisal and reward systems were further developed to integrate BHP’s new strategic direction. In appraising performance, “the balanced scorecard approach and Key Performance Indicators (KPI)” evaluates both financial and non-financial performance (BHP Billiton, 2002a). For instance, at Ekati Diamond Mine a non-financial measure like the OH&S scorecard is integrated into senior management’s personal performance scorecard, which is directly linked to remuneration (Randolph, 2004). Individuals from line operations, supervisors, plant managers and executives can collaborate to evaluate the actual performance (Bascur & J.Patrick, 2003), and year-end comparisons are then made as “threshold, target or stretch” and are used as a measure of individual, customer sector group and overall performance. For example, one of BHP's non- financial goals is “zero fatalities” in the workplace (taken form BHP annual Report). In 2004, due to 17 fatalities, none of the executive team members received an award in relation to this HSEC measure Poicies (BHP Billiton, 2004) . This lets us see that policies are followed by practices (comparison of company rhetoric with reality). The company reports that performance management is strengthened through regular face-to-face feedback, reviews and open communication. Every employee receives a formal performance appraisal from his/her manager at least once a year, providing two-way feedback (Fox and Trinca 2001). In the past, BHP has been criticised both by investors and the media for rewarding non-performance in its hefty executive packages (McCallum 2001; Beveridge 2002;(BHP Billiton, 2004). For example, in 1997, CEO John Prescott’s A$2.4 million pay package remained steady despite the 61% decline in profits (Sargent 1998). In the Financial Times listing of salaries paid to executives of the top 200 companies on the London Stock Exchange in 2002, Gilbertson (CEO 2002–2003) ranked 21st on a salary of £2.7 million ($6.5 million), Kesler (executive) was just behind him on £2.6 million and Munro (executive) also made the list at £1.5 million (Sykes 2004; Ryan and Howarth 2003; Oldfield 2002). BHP, while striving to attract the best talent , has sought ways to advance its executive remuneration system. The Remuneration Committee was established in 2001 to support and advise the board on determining the executive remuneration policy. The resulting “Company Remuneration Report”, which became a subsection in the annual report, improved transparency for investors and detailed the renewed Group Incentive Scheme (GIS), which underlined the importance of long-term performance. A significant feature of at-risk pay and

151 performance-based pay is the use of performance hurdles as a prerequisite for vesting, which emerged as a result of shareholder groups making performance hurdles virtually obligatory in order to obtain shareholder approval specifically for executive option plans (O'Neill & Berry, 2002).

6. Professional Identity and Culture The Royal model specifies that organisations in which employees identify more with the organisation than with the profession are those in which there is a strong dominant culture and where networks are structured to be top down. Generally, the data suggest that BHP has a very strong culture. BHP’s size, power and long history as ‘The Big Australian’ helped maintain its culture for over a century in the Australian mining industry (Zheng, et al., 2007). BHP was known for its “militant unionism, inefficient labour usage and hostile industrial relations” (Kelly & Underhill, 1997). Until the late 1990s, BHP continued to represent the “character of Australians: tough, rugged men who could crash though any obstacle" (Hanson and Stuart 2001). During that time, BHP’s management style was considered “arrogant and incompetent" and the organisation was described as a "self-obsessed, process-driven, bureaucratic dinosaur” (Sykes 2005; Economist 1992). However, in the late 1990s, data suggest that BHP recognised the need for change. Firstly, to compete with global companies, it needed to increase productivity and lower costs. Secondly, it had to regain the trust of investors and major stakeholders. During 1997/1998, BHP underwent a major restructuring, with CEO Anderson lowering costs by retrenching large numbers of workers and eliminating unproductive investments, such as Newcastle Steel (closed down) and One-Steel (spin-off). BHP also took advantage of the decentralised domestic industrial relations system and began to offer individual contracts (AWA) at some of its sites (Hewett, 2001). While externally displaying a commitment to sustainable development and shareholder value, internally the culture had to be aligned. The move towards a sustainable business model meant the somewhat reckless culture had to be abandoned and replaced with an understanding that recognised multiple stakeholders and their role in the company’s long-term success. The culture change began with CEO Anderson (1998–2001) writing the new Charter, whereby the measure of success was altered to include the contributions made to primary stakeholders. BHP

152 defined the new culture as “a high performance, high trust work culture with win–win relationships” (HPWS). Due to the downsizing and introduction of AWAs, BHP received much criticism, and drew concern that it would abandon collective agreements altogether to force out the unions. In their study, Mitchell and Fetter classified BHP’s introduction of AWAs at Iron ORE in 1999 as motivated by “cost-reduction purposes” and de-collectivising rather than “productivity increases”, and aimed to “squeeze[e] out the unions and to produce flexibilities in working arrangements with unions” (R. Mitchell & Fetter, 2003). The Corporate Rate Report defined the BHP’s actions as inconsistent with its commitment to the UN Global Compact ("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004) BHP continued to offer AWAs but it retained collective agreements for 60% of BHP's global workforce as of 2004. The simultaneous introduction of HPWS and downsizing represented contradictory HR policies, making it difficult for some employees to internalise the new culture as quickly as desired. Workers were concerned about job security and the new arrangements made employees extremely insecure about future employment opportunities (Failes, 2001). The company had to rebuild trust not only among shareholders but also the remaining employees. Furthermore, BHP had to contend with loss of skills and the challenge of managing a large peripheral workforce80. Nevertheless, by attempting to adopt a HPWS, BHP demonstrated the importance placed on employees. Changing HR practices confirmed BHP’s aim of building trust with employees. During the shutdown of Newcastle Steelworks, a consultative Transition Steering Team was formed to enable a better transition for laid-off employees, (BHP Billiton, 2001b) (S. Maiden & Richard, 1999). The merger with Billiton posed another challenge for the new culture. Despite both companies possessing a long history in the same industry, BHP and Billiton had differing cultures. Billiton had grown into a very large company with the help of its entrepreneurial spirit, whereas BHP was known for its stability. As the two companies found common values such as adherence to safety, environment and community (Robbins, 2002), the merger with Billiton strengthened the changing values of the BHP and the new Group was labelled a “fairly swift and eager new corporation” (Moldofsky 2007).

80 As of 2004, besides a core workforce of 35,070 permanent employees, there were as many as 38,000 contractors working for BHP’s operations. At BMA (BHP- Billiton Mitsubishi Alliance) for instance, half of the workforce consisted of contractors (Zheng, et al., 2007).

153 In relation to cooperation among unions, employees and the company, a dual structure is observed; there are worksites in which BHP has reasonably close relations with the union, as in the Illawarra region, and there are worksites where BHP has “de- collectivised” and this partnership does not exist, as in the Pilbara region, (M. Jones, Marshall, & Mitchell, 2007). Using the Human Capital view the smooth relations with unions and workers is highly important and needs to be closely watched for their effect on productivity and the business results. For instance, disagreements and strikes in multiple sites (i.e., Escondida Mine 2003, Cerro Colorado Copper Mine 2002, Worsley Alumina Refinery 2005) interrupted business and pointed to employee dissatisfaction across the organisation. Overall, publicly available data indicate BHP is matched to an organisation type in which employees identify more closely with the organisation itself rather than the profession. There are employees from many different professions working in the company, such as engineers from various disciplines (Mining, Electrical/Electronic/Instrument, Mechanical, Maintenance, Process/Chemical/Metallurgy, Petroleum/Reservoir, Civil/Structural), business specialists and skilled and semi-skilled workers. The promise of a high-trust and high- performance work culture has not yet been fully delivered. While it is difficult to say all employee groups strongly identify with the culture, evidence suggests BHP strongly encourages employees to work and live according to Charter values and internalise the new culture.

6.5 Research Question 2: Is there a knowledge gap between equity analyst reports and reporting of Sustainable Human Resource Practices by companies? In order to interpret analyst recommendations, the researcher has utilised equity reports prepared by two investment banks and several independent research institutions covering BHP from 1999–2004. For each year a random selection was made from each set, with 59 reports used overall. These reports provide the results of analysts’ valuations of BHP’s stock value. The length of analyst reports consulted in this study range from 1 to 22 pages, with most being three to five pages. The time interval between each report differs among investment banks and case companies. The size of the company, distribution of ownership and power of its investors can determine the media and analyst coverage a company receives. Very often, the announcement of financial reports (yearly, half yearly and quarterly),

154 company announcements, mergers and acquisitions, company scandals, investor briefings and site visits may affect the number and length of reports published. The reports typically include a recommendation section, financial numbers and ratios section, a graphical representation of the share price and a narrative section. The final analyst recommendation, which is usually either ‘buy, hold or sell’, or ‘underperform, market perform or outperform’ is an indicator of the analyst’s outlook on the shares in the short/long term. The financial sections scrutinise past financial data and ratios as well as future earnings estimates. The narrative sections often comprise discussions of share-price movement based on future earnings changes. Analysts have linked earnings estimates with quantitative indicators such as “future changes in sales” (market leadership), “prices” (e.g. oil price), “costs”, “past profits” and “strong macroeconomic factors”. Analysts also anticipate annual general meetings, board meetings, industry-specific meetings, sale of subsidiaries, profit result announcements and the closure of problematic mines impacting earnings results and influencing the share price and recommendations. In addition to the presentation and discussion of structured financial data, the reports also contain some loose qualitative data. However, further analysis of these sections indicates that soft and qualitative information is not systematically sought but instead is applied randomly where certain information or circumstances arise. In their discussion, analysts state that their primary sources of information are quarterly, half yearly and annual financial reports and company announcements. Examination of these sources in answering Research Questions 1a and 1b of this study previously indicated that annual reports provide only part of the qualitative data originated by organisations. And there is almost no Human Capital data in the annual reports or sustainability reports as reporting of it is not mandated by the regulations. Analysts also pose questions to organisation members at site visits (Samarco Iron Ore Visit), luncheons (e.g. with the CEO), analyst briefings and presentations (e.g. strategy briefing by executive committee of Aluminium Group, Energy Group). A review of such information as available on company websites and analyst reports indicates the type of information analysts have requested from company officials; directly after the merger, analysts asked questions about “business conditions, profitability, development projects, share structure issues, strategy development, marketing functions and earnings goals”. Later, analysts wanted to know about “transparency in coal sales, steel sales and costs”. Apart from the replacement of the CFO and the closure of the Ok Tedi mines (PNG) and HBI plant, they did not directly request a great deal of qualitative data. Further, BHP's then vice-president of

155 sustainable development, Ian Wood, confirmed that “mainstream investors and analysts seldom attended the company's briefings on safety, environment and community issues” (Berger, 2006). However, an examination of the company reports in answering Research Question 1b indicated that voluntary reports (CSR reports, Governance, Environment and Sustainability Reports) may at least give insights regarding the functioning of the organisation and aid to sift reality from rhetoric as suggested by this study. Evidence suggests the market does not like to link share-price changes to intangible indicators, namely, variables that cannot be quantified. In the subject reports, long-term success and profits have been attributed to better/excellent management in several cases, but this “excellent management” is not defined or detailed, as it is something that analysts cannot quantify. Further, both before and after the BHP and Billiton merger, analysts did not ask how the human side of the merger would be managed and did not mention it as an important element in their reports. However, research shows that between two-thirds and three-quarters of all corporate mergers fail (Marks & Mirvis, 1992) and that effective management of the common culture and the workforce is essential for the success of any merger (Robbins, 2002). In contrast, regarding the merger, analysts have attributed to it “cost savings, more consistent earnings performance and immediate staffing of key positions”. One analyst following the sudden departure of the CEO confirmed the difficulty associated with analysts relating human resource issues to value creation:

First, the issue of management change has been a drag on the companies’ share price performance over the past 50 or so days since the departure of the former CEO. Whilst this issue is intangible, in the sense that it is not necessarily possible to wrap earnings changes around personnel changes, it is nevertheless important to the perception of future value creation. Perhaps the clarity of vision, and the perspective, outlined by the new CEO, will reassure those in the market that continued to harbour concerns about the recent management changes putting to rest some of the more Machiavellian perspectives. So with the gradual dissipation of management concerns the share price should take more direction from other factors, both internal and external. (CSFB, 24 Feb 2003, First Alert)

Overall, review of equity analyst reports indicates that analysis of intangible assets does not exist. There is somewhat limited use of qualitative data, and analysts may not collect soft information or systematically integrate it with financial analysis. In conclusion, there appears a knowledge gap between the analyst reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital.

156 6.6 Research Question 3: How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making predictions about the future financial performance of ASX-listed companies?

The review of the information asymmetry in the capital markets have shown that not disclosing Human Capital information may cause investors to misjudge company value, lead to mispricing of shares and eventually create inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack good information access. There were several examples for the information asymmetry that the Human Capital Analysis depicted at BHP. Firstly, the data collection and analysis of Human Capital data for BHP have highlighted that “leadership, living up to the values stated, corporate culture, workplace relations that show themselves in labor relations and given importance to improving occupational health and safety” are significant Human Capital related indicators for BHP that need to be evaluated over time as a part of the Human Capital. None of these items were reported or evaluated in the analyst reports. The follow up of significant Human Capital information such as “employee safety” and “industrial relations” gave insights for the future financial performance of BHP. In many instances, due to workplace accidents and disagreements with the unions, work has stopped at BHP worksites, causing loss of productivity at mines. In contrast these were not included as a part of the equity reports. Using the Human Capital lens, a qualitative analyst can give early warnings for the future earnings of the company with the follow up of these practices. From the Human Capital point of view it is also important to see how Human Capital becomes a partner to the strategy setting and implementation phases of organisational sustainability. On the other hand, the review of BHP’s corporate history has confirmed that continuity of the environmental and social performance is highly significant for BHP’s future earnings. However, the study of the analyst reports show that even if some equity reports have included corporate governance-related information, none of them have reported on environmental or social performance. Organizational sustainability and how leaders and employees contribute to these can provide valuable insights into a company’s future earnings. At this point it is important to

157 note that to be able to sift “reality” from the “company rhetoric” is highly significant for following Sustainable People Management practices of a company. When BHP was exploiting the environment and having disputes with the local communities at its OK Tedi Mines (PNG) during late 1980s to 1998 the investment community didn’t really saw what this could cost the company and they continued to follow and report on the “company rhetoric”. Mining companies can risk their license to operate in mining regions caused by community concerns and governmental regulations besides receiving legal costs and fines. Moreover, if a company is known to be exploiting its environment, these concerns can extend to other parts of the world. Using the Human Capital lens, a qualitative analyst can give early signs for the future financial performance while following the “lack of policies, leadership and employee support” for these highly sensitive issues. Conversely, equity analysts started to forward questions about the mine and its future only when BHP was forced to publicly admit that OK Tedi Mines was an environmental disaster. Naturally, the financials of the company were threatened, when it had divested its 52 per cent shareholding to the PNG Sustainable Development Program Ltd in 2002 and even got sued by 13,000 villagers for civil damages exceeding $US4 billion in 2007. Considering the differences in understanding of Human Capital in analyst reports and what Human Capital analysis have depicted it is highly important to close this gap for improving the investment recommendation process.

6.7 Company Rhetoric vs Reality Compared Through Secondary Sources

This section suggests to sift “company reality” from “company rhetoric” through triangulating “company originated data” with “other sources”. “Company-originated documents” are obtained through annual reports, analyst briefings, presentations, sustainability reports and websites and “other sources” are obtained through academic articles, books, magazine and newspaper articles and industry reports. And through the process of comparing and contrasting the section demonstrates how Human Capital Analysis can overcome the inaccuracy/ reliability problems associated with voluntary company reports. The comparison is conducted at three sub-stages; policy framework, implementation of policies and public accountability. BHP compares its relationship with stakeholders to “the crafting of a rope” and sees it as a critical component of sustainable development. At the heart of the rope there are local and indigenous communities, employees and contractors, shareholders and customers.

158 BHP defines its key stakeholders as: People who are adversely or positively impacted by our operations, those who have an interest in what we do or those who have an influence on what we do (HSEC Report).

1. Policy Framework: Based on the data gathered from publicly available sources, BHP is considered to be operating at a very high level in terms of policy development and monitoring for high levels of corporate governance.

Early on, BHP supported a variety of community programs. As early as 1917, at Port Pirie and Whyalla, it contributed to accident funds, dental clinics, an eyesight conservation scheme and housing loans (J. Guthrie & Parker, 1989). While BHP continued its commitment to local communities over the years, the many environmental disasters in the metals and mining industry made communities increasingly concerned about the activities of miners. Industry leaders realised they were in real danger of losing their “social licence to operate”. Mining was viewed primarily as a source of environmental degradation and social upheaval (Walsh 2002 taken from (Yongvanich & Guthrie, 2005)). A change then occurred in BHP’s approach to stakeholders; the company started to accept the interest of stakeholders other than shareholders. Later CEO Gilbertson described the 1997–2001 period as follows: “a wiser BHP Billiton has emerged, a company strongly committed to the philosophy of Sustainable Development” (BHP Billiton, 2002c). During this period BHP adopted a more proactive approach in its relations with stakeholders and implemented both external and internal changes. The industry aimed to demonstrate commitment to sustainable development by pursuing voluntary initiatives, such as Global Mining Initiative (GMI), World Business Council for Sustainable Development (WBCSD)81, “Greenhouse Challenge Agreement”82 and the Australian Minerals Industry Code for Environmental Management83 (Kelly & Underhill, 1997) (www.bhpbilliton.com). By committing to these voluntary initiatives, transparency increased through the added reporting requirements. For example, obligations under the Minerals Code included the production of an annual environment report as well as a self- assessed annual Code implementation survey (www.minerals.org.au/environment/code); the

81 A coalition of 150 international companies that share a commitment to the environment and to the principles of economic growth and sustainable development. 82 In 1996, Australian Government's "Greenhouse Challenge Agreement" had required the voluntary reduction of greenhouse gas emissions by signatories. The key Act that had improved regulatory framework was the Environment Protection and Biodiversity Conservation Act 1999 (EPBC Act). Under the EPBC Act any group or individual (including companies) whose actions may have a significant impact on a matter of national environmental significance needs to apply for approval for projects (www.environment.gov.au/epbc). 83 In 1996, Minerals Council of Australia has launched the Australian Minerals Industry Code for Environmental Management. In developing this code minerals industry wished to demonstrate its commitment to managing the environmental aspects of its operations. The Code underwent a review in 1999 to ensure that it remained relevant to the needs of the stakeholders. Upon World Wide Foundation’s (WWF) report, the amended Code included the engagement of the community about the environmental performance of operations (Deegan & Blomquist, 2006)

159 outcomes of the Global Compact Progress Assessment were included in the 2004 HSEC report. BHP was an industry leader in such initiatives. BHP also committed to the UN Universal Declaration of Human Rights (UDHR) in 2001 and UN Global Compact84 in 2003, the US–UK Voluntary Principles on Security and Human Rights in 2001, ICMM Sustainable Development Framework85 and obtained ISO 14001 certification86 for its major assets. Overall, these voluntary commitments resulted in BHP improving its community consultation process and accountability. Internally, BHP endeavoured to build trust within the company, starting at board level. Post merger, BHP strengthened its board policies87 in line with the changing business environment and formed new board committees. Previously, board committee members were not independent, as recommended by new guidelines88 (Psaros & Seamer, 2002). Post merger, all three board committees (Audit, Nomination and Remuneration) were reconstructed with four independent members each and the Audit Committee had a separate chairman, as recommended in the US, and one member (the chairman) had accounting or related financial management expertise (BHP Annual Reports 2001, 2002). In 2003 they also formed a “Disclosure Committee” to disclose board policies on the company website. Secondly, it demonstrated its commitment to stakeholders by reshaping Health, Safety, Environment and Community (HSEC) policies. A board committee, the HSE Committee, was established to “secure governance at the highest level” (2001 HSEC Report). In the new system the Charter, Sustainable Development Policy, HSEC Management Standards and Guide to Business Conduct guided stakeholder relations. The Charter defines a clear set of values that “encourage employees to see stakeholders as integral to firm success” (L. D. Black, 2006). For BHP success is not only “superior returns to shareholders” but also satisfied customers, suppliers, community and employees (www.bhpbilliton.com). The statement of “good corporate citizen wherever we go” is frequently used in public speeches by management, confirming that the values in the Charter are applicable to employees around the world as well as consultants, contractors and business partners (www.bhpbilliton.com). For example, at BHP Billiton Iron Ore, all new

84 The UN Global Compact’s environment principles are: Principle 7: business should support a precautionary approach to environmental challenges Principle 8: undertake initiatives to promote greater environmental responsibility; and; Principle 9: encourage the development and diffusion of environmentally friendly technologies (www.unglobalcompact.org). 85 International Council on Mining and Metals (ICMM) has developed the Sustainable Development Framework in 2003 and asks from members to apply and report against its principles . 86 ISO 14001 is an international standard for environmental management systems. It was first published in 1996 and it applies to those environmental aspects, which the organisation has control and over, which it can be, expected to have an influence. 87 It adopted policies like Securities Dealing Code, Securities Dealing Policy, Provision of Other Services by the External Auditor, Market Disclosure and Communications Policy, Enterprise-Wide Risk Management Policy and the Independence of Directors Policy. 88 In Annual Report 2000, it was reported that out of ten directors eight were non-executive but actually only four were independent (Psaros & Seamer, 2002)Later, this ratio has changed to nine independent non-executive and two executive Directors.

160 major contracts had provisions setting minimum required percentages of indigenous employees (HSEC Report 2001), setting a best practice for others to follow. In NSW, the Government’s Workplace Health and Safety Strategy (2005–2008) followed BHP’s practices, requesting a 40% reduction in contractor injury rates by 2012 (NSW Department of Primary Industries, 2005). BHP’s Guide to Business Conduct complements BHP’s Charter values and is monitored by a Global Ethics Panel, adhering to the higher standards of the US Sarbanes Oxley Act, making the Guide available in seven different languages, incorporating it into BHP’s HSEC Audit program and the existence of regional helplines reinforce the conformity of the workforce and demonstrate BHP’s sincerity about good business ethics (BHP Annual Report 2002: Corporate Governance). The value system is transferred from the Charter to lower management levels by a cascading system of policies, management standards, guidelines and performance targets. The HSEC Policy states that BHP is committed to sustainable development. “Continual improvement in performance, efficient use of natural resources and aspiration to zero harm to people and the environment” are essential elements of ‘Working Responsibly at BHP Billiton’. In explaining its drivers for sustainability, the ability to attract better employees and gain acceptance from community members and governments stand out as BHP’s main reasons for commitment. BHP acknowledges that by investing in communities, it receives acceptance and support, making it easier to do business (www.bhpbilliton.com: HSEC Report 2004, drivers). Critical community relations such as indigenous relations are given special attention in the HSEC Policy, which specifically states, “wherever we operate we will . . . respect the traditional rights of indigenous peoples . . . and value cultural heritage”. Standards such as Environmental Management Standards89stemming from the HSEC Policy are consistent with externally recognised standards and codes. The adherence to standards is reported against measurable and specific performance targets90. At a functional level the HSEC Forum, comprising corporate representatives and HSEC functional heads, sets direction, identifies priority issues, and monitors performance (HSEC Report 2001). At site level, besides BHP standards, local laws shape the overall HSEC program (Ekati Mine HSEC Report 2004). The structure lets site managers apply the standards for their plant- specific needs and they receive specialist advice from functional personnel and utilise newly

89 They are set in 1999 and comprised twenty Standards and eight Guidelines. The environment standards included environment, energy, greenhouse, water, waste, land management and product stewardship. 90 There were 21 HSEC standards in 2001, after a revision in 2003 there are 15 HSEC standards.

161 developed safety improvement methods91. The response to company-wide issues is managed through specialist networks. Accountability is assured through the individual responsibility given to all line managers in achieving HSEC targets. The yearly internal HSEC audit program and external audits (every three years) ensure the effective implementation of Management Standards across the group (BHP Annual Reports) (P. B. Lawrence, 2003). According to EOWA reports, various BHP worksites have not had policies to attract a diverse workforce for non-traditional roles. In its annual reports, BHP acknowledges the need to adopt new policies and practices to help employees achieve work–life balance (BHP Annual Report 2002). At a regional level in Australia, BHP implemented initiatives such as guidelines for flexible work options, an elder care information kit and an employee assistance program. BHP’s capacity to renew was evidenced in the creation of a Climate Change Policy for 2002–2007 and established a greenhouse target after receiving a low global warming score in the FTSE 100 Companies Environment Survey92. Likewise, BHP developed a company- wide operation Closure Standard in 2004 to complement its existing Management Standards.

2. Implementation: It is difficult to evaluate a company’s actual performance using only publicly available data. Each piece of evidence needs to be confirmed by secondary sources. Working through the evidence collected from sources produced by the company (ex: annual reports, media announcements, sustainability reports, briefings, website) and confirming it with secondary sources (newspapers, magazines, academic articles, interviews, observations by third parties), the following conclusions are reached.

a. Approach: The previous section indicated that BHP has an excellent policy and systems development and renewal capacity. However, further study of the ways these policies are generated points to a top-down approach, with little input from lower levels of management and employees, with the exception of HSEC policies, which encourage individual implementation and creativity. BHP acknowledges that community relations need to be “continually revisited and redefined in terms of shared purposes and issues of concern” (Morland, 2006) and recognises that this could be done through local interaction. Under this framework stakeholder identification is reduced to site level from a unified set of stakeholders (HSEC Management Standard #7, 8.5). Sites are required to consider specifically any minority groups (such as

91. Some examples are the Incident Cause Analysis Method and Positive Attitude Safety System (HSEC Report 2004) 92 The Company is included in the FTSE 100 Companies Environment Survey since 1998.

162 indigenous groups) and any social and cultural factors that may be critical to stakeholders (www.bhpbilliton.com 2003 and 2006). In that sense, the HSEC Management Standards provide the general performance expectations of community involvement from work sites and business units, but “the method of implementing these standards” is left to the “individual discretion of managers” (L. D. Black, 2006). The majority of community support is managed at the local level, often through foundations. For example, since mining began at Escondida Copper Mine in northern Chile in 1990, BHP has supported local communities through the Escondida Foundation. At the Mozal Aluminium Smelter in Mozambique malaria is epidemic; BHP’s Mozal Development Trust works with partner organisations to reduce new malarial infections in Southern Mozambique. Similarly, the work environment can involve high risks for employees, such as countries like South Africa and Mozambique, with very high HIV/AIDS ratios. BHP has managed this risk by introducing local support programs to help prevent employees from acquiring the disease, and cooperates with local governments, community organisations, NGOs and industry groups (Fast, 2004) (P. B. Lawrence, 2003).

b. Performance Targets: Examining policy and management standards implementation processes has demonstrated that achieving performance targets is very important and monitored very closely. Further, in some instances standards are implemented that are stricter than regulations require93. However, how these targets are achieved is not controlled stringently. The company announces both performance achievements and shortfalls. For instance, the Classified Injury Frequency Rate94 has fallen from 6.51 in 2001/2002 to 5.18 in 2002/2003 and 4.95 in 2003/2004. BHP’s firm stance on performance targets has enabled innovative ways of doing business and new technologies. At Dendrobium underground coal mine (NSW, Australia), the ventilation shaft was constructed without anyone entering the shaft. The project set new industry standards in safety performance and environmental care (Fast, 2004). Human resource management practices are also closely aligned with achievement of performance targets. The new employee selection criteria stress company values. At BHP Steel, new training programs were initiated to help managers reduce the impact of mills on the environment and understand technological developments to minimise dangerous emissions

93 The required occupational exposure limit of employees is set below the local regulation limits in 2003/2004 (HSEC Report 2003). 94 The number of classified injuries per million work hours.

163 (Kelly & Underhill, 1997) (Poltorzycki, 2002). Executive remuneration is partially dependent on achieving HSEC Targets and there is a strong network of environmental professionals (100 engineers) working at BHP work sites, which helps to implement new standards (Poltorzycki, 2002). Management Standards are also part of the investment process, with the new Closure Standard an integral part of investment and governance processes. BHP has developed new criteria for investments such that they will not participate in a new project that dumps tailings in rivers and it will not seek to mine World Heritage sites (BHP Billiton, 2002c) (www.bhpbilliton Michael Rae, Senior Policy Officer – Business and Industry, WWF – Australia). In 2004, the Department of Industry and Resources charged BHP for fatalities at Boodarie Iron Mines. After considering the investment required to improve OH&S conditions to BHP levels, BHP decided to shut down the plant, indicating a firm stand on OH&S standards. BHP’s insistence on performance targets has certainly improved business results; OH&S changes have increased productivity. Mozal Aluminium Smelter in Mozambique and Escondido Copper Project in Chile initially had high accident frequency rates, with many interruptions to production. But through improvements in behavioural safety, fatalities and injuries were reduced (Salamon, 2003). When production continued, goals were attained in a shorter period of time. A study of the implementation of Human Rights Standards at BHP Billiton South Africa’s Bayside Aluminum Smelter (Lawrence 2003) examined measures undertaken to uphold human rights and the fit between Standards and practice. Lawrence reviewed internal audit reports from 2002/2003 and conducted interviews, reporting that the Performance Requirements are based on process rather than an implementation approach and found that the audit reports were inadequate in evaluating human rights issues at worksites. He pointed to the weak human rights fit between standards and operations (P. B. Lawrence, 2003). c. Internalisation of Values: It is important for companies to show that they live up to their stated values. The involvement of top management in culture creation, policy development and HSEC programs has been influential in creating awareness of company values among employees. For instance, the Forum on Corporate Responsibility, where members of the senior management team meet quarterly with leaders of key non-government organisations (NGOs) and community members set a good example for leaders’ community involvement (Poltorzycki, 2002), (www.bhpbilliton.com.). However, the analysis suggests that

164 not all standards are applied uniformly among geographically spread business units or the new culture is not fully internalised. The case studies presented in HSEC Reports display how BHP implements policy. While there are many successes, in some cases standards have not been understood or applied by managers. Black’s study, through interviews with BHP managers, found managers did not apply the criteria of “stakeholder satisfaction” consistently in evaluating community dialogue. Some managers believed unsatisfied stakeholders would report to the company, ignoring the power relations between the company and the stakeholders (L. D. Black, 2006). In 2004, the company halted operations in its Tintaya mine in Peru due to increased community concerns (R. Gale, 2005). Moreover, BHP was heavily criticised for human rights abuses at some of its operations. BHP’s “involvement in allegedly unlawful exploration for nickel in Pujada Bay in the Philippines”, “failure to address the cases of long suffering communities who were forcibly evicted for the expansion of the El Cerrejon coal mine in Colombia95 (Mineral Policy Centre (Australia), 2005) and intentions to mine on Gag Island in Indonesia despite ecological and community concerns display inconsistent policies and practices. Similarly, BHP failed to implement policies and cease harming the environment; environmental incidents occurred, like acid water seepage resulting in the release of tainted water outside BHP’s containment system in Canada as of 2004 (HSEC Report 2004). Oxfam Community Aid Abroad stresses the importance of “independent verification of policy effectiveness” to transfer policy into changes in practices("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004). According to a series of studies96, from 2000 to 2003 BHP has recorded an improvement in environmental performance. This coincides with a fall in environmental incidents and fines from 1999–2004 (BHP HSEC Reports). Evidence suggests BHP seeks assistance from external sources to monitor the fit between policy and implementation. For instance, BHP Billiton Mitsubishi Alliance has commissioned an independent evaluation of its community program by the University of Queensland, Centre for Social Responsibility in Mining, to provide external analysis of the various activities and

95 In Colombia, allegedly during 2001-2002 BHP and its consortium partners while operating at the El Cerrejon Coal Mine had destroyed the village of Tabaco. BHP have not replied the residents’ request for reimbursement. Even more, the Consortium is accused of forcibly displacing a number of Wayuu Indigenous and Afro Colombian communities at Cerrejón Norte coal mine in 2004 (Mineral Policy Institute, 2004) The Consortium has bought up all the land surrounding the community and cut the Tamaquitos community from access to public transportation, education, health services, or traditional food sources from hunting. The Consortium is said to pay the Columbian army for security in the area. On April 2004, 150 paramilitary men had arrived in the village of Bahia Portete and assassinated 12 people (Barros, 2005). Locals have abandoned the land and sought refuge in Venezuela. BHP had refused to negotiate with the community. 96 In years 2000 and 2001 Australian Conservation Foundation (ACF) has participated in the Age/Sydney Morning Herald Good Reputation Index (the GRI). ACF’s contribution to the GRI was to provide its perception of the environmental performance of Australia’s top 100 companies. In 2003, ACF joined The Australian Consumers’ Association (ACA), Oxfam Community Aid Abroad (Oxfam) in assessing corporate responsibility performance of the Australia’s Top 50 Listed Companies (Corp Rate Project) BHP’s average score rose to 10.5 out of 30 in 2003, up from 7.5 in 2000.

165 areas for improvement (CSRM, 2005), but these external audits are not applied consistently among operations.

3. Accountability: Companies need to demonstrate their commitment to communities through transparency in information transfer and involvement in decision-making, with community consultation becoming a very important part of mining operations (G. Greene, 2002). Best practice environment management for mineral resource explorers and developers include involving the community and communicating how mining will affect it (Department of Industry Tourism and Resources, 2006). BHP’s contribution to communities through local initiatives and partnerships suggests that it aims to live up to the Charter values. It has abandoned its historical approach of providing housing or schools and has adopted a more participative approach. BHP has also adopted a standardised method of non-financial information reporting and has become an industry leader in adoption and development of voluntary reporting standards. It is certain that BHP is committed to long-term relationships with the communities it does business with, but it also needs to monitor implementation of policies and choose to report bad news as well as good.

a. Consultation and Dialogue: Evidence suggests BHP engages in open dialogue with communities. For instance, residents’ views were considered when building a road to the Cannington Mine in Queensland (L. D. Black, 2006); there was an adequate consultation process at Illawarra Coal Operations (NSW) (HSEC Report 2004); Northwest Territories Diamond Project (EKATI™) in the Canadian Arctic started operations after consultation between BHP, government and four Aboriginal groups (Couch, 2002). BHP received the Australian Prime Minister's Award for Excellence in Community and Business Partnerships in 2003 and Business Excellence for Innovation from the Global Business Coalition on HIV/AIDS in 2004. Storebrand in Norway researched the mining industry and ranked BHP Billiton 'best in class' out of 21 metals and mining companies for its environmental and social performance (www.bhpbilliton.com.2003). Conversely, inconsistencies in the sector and at BHP confirm concerns of local communities about their voices not being heard within the industry (Sethi & Emelianova, 2006). Evidence suggests stakeholder dialogue is not well understood or applied evenly among BHP managers (L. D. Black, 2006). For example, BHP recently constructed a new tailings dam without the consent of local communities at Tintaya mine in Peru, even though there was said

166 to be trust among parties("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004). There are also concerns about human rights abuses. BHP requests stakeholders to offer suggestions but has not reported on any suggestions made. In this regard, BHP lags behind leader companies like Shell. Since the introduction of its Sustainable Development report in 1991, Shell has maintained ‘Tell us what you think’ attachment, and for every completed attachment, a tree is planted (Maharaj & Herremans, 2008).

b. Transparency: In Australia, environment, health and community reporting is mostly done voluntarily, with companies choosing their preferred format. Prior to 1998, BHP was not transparent in reporting negative news to stakeholders. A study examining BHP’s social and environmental disclosures from 1983–1997 indicated BHP relayed mostly positive information in reports (Deegan, Rankin, & Tobin, 2002). Another study shows BHP's 1995– 1996 annual report was quiet positive about its Bougainville operations (Papua New Guinea), while actual attitudes of indigenous people in the region were negative (Lehman, 1999). Similarly, BHP was not transparent regarding the environmental crisis at OK Tedi Mine (PNG). However, from 1998/1999 BHP became more transparent in its stakeholder communications, in initiating and adopting new reporting mechanisms such as the Global Mining Initiative (GMI)97in 1999. Furthermore, in terms of corporate-governance accountability, BHP is found to be operating at a very high level. Corporate Governance appeared as a subheading in BHP’s annual report for the first time in 1994, the same year of the revolutionary King 1 Report98, before it became mandatory in Australia99. It was a page- long brief about internal controls, compensation and remuneration of directors and the committees. Before the merger, the corporate-governance section had improved and was very comprehensive. Post merger, BHP began publishing a separate corporate-governance

97 Global Mining Initiative was an initiative by nine of the largest mining and metals companies. GMI had later transformed itself into the International Council on Mining and Metals (ICMM). In 2003, ICMM launched the Sustainable Development Framework and in 2004 completed Mining and Metals Sector Supplement to Global Reporting Initiative97 (GRI) 2002 Guidelines. ICMM asks member companies to report in accordance with the GRI 2002 Guidelines and the Mining and Metals Sector Supplement. (International Council on Mining and Metals, 2006). The initiative has been criticised heavily by some NGOs in the area of “addressing issues from the industry’s point of view” (Sethi & Emelianova, 2006)Sethi and Emeliovana found the quality of the reports produced by the members as to lack tools for comparative analysis and targets and absence of systematic analysis of the companies' operations and their compliance with the ICMM's ten principles. The initiative set a good example for self-regulation and voluntary reporting in the industry, which BHP had been an active member (G. Greene, 2002) 98 King 1 Report was released in 1994 by King Committee on Corporate Governance in South Africa. 82 reports around the world were modelled after it. (Ping, 2003) 99 After 1996, the ASX Listing Rule 4.10.3 made it mandatory for all listed companies to disclose their main corporate governance practices in their annual reports (Ramsay & Hoad, 1997).

167 statement in its annual report. The dual-listed company structure and the NYSE demanded BHP become more transparent than the level required in Australia. In 2001, BHP began to publish a full Health & Safety and Community Report, having not previously systematically collected non-financial data100. Internally, the need for collecting “social metrics data” was stressed (2001, HSEC Report) a company-wide central HSEC reporting and storage system was introduced . By 2004, 98% of work sites had a Community Relations Plan and performance reporting, and a Business Conduct Helpline for addressing community complaints. The full HSEC report was prepared in conformance to both BHP’s Management Standards and Australian Minerals Industry Code for Environmental Management. In this report BHP openly disclosed the consequences of the deviance from the targets. The Group published its first combined HSEC report in 2002 and following consultation with stakeholders, a shorter version was printed in 2003. This practice supports BHP’s philosophy that "each corporation should determine for itself if any CSR reporting it believes to be appropriate and notes that there is no one formula that will apply universally to all corporations" (Chua, 2006). BHP utilised technology to deliver information to stakeholders online, delivering annual and quarterly annual reports, significant speeches, production and sustainability reports, webcasts and site reports in a timely and user-friendly way. Both the merged company and work sites published EOWA reports, which have given insights about BHP’s equality principles and have pushed BHP to improve diversity. In 2003, BHP started to report non-financial information against GRI 2002 Sustainability Reporting Guidelines, the Minerals Supplement and ICMM’s Sustainable Development Framework Recommendations (2003). The differences of reporting aspects such as biodiversity information have been aligned with GRI Guidelines. The use of a traffic- light system in the HSEC Targets Scorecard to display deviance from targets by classifying performance as declining, on track or improving sets a good example for best practice. Furthermore, deaths, injuries, environmental incidents and fines received are quantified and detailed, enabling BHP to report negative outcomes. For instance, Port Kembla Steelworks received two fines in 2002 and two significant environmental incidents were reported in 2004. BHP has commissioned a third party (URS) to independently review its sustainability reports, and includes the views of third parties like WWF in HSEC Reports. A Corp Rate study acknowledged that BHP was among the few companies in Australia to utilise the GRI

100 Only a few BHP sites had collected “number/resolution of complaints” and some work sites had set performance indicators in terms of local or indigenous employment.

168 guidelines, stating the BHP Remuneration Report is an “excellent example”("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004). BHP has received the Australasian Reporting Awards “Continuous Disclosure Award 2004”, “Corporate Governance Reporting Award 2004” and “Special Award in Environmental Reporting” and IR Magazine Australia’s “Best Investor Relations 2005” for its increased transparency. BHP’s inclusion in the Dow Jones Sustainability Index and the FTSE4 Good Index show the appreciation of the investment community. Despite these examples, evidence suggests BHP remained selective in terms of reporting negative news; when it divested its 52% shareholding in the OK Tedi Mine to the PNG Sustainable Development Program Ltd in 2002, it assured stakeholders communities consented to its exit and the mine would be well managed. However, reports claimed no consent was given and resulting environmental damage would last 100 years. Subsequently, 13,000 villagers sued BHP for civil damages exceeding $US4 billion (SMH, 2007). During 2001–2004, BHP reported there were no human rights transgressions, but external sources indicated many community concerns in various BHP work sites. The above section describes the strategies, sustainability policies and processes implemented by BHP. The section streams through BHP’s governance for stakeholder management and progress in social, environmental and communal performance. Through using this data it demonstrates how to triangulate company originated data with data found through secondary sources. The next section will discuss the results of the Human Capital Analysis Process .

6.8 Human Capital Classification Process

The first tool suggested by the Royal and O’Donnell (2005) model is the historical context of a listed firm. Based on the data gathered from publicly available sources, below is the historical context and a macro analysis of BHP Billiton’s environment.

6.8.1 Macro Analysis of BHP’s Environment The resources industry has been an important part of the Australian economy and equity market since the mid-1800s, when the extraction of minerals first started and financing through the stock exchange followed. The contribution of the industry to the Australian economy and employment continued throughout the twentieth century, despite its diminishing weight in relation to other newly emerging industries.

169 In 2004, the Mineral Council of Australia reported that 90% of Australian mineral production (by value) was exported (A$43.1 billion) and the mineral industry accounted for about 6.5% of Australia's gross domestic product. Australia’s major commodity exports include coal, gold, iron ore, oil, aluminium, alumina and copper (MCA, 2004b). The resources sector continues to be important to the equities market, compromising 29% of total ASX market capitalisation and 41% of all ASX-listed companies by number (2008 numbers,(ASX, 2009). Exploration, extraction and production of minerals is highly scale-intensive and there are long waiting times for realisation of investments in the sector. On the other hand, demand, and—hence the price trends—is cyclical, and unfortunately for the producers of commodities, from 1970s–2000 the price has moved primarily downward (Barta, 2006; Upstill & Halla, 2006). During this time, the industry structure gradually changed. Production moved to East Asia, South America, Africa, and the former Eastern Bloc countries, as a result of “depletion of former ore resources” and “deregulation of mining” in these new destinations (Crowson 2006 cited in (Upstill & Halla, 2006). An implication of the low profitability associated with the industry is consolidation; small mining companies are replaced with larger, global companies. In the US, of the ten copper producers, only two remained by the 2000s (Barta, 2006) and of the 50 largest mining companies globally in 1990, only 28 remained by 2003 (La Nauze and Schodde 2004 cited in (Upstill & Halla, 2006)). Yet in the 2000s the two major players in Australia were Rio Tinto and BHP-Billiton, and Alcoa in the US. These new global companies operate in geographically disparate locations, extracting “a wider variety of commodities” and are very powerful in setting commodity prices (Barta, 2006). In 2003, the downward trend for commodities began to reverse, mostly as a result of rising demand from China for iron ore, nickel and copper (Trounson, 2003) and also the recovering world economy in general("A certain shine; Commodities.(The appetite for commodities)," 2005). The period was defined by some as the “longest-running commodity boom in decades” (Barta, 2005). In 2003/04, average world mineral prices ($US) rose by 18% (MCA, 2004b) and the ASX/S&P 300 GICS Materials Index, which was in the range of 4000 in 2003, exceeded 8000 by mid 2005 (www.netquote.com.au, www.asx.com.au). The MCA reported that the total revenue recorded by Minerals Industry Survey respondents in Australia rose by 9% to $40.7 billion in 2003/2004 and employment rose by 6% to 64,527 (direct employment and contractors) (MCA, 2004b). BHP Billiton fully benefited from this boom, with revenues rising from US$16.5 billion in 2003 to US$23.5 billion in 2004 and profits almost doubled to US$3.5 billion.

170 Investors rallied to buy BHP shares and the share price, which was under A$10 in 2003, rose above A$20 in 2005. Further, in the US, the price of BHP American Depositary Receipts (ADR) more than doubled (Barta, 2005a). By buying BHP shares, “investors believed they were buying China's growth” (Barta, 2005a), as China became BHP’s number one customer, with revenues as high as $US12.5 billion in 2004/2005 (West, 2005). During the boom the costs of production rose along with the price increases, which were attributed to supply issues (Andrusiak & Trounson, 2005). For BHP, in 2004/2005 core copper and iron ore mines were in short supply (Barta, 2006). During the down time (1970– 2002), companies were cautious in developing new mines, and invested less on new mine development, research and technology, and skills development (Trounson, 2003). This created major supply shortages during the boom. MCA Chairman, Greig Gailey, pointed to the decline in minerals exploration, inadequate infrastructure development and lack of skilled human resources as critical factors impacting the industry’s long-term performance (MCA, 2004a). Externally, the resources industry as appears to be a low-technology industry, but (Upstill & Halla, 2006) warn that this view is misleading. They assert that the true contribution of technology can only be understood if aspects like “mineral exploration activities, non-R&D expenditures on design activities, exploration of markets for new products and the contribution of new technology from other industries” are taken into consideration. (Upstill & Halla, 2006) state that development of new technology takes years (e.g. BHP’s Falcon Technology) and the industry will suffer from years of underinvestment. They also point to the sophisticated set of skills needed from engineers and miners to operate the new technology. Unfortunately, Australia was one of the countries that suffered the most “from shortages of skilled labour” during the boom (Barta, 2006), (Barta, 2005a), which can be partially attributed to low training levels in companies. The new structure of the industry in which large, powerful global companies need to manage portfolios that are diversified by product and geography requires new sets of skills from managers and BODs. Mining companies are now more like large financial portfolios in which “sophisticated risk-analysis tools” are needed “to understand supply and demand trends” (Barta, 2006). It is also the case that global companies are expected to be more environmentally and socially responsible for their actions. To do business, they need to cooperate with many more stakeholders than previously. BHP’s CEO Chip Goodyear defines the challenge as follows:

171 a growing number of countries are becoming more protective of their natural resources. This will make it harder for BHP Billiton and others to refill the pipeline with new projects once the current ones get up and running. (Barta, 2005a)

While minerals exploration promises high returns for investors, not all exploratory activities have positive results, and even when it is worthwhile extracting the minerals, the lag between initial discovery and sales can be quite protracted and costly. In this cycle, investors are commonly asked to be patient and have trust in management’s capability and the expertise of producers (BHP Annual Reports 2002, 2003). In return, it is essential to provide accurate information about the activities of the companies to the patiently waiting investors. The industry, in its attempts to rebuild trust, has initiated and adopted voluntary reporting mechanisms (refer to BHP Corporate Governance section). Further, ASX has imposed additional reporting requirements on mining and exploration activities (ASX Listing Rules, Ch 5) and in December 2004, the industry and ASX developed the revised version of the “Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves” (JORC Code). The Code includes the minimum reporting standards and guidelines for the mining industry, and is binding on professionals (MCA, 2004b). However, none of this mandatory and voluntary information provided by public companies can alone reflect the potential of companies. This information needs to be evaluated together with other publicly gathered information through a lens of human capital analysis to reflect companies’ true value. The above information summarises the changing nature of the resources industry, citing important external influences as a part of the Model of Drivers of Sustainable People Management Systems (Royal 2000). The macro analysis underlines the changing demand and supply patterns and the new players in the arena, further noting that in the near future companies that plan to stay competitive will need to be able to forecast supply-and-demand patterns, manage large diversified portfolios, improve the skills of the workforce through both internal and external training, invest in new technology and manage a variety of stakeholders by being accountable and staying in close dialogue with them. Applying the tool, it is possible to evaluate the historical context of BHP; the company that was known as a great performer in the ASX stumbled through the 1990s, but managed to realise a great comeback with the changes made to the overall company structure in 1998–2001 and post the BHP and Billiton merger. Flushing out unprofitable investments, and thereby cutting costs, simplifying the organisational structure, and diversifying its product portfolio through globalisation and inorganic growth, aided in creating a better company. This all

172 happened under the guidance of BHP’s visionary leaders, aided by the new management structure. In 2003, the new BHP Billiton was ready to face the challenges of the changing market. Therefore, when the resources boom hit the markets, BHP’s profits increased dramatically, as did the share price. It had once again become an attractive share for investors in 2003–2005. To further understand the internal strength of BHP’s Human Capital Systems, it is necessary to examine the specific human capital indicators. The following section will examine and evaluate the human capital indicators of BHP during 1999–2004.

6.8.2 Sustainable Human Capital Practices The alignment of human resource management systems with the stated corporate strategy is significant for achieving a sustainable competitive advantage. In the literature, the existence of a large pool of skills or effective alignment of existing skills with the strategic direction, behavioural training and human-resource practices are stated to contribute to the success of the organisation (P. M. Wright, Dunford, & Snell, 2005); Huselid 1995). The Royal and O’Donnell model (2002) suggests that the study of human capital systems that comprise recruitment, training, career planning, rewards, job characteristics and professional identity give a better insight to the functioning of the management systems of the organisation and help to better anticipate future events within the organisation. In the case of BHP, the culture, recruitment, training and reward systems of the company should demonstrate the level of consistency within human-capital systems and consistency with strategy and how human capital systems contribute to financial, human and environmental performance. The new BHP corporate strategy was defined as “customer driven and focused on markets it serves” ((BHP Billiton, 2002a)). When reshaping BHP, CEO Paul Anderson (1998–2001) transformed the existing bureaucratic culture to fit the new corporate strategy. With his efforts and effectiveness in “culture creation”, in a manner of speaking he had become the new founder (Schein, 1990). He personally set the new value system and the Guide to Business Conduct, which is applicable to all employees as well as consultants, contractors and business partners. Schein lists the founder’s (leader’s) belief system, how he reacts to organisational crises, role modelling, organisational systems for selection, promotion and rewards, among others, as important elements for embedding a new culture in the organisation (Schein, 1990), p. 115). Anderson’s leadership in writing the new BHP

173 Charter personally, followed by the creation of systems, management standards and performance targets, combined with a clear corporate strategy, enabled the new culture to become embedded among the employees. On the other hand, the literature also suggests that a vision that is created top-down might slow down the “bottom-up dynamics”(Fey & Denison, 2003). Moreover, a diverse company of this size will have functional and geographic subcultures that require flexibility with its policies. While the integrative approach of BHP for culture creation lacked this approach101, there was an awareness and acceptance of the new value system among employees. Another challenge was the creation of a “common culture” for the newly forming Group in 2001 (Robbins, 2002). Basically, the two groups had historical and cultural differences, which made this task more difficult, but they had agreed on key values such as “safety, environment and community” (Robbins, 2002). Despite some initial problems at the board level (the new CEO quitting after the merger), the new group overcame these very swiftly. The new culture was defined by the company as “a high performance, high trust work culture, with win–win relationships”. The analysis confirms that eventually an appropriate fit was formed between company strategy and the desired company culture. While it is difficult to link the new culture with immediate financial, human and environmental performance, the accomplishment should be evident in the changing practices. Leadership is an asset vital to the continued success of a company. Accordingly, Paul Anderson’s view of BHP shaped its future; his approachable, “down to earth” leadership style (Kavanagh, 2001) and setting up a clear strategy were effective in re-shaping BHP. He managed to pursue the Billiton merger despite much opposition. However, when Brian Gilbertson (2002) replaced him, Gilbertson brought with him the entrepreneurial spirit of Billiton, as well as an “arrogant and unapproachable” character, which was a poor fit for both the new group and the board. Conversely, the subsequent appointment of Chip Goodyear as CEO (2002–2007) has proven to be a success. A macro analysis of BHP’s environment demonstrates that leadership and management qualities like international markets experience, ability to conduct risk analysis, sensitivity to social issues, and managing multiple stakeholder groups are essential for leading the company and ensuring its long-term sustainability. Chip Goodyear possessed these qualities and was an integral part of the restructuring process since joining the company as CFO in 1999. By the time he completed his tenure as CEO, BHP’s market share had

101 The author cites the Global Conduct System that is distributed to divisions without any revision. (Segan, 2006)

174 reached US$200 billion, had recorded a profit of US$13.7 billion and had issued dividends of US$ 47 cents/share for 2006/2007 (Zonneveldt, 2007) BHP annual reports 2007). Due to the importance of leadership, attracting and retaining leaders and managers is vital for the continued prosperity of the company. BHP has been known for recruiting apprentices, technicians and engineers at entry level and developing them internally as managers. As a result, the company possesses a strong pool of technical skills. However, a global resources company aiming to grow through the effective management of its portfolios and assets was also required to recruit externally managers and executives with relevant experience, such as international experience, financial markets knowledge, exposure to the resources industry and leadership qualities. Enhancing the skills pool, specifically at the top level, combined with BHP’s strength in succession planning, is evident in the strategy execution, stability and continued trust in the company. Leading a global, diversified, dual-listed and huge company like BHP requires senior executives to assume a great deal of responsibility. Attracting high-calibre executives that will accept this responsibility and can lead 30,000+ employees and as many contractors means remuneration must also be attractive. This poses a great challenge for the board, which was repeatedly criticised by both investors and the media for rewarding non-performance and for hefty executive packages. To overcome this challenge, firstly, the Remuneration Committee was established to oversee the executive remuneration system, while the renewed Group Incentive Scheme (GIS) underlined the importance of long-term performance by including at-risk pay and performance-based pay. Further, shareholder approval was introduced for executive option plans. Secondly, the company attained greater levels of transparency through “The Company Remuneration Report”, which discloses much more information than the ASX and AASB requires102. Finally, the revised reward and performance appraisal system emphasises the attainment of non-financial goals, which complements the new value system. By establishing clear performance targets that are measurable and complementary to the corporate strategy, the company ensures an overall alignment in its human resource management systems. The macro analysis of BHP’s strategic environment revealed shortages of skilled labour in the geographies in which the company operates. Human resource management activities that can overcome this problem are training and workforce planning. In remote areas, BHP introduced training initiatives and development programs for local communities, in

102 Continuous disclosure close of ASX requires the remuneration of the CEO and the top five executives to be disclosed in the annual report. Australian Accounting Standards, AASB 1046, issue date Jan 2004

175 collaboration with local universities and institutions103. Importantly, the new skills-based pay system encourages employees to undergo training and become multi-skilled. The new training programs also focus on key corporate values such as OH&S and environmental sensitivity (BHP Annual Report). Lastly, the company has formed a large peripheral workforce, which gives flexibility during times of growth and uncertainty, and despite its geographically disparate operations, BHP has demonstrated a capability to manage 38,000 contractors (2004). Overall, the positive effects of skill enhancement and workforce planning will emerge as reduced costs and increased production, as illustrated during the commodities boom in 2003. The historical analysis of BHP points to “returns to shareholders and growth” as the company’s major drivers prior to 1998. However, during that period the company was unable to realise these goals, as mere recognition of sole shareholder rights was not sufficient to sustain the company. After 1998, BHP acknowledged the interests of other stakeholders in the company and began to view them as a critical component of sustainable development. In its annual reports (2002–2004) BHP’s relationship with stakeholders was compared to “the crafting of a rope”; at the heart of the rope were local and indigenous communities, employees and contractors, shareholders and customers. BHP shifted its measure of success from financial figures (shareholder returns) to its benefit to suppliers, customers, communities and employees, which helped to achieve improved transparency. Corporate governance was strengthened through updating board policies, board structure and board committees and adopting voluntary guidelines104. Transparency improved even further after the adoption of GRI 2002 Sustainability Reporting Guidelines. These changes are likely to result in improved social and environmental performance and build trust in the company. The above analysis demonstrated that there is a high level of consistency between BHP’s human resource management systems and strategy, and internal consistency in its practices. Furthermore, as (C. Royal & O'Donnell, 2008a) suggest, consistency and appropriate fit of practices aid in the execution of strategy and improve BHP’s financial, environmental and social performance.

103 BHP Billiton Mitsubishi Alliance launched A$50 Million Skills Development Program in cooperation with University of Queensland and Central Queensland University (BHP Sustainability Report 2006). 104 Complied with the UK Combined Code on Corporate Governance Guidelines and Australian Stock Exchange Recommendations. Reported on differences with New York Stock Exchange Requirements.

176 6.8.3 Strengths and Weaknesses Royal and O’Donnell’s (2005) model suggests the internal strengths and weaknesses of a company are considered when evaluating the investment potential of that company. The analysis of BHP’s management practices using publicly available data suggests that from 1999–2004 the “Big Australian” transformed into a strong, diversified and global company. BHP combined it century-long mining experience with Billiton’s international experience to form a giant, dual-listed company, and continued its inorganic growth through acquisitions. Improved corporate-governance practices and greater levels of transparency helped it earn shareholder trust and improved dialogue among stakeholders. During this time it demonstrated great leadership and change potential, during the re-structuring process in 1998 and during the successful merger in 2001. In addition to these radical change- management programs, incremental change programs are implemented, and internally consistent management policies, standards and practices are upheld. Its updated culture, effective succession-planning strategies, internal career progression, strong knowledge- management systems, and internal and external training opportunities are all strengths of the company. There are also weaknesses associated with BHP that require external oversight. The board must continue to hire individuals with international markets experience and from a wider age range. Further, female representation continues to be a problem throughout the company, particularly at higher levels, and reduced internal training opportunities and skilled labour shortages remain an issue. The reduction of R&D expenditure may hinder new product innovation, thus jeopardising BHP’s leadership in exploration and production. The large peripheral workforce and major downsizing risk low commitment among employees, and while relations with unions are primarily positive, lay-offs and the introduction of AWAs have strained such relations, especially in Australia. Policies applied with a top-down approach leave little room for creativity and can be a mismatch with a diversified organisation structure. Environmental hazards associated with extraction and final use of BHP’s products (e.g. coal) continue to cause concern for stakeholders and there are cases of human rights violations at several worksites. These concerns could result in BHP losing its mining licence, costing millions of dollars in future earnings and loss of reputation. It is forecast that in the near future nations will become more protective of their national resources, which will likely slow extraction of mineral resources. Increasing awareness of global warming may attract harsher environmental regulations. Moreover, as BHP has attaining virtual monopoly in certain markets, anti-trust laws may be a concern for

177 further growth. A slowdown in the world economy resulting in decreasing demand from developing countries, combined with fewer growth opportunities, may disappoint the shareholders. BHP can overcome these external threats if it capitalises on the opportunities that exist in its external environment; while there are well-developed stakeholder- management policies and standards in place, greater levels of support and training are required to manage these relationships consistently in practice.

178 Chapter 7: National Australia Bank Limited

7.1 Introduction

National Australia Bank (NAB) is the second case company analysed to answer the research questions. The chapter begins with a review of the company’s history, covering important turning points, continue with answering the research questions, and follow with comparing company rhetoric with reality. Later, data collected through this process will be used in applying the Human Capital Analysis tools. This process will identify NAB’s sustainable human capital practices that will affect its share price.

7.2 NAB Company History

National Australia Bank, established in 1858 in the state of Victoria, is an international banking group that operates in Australia, New Zealand, United Kingdom, Asia and the United States, and is one of the big four banks in Australia. Through its subsidiaries and branches NAB offers services to its retail, corporate and institutional customer base, which amounts to more than 10 million customers globally (National Australia Bank, 2004) Its overseas operations (44.6%) generate a notable part of its profits105 and NAB views itself as a “net exporter of services” for Australia (2004 NAB Annual Report),(NAB, 2006). Historically, NAB’s core strength has been in retail banking and in total 79% of profit is derived from financial services (2004 Data). As of 2004, NAB’s retail brands included National Australia Bank (Australia), Bank of New Zealand (New Zealand), Yorkshire Bank and Clydesdale Bank (United Kingdom) and it operated 2,218 branches and service centres and 3,155 ATMs globally. NAB plays an important role in the Australian economy. In 2005, NAB was the third- largest Australian company by revenue in the Fortune 500 Global list after BHP Billiton and Coles Myer. Its assets were valued at A$411 billion, profit was A$3.2 billion and it employed over 43,000 people106 (2004 Data). In the first years following its establishment, the bank grew in the states of Victoria and South Australia through providing services to merchants involved in gold trade (Fung, Bain, Onto, & Harper, 2002). Despite a series of obstacles during the first half of the

105 2003/2004 Profits, Regional Distribution: Australia 65,4 per cent, Europe:16.5 per cent, New Zealand:11 per cent, US: 5 per cent and Asia: 2 per cent. 106 More than half of the employees are in Australia. Total full time equivalents: Includes part time and non-payroll fts.

179 twentieth century (Great Depression, World Wars I and II), NAB’s expansion continued, with new branches opening and acquisitions taking place throughout the 1970s. In the late 1970s the Australian economy encountered problems of “high inflation, exogenous shocks and declining effectiveness of monetary policy” (Hess, 2007). The Australian Financial System Inquiry, conducted by a committee chaired by Keith Campbell, was formed in 1979 to examine the financial system. The committee made its final recommendations in 1981 for the deregulation of financial markets and related operational changes (The Campbell Report). The recommendations were grouped by (Hess, 2007) as changes to macroeconomic management, abolition of direct controls on interest rates and portfolio composition, strengthening of regulations aimed at preserving system stability, and removal of barriers to entry to the financial system. In the twenty years following deregulation, the banking sector was highly affected by the structural changes that accompanied the process. The barriers between different segments of the finance industry were removed and there was increased competition from domestic and foreign-owned institutions (See macro environment of NAB section for an explanation). Banks had to make various organisational and strategic changes to secure their positions. NAB responded to the changing business environment in several ways. Firstly, National Bank of Australia Limited merged with the Commercial Banking Company of Sydney Limited (CBS) to form National Australia Bank Limited (NAB)107. This helped to improve its customer and asset bases. With the merger, NAB reached a market share of 25%, behind Westpac (32%), which had also formed as the result of a merger108 (R. A. Ferguson, 1990b). Secondly, NAB underwent a reorganisation with McKinsey during 1980/1981. After the CBS merger, opportunities for NAB to grow domestically were limited and the financial deregulation process had also made the markets more competitive (R. A. Ferguson, 1990b; Fung, et al., 2002). As a result, NAB planned to capitalise on its retail banking experience overseas. The bank had made earlier attempts to penetrate overseas markets109 but these were mostly done to follow customers’ trade-related businesses (Fung, et al., 2002). After the merger, NAB rapidly expanded overseas by opening up representative offices in Asia, the USA and Europe (1982–1989). However, the real expansion took place with the acquisition of local banks in Scotland (Clydesdale Bank 1987), Ireland (Northern Ireland Bank 1987), the UK (Yorkshire Bank 1990) and New Zealand (Bank Of New Zealand 1992)

107 The first name was National Commercial Banking Corporation of Australia Limited 108 Bank of New South Wales and Commercial Bank of Australia merged to form Westpac Banking Corporation (Westpac). 109 Opened offices in Mauritius (1859), London (1864), Singapore (1971) Jakarta (1973) and Hong Kong (1974)..

180 (www.nabgroup.com). NAB strategy in overseas expansion was to capitalise on its core competency of retail banking experience, rather than entering wholesale markets as its competitors did (Fung, et al., 2002). Lastly, the company answered increased customer demand for better services and competition by improving its technology110. After the deregulation of the financial markets in Australia, financial institutions lowered lending standards and there was a rapid increase in the credit given to the private sector. Bad loans combined with an asset price boom resulted in many bankruptcies in the early 1990s (Australian Treasury, 2005). In general, the profitability of the banks had dropped, their asset quality had deteriorated and as of 1991 there was “$26 billion in bad and doubtful debts” in the industry (Howard, 1991). Moreover, consolidation in the form of M&As that began in the early 1980s continued at an increasing pace111 (Baethge, Kitay, & Regalia, 1999) Table 1.1, p. 6). Banks also cut branch numbers112 for rationalisation through cost-cutting (see Macro Environment of NAB). By 1994, the banks were gradually recovering, but NAB was doing particularly well, as a result of its conservative approach and successful overseas investments (Timewell, 1994). Due to favourable returns from overseas banks,113 NAB considered investing in the USA. It acquired Michigan National Bank (US) in 1995 for US$1.56 billion and HomeSide Lending (US) in 1997 for US$1.7 billion. These two acquisitions were different from the previous ones in the following respects. With the retail bank acquisitions in Ireland and UK, NAB was transferring its core knowledge overseas, while the US acquisitions were intended to transfer the learned knowledge back home (Fung, et al., 2002). Don Argus (then Chairman of NAB) recognised the US acquisitions as ‘reverse leverage’ (Fung, et al., 2002). In an interview, Joe Pickett (then Chairman and Chief Executive of HomeSide Lending) stated that what interested NAB about HomeSide Lending was its “superior technology" (Bergsman., 1998). HomeSide Lending had low-cost mortgage processing capacity, which NAB promised to bring to Australia (Boreham, 1999b). However, NAB soon divested both assets, with Michigan National Bank being sold to ABN Amro in 2000 for US$2.75 billion, at a capital gain of US$800 million (Fung, et al., 2002), and HomeSide being sold to Washington Mutual for US$1.9 billion after incurring a total of A$4 billion in losses in 2001.

110 Technologies like EDP and micro computers were used to increase speed and internal communications at the branches (P. Murray, 2003) In 1986, it had announced that it would invest $800 million over six years for upgrading the system of 1500 branches (R. A. Ferguson, 1990a) According to a technology provider NAB has started as early as 1988 to store information for its Relationship Management program and acquired and applied CRM technologies in the 90s (Khirallah, 2001). 111 Between 1990-1995 there were 129 mergers, between 1996-2001 there were 389 mergers. (K. Davis, 2007) 112 In Australia the branch numbers peaked at 7,064 in 1993 and dropped to at around 6,500 in 1996 and the closures continued through 2000s.(ReserveBank, 1997). 113 In 1994 the Clydesdale, Yorkshire and the National Irish Banks have contributed 30% of group operating profit (Timewell, 1994)

181 An important reform implemented in the financial sector after the Campbell Inquiry was the Financial System Inquiry (also known as the Wallis Inquiry) in 1997114. One noteworthy component of the Wallis Inquiry was a ban on mergers among the four major banks (four-pillars policy) (Inquiry, 1997) which encouraged the big four banks to grow in other directions. Another important implication of the Inquiry for NAB was that it had the supported development of financial services companies utilising holding company structures (Inquiry, 1997). After this period, NAB tended to move more in the direction of a regional financial services provider rather than a retail bank and immediately started a global restructuring program (Cornell 1997; Reuters 1998). In the late 1990s, while NAB was financially very successful, investors accustomed to continued growth and earnings were concerned over a slight drop in profits in 1998115. Media and analysts criticised the bank for not having “a clear strategy” (McLachlan, 1999) and for being close to a “conglomerate” with “geographically diverse operations and offering few synergies” (Knight, 1999). In 1999 Frank Cicutto, an internal recruit, became the CEO and declared he wanted to grow the company and was not afraid of change. As the bank was cash rich, analysts recommended a new acquisition or a share buyback (Boreham, 1999a). At the time, expansion into funds management was seen as having greater growth potential, partially because of the compulsory Australian superannuation pension scheme ("National Australia to buy MLC ", 2000). NAB initially wished to buy AMP, the leading wealth-management company in Australia, but instead in early 2000 acquired MLC Group from Lend Lease Corporation for A$4.56 billion. With this acquisition NAB became the third-largest fund manager in Australia after the Commonwealth Bank and AMP ("National Australia to buy MLC ", 2000). In 2001, NAB began a new restructuring campaign called “Positioning for Growth” (NAB Annual Report 2002), which was in part done as a result of the MLC acquisition and in part as an answer to increasing scepticism about NAB’s management (Bennett, 2000). Under the new structure, three regional business units were created—Australia, Europe and New Zealand—which offered integrated financial services. Wholesale financial services and wealth management remained global businesses and all were supported by the centre in

114 Both the Campbell Inquiry and the Wallis Inquiry were made to increase competition and bring efficiency to the financial system (Liebowitz & Wright, 1999). The Wallis Inquiry and the resulting report made 115 recommendations in three broad categories for improving the regulatory framework. The regulation of the banking was taken from the Reserve Bank and given to the newly established APRA. 115 NAB had recorded profits of A$2,223 million in 1997, A$2,014 million in 1998, A$2,821 million in 1999 and A$3,241 million in 2000 (Taken from Annual reports).

182 Melbourne. Overall, the program aimed to simplify the organisational structure, gain efficiency and generate cost savings. During this period, management was criticized for numerous reasons. Brian Johnson, the financial analyst of JP Morgan Securities, called these issues the “14 deadly sins of NAB in less than three years” (A. Hughes, 2004a). Firstly, in 2000, two software companies claimed damages in excess of A$50 billion from NAB (known as the AUSMAQ case) for failing to fulfil a promise to fully exploit the potential of an electronic trading system that NAB had bought. The case was dismissed in 2002 after drawing much attention in the media and creating anxiety among investors (Hughes 2000; . In 2002, NAB had to compensate 270,000 investors by $60 million due to over-charges in a unit trust in the MLC division (Boreham, 2002). In 2003, an employee at the Korean operations was found to have forged certificates of deposit and promissory notes for an amount of A$76 million(NAB, 2003). In 1998, National Irish Bank was accused of withdrawing funds from customers' accounts without their knowledge("NIB scandal spotlights ethics ", 1998). The allegations against the bank continued, with “overcharging of fees, underpaying of interest, tax evasion and non- payment of deposit interest retention tax” (D. Hughes, 2004) amounting to $110 million in costs. In 2003, NAB made a second unsuccessful attempt to buy AMP (Moore, 2003). The ultimate breach of faith in the company were the losses NAB incurred at its currency options desk amounting to A$360 million in January 2004. NAB foreign exchange traders had breached the bank’s risk limits, were involved in unauthorised foreign exchange trading activities and had concealed losses for an extended period of time. According to the report prepared by PriceWaterhouseCoopers (PwC) the excessively risky trading had been going on at least since 2000, but increased from 2003–2004116 (PricewaterhouseCooper's, 2004). Even if the direct cost of the foreign exchange losses was only a fraction of the HomeSide write down, the bank incurred high indirect costs as a result of negative publicity and scrutiny (McCallum, 2004). As a consequence of the scandal, the Chairman Charles Allen and the CEO Frank Cicutto resigned and four managers involved in the scandal were dismissed. APRA conducted an audit in March 2004 and imposed certain conditions on NAB117. It wasn’t the loss itself that drew scrutiny but also the “boardroom infighting” that

116 Key points of the PWc Report: The report noted that there was inadequate management supervision in NAB's markets division, weaknesses in control procedures, failure of risk management systems and an absence of financial controls in the division, the company lacked compliance culture within the markets division of NAB and there was a tendency to suppress bad news rather than be open and transparent about problems. 117 NAB Annual Report 2005: In March 2004, APRA conducted a review of the Company’s market trading activities and identified specific actions required by the Company: _ the Company would remain under close supervision by APRA until these actions were implemented; _ the Company’s internal target total capital adequacy was to rise to 10%; _ the Company’s approval to use an internal model to determine market risk capital was withdrawn; and

183 went on throughout the year (McCallum, 2004a). As a result, a new board and management team were appointed before the year end (Annual Reports 2004, 2005). The drop in the 2004 profit118 was disappointing for investors, especially in comparison to the rise of profits of the other two large Australian banks. As a result of the turmoil, customers were reluctant to deal with the bank. In that year’s corporate social responsibility report it was stated that there was a drop in NAB’s home loan lending and a decrease in the likelihood of non-NAB customers choosing NAB when selecting a new financial institution (NAB, 2004d). The new management team admitted that the recovery would take more than two years (B. Brammall, 2004; NAB says recovery could take two years," 2004). Investors were uneasy with NAB’s overall performance and institutional investors wanted to see NAB cash in some of its investments ("National Australia Bank (NAB) is under institutional shareholder pressure ", 2004); the income from Financial Services Europe had dropped substantially (37%) in 2004 (NAB 2004 Annual Report), (McCallum, 2004). In 2005 NAB sold National Irish Bank and Northern Bank to Denmark's largest bank, Danske Bank, for A$2.5 billion at a A$1.1 billion profit (NAB Annual Report 2005) (L. Murray, 2004). Internally the scandal forced NAB to reconsider its priorities and address the problems of “culture, risk management and compliance”. The new management began with a culture change. The 2004 Annual Report stated the revised corporate principles119, which stressed the importance of honesty and accountability. From 2004–2006, NAB continued with its organisational change program, which was planned to cost A$838 million in total (NAB 2005 Annual Report). The program’s efficiency increases resulted in approximately 1,800 redundancies over the next two years. From 2005–2007, NAB’s profits continued to rise and in 2007 the asset size reached A$574 billion, up from A$422 billion in 2005. NAB recorded improvements in its cost base and in 2007 management declared that the recovery from the 2004 crisis was complete (Annual Report) ("How the banks compared ", 2007). NAB’s return on equity improved, but still fell below the industry average120 ("How the banks compared ", 2007). By contrast, the

_ the Company’s currency options desk was to remain closed to corporate business and proprietary trading until substantial progress has been made to redress the issues raised by APRA in its report 118 NAB: Attributable profit to members of the Company after significant items dropped 19.7 percent down to A$ 3,177 million in 2004 . Commonwealth Bank: Attributable profit to members of the Company after significant items rose 28 percent to A$ 2,572 million in 2004. Westpac: Attributable profit to members of the Company after significant items rose 16 percent down to A$ 2,539 million in 2004. 119 NAB 2004 Annual Report: The Corporate Principles are; Being open and honest, take ownership and hold ourselves accountable (for all of our actions), expect teamwork and collaboration across our organisation for the benefit of all stakeholders, treat everyone with fairness and respect, value speed, simplicity and efficient execution of our promises. 120 2007: The average return on equity (ROE) for the big five banks rose from 20.6 to 21.2 per cent in 2007. Westpac ROE 23.8 per cent, St George’s ROE 23.2 per cent, Commonwealth Bank 22.1 per cent and NAB ROE of 17.1 per cent.

184 other Big Four banks used this period to their advantage and expanded their business considerably. For two decades (1984–2004) NAB had been the largest financial services institution by market capitalisation listed on the Australian Stock Exchange (ASX) (Bruce Brammall, 2005). However, in 2005 it gave away this title first to the Commonwealth Bank and then to Westpac. In 2007, the financial services sector was performing well, and the S&P/ASX GICS Financials Index peaked above 7000. NAB’s share price rose above $40 during 2007, up from $30 in 2005. However, during 2008–2009, the S&P/ASX GICS Financials Index dropped below 3000 and growth was reversed throughout the global financial crisis. It was noted that NAB was the “most vulnerable of the big Australian banks to the crisis through its exposure to derivatives, its relatively heavy exposure to business borrowers and its ownership of a British banking franchise” (M. Maiden, 2009). NAB’s earnings dropped in 2008 and the share price fell sharply to around $30, and even dropped below $16 in 2009. The Australian banking sector has since proved its credibility by surviving the tumultuous period. Of the twenty AA-rated banks globally, only eight remained after the financial crisis, and four of them were Australian (Murdoch, 2009b). As of January 2009, Westpac became the world's ninth-largest bank ($US28.2 billion), followed by the Commonwealth Bank as fifteenth, National Australia Bank as seventeenth and ANZ as nineteenth (Murdoch, 2009a). The above company history briefly summarises the background of a large global company. Following this history, publicly available data for NAB will be utilised to answer the research questions.

185 7.3 Research Question 1-A Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable HR practices? The use of the disclosure index on the annual reports of NAB displays that the company complies with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999-2004 and goes beyond these requirements. The only reporting requirement that was not found in the annual reports was the “auditor remuneration” (AASB 1034.5.3)121 for the years 2001 to 2004. Similar to BHP, NAB has reported on the existence of an Audit Committee122 (ASX, 2004) before it became a requirement to report. Chapter 5 has shown that there are relatively more regulations controlling the financial institutions than many other industries. Moreover, the Group's branches and banking subsidiaries in Europe (Great Britain and Ireland), New Zealand and the US are subject to supervision by the Financial Services Authority, Central Bank of Ireland, Reserve Bank of New Zealand (RBNZ), and the Office of the Comptroller of the Currency, respectively. Furthermore NAB’s fully paid ordinary shares were quoted on the London Stock Exchange, the Tokyo Stock Exchange, the New York Stock Exchange and the New Zealand Stock Exchange besides the Australian Stock Exchange. Overall, these external requirements certainly increase the reporting quantity of the Bank, however it does not necessarily improve the quality of its reports in regards to Human Capital reporting.

7.4 Research Question 1-B

How much more than the mandatory regulations do these companies report or make available to the general public?

For answering this research question annual reports of NAB, other company originated data (sustainability reports, website..) and other data obtained from secondary sources (academic articles, books…) were collected and analyzed separately.

121 AASB 1034.5.3 became operative in 2001. The company reported on this item starting 2002. 122 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year.

186 The study of the annual reports have shown that they can be good sources for gathering information about NAB’s corporate strategy, restructuring programs and executive and directors’ remuneration (required by mandatory regulations). There was also some Human Capital data that is not found in the other case company reports, such as; aggregate training costs, details of the training programs for various employee levels and a breakdown of employee numbers. However there was a need for more Human Capital data to reveal the sustainable human resource practices of NAB. The search for Human Capital data in the public domain other than the annual reports has revealed that there was more qualitative data for NAB in the public domain. But the quality of Human Capital data somewhat improved after 2004. This time period coincided with the increased legitimacy needs of the new management right after the Foreign Exchange Crisis in January 2004. The data found in the narrative sections of the annual reports and sustainability reports was combined with other data found from the secondary sources and a Human Capital database for NAB was constructed. This data was sorted using the six indicators of the “Drivers of Sustainable People Management Systems” (Royal, 2000) and presented in a checklist matrix displaying the available Human Capital data in the public domain, otherwise within the reach of the security analysts. Next section will present the results within the framework of the model by Royal (2000).

NAB Sustainable Human Resource Management Indicators

1. Job Characteristics a. Competencies: The Royal Template classifies organisations that have competencies at high-order contextual and theoretical knowledge, possess occupational specialist positions and high levels of creativity as professional organisations.

Knowledge Competencies: In terms of knowledge and technology acquisition it is found that NAB functions at a high level. Investments in technology keep NAB at the forefront of technological developments; NAB was among Australia's top three largest users of technology in 2004 (Edwards, 2004), the same year in which the organisation started using technology to help filter and track the 2.7 million transactions handled by the bank each day (J. Adams, 2006). The new IT system aided NAB in storing customer-related information in a

187 "national leads" system whenever a customer completed a transaction (J. Adams, 2006). In this way customer-specific information could be used for improved sales and services and was maintained within the system. On the other hand, the data suggested that the implementation of some technology projects was slow, troublesome, costly and poorly coordinated (Connors, 2004). In 2000, two software companies (owned by Mr Maconochie) claimed damages in excess of A$50 billion (AUSMAQ case) from NAB for failing to fulfil a promise to fully exploit the potential of an electronic trading system that NAB had bought (Hughes, 2000). Lastly, there is not much evidence suggesting that NAB has integrated experiential and organisational learning into its daily operations, nor that it has the capability to capture knowledge or share knowledge. Overall, in terms of knowledge competencies, it is found that NAB scores highly on technology acquisition but there is no indication that it uses its knowledge capabilities at a high level.

Skills competencies: In terms of skills competencies, companies that have occupational specialist positions as opposed to well-defined routine positions are considered professional organisations. These organisations find innovative ways to perform work and skills development. The majority of the NAB workforce consists of permanent full-time and part-time staff123; the high percentage of core workforce suggests that NAB has greater control over skills development. Organisations that have gone through massive downsizing, such as NAB, face a loss of skills in the short term unless they upgrade the remaining skills- pool, as Dunphy and Benveniste (2000) remind us (D. Dunphy & Benveniste, 2000). Even if Cicutto had promised “focused performance management, talent review and identification and career path development” as a part of the new high-performance work culture, the data didn’t reflect that NAB was innovative in recognising operational skills (NAB, 2002) The upskilling of employees focused on sales skills (NAB, 2002), which didn’t guarantee that they were the skills that employees agreed to advance. In an employee satisfaction survey conducted in 2003–2004, only 60% of employees felt there were career opportunities for them within the organisation (NAB, 2004d), which points to several issues. Firstly, employees may feel there is lack of recognition and development of skills and, secondly, they may feel there lacks a clear career ladder. It can be expected that an extension of the Talent

123 NAB workforce consists of full time (76 percent), part-time (20 percent), casual and contract employees (4 percent).

188 Management Program to all the employees after 2004 and the individual development plans that are reviewed quarterly will improve the skills base of the organisation.

Creativity competencies: In terms of creativity competencies, companies that encourage new idea generation are considered professional organisations in the Royal template, with a continuum ranging from low to high. Historically, a banking career at NAB has been defined as “highly autocratic, [with a] high level of management controls and routine positions” (Baethge, Kitay, & Regalia, 1999). Teller jobs, which were once very prestigious, are now an entry level positio(Baethge, et al., 1999)n that requires little training and is lower paid; moreover, they are becoming sales roles . As Baethge, Regini and Kitay noted, the new sales role provided little room for innovation or initiative taking. In terms of creativity competencies, the data do not indicate NAB designs its systems to increase innovation and creativity.

b. Management Control: Companies with low levels of management control and high levels of employee discretion and control are on the higher end of the continuum for professionalism. In the past, NAB’s Book of Regulations contained more than 600 rules formalising tasks; a highly bureaucratic organisation, NAB is often referred as the “dead hand of Melbourne” (NAB, 2004a). The 2001 restructuring program aimed to transform the formalised hierarchy to a flatter team-based structure. The program was developed to eliminate the unnecessary levels of management and ideally work as one “high-performing team” by empowering employees. Yet, prior to 2004, the data do not show that the organisation successfully completed this transformation. For instance, there was high management control in assessing the newly developed behaviour compliance system.

c. Co-worker Relations/Work Organisation/Teamwork/Communication: In the Royal template, companies that maintain high levels of vertical and horizontal communication, co- worker interdependency and team-based structures with a flatter hierarchy are on the higher end of the continuum for professionalism. There is not much evidence regarding how internal communication occurs at NAB, with the exception of an internal TV network and intranet used to deliver new policies and messages to employees. There are no case studies or examples provided by the company demonstrating the new team structure and its functioning.

189 d. Power/Decision Making/Leadership: The Royal template describes an active consent relationship whereby decision making and leadership are participative and employee- oriented. In this kind of relationship, employees internalise company goals and receive intrinsic rewards from active participation in decision making. In employee/employer/manager relationships, NAB conforms to a super power paradigm, in which supervisory roles are of a highly controlling nature, sometimes through rules and regulations and sometimes through customer surveys that return new measures to be improved. In 2006, unionised employees voiced their concerns about the company developing new performance targets (FSU, 2006a), with some staff being informed with as little as six weeks’ notice that they could be terminated if they failed to improve their performance. The involvement of employees was found to be low across the group. In employee satisfaction surveys only 63% of employees in 2003 stated they were excited about their perceived role in the future of the organisation. To truly involve employees in the internalisation of goals, these goals need to be openly communicated and supported by the managers. The public data suggest that NAB was working towards improving its leadership capabilities, with initiatives including the Leaders as a Coach programme (2001), the on-line Masters of Business Leadership Programme and Leadership Essentials for First Time Leaders. As a result of these efforts overall employee satisfaction increased by 11.5% between 2000 and 2003 (National Australia Bank, 2003b). Frank Cicutto was CEO from 1999–early 2004; with 34 years’ experience at NAB he assumed the position from Don Argus. Much like Argus, he followed a growth and international expansion strategy and had the faith and support of the board during this period. Following his forced resignation in 2004, his leadership was described as follows; “he had encouraged a culture of profits at the expense of prudence”(Comanescu, 2006), there was a lack of transparency (Rolfe, 2004) and there was a need for leadership. It is interesting that these views exist despite the many leadership programs initiated and awards received. A huge jump in employee satisfaction was recorded in 2004/2005 (at 68%, as compared to 60% in 2003/04), which was an indication of the favourable response to the new leadership.

2. Recruitment The Royal template suggests that the professionalism set of human resource practices are those that encourage an employment relationship where recruitment and career progression occur across all levels of the firm. Organisations in which positions are filled

190 using both internal and external resources and where qualifications and experience are the major criteria for selection fit the professionalism definition. In terms of recruitment practices, NAB has moved from a traditionalist structure to one of professionalism. Recruitment at NAB is similar to that of organisations in which job characteristics imply the existence of occupational specialists. Job openings are announced both internally and externally. For junior positions, graduate centres, the media and the company website are used; these include teller positions, call centre roles and customer service representatives. For senior management positions, both internal and external resources are used; for instance, Frank Cicutto (1999–2004) had been with the company for 34 years before leading the company, whereas his successor John Stewart (2004–2008) had only worked at NAB for a year. Historically, recruitment was carried out by branch managers from a pool of exclusive males who came from non-urban, professional, self-employed or farming families with private schooling (J. Hill, 1982). Commitment to this career industry was guaranteed by entry at the bottom and slow career progression. Now the selection criteria for professionals are both qualifications and experience. According to the Workforce Report 2002, the proportion of employees in the finance sector without any post-school qualifications is decreasing. In May 1999, the total number of employed persons without post-school qualifications working in the finance sector was 52.4%, whereas in 1996 it was 55.5%. NAB is clear about its recruitment policies and procedures, which are found on its career web pages. Tertiary qualifications are becoming increasingly important (Financial Services Union, 2002); a tertiary degree is a requirement for all positions at NAB. For instance, an IT degree is required in the technology department, a finance degree in the finance department and an agriculture degree in a job at rural branches (NAB Annual Reports). A business postgraduate study is essential for upper management professionals and international finance industry experience is stated to be valuable for complementing NAB’s international aspirations. Further, its Annual Reports state NAB is committed to increasing the diversity of its workforce. In 1997, NAB became the first publicly listed company to lodge a Disability Action Plan with the Human Rights and Equal Opportunity Commission under the Disability Discrimination Act (NAB, 2004c). Likewise, its commitment to improving the employment prospects of Aboriginal and Torres Strait Islander people is demonstrated by NAB's agreement with the Commonwealth Department of Employment and Workplace Relations to be a Corporate Leader for Indigenous Employment (NAB, 2004b). While such commitments to “key marginalised groups” (NAB, 2004d) were successfully fulfilled by the organisation

191 and received external recognition124, the same couldn’t be said for the representation of women in management; the lack of women at higher management levels was even criticised by shareholders (2006 AGM). More than half of NAB’s workforce consisted of females (60%) between 1999-20004 but they mostly occupied clerical positions. Comparing data from the sustainability reports of the Big Four banks, in 2003/2004 NAB had the lowest female representation at the top management level (19%) (FSU, 2007)125. These issues were addressed within the cultural change program in 2004 and integrated into the new corporate principles but the data suggest it took some time to replace “the blokes’ culture”, as described by a female employee126 (Walters, 2004a). The initiatives began to show signs of effect as the representation of women in senior management increased to 29% by 2006/2007 (FSU, 2007).

3. Training According to the Royal template, organisations that are classified under professionalism tend to adopt an internal/external training philosophy. In these organisations the nature of internal training is on-the-job, conducted by colleagues and peers, and external training is acquired from a tertiary or professional institution, providing a formal degree or diploma. The public information suggests NAB employs both internal and external forms of training and its training structure fits within the occupational category. The organisation aligns its recruitment strategies with training activities. While tertiary qualifications are required for all positions, this is supported by job-related training by superiors, internal trainers and peers. Innovative financial products launched in the markets; technological developments like internet banking; new regulatory compliance requirements added to the competition in both retail and institutional markets and ongoing downsizing demanded NAB invest continuously in training. Training programs at NAB are required to update technology and product knowledge skills, as well as develop the relationship management skills of customer- facing staff. In the early days of banking in Australia, training was conducted under the close supervision of branch managers, and later shifted to short courses in staff training schools. However, after staff resistance to these schools, training returned to the branches in the form

124 High Commendation award at the Australian Chamber of Commerce and Industry Work and Family Awards in 2002 and three Diversity@Work awards for Inclusion of People with a Disability, Inclusion of Indigenous Australians, and for being disability friendly achievement in the 2003 Victorian Excellence and Leadership in Diversity Awards in the category of Employer of People with a Disability. 125 Female Representation at top management in 2003/2004: NAB (19%) ANZ(24%), Westpac(26%) and IAG(30%) 126 “When I was on the senior management committee on policy in audit groups, I was the token secretary for the meeting".

192 of programmed on-the-job courses (Game & Pringle, 1979). Current training programs at NAB incorporate a combination of on-the-job training, competency-based training, in-house workshops and external training courses. In Australia, there are Learning Centres in Sydney and Brisbane that deliver training programs for a range of business units (National Australia Bank, 2003a). The Graduate Development Programs offer new graduates specific training in each business unit and some rotation programs are offered for up to two years. NAB states that leaders are important for carrying the organisation to the next level; as such, the Talent Review Program assesses the leadership skills and overall capabilities of managers against “The National Leadership Standard”. The program that started with five hundred top managers in 2001 was extended down the hierarchy in 2004. NAB collaborates with Charles Sturt University in an online Masters of Business Leadership course, while the Leader as Coach training initiatives and Adviser Campus are aimed at building a coaching culture within the organisation. Support for first-time leaders is provided through the Leadership Essentials program. These programs have been recognised as highly innovative externally127 but public data indicate that from 2004 these programs need to be extended to middle-level management and supported with new corporate values. While NAB’s Customer Relationship Management (CRM) systems were recognised as superior in the industry128, the customer experience at NAB doesn’t fully reflect the investments made in CRM systems and technology. Customer satisfaction surveys indicate that the service quality at NAB branches was found to be slow and insufficient (National Australia Bank, 2002a). One of the causes for such underperformance could be lack of proper training for customer-facing staff. NAB reported that in 2001 it spent $55 million on training; however, the content of the training programs and thus the effectiveness is unknown (National Australia Bank, 2002b). NAB outsourced some of the recruitment and training functions (Kemp, 2001) and employees reported that there were fewer training staff and branches were understaffed (FSU, 2006b). In an industry in which there are high turnover rates and downsizing,129 lack of training and understaffing may result in employee dissatisfaction and low employee retention. Gondolfi, in a study of a downsized bank in Australia, displayed the importance of the development of human skills and competencies (personal development and growth) for better coping with downsizing (Gandolfi, 2006). Two

127 International Consortium for Executive Development Research, and global Corporate Leadership Council have recognised the excellence of these programs. 128 NAB’s CRM technologies has won awards as the Relationship Strategy - Institute of Financial Services UK & British Telecom, November 2001 and Australian Bank of the Year, Best Use of Technology—The Banker Awards (Financial Times, UK), September 2002 (NAB, 2002) Performance Highlights). 129 2003-2004 Employee turnover at Westpac 18,5% ; at NAB 2003-2004: 15.1% for the NAB Group 18% for Australia and 16.3% for NZ (PricewaterhouseCooper's, 2004), (Cicutto, 2003).

193 other Australian-based studies have pointed to the need for developing behavioural skills for finance sector employees in addition to technical skills (Jackling & Sullivan, 2007; Sappey & Sappey, 1999). In 2002 NAB implemented two training initiatives that achieved measured improvements in customer satisfaction by 2004130. Nevertheless, customer satisfaction continued to be an issue even after 2004 and the new management underlined the need as follows:

we also have to increase our people capability, because I mentioned it being dumped down. We've got to make sure that we train them properly in a whole range of products and we improve the branch experience for the customer. That's, at the end of the day, what it's all about (CEO John Stewart, Q4 2005 National Australia Bank Earnings Analyst Briefing and Conference Call).

In an environment in which redundancies131, restructuring and cultural change are ongoing, innovative training programs such as the web-based Global Learning Management (implemented after 2005) should be replicated.

4. Career Opportunities Internal career ladders within organisations offer opportunities for promotion and employment security. Opportunities for both internal and external careers occur in organisations which have occupational specialists. According to the Royal model, in these organisations recruitment occurs both at the bottom and higher levels, and training is essentially external through degree courses supplemented by internal on-the-job learning. Public data suggest there is a dual career structure at NAB, with career opportunities available internally and also the opportunity for experienced people to join at higher points of the career ladder. There are numerous examples of employees that joined NAB at junior levels and stayed with the organisation throughout their career, for example, former CEO Frank Cicutto had been with NAB over a quarter of a decade, but such examples are diminishing in frequency. Training provided to graduate recruits enables them to start working in a number of professions within the business unit and progression among business units is also possible. In units where higher-level professional knowledge is important, such as finance, career progression occurs not only with on-the-job training but through attaining post-graduate

130 According to Financial Institutions Customer Monitor customers who were very satisfied or quite satisfied with NAB as their main financial institution jumped from 74.1% in the June 2004 quarter to 82.9% in the September 2004 quarter ("A Champion of Corporate Governance," 2004) 131 Between 2005-2007 : 2500 new redundancies planned.

194 degrees. In some business units, as in agribusiness or technology, the career path is much clearer, such as entry-level as a graduate recruit and experiencing a gradual progression (NAB, 2004b). Historically, staff was recruited at school-leaving age and worked up the pyramid through in-service training courses. It was common to hear stories of people starting as a messenger and becoming a managing director (Game & Pringle, 1979). Banking was a career industry, particularly for males with a high commitment to their organisation. But the ‘cradle-to-grave’ employment within one organisation disappeared as banks adapted to the new competitive environment (Still, 1997). The “new form of employment” introduced a "sales culture" to the banks (Baethge, et al., 1999). As Baethge, Regini and Kitay noted, this brought an emphasis on a new set of sales skills and caused a “narrowing of task variation” for many employees. Operational jobs were taken to large centralised units and a dual labour market emerged. Low levels were filled by younger females, while top levels that required decision skills were filled by male employees, away from branches (J. Hill, 1982). As a result, the clear career path based on gradual job training in banking diminished, leaving a more chaotic structure. When the trend of loyalty to a single organisation lessened, the trends indicate that new finance professionals identified themselves more with the profession than the organisation. In 2000, the average proportion of Australian employees, across all industries, who had been in their current job for more than 12 months, was 84%, while only 77% of finance employees fell into this category(Financial Services Union, 2002). The reasons for male resignations in the industry were found to be lack of opportunity for promotion, insufficient job satisfaction and frequency of transfers. Restructuring and downsizing132 also resulted in a decrease in employment security at NAB, and only 60% of employees said they perceived strong career opportunities within the company (NAB, 2004d). The new management had to work at setting clear career paths for all levels of employees, supplemented by the new training programs.

5. Rewards The Royal template indicates that for organisations whose employees are occupational specialists and in which dual career ladders exist, a highly variable and performance-related pay structure exists. The data show that NAB was in transition from a traditional to professional organisation, and the change was slow.

132 During 2000-2005 NAB shed ten thousand jobs.

195 In the past, the reward system in the banking sector was geared towards higher fixed pay with a low variable component. In time, the variable component of the reward system has risen as the pressure on both individual and group performance increased. This shift has been recorded in NAB’s 2004 annual report; “The journey to the current reward mix started many years ago from a position of 100% fixed remuneration”, noting the new reward mix of executives as a worthy development133. From 1999–2003, notable consideration was given to improving the performance appraisal system at NAB. In the 2002 Annual Report, one of the three stated goals for the year ahead was to install a new Performance Management Framework (National Australia Bank, 2002b). A considerable aim of the system was to extend appraisals to include all employees, with emphasis on appraising both individual and team performance through the “Talent Review Program”, although it initially only included the upper levels of management. The offering of a company-wide share plan in 2004 was the result of these consistent efforts. Among the five core strategies listed in the 2000 corporate annual report, the themes of “global growth”, “providing diversified income streams” and “creating maximum shareholder value” emerged as strategic goals. Needless to say, the performance and reward systems supported the achievement of these goals, mostly measuring sales and financial performance and rewarding short-term results. The reward system emphasised short-term incentive rewards that were paid in cash (National Australia Bank, 2004) and the long-term incentive plans were linked directly to the growth in NAB’s share price (National Australia Bank, 2002b). Measuring only economic performance, the system supported the culture of “profit is king”134. Later, one of the traders responsible for the foreign exchange crisis, David Bullen, in his book titled Fake: My life as a Rogue Trader explained how the system was easily manipulated. He recalled that “management asked each trader personally for their opinions on appropriate bonus amounts, which provided the traders with an opportunity to predetermine their profits” (Bullen 2004, p. 39 cited in (Dellaportas, Cooper, & Braica, 2007)). Part of the series of changes that were made in 2004 involved the performance management and rewards systems. Unlike the prior value system aimed at providing value only to shareholders, the new system recognised customers, employees and communities as important stakeholders (NAB, 2004d). The renewed reward policy supports the new corporate principles by including key performance indicators that have both financial and non-financial

133 The reward mix included 25-30% fixed remuneration, 30-35% short term incentive and 40-50% long term incentive for the Managing Director and Chief Executive Officer (PricewaterhouseCooper's, 2004). 134 An expression used by the corporate and institutional banking staff in interviews with APRA officials (A. Hughes, 2004b).

196 components for measuring performance (National Australia Bank, 2004). Consequently, the integration of the reward strategy globally simplified the system, giving employees a clear message about the new performance criteria. The introduction of “behavioural and compliance quality gates” for determining short-term incentives helped to communicate that expectations of employees went beyond economic results. The foreign exchange crisis placed every action of the board under the scrutiny of investors, and the new senior executives’ reward packages were heavily criticised in the Australian media (McCrann, 2004). However, an important part of the new strategy was to have at-risk elements and long-term focus for executive remuneration, whereby rewards were to be received progressively over the executives’ contract depending on the group’s performance. Linking the executive’s performance to its contribution to corporate social responsibility criteria was implemented after 2005 (NAB, 2005). Prior to the 2005 CSR report, the company publicised little information about the breakdown of employee numbers, their salary levels and agreements with unions. Regarding salary levels, NAB stated that it targeted the market median levels in the finance industry (National Australia Bank, 2004) and rewarded employees regardless of gender (National Australia Bank, 2003b). However, later a chart published in the NAB 2005 CSR Report showed that females continued to be paid less than males in similar positions. In its Annual Reports NAB noted that it had held “successful pay negotiations” with the IBOA and Unifi in Europe, Finsec in New Zealand and FSU in Australia (National Australia Bank, 2001). An examination of other sources showed that this was mostly true and there were no interruptions to work at NAB due to prolonged pay negotiations (FSU, 2006b). Relations with unions were to improve further as the company demonstrated the acceptance of all stakeholders’ interests in the company. A global conference of financial services unions that NAB hosted in 2004 confirmed this aim. Overall, the changes made to the reward systems during 2004 were all very positive and were strongly reinforced by other human resource management systems. However, acceptance of these systems by many employees other than senior management took some time (NAB, 2005). A biennial employee survey showed that there was a big drop in satisfaction levels for “rewards and recognition other than pay” from 2003 to 2005135 (CSR Report 2005). In 2005 and 2006 employees reported that new performance measures, combined with understaffing in some branches due to off-shoring and job cuts, placed extra stress on them (FSU, 2006a).

135 Totally agree: 58 percent in 2004/05, 67 percent in 2003/04.

197 Certainly, sustaining and improving the engagement of employees during this time was highly difficult due to ongoing change activity and redundancies (FSU, 2005).

6. Professional Identity and Culture The Royal model specifies that organisations in which employees identify more with the organisation rather than with the profession are those in which there is a strong dominant culture and where networks have a top-down structure. In the past, bankers identified themselves with the organisation rather than the profession and there was a strong dominant hierarchical culture at NAB. However, the trend within the industry is changing. According to 2002 statistics, finance professionals change jobs more frequently than those in other industries136, and thus are tied less to the organisation but more to the profession. With a company history spanning over a hundred years, forty thousand employees and global operations spread over five continents, NAB had become an organisation with a “complex organisation structure” and a “cumbersome bureaucracy”, as defined by Elizabeth Hunter, head of People & Culture at NAB (Finch, 2006). The company had adopted various programs aimed at simplifying the business structure or the changing the culture but had little success137. During the 1990s, the board and management were very happy with the continued growth in business and earnings138, and the expectations of shareholders had also risen. In reflection of this appreciation, the corporate strategy was based on growth in business and returns for shareholders. The messages sent by leaders, hence the corporate culture, replicated the corporate strategy, and a culture developed in which economic results were highly valued. . Shortly after taking the CEO position from Don Argus in 1999, Cicutto announced that his priority would be growth just like his predecessor. At a business lunch in Melbourne he had said that he saw “enormous short-to-medium term growth opportunities for its core banking businesses” and would put the bank “on steroids” ("Cicutto ready to take on fresh challenges," 1999). In the investor briefings he openly discussed corporate success via improvements made to shareholder value through increased sales, acquisitions and financial returns (Cicutto, 2000b). He repeatedly sent a message that a transformation would be achieved through “emphasis on growth”(Cicutto, 2002). Even the new restructuring program was titled

136 “The average proportion of Australian employees, across all industries, who have been in their current job for more than twelve months, is 84%. However, only 77% of finance employees fall into this category”(R. Gray, 2002). 137 NAB went through a reorganisation with McKinsey in 1980/1981 and in 2001: Positioning for Growth. 138 Return for assets between 1986 – 1999 have been steady and above industry average for National Australia Bank. 0,72 (1986), 0.70(1987), 0.83 (1988), 1,04(1990), 0_81(1991), 0,78 (1992), 0,95 (1993) 0,97 (1994), 1.36(1995), 1.34 (1996), (Roberts & Amit, 2003).

198 “Positioning for Growth”, reminding all the stakeholders what their strategy was about (Cicutto, 2002). In the relatively few instances that the culture change was discussed, it was described as a change towards a “high-performance work culture”(Cicutto, 2003). However, at NAB this culture was defined rather narrowly 139compared to the definitions found in literature (please refer to Chapter 2); for example, it didn’t include employees’ involvement in values- setting or decision-making. The communication networks were also problematic, as the culture allowed only good news to be shared within and outside of the bank. Cicutto himself proved this when he failed to provide timely and accurate information about the reasons for the losses incurred at HomeSide Lending in 2001 (Muolo, 2001). In one interview, institutional investors stated that they questioned bank officials about HomeSide Lending losses but received no reply (Arbouw, 2004). In summary, until 2004 NAB’s management created a culture in which employees were encouraged to take bigger risks to achieve higher performance results. The human resource systems supported this performance-based culture. The change program initiated in 2004 under the new management put risk management and compliance at the top of the agenda, backed by a need to change the corporate culture (Steward, 2005). Unlike the previous management, culture change was given the utmost importance and explained through a clear outline of expectations through the new Corporate Principles. A principles benchmark survey was started to measure culture and leadership capabilities were monitored more closely (National Australia Bank, 2004). Support for culture change was provided through new systems and management practices. All employees were issued with a Statement of Corporate Principles, supported by an employee awareness campaign. Leaders have become role models in practising these principles. In his briefings to the investors, new CEO John Stewart was very open and honest, reporting not only the good news but also the bad news. He was open enough to report that “in 2004/2005 both employees and stakeholders are unhappy, customer satisfaction is declining and the leadership team is fragmented” (Steward, 2005). The publication of the confidential APRA report on NAB’s website (APRA, 2004) demonstrated the seriousness of the new management in pursuing transparency. Unlike the previous management, CEO Stewart was more inclusive of stakeholders’ interests. He explained corporate progress

139 HPWS Defined by Cicutto: Great People : Recruit, develop and retain people who have skills and attitude to build excellent relationships and deliver on customer promises; Great Place : Create an environment which values diversity and encourages people to perform to their potential ; Winning Performance : Measure and reward to drive individual and organisational performance.

199 through the development of “culture/ people, external stakeholders, business efficiency and revenue growth” (Steward, 2005). His definition complements the Corporate Principles “created to deliver consistently superior value to shareholders, customers, employees and communities”(National Australia Bank, 2005). Overall, the culture at NAB will continue to change and evolve even though, as the new management often noted, it would take time (Steward & Fahour, 2005).

7.5 Research Question 2: Is there a knowledge gap between the analyst reports and reporting of Sustainable Human Resource Practices by companies?

To extrapolate upon the contents and recommendations of the analysis, this study consults reports prepared by three investment banks covering NAB during 1999–2004. A random selection was made for each year from each set, with 74 reports in total being used. These reports display the results of analysts’ valuations of NAB’s stock value computed using information that is in the public domain. In comparison to the other two case companies, analysts have used more qualitative data in writing recommendations for NAB centring on frequent management changes, restructuring programs and strategy. One possible explanation for the use of more qualitative data in analysis could be related to the type and amount of data provided by the company through annual reports and investor briefings. Hence, a study investigating the voluntary reporting of intellectual capital in Australian and Hong Kong firms showed that NAB placed great value on the internal capital elements covering policies, procedures, re-engineering and other processes, and quality certifications associated with the firm (James Guthrie, et al., 2006). Analysts tend to ask more questions about operations and recovery plans when a publicly listed company encounters a crisis. For NAB this was the HomeSide Lending writedown and sale in 2001–2002. However, a review of the reports indicates that most of the analysts’ questions were left unanswered during this period, causing some of them to conclude a lack of transparency of management. In response to the huge financial loss, the company changed the Chairman of the Board and sold Michigan National Bank. More importantly, the company implemented a new restructuring program with McKinsey that promised great costs savings. Most analysts, after listening to the CEO’s announcement about the new “Positioning for Growth” program, replicated in their reports NAB’s expectations of

200 the change program. They linked the potential success of the program to future cost reductions through the simplification of processes, downsizing and outsourcing. Only some were sceptical about the changes and early on warned against “premature external assessments of savings” and “downsizing” (Macquire Research Equities, 2001). Further concerns included lack of relevant experience of the newly appointed executives and lack of clear career paths for them, gaps in depth of experience in different departments, and loss of skills due to managers leaving. Overall, all analysts approved the new strategy that promised growth through acquisitions and regionalisation. On the other hand, very few discussed change through the eyes of the employees and its potential contributions to improved human resource practices (soft measures) that could result in the sustained performance of the company. More importantly, the positive analysts that repeated the company’s claims that “there will be clear lines of accountability”, “culture change”, “more community involvement” and “acknowledging broader social responsibility” rarely followed up on these programs during the implementation stage. For instance, for the development of a high-performance work culture, analysts never questioned employee satisfaction and engagement, diversity, workplace relations or employee health and safety. Furthermore, even when NAB announced investments in intellectual capital (IC) or knowledge management, analysts were unable to place a value on it. The value analysts place on investment in IC is reflected in the statement:

While it is important to continue to develop e-commerce initiatives and invest in intellectual capital, cost control remains one of the key drivers in assessing management performance.

Discussions about corporate governance, which is an essential element for the long-term success of the company, increased over the five years examined in the analyst reports. Then again, whilst certain elements of corporate governance received attention, some essential ones were ignored. For instance, transparency and continuous disclosure have been stressed as important elements for building trust among investors, yet several times analysts commented that they observed NAB reflecting itself differently than it actually is and taking decisions to impress investors. Their views were reflected as follows:

Another populist action by NAB…. To this extent we see populism as perhaps driving process more than it should. (CSFB, Feb 2004).

201 While analysts stressed the importance of providing timely information to the investors, after the failure of HomeSide Lending, analysts stated that management failed to provide information about NAB’s losses (Arbouw, 2004). Similarly, during the Ausmaq dispute management assured investors it would “release information over the trial period”, but it never did. On yet another occasion, an internal communication about the restructuring program at NAB was leaked to the media before the official announcement and created speculation in the market (2001). The second most frequently commented-on element of corporate governance at NAB was the composition, number and experience of directors on the board and the remuneration of executives. On the other hand, prior to the 2004 foreign exchange crisis, risk management, accountability and board culture were seldom discussed, perhaps because of the indirect link between corporate governance and short-term earnings. A study conducted in Denmark found that financial analysts only include information they regard as relevant to support the investment recommendations they supply to investors (Arvidsson, 2003). Another reason may be a lack of knowledge about the link between good board practices and the long-term sustainability of the company, which became more evident when analyst recommendations were still outperform or neutral during and after the foreign exchange crisis in early 2004.

Our impression at this stage is that this development will not result in any substantive changes in strategy regarding the extent or nature of any of NAB’s foreign exchange or financial markets activities. We would expect at least some review of operational risk management procedures given the apparent weakness revealed…..None of the customers are directly affected. - Recommendation: Neutral (CSFB, 14 Jan 2004, NAB losses question credibility)

In this case, the time lapse caused by a knowledge gap was evident in their comments. Only after the analyst learned future earnings were to be flat could they link the foreign- exchange losses to negative sentiment and loss of management credibility and change their recommendations accordingly. Answers to Research Question 1b for NAB has shown that the company goes beyond its mandatory regulations in reporting information about its Sustainable People Management Practices. This information is much less in the annual and sustainability reports and more in the other sources for NAB. Nonetheless, there is also some missing Human Capital data in the public domain, which can not be obtained as this research replicates the regulatory environment that the analyst find themselves in and uses only publicly available data. On the other hand, the analysis of the security analyst reports show that analyst include top

202 management specific issues and lack the methods to make meaning of Human Capital data within the Human Capital framework. In conclusion, there is a knowledge gap between the analysts reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital. The gap is partially a result of analysts’ ignorance and acceptance of facts as they are presented and partially a result of the lack of transparency of NAB’s leaders.

7.6 Research Question 3 How important is it for analysts to be able to bridge the knowledge gap, within the financial regulatory services framework, when making predictions about the future financial performance of ASX-listed companies? There were several examples for the information asymmetry that the Human Capital Analysis depicted at NAB. The data collection and analysis of NAB have highlighted that “leadership, accountability, transparency, corporate culture and knowledge management” are significant Human Capital related indicators for NAB that need to be evaluated over time as a part of the Human Capital. Only few of these items were reported or evaluated in the analyst reports. The literature review has presented that accountability and openness of the management of corporations could be strong indicators of future growth and sustainability. The follow up of significant Human Capital information such as “transparency” and “board culture” gave insights for the future financial performance of NAB before 2004. The lack of good corporate governance practices have resulted in NAB to experience a corporate scandal in early 2004, which had both financial repercussions as well as loss of reputation and market share. In contrast, the findings of this study demonstrate that equity reports included information on only some corporate governance elements; such as “board structure” in the form of “independent vs. dependent directors, transparency and remuneration strategies” but excluded items like “board culture, directors’ relevant experience, risk management strategies, compliance measures and accountability” that could have helped them to develop a deeper level of understanding of corporate governance practices. Different then Human Capital Analysis, analysts prefer to use the company rhetoric. NAB just like Enron, was receiving extensive recognition for its good corporate governance practices all the time when internally it was suffering from excessive risk taking, low level

203 compliance management and accountability problems. Media and analysts knew about the “Profit is the King Culture” at NAB and they were very positive about what it promised for the future; growth. Considering the differences in understanding of Human Capital in analyst reports and what Human Capital analysis have depicted it is highly important to close this gap for improving the investment recommendation process.

7.7 Company Rhetoric vs Reality Compared Through Secondary Sources

1. Policy Framework: Based on the data gathered from publicly available sources, it is not possible to define clearly how NAB operates in terms of policy development and monitoring for corporate governance and stakeholder management. This lack of clarity points to a lack of comprehensive approach in stakeholder management. A more clear conclusion is that the company did not possess a coherent business model for sustainability between 1999–2004.

Prior to starting the analysis, a background study of the banking sector and NAB’s leadership position in the sector created the expectation that NAB would have superior management practices, risk analysis and board practices. Additionally, it was also expected that NAB would be proud to reveal this to stakeholders and to reduce information asymmetry. Hence, a study investigating the voluntary reporting of intellectual capital in Australian and Hong Kong firms showed that NAB placed great value on the internal capital elements covering policies, procedures, re-engineering and other processes, and quality certifications associated with the firm (James Guthrie, et al., 2006). However, this study of NAB’s publicly available documents did not present much evidence confirming the strength

204 of its policies and internal management systems for sustainability. This was even more evident in relation to the board systems. The evidence rather demonstrated that advanced management systems were used only for improving relations with certain stakeholder groups. According to Waddock et al (2002), to install principles of sustainability, responsibility needs to be built into corporate vision and associated values. Consequently, top management needs to show commitment by communicating this to the organisation and other stakeholders such as suppliers (Waddock, et al., 2002). Under Cicutto’s leadership (1998– 2004), as the focus was on providing shareholder value, company strategy was set on sustained growth and profits In relation to considering stakeholders’ interest in NAB’s decisions and activities, the approach was rather superficial. Cicutto’s public speeches and presentations from 1999–2001 included statements like “earn respect from all our stakeholders” or brief sections on stakeholder management such as “relations with stakeholders” that didn’t go beyond sharing the latest employee satisfaction surveys (Cicutto, 2000a). The 2000 NAB Annual Report stated that one of the many organisational aims was “growing profits for stakeholders”, which underlined the profit-focused policies of NAB. The same report had a short section on corporate social responsibility, which summarised how the company was challenged by social and environmental pressures while trying to sustain growth for shareholders. From 1999–2001 unions and customer groups were highly critical of banks’ profit-maximisation policies, cost-cutting initiatives, branch closures and downsizing. When Prime Minister John Howard reminded banks of their social obligations, Cicutto responded in a public speech as follows:

Governments cannot simply withdraw from services provision, increase their share of corporate tax revenue, and at the same time argue that corporations are obligated to fill community service delivery gaps,("Cicutto ready to take on fresh challenges," 1999).

During this period, the Financial Services Union (FSU) had taken several steps to raise employee and customer concerns140 in the public arena but NAB’s response did not change much. In another speech Cicutto stated:

What appears to be happening is the obligation of the State to meet the needs of the disadvantaged in the community has now become the social responsibility of major corporations such as banks….No other industry is mandated or even requested to

140 FSU asked major banks to have a shareholder resolution at their AGMs for banks to aim long-term profit maximisation by addressing community concerns. During 2001 elections FSU developed a Social Charter for banks that demanded government regulation to safeguard community interests (Cutcher, 2004) (Cutcher, 2004b)

205 provide “free services”…no other industry is mandated or requested to provide access to its services wherever people want that access (Cicutto, 2000b).

What finally initiated change was the critical review of the Australian Bankers Association (ABA) in 2001. The ABA recommended changes be made to the Code of Banking Practice and initiated a “safety net plan” for the disadvantaged and people living in rural areas (Cutcher, 2004b). As a response to the initiative, the Big Four banks took various “self-regulating” measures such as offering services to low-income earners and becoming more aware of community concerns. In the same year NAB’s annual report had a brief section entitled “Community” that replaced the corporate social responsibility section of the 2000 Annual Report. Simultaneously, the company activated its Community Consultation Forum and started to offer a National Concession Card Account that provided fee-free banking to customers who were pension, healthcare or seniors' health card holders (National Australia Bank, 2000). According to Dunphy’s “Sustainability Phase Model”, organisations move in stages to become totally sustainable. The evidence from 1999–2001 suggested that NAB’s management for sustainability was akin to the stage called “compliance”, whereby cost efficiency and growth still dominated business strategies, and community concerns were addressed only when the company faced risk of prosecution. Moreover, there was almost no leadership supporting sustainability and little integration between policies for stakeholder management. Throughout 2002–2004 there was a gradual change in this approach, whereby the importance of stakeholders and social responsibility was stressed more frequently in company presentations and briefings. A global Corporate Social Responsibility Council was established, together with Regional Councils and community forums. Financial institutions have highly sophisticated and complicated internal risk- management systems, as market risk, credit risk, liquidity risk, operational risk, legal and regulatory risk all need to be managed with care. They are closely monitored by regulators, even after deregulation of financial markets. Regulators take “capital adequacy, sustainability of earnings, loan loss experience, liquidity, concentration of risks, potential exposures through equity investments, funds management and securitization activities and international banking operations” as relevant standards for measuring riskiness of banks ((National Australia Bank, 2000): measures used by APRA).

206 In Australia, the prudential regulator of the Australian financial services industry, APRA, oversees the activities of the NAB Group141, while NAB's banking subsidiaries in the United Kingdom, the Republic of Ireland, New Zealand and the United States are supervised by local regulators. APRA is a relatively new agency and immediately after its establishment its effectiveness in supervising financial institutions was widely debated, particularly after the collapse of the insurance company HIH in 2001142. During this transition period in which the external regulator was not as effective as desired, the existence of effective internal control mechanisms became essential to ensure appropriate corporate governance practices for the banks. Despite the level of detail in communicating customer-related policies and environmental policies, there is little in NAB’s public information on corporate governance policies. Throughout 1999–2001 the mechanisms of the board are very vaguely described in the annual reports. Principles about ethics, committees, continuous disclosure and the corporate governance framework are briefly outlined, as well as external recognition of its governance practices over the years143. However, there is not much information on how risk is managed or measured. In the 2002 Annual Report there is a short paragraph about risk management, which is explained as follows; “directors receive regular reports from Risk Management on areas where significant business risk or exposure concentrations may exist”. In the same year the board was provided with a Corporate Governance Policy Framework (National Australia Bank, 2002b) and a Risk Committee of the Board was established by 2003. Furthermore, there are no details provided regarding how principles are passed down to lower levels, how standards are imposed at lower levels or how management accountability is assured.

2. Implementation: The company has shown varying commitment levels to stakeholder groups during the sample period. NAB has not yet integrated principles of sustainability into decision making. Management problems have resulted in delays of technology adaptation.

141 It was formed in 1998 for uniting the duties of multiple state and federal agencies.APRA operates under the Basel Committee on Banking Supervision framework. The Basel Committee provides a forum for regular cooperation on banking supervisory matters. Its Core Principles for Effective Banking Supervision is a blueprint for an effective supervisory system (Bank for International Settlements, 2009). 142 The Royal Commission report, that was written for examining the HIH case, noted that “the manner in which APRA exercised its powers and discharged its responsibilities under the Insurance Act fell short of that which the community was entitled to expect from the prudential regulator of the insurance industry” (Australia. Royal Commission 2003: para. 24.1.13) taken from (L. D. Black, 2006). 143 2001 Annual report: The Audit Committee has regard to world best practice in auditing standards (Muolo, 2001); 2002 Annual report: NAB was recognised by the independent research undertaken by the University of Newcastle, as one of nine companies with the highest corporate governance rating when compared with Australia's top 250 listed companies(NAB, 2002)

207 Being a participant in the community that a retail bank serves is an important activity of a bank. NAB has been an active part of both the rural and urban communities since its establishment. In the past, bank managers were among the most respected people in the community. Peverill, the founder of the first banking employees union BOA, states:

When I was in Mildura the Mayor wouldn’t plan a reception without first checking to see if I could attend… because I was the manager of National Bank and he wanted the bank to be represented at all functions (J. Hill, 1982).

However, this relationship between the big retail banks and the community at large has changed following the deregulation of financial markets. As Cutcher noted, banks have forgotten the importance of the service relationship and the community at large feels exploited144 (Cutcher, 2004b). NAB is seeking to establish the same level of engagement through the programs it initiates and voluntary employee programs. A review of its annual reports demonstrates many examples of this commitment, where every Australian employee may take up to two days’ paid leave per year to perform community work. Programs initiated by employees receive awards (National Australia Bank, 2000); there are country-specific community programs (UK, USA, New Zealand); and the company cooperates with numerous Community Link Partners (National Australia Bank, 2001). NAB has gone to great lengths explaining its environmental systems and practices, has had environmental risk assessment policies in place since 1992 (NAB, 2004d), and has joined multiple local and international environmental programs.145 Several records confirm that through these initiatives NAB has led the industry to develop indicators for the finance sector. As a consequence of taking part in these initiatives, NAB has also upgraded its internal policies and practices. For instance, after signing the United Nations Environment Program Financial Institutions Initiative, NAB started to consider environmental risk when assessing lending risk and adopted a single environmental management system that is consistent with ISO14001. The new Australian headquarters of NAB became Australia's first commercial building to achieve a four-star energy rating. Until 2003 NAB’s environmental performance had not been outstanding146 but the implementation of a single environment management system in 2003 demonstrated a change in its approach to better managing

144Hugh Mackay’s comments on the changing social attitudes of the Australians about banking : “As a direct result of the deregulation of the banking system, Australians have come up to the conclusion that banks are aggressive, commercial marketing organisations who are out to maximise their own profits” (Mackay, 1993) Taken from (Cutcher, 2004b) . 145 Australian Government's Greenhouse Challenge (1997), United Nations Environment Program Financial Institutions Initiative (2001), GRI/UNEP Fi Working Group and 'VfU Revision' working group(PricewaterhouseCooper's, 2004). 146 Corp Rate study has rated 12.5 out of 30 for NAB’s environmental performance.

208 sustainability. Further, NAB’s shareholders demanded the company invest in environmentally responsible companies ("NAB shareholders vote for forests," 2003). NAB defines its business as “Customer Relationship Management”, thus policies and systems developed to enhance relations with customers are given the upmost importance in company communications. Historically, investments in technology such as the EDP, Credit Card Processing and ATM technologies have been the banking industry’s answer to changing customer demands. The company’s efforts have been externally acknowledged by third parties147. Then again, despite NAB’s high-value investments in infrastructure148, the public data point to problems during the implementation process and management of these structures. A few of the indications to this finding were the frequent management changes in the IT department, the delay in implementing overly ambitious projects and ownership problems of projects (Connors, 2004). Despite continuing efforts, customer satisfaction surveys in Australia indicated that the service quality of NAB continued to be unsatisfactory and slow (Half Year Results (NAB, 2004a). In Europe little has been spent on enhancing the customer experience.

3. Accountability: As the size of funds deposited with financial institutions grew as a result of government- enforced superannuation schemes, community expectations for greater accountability increased. The community wanted to see that banks were there not only to exploit them but to build a two-way relationship based on trust and open communication and to manage funds responsibly.

The accountability of management and the board had represented many signs for close examination in the period leading to January 2004 that went unnoticed for many parties. The bank was less than transparent with its stakeholders about critical issues. The approach and methods for reporting improved from 1999–2004.

Issues with the board that had to be closely monitored were as follows: Firstly, the experience of the board members was not sufficient to govern the bank. From 1999–2002, the

147 2002: “best use of technology to help improve marketing and customer service capabilities” ("CSR: The Road ahead," 2002). 148 The information technology project developed with IBM in 1995 (McKenzie, 1995/1996), Investments made in customer management such as the fraud detection software and automated application processing("National Australia to buy MLC ", 2000), its Customer Relationship Management System, a product of 15 years of development and refinement (National Australia Bank, 2001, p. 6 taken from (Ax & Marton, 2008). regional projects and adaptations (PR Newswire Europe, 2005) the pilot customer quality program in New Zealand, the new Customer Charter (NAB, 2004b) the software that NAB is using to track its 2.7 million transactions each day (J. Adams, 2006).

209 board was compromised of 8 independent directors and 1 executive director (CEO). While in the annual report the “diversity in the background of the directors” was explained to possess great potential due to the “broad industry knowledge” they provided (National Australia Bank, 2002b), experience in banking and financial markets was critical. Examining the backgrounds of the directors showed that only the CEO Frank Cicutto and later John Steward, the head of UK operations, who joined the board in 2003, had banking experience. Subsequently, following the FX crisis in 2004, NAB received criticism over having directors with no banking experience (Arbouw, 2004). After the board renewal process in 2004, new board members were chosen with experience in banking, finance, auditing and law ((National Australia Bank, 2004) Report of the Directors). Secondly, when NAB’s subsidiary HomeSide incurred a loss of A$4 billion, there were no real consequences for the senior managers or the board. In the 2001 Annual Report it was simply explained as follows: we sent a senior team in to review the operation, and this uncovered an error in an interest rate assumption in an internal model used to determine the fair value of HomeSide's mortgage servicing rights (National Australia Bank, 2001).

An independent legal review concluded regarding the HomeSide loss that there was “no evidence that the Company's directors or executives were derelict in their duties” (National Australia Bank, 2002b). As a result, the company only appointed senior executive members to subsidiaries and revised internal policies for subsidiary oversight. With the sale of HomeSide the issue was buried in history, with no consequences for the directors and executives and no review of risk-management systems. Thirdly, in 2002/2003 APRA conducted a review of NAB’s credit limits and contacted the company twice in 2003 to request improvements however, such warnings were not taken seriously by the board, which never reported openly to the shareholders. Lastly, even though Cicutto performed poorly, the board did not question his capabilities until the Foreign Exchange Crisis.

a. Consultation and Dialogue with Stakeholders: An understanding of the need to establish a two-way dialogue with the community has not yet materialised during the sample period. NAB established a formal Community Consultation Forum in 1999, but it was not active. Only after changes in the external environment was the forum activated in 2001 (National Australia Bank, 2001). While NAB

210 displayed many examples of community programs and philanthropy activities, a vigorous and ongoing consultation and dialogue relationship was not evident. b. Transparency: NAB issued a continuous disclosure policy to fulfil the requirements of the ASX Listing Rules in 2001 and later exceeded what the Rules required. The Horwath 2002 corporate governance report that analysed the governance structures of Australia's top 250 listed businesses found that NAB was equal first when ranked with eight other companies (National Australia Bank, 2002b). NAB was also recognised by Reptex as the top company in Australia in reporting social environment and other information to stakeholders. The analysis of documents such as annual reports, website and supplementary reports produced by NAB shows that NAB’s disclosures about intellectual capital elements dramatically increased during the time period examined (1999–2004, 2004–2006). For instance, in 2002 NAB established an External Stakeholder Forum on its website and a review reveals the content has improved dramatically in subsequent years149. Further, in 2003 NAB started to publish a Balanced Stakeholder Card against 30 key performance indicators and in 2004 released its first externally audited, stand-alone Corporate Social Responsibility Report, benchmarking economic, social and environmental performance against the Global Reporting Initiative (National Australia Bank, 2004). Despite NAB’s accomplishments in sustainability reporting, some investors felt NAB has not been transparent. Paul Xiradis from Ausbil Dexia's told Bloomberg that Mr Cicutto had not been “forthcoming over the years of his leadership” in providing information to investors (Rolfe, 2004). Peter Morgan from 452 Capital, an institutional investment firm, confirmed this view when he said:

we questioned the bank a number of times, including visiting the chairman and we were run around and treated pretty badly, there was no ownership of HomeSide, things were happening behind the scenes and the market lost confidence (Arbouw, 2004).

However, after the management and board change in early 2004, the briefings given by the new management displayed more sincerity and self criticism (NAB, 2004a), (Fahour, 2005). This section has shown that from 1999 to January 2004 there was a big discrepancy between company rhetoric and the reality of analysing company practices and reporting to the

149 For this study the company website is examined through 2003-2009.

211 stakeholders. Fortunately, this gap narrowed following the corporate transformation from January 2004-2006.

7.8 Human Capital Classification Process

The first tool suggested by the Royal (Royal and O’Donnell, 2005) model is the historical context in which a listed firm is studied. Based on the data gathered from publicly available sources, below you will find the historical context and macro analysis of NAB’s environment.

7.8.1 Macro Analysis of NAB’s Environment The financial services sector is the largest industry sector by market capitalisation150 on the Australian Stock Exchange (ASX, 2010a). The sector consists of trading and investment banks, asset managers, insurance companies, real estate investment funds (REITs) and other providers of financial services. The sector has experienced “uninterrupted growth for almost two decades”151 and combined with insurance it has become the third largest sector in the “service-based economy”152 of Australia (Austrade, 2008). It has even exceeded mining in size, traditionally the country’s leading sector. From 1993 it has doubled its asset size every five years153 and it employed 344,000 people in 2002154(Financial Services Union, 2002), (Austrade, 2008; FSU, 2006/2007; www.fsunion.org.au, 2006/2007)). This strong growth has been attributed to advancements following the deregulation of the financial markets, increased participation in global markets, a two-way interaction with a strong Australian economy (fourth largest in the Asia-Pacific) and compulsory retirement schemes. In the last two decades of the twentieth century, the financial markets in almost all OECD countries have gone through rapid change, including “deregulation, privatization and technological change” (Baethge, et al., 1999), p. 3) and “financial innovation” (E. P. Davis, 1996) p. 57). In Australia, the deregulation process of the financial system started with the Australian Financial System Inquiry (the Campbell Inquiry155) in 1981. The Inquiry and the recommendations that followed were aimed at achieving efficiency improvements and

150 35% market capitalisation as of January 2010. 151 It has grown on average 5.4 percent through 1997 to 2007, third after communication services (6.8%) and construction (6.4%) The industry has contributed 8.6 percent to Australia’s Real Gross Value Added in 2007 (generated A$81 billion). 152 As of 2005; 75.3 percent of the civilian employment worked in the services industry. 153 $A773 billion (1993), $A1,274 billion (1998), $A2,072 billion (2003), $A 4,209 billion (2008). 154 Of the 344 thousand people: 157 thousand people worked in finance, 75 thousand people in insurance and 113 thousand people in services. Employment reached 400 thousand people in 2008. 155. The Campbell Inquiry led to floating the dollar, allowed in foreign banks, dismantled exchange controls and abolished interest controls(ASIC, 2004).

212 enhancements to the competitiveness of the industry (Kent & Debelle, 1999);(Australian Treasury, 2005). The period after the deregulation of the financial system has witnessed major changes in Australia. Ferguson (1990) has very rightly likened the changes to “the elimination of low speed limits on a highway” (R. A. Ferguson, 1990b). The banking industry, the leading sector of the financial services sector156, has changed dramatically, whereby new competitors have entered the market, new products and services have been introduced and the regulatory framework has been reformed. Prior to the 1980s, the banking industry was highly regulated, the number of products offered was limited and there were many small-sized regional banks (Roberts & Amit, 2003). There was little competition on pricing or product differentiation, which resulted in above- average returns on commercial banking activities compared to many other nations (Hawtrey, 2003). The deregulation process aimed to change this by introducing new competition into the market and encouraging local banks to become competitive globally. This process and the following reforms created many “new institutions and markets” (Bain & Harper, 2000); firstly, in 1985 16 foreign-owned banks were invited to establish trading operations in Australia (Australian Treasury, 2005). During this time, in addition to foreign-owned banks, some new regional banks that converted from building societies and non-traditional financial suppliers also entered the market. In the 1990s the Federal-Government owned Commonwealth Bank was privatised and joined the competition (Australian Treasury, 2005). As the market have opened up to foreign-owned banks, the regional banks used “size as a defensive strategy to foreign entry” (Sturm & Williams, 2004), (Williams, 2003) and merged to form larger banks, namely NAB, ANZ, CBA and Westpac (the Big Four banks hereafter). As a result, the market had become very concentrated157 around these Big Four banks (R. A. Ferguson, 1990b) and further mergers among them and two insurance companies were prohibited firstly by the Six Pillars Policy and later by the Four Pillars Policy, as suggested by the Wallis Inquiry in 1998 (S. Wright, 1999). After their initial entry, some foreign banks that were not profitable left the market or merged with other banks. In 1992, limits on the number of new banks that could be established were removed and more foreign-owned banks entered the market (Australian Treasury, 2005). In the two decades following deregulation, the assets of the Australian banking industry increased to over A$1,000 billion in 2004 (APRA, 2002b, 2009). In November 2004,

156 Banking industry accounts for 50 percent of the total assets of the financial services. 157 Big Four banks accounted for 68 per cent of total banking assets as of 2002 (APRA, 2002).

213 the number of banks in the Australian financial services market reached 51 (up from 16 in the early 1980s), of which 37 were foreign owned (APRA, 2009). Besides the Big Four banks, regional banks, credit unions and building societies operated in the retail banking sector. Increased competition, the development of technology and customer requests for ‘sophisticated products’ (Kent & Debelle, 1999) caused banks to introduce new products, services and distribution channels. Technology made it possible to introduce new services like (Kent & Debelle, 1999), p. 10), as well as enabling the industry to gain productivity increases (Sturm & Williams, 2004). A study examining innovation activity in the retail banking sector found that “twenty-six major distribution, process, and product innovations were introduced and thirty-four other follow-on innovations were also identified” from 1981– 1995 (Roberts & Amit, 2003) p. 111). Prior to the deregulation period, banks competed by maintaining “extensive branch networks rather than pricing” (Kent & Debelle, 1999)p. 11), and therefore branch numbers were highly swollen. The development of technology, the introduction of new distribution channels and “self-service” options (Baethge, Kitay, & Regalia, 1999)p. 9) have lessened the need for maintaining large numbers of branches; and this combined with cost concerns has resulted in the reduction of retail branches operated by the major banks. From 1997–2004 more than 1200 branches were closed by the five large banks (down to 3,700) (FSU, 2006/2007), as around Australia banks began to offer services through alternative channels, such as post offices. In 2003, NAB offered banking services through 3,010 Australia Post outlets (National Australia Bank, 2003b). As branch numbers decreased, office processing functions were centralised at bank headquarters or offices away from the retail banks (Lansbury, Kitay, & Wailes, 2003). As Lansbury, Kitay and colleagues noted, for retail customers, who were used to receiving face- to-face service, the new interface for their enquiries was either call centres or self-service options. Branches had become the new “sales outlets”, with the help of computer technology that provided a “full range of financial information on customers” (Baethge, Kitay et al. 1999). The staff that were left at the branches were encouraged to treat every customer as a new sales opportunity rather than providing services (Baethge, et al., 1999)p. 12). In uncovering the new type of relationship between customers and banks in Australia, Cutcher stated that the new role was highly dissatisfactory for retail bank customers as well as employees (Cutcher, 2004b).

214 After the introduction of the compulsory superannuation retirement scheme in 1986, there was a substantial rise in the household superannuation assets158 of Australians as a percentage of GDP, while investments in deposits remained the same (Kent & Debelle, 1999)p. 7), (Connolly & Kohler, 2004). As the size of available funds for investment grew in Australia, there was also growth in the use of wealth-management vehicles. The decreasing profits received from bank deposits and the availability of more profitable markets caused the Big Four banks to search for growth in other areas. Some acquired operations overseas and others entered into “non-traditional areas of banking” domestically such as wealth management, stock brokerage (Argent, 2002) and home loans. In time, the Big Four banks’ dominance in retail banking lessened159 and they became full-range banks that are diversified both geographically and in sources of income. For instance, NAB’s leading strategy was to “[d]eliver solutions that help meet customers’ complete financial needs” (National Australia Bank, 2003b). Since the mid 1990s the banking industry has kept the average return on assets (ROA) above 1% despite the tightening of the net interest margins and increased competition (Hess, 2007). Hawtrey, in his comparative study investigating international trends in banks’ interest and non-interest income, stated that the consistency in ROA, despite the falling gross income ratio,160 is a result of decreasing operating costs. Banks have managed to stay profitable mostly by closing branches and raising new sources of income (Hawtrey, 2003). For NAB, even if more than 75% of net profits continue to come from financial services, its wholesale market and wealth-management activities are strong and growing161. Competition has also initiated banks to fight for “high-value customers”; customers with available assets to invest in wealth-management products. While banks provided these group of customers with more personalised and premium service, “low-value” customers were directed towards using technological products that were highly impersonal (Baethge, et al., 1999; Cutcher, 2004b). Sadly, the new service approach that segmented customers according to their sales potential told customers that banks viewed them in a “more instrumental way, as a source of further profits” (Cutcher, 2004b)p. 213). Overall, retail banking customers were highly dissatisfied as a result of branch closures, decreasing service levels, increased fees and customer segmentation. A customer satisfaction survey across the industry conducted by ACA

158 Superannuation Assets in Australia: June 1990-A$ 124 billion, September 2004-A$648.9 billion (APRA, 2005). 159 Total deposits of the Big Four banks have declined to 43% of the total market in 2000 (Argent, 2002). 160 Gross Income Ratio: income from interest and non-interest income to total assets. It has fallen from 4.2 percent of total assets in 1992 to 2.9 in 2003. 161 NAB managed $73.4 billion worth of assets on behalf of 2.8 million retail and corporate customers in 2003 in this market (Cicutto, 2003)

215 indicated that in 2002 only “11% of the customers were very satisfied with the service they have received” (Cutcher, 2004b). From 1999–2003, NAB did not acknowledge the high customer dissatisfaction in its annual reports, but it did implement several initiatives to improve customer satisfaction. For instance, in 2004 it changed its structure from a divisional to a regional business model. Its annual report stated, “The new structure will enable us to improve integration across divisions and build a more customer-focused organisation.” Another important development in the Australian finance sector following deregulation was the subsequent changes in the workforce structure, with branch closures resulting in massive retrenchment of employees. According to FSU records, between 1991 and 2001 the Big Four banks downsized around 55,000 jobs. Most of these job losses were related to the closure of branches, causing customer representative jobs to be lost. Nevertheless, between 1986–2002 the total size of the workforce grew, and flexible job arrangements offered in the sector increased, with part-time employment reaching 20% of the total workforce by 2002 (Financial Services Union, 2002). According to Junor, permanent part-time employment was introduced into Australia as “a systematic human resource management strategy” in the early 1970s, firstly in the banking sector (Junor, 1998). Traditionally, these positions were mostly occupied by women162. However, an emerging trend is that while the dominance of females in the part-time workforce continued (80% in 2002), there was a strong growth in male part- time employees (78% between 1998–2002) (Financial Services Union, 2002). NAB had one of the lowest part-time ratios in the sector, with 19% in 2004 (FSU, 2006/2007). Another significant change occurred in the occupations of individuals in the sector. Employment in professional or managerial positions grew while employment in clerical positions fell. This can be attributed to the diminishing customer service positions in closing branches and rising employment in back-office positions at retail banks and services to the finance sector. Between 1998 and 2002 there was 40% growth in associate professional occupations in the finance sector (Financial Services Union, 2002). These positions require more analytical skills as well as finance and technology knowledge received through tertiary and higher education. For customer-service positions, sales skills combined with technological knowledge were important. As the educational requirements expected from employees altered, the industry has become “one of the most educated sectors” in Australia163 (Austrade, 2008). Overall, changes in the structure of the workforce was evidence for the replacement of basic clerical jobs with technological innovations and the rising importance of

162 Women employment at permanent full time jobs was 87% between 1987-1997 (Junor, 1998). 163 38 per cent of people employed in the industry has a tertiary qualification (Austrade, 2008).

216 the skilled workforce to use the high-technological systems to offer the new sophisticated products. The Workforce Report 2002 recorded that historic role differences between men and women continue in the sector and women are concentrated in lower-level occupational classifications. The industry164 has the one of the lowest representations of women at the management level, despite their majority in the total workforce (43.2% in 1977 (Game & Pringle, 1979)) and 52.5% in 2002). Further, the upward trend is very gradual165, with female employees occupying about 27% of the associate professional jobs and about 75% of the clerical jobs (Financial Services Union, 2002). As the Federal Sex Discrimination Commissioner stated, senior managers are chosen from the full-time workforce pool, which is mostly dominated by males (Goward, 2005). Despite ongoing efforts, the historical, structural and cultural barriers for women continue to exist. An attitude survey conducted at the national level among 3900 employees at three major Australian banks showed that women felt “disadvantaged” to men in respect of recruitment, selection, promotion, transfer, conditions of service and personal qualifications in the workplace (Still, 1997). Some banks have started to overcome this systematic disadvantage by applying more proactive strategies in their human resources practices. A series of studies conducted on Westpac observed that the bank has steadily increased women’s representation in management levels beginning in the mid 1990s. It has gone beyond the mandatory requirements of the Equal Opportunity for Women Act and demonstrated that it considers gender equality as a key to long-term business success and sustainability (Beck, 1999), (Beck, 2005). The other banks were slower than Westpac but some progress has been recorded in the last few years. According to the Big Four banks’ sustainability reports, the percentage of females in senior management positions has risen to a range of 27–32%166 in 2006/2007 (FSU, 2006/2007). The changes that accompanied the deregulation process have also strained workplace relations. Downsizing and the attendant low job security, increase in part-time and casual work, outsourcing of non-core functions, longer working hours, changing roles of customer- service officials to sales and the pressure on increased performance in terms of sales have

164 Analysis of 1994/1995 Affirmative Action reports of 75 Finance Industry organisations have shown that 15 percent of women were classified as managers and administrators (Still, 1997). A study that examined the trend of women at supervisory, management and senior management positions between 1988/89-1995/6 found that their representation was improving (Metz & Tharenou, 1999). 165 Historically, young and single women that have joined the banks after WW2, typically operated switchboards and typewriters and had no contact with customers, were given no custody of cash and were required to resign on marriage (John Hill, 1982). For this reason they were on the lowest grade of the career pyramid. With the centralisation of the industry after 1970s male employees moved to the headquarters, leaving females at the branches. 166 The lowest level of females in senior management positions is NAB, with 19 percent in 2003/2004, 21 in 2004/2005, 20% in 2005/2006 and 27 percent in 2006/2007 females in senior management positions.

217 caused high employee dissatisfaction in the sector (Baethge, Kitay et al. 1999), (Lansbury, et al., 2003), (Cutcher, 2004b). Decentralisation of employment relations and the introduction of individual contracts (AWA) in 1997 also affected workplace relations in the banking sector. Argent noted that two of the Four Big banks offered individual performance-based contracts to their branch managers (Argent, 2002). Prior to deregulation, the industrial relations environment was defined as “adversarial but peaceful”, but has become rather “dispositional” in the wake of the strained relations between banks and employees . The regulatory framework was also restructured as a result of the changes in the industry. After the Wallis Inquiry in 1998, the Prudential supervision of authorised deposit- taking institutions (banks, credit unions, building societies), life and general insurance companies and superannuation funds were given to APRA. As ASIC and the ASX impose certain reporting requirements on publicly listed companies, so did APRA on the banks. Furthermore, the Australian Bankers' Association, with the aim of protecting the rights of banking customers, also revised The Code of Banking Practice in 2002. The revised Code, which would take effect after August 2003, outlined best practice banking standards, including major commitments and obligations to customers, commitment to be examined by an independent external body and greater transparency (ABA, 2002). The new Basel II recommendations (2004) made by the Basel Committee on Banking Supervision asked banks to align regulatory capital requirements more closely to the underlying risks they faced (Basel Committee on Banking Supervision, 2004). It was expected that despite its benefits for institutions, there would be costs associated with complying with the new standards (VanHoose, 2007). Besides the mandatory requirements, banks themselves signed on to several voluntary reporting initiatives such as the UNEP Fi Agreement167. All the Big Four banks have been signatories to this agreement. Another trend is the production of voluntary sustainability reports. NAB, ANZ and Westpac have begun publishing stand-alone sustainability reports prepared in accordance with GRI Reporting Guidelines.

Future Trends and NAB: The Reserve Bank estimates that the size of superannuation fund assets will continue to grow solidly in Australia in subsequent years, signalling further market expansion(ReserveBank, 1997). The existence of a large asset base for investments makes the local market attractive for both local and foreign banks, thus increasing competition, which will

167 A global partnership between UNEP and the Finance Industry. Among its aims are a commitment to sustainable development and environmental management can be listed.

218 come from all directions, particularly from “non-traditional sources”, as described by the CFO of NAB, M. Ullmer SF Fin (Fahrer, 2006). NAB offers sophisticated products and services through newly developed distribution channels, which are made possible through technological innovation, which are made necessary by competitive forces. Achieving economies of scale in technological investment would lower the cost of investment, encouraging many banks to grow or even continue to merge and acquire. Based on these assumptions it is expected that M&A activity will continue in the near future, including NAB, and the number of financial conglomerates will increase (Bain & Harper, 2000) and the Four Pillars Policy of Australia may be softened (S. Wright, 1999). In the last twenty years the Australian banking sector has become the third most cost- efficient sector among its international peers (Hawtrey, 2003). Cost efficiencies168 have been achieved through rationalisation and branch closures. While customers have been receptive to new technologies, certain customer segments, such as the older population of Australia, prefer personal interaction. While ongoing improvements in the cost base are expected to continue, if at a slower pace, NAB must identify the right mix of branches and technological alternatives. The gross income of banks consists of interest income and non-interest income. Increased competition has resulted in the narrowing of interest margins, causing income from retail banking to drop, a trend that is estimated to continue (Hawtrey, 2003). Erstwhile growth in home loans is also expected to slow after 2003. By contrast, non-interest income and Australian bank fees have reached international levels and are not expected to increase (Hawtrey, 2003). Based on these assumptions, it is expected that NAB cannot inflate interest income or fees and as such will need to strengthen its local customer base for sustained profits. Banks that offer full-range of services and innovative products will have an advantage, as “customers want one-stop shopping” (Hawtrey, 2003). Therefore, NAB will need to improve its innovative capabilities. Relationship management and understanding the needs of customers is essential not only for the wealth-management segment but also for all other services. In an environment in which customers have lost trust in the financial system, it is essential to build trust by showing commitment to regulatory and voluntary guidelines and transparency. Even if the short-term application of new regulatory guidelines appears cumbersome and costly, in the long term NAB and its customers will benefit from applying best practice. In the fast-changing banking sector environment, in order to achieve organisational success there is a need for employees to adapt to change. Banks that can attract highly trained

168 The cost ratio for Australian banks has declined from 3.0 percent of total assets to 1.5 percent between 1992-2002 (Hawtrey, 2003).

219 and skilled employees and continue investing in human resource systems may achieve desired levels of employee engagement, customer service and technology adaptation. In conclusion, considering the environmental factors affecting the banking industry, it can be said that the globalisation of finance sector has become an important determinant for the Australian banking industry’s future profitability. In more concrete terms, changes in the world economy and financial markets will also to some degree affect NAB’s profitability. The cost base for NAB is influenced by ongoing investments in technology and innovation, expansion in new markets, the training needs of employees and reporting requirements brought on by new regulations. On the other hand, while revenues may rise as the local market expands, they are restricted by world service fee rates. The above discussion summarises the changing nature of the banking industry, citing important external influences as a part of the Model of Drivers of Sustainable People Management Systems (Royal, 2000). The macro analysis demonstrates how banking has become a knowledge-intensive industry through the sophisticated products it offers, utilisation of the latest technology and the employment of knowledge workers. Further, it foresees that to remain competitive banks will need to offer low-cost and innovative products and provide a full range of services that aid cross-selling, balance the use of face-to-face customer interaction with the use of new technologies, manage an increasing part-time workforce and understand flexibility needs, manage a highly educated professional workforce that has low commitment to organisations and follow and answer the changing expectations of society. Applying the tool, it is possible to evaluate the historical context of NAB. NAB had a good share price performance from 1999–2003 in comparison to the GICS Financial Index but stumbled in mid 2004. The foreign exchange crisis and the ensuing turmoil caused both customers and investors to lose trust in NAB, and combined with its lower than expected profits, NAB’s shares lost attractiveness. Fortunately, a successful recruitment effort put the right leaders in the right places. Acceptance of the mistakes made and the readiness of the top management for leading a comprehensive culture change program should have encouraged the investors to closely watch the program and its results during 2004–2005. If the follow-up of this process demonstrates NAB’s capacity to change and transform into a more innovative and knowledge culture, the bank would be able to defend itself against the threats in its external environment and exploit the opportunities to become an attractive investment again.

After considering the macro environment of NAB, questions arise that cannot be answered without reference to internal systems. How did NAB, the Audit Committee of

220 which was named among the world’s best and which has received awards for its leadership, encounter a corporate governance crisis in 2004? Why was NAB’s recovery so slow in 2004– 2005 and how did it lose its market leadership to competitors? Royal and O’Donnell’s (2008) study states that human capital analysis is needed for knowledge-intensive industries like banking and biotechnology. To be able to answer the above questions, it is necessary to examine the specific human capital indicators and related systems. The following section will report and evaluate NAB’s human capital indicators.

7.8.2 Sustainable Human Capital Practices

The alignment of human resource management systems with the stated corporate strategy is essential for a sustainable competitive advantage. In the literature, the existence of a large pool of skills or the alignment of existing skills with the strategic direction, behavioural training and human resource practices as a system are said to contribute to the success of the organisation (P. M. Wright, et al., 2005), (Huselid 1995). The Royal and O’Donnell model suggests that the study of the human capital systems comprising recruitment, training, career planning, rewards, job characteristics and professional identity will give a better insight to the functioning of the management systems of the organisation and help to better anticipate future events within the organisation. For strategy execution, specific systems of recruitment, professional development and culture appear to be significant for the banking industry. Under Cicutto’s leadership (1999–Jan 2004) the corporate strategy was based on sustained growth and profits. This aim was encouraged by the board and shareholders, placing additional pressure on the leaders to perform in the short term. Hence, the corporate culture was shaped under these special circumstances. Cicutto’s top-down and ambitious leadership style reinforced the sentiment that “profit is king” and management asked employees to perform at the highest levels. From the view of general systems organisational theory, to maintain stability there will be internal adaptation to environmental forces and evolution will continue with the aid of feedback (Kast & Rosenzweig, 1972), p. 453). However, the short-term emphasis at NAB prevented proper alignment of the internal systems of the organisation with the realities of the external environment, resulting in crisis at several levels. For NAB, systems of corporate governance, culture and professional development appear significant for strategy execution.

221 Firstly, the proper functioning of the high-growth and profit strategy required the corporate culture to be balanced with a sound value system and good governance practices. Unfortunately, the previous growth and profits made the board overconfident in terms of management, and this combined with a lack of banking and audit experience on the board prevented the appropriate internal control mechanisms and accountability from being built into the system. Lack of a sound values-based management system and strong internal control mechanisms made monitoring risky and geographically spread operations even more difficult. In the period leading up to January 2004, management made numerous mistakes such as acquiring unsuitable operations, making risky investment decisions and failing to execute results due to of control and management problems. These failures, combined with lack of transparency, caused customers and investors to lose trust in the company. Secondly, NAB’s human resource management systems did not support the aspired high-performing culture. Elements of a high-performance management culture as defined by Pfeffer such as selective hiring, training, elimination of status levels, sharing of information and high compensation were apparently not applied (Jeffrey Pfeffer, 1999). Although a teamwork structure was being implemented, it wasn’t reinforced with rewards based on team performance. The reward system rather encouraged short-term results based on individual cash rewards or bonuses, while there was little emphasis on behavioural components. The financial rewards offered to a select group of employees encouraged them to take higher risks with no real consequences. In the absence of individual performance appraisals, incentives or formal recognition programs, for the rest of the employees there was little motive to perform well. Thirdly, even when human-resource policies were implemented, management practices sent unclear messages to employees about the application of them. David Bullen, one of the traders responsible for the foreign exchange crisis, noted how systems of recruitment, career advancement and rewards were distorted to promote overly ambitious, money-making individuals to the foreign exchange trading department (Dellaportas, et al., 2007). Fourthly, the systems didn’t encourage the rights of primary stakeholders to be acknowledged equally, even though the leaders declared it was important for the bank. Most importantly, employees felt their rights were the last to be considered. Ullrich (2007) warns about mistakes leaders make in installing a future strategy, one of which is to implement a new strategy with the old capabilities, and another is investing in the latest fads and initiatives (Ullrich, 2007). The data indicate that NAB was openly making

222 the first mistake while trying to implement new strategies and culture change with the old capabilities. The macro analysis shows that the banking industry has transformed into a highly knowledge-intensive stage, which requires NAB to upgrade its social capital to stay competitive. However, the human capital analysis indicates that despite the fast-changing environment and massive downsizing, NAB has scored low on developing social capital and up-skilling its workforce with the required capabilities. In regards to social capital, NAB rated high on knowledge acquisition but low on implementation, was not innovative in recognising operational skills, asserted high management control, and failed to encourage creativity and a culture for knowledge sharing and communication. In 2004 the change that occurred was a transformative change, as Dunphy (2000) describes, which required the replacement of board members and the executive team, as well as radical changes in values, strategies and processes (D Dunphy, 2000), p. 258). The new management aimed to install better corporate governance practices and values-based management practices. The new CEO, John Stewart, displayed a good understanding of the type of leadership needed at NAB and struck a balance between control and the growth needs of NAB by installing Michael Ullmer as the new CFO (who had an audit background) and Ahmed Fahour as the CEO of Australian operations (who had business growth experience). The new corporate principles of honesty, openness, accountability and care for all stakeholders were supported by new systems and practices. While the new regional organisational structure built accountability into the system, Stewart set a good example by being transparent in his own communications. Human resource management systems such as the performance appraisal and reward system created behavioural and long-term components. Selective hiring practices were adopted, such as the recruitment of service-oriented staff. Despite the enthusiasm of management and positive improvements in the systems and policies, the transformation of the highly controlling and bureaucratic culture to a team- based, flexible and high-performing culture was gradual. (D Dunphy, 2000), p. 259) explains that transformative change is initially painful and demotivating for the workforce, especially when the change program is initiated at management level and there is need for a voluntary contribution from all levels of the organisation, which was not realised at NAB. Debowski (2006) states that competencies necessary for knowledge-intensive firms like collaboration, information skills, management skills, strategic planning and relationship management take time (Debowski, 2006). In NAB’s case, the changes did indeed take time to implement, as these skills were developed through new practices.

223 In the future NAB management must continue to build a positive reputation in the financial services by continuing to improve corporate governance practices and clearly communicating the organisation’s aim to carry on evolving toward better practices. Maintaining an effective board and attracting qualified executives should be an ongoing focus, and risk awareness and accountability should be integrated and managed at the front line as well as at the divisional level and the group level, to become part of the human resource management system. Ongoing changes in the external environment of the bank would be better managed with an engaged and skilled workforce, and as such NAB should strive to attract and maintain quality personnel and work toward improving knowledge worker skills. The above analysis has shown that the correlation between the human resource management system and the stated strategy at NAB from 1999 to January 2004 was low. While, this has improved significantly since that period, (C. Royal & O'Donnell, 2008a) suggest, that better consistency and appropriate practices will bring NAB a contingency view169 that may aid the company in executing strategy and thereby improving its financial, environmental and social performance.

7.8.3 Strengths and Weaknesses

The Royal and O’Donnell (Royal and O’Donnell 2005) model suggests that the internal strengths and weaknesses of a company should be taken into consideration when evaluating the investment potential of that company. NAB expanded upon its century-long retail banking experience through acquisitions of financial services companies to become the largest full-services bank in Australia. Its strong customer base and knowledge enabled the bank to expand rapidly in the domestic market and grow outside of Australia. Through investment in technology the bank was able to offer new products and services to its customers. Its historically positive relations with the community were re-established through community programs of which employees have become a part. The bank also committed to voluntary initiatives for improving its social and environmental performance and reporting practices. The new board established in 2004 offers a balance of skill and experience, and managers and higher-level executives demonstrate great potential for initiating change.

169 Resource dependence and contingency theories suggest that firms develop strategies and processes that best fit changing external conditions as they adapt to new contexts (Katz et al. 2003:574) taken from (Ross & Bamber, 2009).

224 Despite its various internal strengths, NAB has significant internal weaknesses that it must work to redress. NAB currently rewards its qualified and experienced senior executives at above-average rates, which is often criticised by investors. As such, NAB needs to better plan succession and leadership development within the organisation; management need to balance short-term performance with long-term goals of sustainability and workforce development; sustainability measures should be better integrated to human resource systems and consistency maintained. Knowledge-intensive industries favour strong internal communication lines and creativity, an area in which NAB performs very poorly. Further, the diversity of the workforce is not at desired levels. In light of the macro analysis, it is highly likely NAB will choose to grow through acquisitions or international alliances, which will require change to become a part of the corporate culture.

225 Chapter 8: Telstra Limited

8.1 Introduction

Telstra is the third case company analysed in this study in order to answer the research questions. This chapter will begin by giving a general company history, will answer the research questions, and will then apply the Human Capital Analysis tools to the data collected from the public domain.

8.2 Telstra Company History

Telstra is the leading telecommunications company in Australia. The company offers a full range of services throughout Australia, providing more than 10.3 million fixed line and 6.5 million mobile services170 and network services, including Internet, pay TV and multimedia (Telstra, 2004g). Telstra also serves customers through online, telephone-based services as well as Telstra shops, Telstra licensed stores, Telstra business stores and indirectly through 3,000 licensed retail outlets. Its international businesses include Hong Kong CSL Limited (mobile operator); TelstraClear Limited (full-service carrier in New Zealand) and Reach Ltd (wholesale providers in the Asia-Pacific region). Telstra shares are listed on the Australian Stock Exchange, the New Zealand Stock Exchange and the New York Stock Exchange. Telstra plays an important role in the Australian economy, with assets valued at A$34 billion, revenue at A$21 billion, and contributing 1.6% value171 to the Australian GDP and employing over 40,000 people in 2004 (Telstra, 2004e). It was the second-largest corporation by market capitalisation172 in Australia and the fourteenth-largest telecommunications company by market capitalisation in the world in 2004 (Telstra, 2004e). Telstra is one of only two Australian companies to be listed on the FTSE4 Good Index and has been included in 10 out of 12 socially responsible investment funds in Australia (Telstra, 2001). Telstra was founded in 1901, when the Postmaster-General's Department (PMG) was established by the Commonwealth Government to manage all domestic telephone, telegraph and postal services. In 1946, the Overseas Telecommunications Commission (OTC) was

170 Its services include basic access services to homes and businesses in Australia; local and long distance telephone calls in/to and from Australia; mobile telecommunications services; data and internet services; management of business customers' IT and/or telecommunications services; wholesale services to other carriers and carriage service providers; advertising, directories and information services; and cable distribution services for FOXTEL's cable subscription television services. 171 Value added is the difference between sales revenue and the cost of raw materials and other goods and services purchased as inputs. 172 Telstra’s market capitalisation was at $60 billion in June 2002 and $64 billion in June 2004.

226 established to manage international telecommunications services and in 1975, the Australian Telecommunications Commission (Telecom Australia) was established. Since then, Telecom Australia has changed names several times, until in 1993 Telstra became the legal corporate name of the merged entity of Telecom Australia and OTC (Telstra, 2004d). The company underwent a partial privatisation in November 1997, whereby the Federal Government sold approximately 33.3% of the shares to the public and in September 1999 a second public offering was completed, whereby 16.6% of the shares were sold. In comparison to other countries, the privatisation of the Australian telecommunications company was a long and painful process (Rifkin & Fulop, 1997). The differing views of the Liberal and Labor parties (Fairbrother, Paddon, & Teicher, 2002) and widespread opposition to the sale by people living in remote areas 173 had played a role in this process (Ross & Bamber, 2009), (Craig, 1999). The last stage in the privatisation process was completed in 2006174, reducing the Government's ownership of Telstra to 17%. This portion was placed in Australia's Future Fund, which provides superannuation and pensions for Australia's public servants. In 2009 the Future Fund sold off more shares, reducing the Government's stake in Telstra to 10.9%. Prior to 1991, Telstra held a monopoly in the telecommunications market. During that time Telstra’s mission was to “connect a telephone to every person in Australia”; as such, “long-term technical projects tended to gain priority over individual customers” (Batt, Colvin, Katz, & Keefe, 2004). Telstra had a reputation for unsatisfactory service and was not very responsive to customer complaints (Bromby, 1997). In 1992, the Government began to open up the market to competition. Optus was the second company to provide fixed line and mobile services and Vodaphone was granted a licence for providing mobile services. By opening up the market the Government aimed to improve the quality and variety of services provided to the Australian public. To accommodate the new market conditions, Telstra had to change. Frank Blount (CEO 1992–1999), an American, was appointed to transform the state-owned, traditional monopolistic phone company into “a telecommunications and information services provider”. Immediate changes in Telstra’s strategy and organisational structure took place; marketing, cost efficiency, the introduction of new technologies, faster decision making and better human resource planning became a critical part of Telstra’s operations. In the 1994 Telstra Annual report, Blount displayed a very competitive message:

173 Telstra's universal service obligations require it to provide customers with reasonable access to telecommunications services throughout Australia. 174 The Telstra Corporation Act restricts foreign ownership. Foreign persons collectively cannot control more than 35 per cent of the non- Commonwealth owned Telstra shares, and individual foreign persons cannot control more than 5 per cent of them (Telstra, 2000b).

227

We must begin to drive change and to embrace such change. ….. We must meet, and exceed, the expectations of our customers in terms of service, value and quality. We will meet this challenge by looking outwards to enhance both our markets and customer choice and inwards to improve processes, systems and behaviours (Telstra, 1994).

Telstra has taken multiple steps in achieving cost efficiency, among which outsourcing and downsizing were the most visible. By 2004, Telstra had more than halved its number of employees to 40,000, down from 87,620 in 1988 (Barton, 2002). The company had also revitalised its employment relations to fit with its aims of cost efficiency and a leaner organisation; regarding these ends, unions and collective agreements were seen as obstacles (Barton, 2002). Telstra simplified some of its award conditions with the 1998–2000 Enterprise Agreement (Chu, 2001) and after the introduction of the Workplace Relations Act in Australia started to offer AWAs. The two unions that represented the employees, CEPU and CPSU, strongly opposed downsizing, the introduction of AWAs and the privatisation of Telstra. In addition to gaining cost efficiency, Telstra aimed to grow its business through local and international partnerships and acquisitions, such as FOXTEL and Reach. In 1995, Telstra formed a joint venture with News Corporation and Consolidated Media Holdings to form FOXTEL, a cable TV network providing 20 channels. It was the first application of broadband digital cable in Australia and in 2002 reached over 800,000 subscribers with 45 channels (FOXTEL, 2007) (Telstra, 1995). Telstra’s investment in FOXTEL was initially criticised due to the long-term payback period175 and low membership (Bromby, 1997), as well as disagreements about the ownership and future of pay-TV. However, the content- sharing arrangement between FOXTEL and Optus Television in 2002 was viewed positively by management and the media (Drury, 2000) (Clark, 2002; Nicholas, 2002). With financial backing from powerful media companies, FOXTEL advanced its digitised cable network, complementing its digital satellite service, and by 2004 FOXTEL was the leading company in the pay-TV market176, beating its rivals Austar and Optus (Hargrave, 2004). Another joint-venture Telstra established was Reach, a Hong Kong-based telecommunications company. Together with Pacific Century Cyberworks (PCCW), Telstra funded Reach by selling assets in 2001. After its establishment Reach faced intense

175 In 1997 Telstra announced that it would set aside $1.72 billion to repair its own mistakes, such as entering pay –TV. FOXTEL had recorded its first profit only after 10 years. In 2005/2006 before tax but after depreciation and interest of $4 million was recorded (L. Murray, 2006). 176 In 2002 FOXTEL had 53% market leadership (Telstra, 2002a).

228 competition in the market and, combined with the Asian financial crisis, in 2003 found itself approaching bankruptcy. As a result Telstra had to write down almost $1 billion and another $1.1 billion for CSL, Telstra’s mobile telephony business in Honk Kong. However, by 2004, Reach was Asia’s largest international wholesale carrier of combined voice, international and private leased lines and IP data services (Telstra, 2004e). Telstra has made various investments in Asia, building telephone networks in Java, an office in Beijing, and engaging in business development in Korea and Vietnam (Telstra, 1996). However, these have contributed very little to overall profit (as little as 2%). Besides Reach and CSL, Telstra also had to write off $295.5 million on the Jindalee Operational Radar Network (JORN) and a defence technology project (Bromby, 1997) outside of Australia. Overall, the company has not been very successful in Asia and has written down almost $10 billion in failed investments (A. Ferguson, 2004b). In 1997, the Telecommunications Act deregulated the telecommunications market by removing all barriers to entry, ending the duopoly of Telstra and Optus (Barton, 2002), and thereby opening up much of Telstra's infrastructure for use by competitors177. Price competition became fierce (Telstra, 2000b) and by 2000, there were 50 licensed telecommunications carriers, and in 2003 there were 88 (Telstra, 2003d). During this time, competition and new service standards pushed the company to improve its services178 and introduce new services to the market. Between 2000 and 2004 Telstra’s growth was much slower than the industry average179, with minuscule growth in revenues and assets180 and profitability suffering. The return on equity (ROE) had dropped from 33.7% in 1999/2000 to 26.8% in 2003/2004 (Telstra, 2004e) and the highest growth in revenues was recorded in mobile data services (34.3% growth in 2004), while growth in fixed lines was almost flat. Telstra still had the lead in local calls (74%), mobile services (46%) and the newly developing broadband Internet services (42%). Nevertheless, Telstra was a good dividend-paying share, with dividends per share reaching 26 cents in 2004, up from 18 cents in 1999/2000. The dividend yield of the stock in 2004 (6.4%) was the second highest among world telecoms181 (Durie, 2005).

177 Referred as Local Loop handling; multiple providers to sell communication services over the same line. 178 Telstra’s service performance for residential customers measured as CSG time frames for installations and fault repairs improved and stayed over the acceptable min level of 90% and 99% of the Telstra business customers experienced a fault free service measured under the Federal Government's Network Reliability Framework (NRF) (ACMA, 2007)Telecommunications Customer Service Guarantee (CSG) Standard 2000 seeks to encourage the timely provision and maintenance of standard telephone services for residential customers. The Network Reliability Framework (NRF) seeks to encourage service reliability for Telstra’s business customers. It came to effect in 2003 179 The sales revenue has increased 0,07% between 2000-2004 (Telstra, 2004e). In 2004 telecommunications have grown at around 4% (Telstra, 2004e). 180 Revenues have increased from $20,5 billion in 2000 to $21.3 billion in 2004; profits before tax had reached $5,8 billion (Telstra, 2004e). 181 The dividend yield of the company continued to increase in the following years. It was the 6th highest (7.07%) in the ASX in 2006

229 The Federal Government had initiated the partial privatisation of Telstra in 1996 (T1) and in 1997, 1.8 million Australians applied for shares issued at $3.30, payable by two instalments182 (O'Leary, 2003). Both instalment receipts traded with a premium after the issue date and the fully paid T1 shares rose to over $9.00 by January 1999 and two dividend payments made. The first share offer occurred under the leadership of CEO Frank Blount, before he left in 1999. Ziggy Switkowski was appointed as the new CEO in March 1999 and the second offering was floated in October of the same year (T2). T2 shares were issued at a final price of $7.40, again payable by two instalments183 (O'Leary, 2003). After the second issue, both T1 shares and T2 shares fell in value. The share price of Telstra continued to decrease, dropping to nearly half its original value (below $4 in 2003/2004). The chairman of the company, Bob Mansfield, resigned in April 2004 after supporting a proposed takeover of an Australian media group (Fairfax) advocated by Switkowski but opposed by some directors (Long, 2004). Following Mansfield’s resignation, Switkowski resigned in December 2004, and was replaced by Solomon Trujillo in July 2005. Trujillo (2005–2009) announced a new transformation program aimed at growth, a modernisation project for the fixed telephone network, and a new 3G mobile network, saying, “Telstra and the Government will build a world-class, high-speed broadband infrastructure within three to five years.” (Trujillo, 2005). However, the plan fell through as a result of disagreements between Telstra and the ACCC (Murphy, 2006). The third offering of Telstra shares (T3) was done under the leadership of Trujillo in 2006. The share price was again to be paid in two instalments, the first instalment of $2.00, and a final price of $3.70. The price of the offering was found to exceed world telecom prices, considering Telstra’s low ROE (Durie, 2005). Since then Telstra has not performed well but is known as a good dividend payer. During 2007–2009 the share price of Telstra fluctuated wildly between $3.50–4.70 and after 2009 dropped below $3.50. The above company history briefly summarises the background of a large telecommunications company. Following this history, publicly available human capital data for Telstra will be utilised to answer the research questions.

(Barnes, 2006). 182 The first instalment was $1.95 ($2.00 for institutions) payable on application and the second $1.25 ($1.30 for institutions) payable in November 1998. 183 Retail investors paid $4.50 and institutional investors paid $4.75 for the first instalment. The second instalment was $2.90 for retail investors and $3.05 for institutional investors.

230 8.3 Research Question 1-A

Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable HR practices? The use of the disclosure index on the annual reports of Telstra displays that the company complies with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999-2004 and goes beyond these requirements. The only reporting requirement that was not found in the annual reports, similar to two other case companies, was the “auditor remuneration” (AASB 1034.5.3)184 for the years 2001 to 2004. Two other items (ASX 4.10.11: Information about Stock Exchanges and AASB 1034.5.1.d: Employee Information Numbers) that were not found in the concise financial reports were found in full financial reports. Telstra is found to be the most open and transparent company among the three case companies. This can be partially attributed to the strict controls imposed on the previously state-owned company. The company reported about the “Audit Committee”185, some parts of “Corporate Governance”186 and “Employee Benefits”187 before they became a requirement to report on (ASX, 2004), (AASB, 2004b). The changes in the reporting requirements have improved the quality of corporate governance reporting. For instance, the Corporate Governance Section of the Annual Report 2000 included basic information about “the board, meetings, committees, business conduct and risk”. And after the ASX Corporate Governance Recommendations were introduced (2003/2004), the Annual Report 2004 Corporate Governance section have added “the roles, membership rules, size, meetings, performance evaluation of BOD, the role of the chairman and audit governance and market disclosure controls”. Moreover, Telstra’s CSR, OH&S and environmental performance information was included in reports.

184 AASB 1034.5.3 became operative in 2001. The company reported on this item starting 2002. 185 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year. 186 ASX listing Rule 4.10.3: A statement disclosing the extent to which the entity has followed the best practice recommendations set by ASX Corporate Governance Council during the reporting period. 1/1/2003. 187 AASB 1028 : Each reporting entity to disclose its equity based instruments/compensation benefits ( for example performance related benefits) in their financial reports. Operative Date: 2002 July.

231 8.4 Research Question 1-B How much more than the mandatory regulations do these companies report or make available to the general public? For answering this research question annual reports of Telstra, other company originated data (sustainability reports, website..) and other data obtained from secondary sources (academic articles, books…) were collected and analyzed separately. Chapter 5 has shown that there are relatively more regulations controlling all three industry groups that the case companies belong to. But within its industry, Telstra had the most reporting requirements as a partially state-owned entity, until it was fully privatized. For instance, the Federal Government’s Greenhouse Challenge Program required Telstra to report on its performance for reducing greenhouse gasses. This explains why it was found more open than other case companies. Moreover, the company took transparency very seriously, there was a Continuous Disclosure Committee chaired by the Group General Counsel and senior management undertook training in relation to Telstra's continuous disclosure obligations. The study of the annual reports have shown that they can be good sources for gathering information about Telstra’s “corporate strategy” and “executive and directors’ remuneration” (required by mandatory regulations). However, despite the quantity of reports published by Telstra, the quality of information found in company originated reports in relation to Human Capital data was very low. Information sets grouped around “environment”, “occupational health and safety”, “customers” and “community service”. Secondly, even though the historical study of Telstra pointed that “knowledge management, skills upgrading, employee relations and workplace organization” are significant indicators for evaluating sustainable human practices of the company almost no information was provided about these topics by the company. These Human Capital specific information was obtained through the use of other sources for this thesis. For instance, the information about “industrial relations and training” was obtained through academic articles and dissertations, government websites, industry reports and OECD reports. Overall, the search for Human Capital data in the public domain other than the annual reports has revealed that there was qualitative data for Telstra in the public domain, but the quality of Human Capital data was still very limited. The data found in the narrative sections of the annual reports and sustainability reports was combined with other data found from the secondary sources and a Human Capital database for Telstra was constructed. This data was sorted using the six indicators of the

232 “Drivers of Sustainable People Management Systems” (Royal, 2000) and presented in a checklist matrix displaying the available Human Capital data in the public domain, otherwise within the reach of the security analysts. Next section will present the results within the framework of the model by Royal (2000).

Telstra Sustainable Human Capital Indicators

1. Job Characteristics a. Competencies: The Royal model classifies organisations that have competencies in high- order contextual and theoretical knowledge, possess occupational specialist positions and high levels of creativity as professional organisations.

Knowledge Competencies: In terms of knowledge competencies, companies with high-order contextual and theoretical knowledge are considered to be professional organisations. Data suggest that in terms of knowledge and technology acquisition, Telstra ranks highly but has not yet transformed itself into a learning organisation and scores low for organisational learning and knowledge-management capacity. In describing Telstra’s R&D processes, the company has shown signs of being at the most advanced level, defined by Liyanage and Greenfield as the “fourth-generation R&D model” (S. Liyanage, et al., 1999). The Telecom Research Laboratories (TRL), which dates back to 1923, have long been a major research and development provider for Telstra, but much of their research was basic. With the deregulation of the Australian telecommunications industry, TRL have become much more oriented toward the company's business objectives and the development of a much stronger focus on research to support the drive for competitive differentiation (Turpin, Aylward, Garrett-Jones, & Johnston, 1996). TRL has worked closely with numerous universities188 and supported university-based research groups, with a high level of engagement from senior TRL managers. After 2000, Telstra aimed to further strengthen its research activities, and so established the Telstra Technology, Innovation and Products division, which brought together product development areas, network technologies, information technology systems and the TRL (Telstra, 2003d). Through “New Wave Labs” Telstra focused on developing competitive products for

188 For example, Commonwealth Government's Cooperative Research Centre (CRC) Program and Telstra Centers of Expertise in selected tertiary institutions. Some examples for the programs are Australian Photonics Cooperative Research Centre with Universities of Melbourne and Sydney, Distributed System Technology Cooperative Research Centre with University of Queensland and Research Data Network Cooperative Research Centre - Monash University.

233 customers such as Wireless Application Protocol (WAP)-enabled phones and mobile EFTPOS in taxis (Telstra, 2002a). The R&D activities had three primary goals; innovation, to open up new opportunities for customers, and to focus on adding social value (Telstra, 2000c), which fit with the strategic goals of Telstra. By involving customers in product development, Telstra had maintained a two-way dialogue189. Despite the recognisable achievements of Telstra, its R&D budget was considerably lower than that of equivalent telecom companies in OECD countries and indicated a decreasing trend190. In terms of technology acquisition and adoption, Telstra was an industry leader. When CEO Blount joined the company he noted that the introduction of new technologies was somewhat patchy (Ross, 2003) 20). However, through incremental improvements Telstra has shown that it recognises the importance of innovation and investments in infrastructure to catch the pace of evolution in its sector191. In 1999, the company completed a five-year program to upgrade, rationalise and digitalise fixed networks and improve systems of billing, sales and customer service. A year later, Telstra announced that it further planned to spend $20–25 billion between 2000-2005 on upgrading national infrastructure and introducing new technology and services to business (Telstra, 2000a). Furthermore, to keep up with the pace, the company established the position of chief technology officer to ensure an aligned strategy and design across the company and decentralised responsibility for IT systems to business units. A survey of senior executives commissioned by PricewaterhouseCoopers (PwC) and Business Review Weekly (BRW) and conducted by the research firm Millward Brown found that Telstra made the “most effective use of technology” and came third in “coping with the future” (Kavanagh, 2001). For instance, Telstra had become an early mover in the broadband area, which brought with it the advantages of being industry leader in providing the service (Telstra, 2000b). On the other hand, it has delayed its investments in renewing the copper network, which contradicted with Telstra’s vision to become an innovative telecommunications company. In terms of organisational learning, there was insufficient evidence to suggest Telstra promotes a learning environment, in which knowledge acquisition and sharing are fostered by formal and informal organisational processes. Over the years the company has developed

189 Telstra Business Network, a managed broadband service for small to medium enterprises, was the first customer solution to emerge from the Telstra Innovation Centres (Telstra, 2004f). 190 A$29 million (2001), A$29 million (2000), A$34 million (1999) A$43 million (1998) was spent on research and development (Telstra, 2000b, 2001). R&D as % of revenue: Telstra 0.3% in 1997 but 0.1% in 2003. The OECD industry average was 1.7% (OECD, 2007). 191 For instance Telstra deployed a digital GSM mobile telecommunications network, a hybrid fibre co-axial cable broadband network, undertook a project to reduce the level of faults in customer access network, deploying a new digital mobile network based on CDMA that will replace analogue network.

234 several portals for knowledge sharing, but there were no signs of mechanisms like communities of practice or portals through which best practices are shared.

Skills competencies: In terms of skills competencies, companies that have occupational specialist positions as opposed to well-defined routine positions are considered professional organisations. These organisations find innovative ways to perform work and skills development. Telstra’s transformation continued, through replacing routine positions with more occupational specialist positions, as well as more flexible work arrangements. The company introduced the concept of supplementary workers192 and the 1998/2000 Enterprise Agreement introduced flexibility to work hours ((Barton, 2002)Table 3.4). The Human Resources Department displayed a very strong hand on employee planning. While CEOs have been the main agents of change, the department had a prominent role in participating in business planning and organisational renewal activity (Shadur, Caught, & Kienzle, 2003). The re-engineering intended to transform the company structure from a public entity to a lean and cost-efficient organisation resulted in a change in the structure of the workforce. Firstly, massive downsizing occurred from 1988–2004. In the first phase, prior to 1992, voluntary redundancies led employees with market skills to leave the organisation, and a less experienced workforce remained, resulting in a large number of dissatisfied customers and bad publicity (Ross, 2003). Ross adds, however, that following this a more strategic approach to redundancies was adopted (Ross, 2003) 115–116). Secondly, some non-core, non-skilled work was outsourced to third parties, and later even some of the semi-skilled and skilled work193. The company received much criticism for this model and at times found itself needing to offer explanations (Telstra, 2004h). Experts state that careless layoffs and outsourcing can result in the loss of firm-specific skills and sometimes outsourcing can become costly (Chu, 2001) p. 2). Indeed, many redundant field workers were re-employed under fixed-term contracts or as 'consultants' (Ross, 2003).

192 A Supplementary Worker is a new type of permanent employee who is able to enjoy flexible working arrangements as well as the benefits of being a permanent employee of Telstra. They are employed as call centres personnel, technical specialists and other administration roles that suit flexible working arrangements. Supplementary Workers are paid an hourly rate and may be offered work on a regular or ad hoc basis (Telstra, 2004b). 193 Ross lists these examples for outsourcing skilled work: Shifting of network construction and maintenance to NDC (1999), sale of its telephone system maintenance and service business to Ericsson subsidiary (2001), and outsourcing of its IT support work to newly created joint venture IBMGSA (1997) (Ross, 2003): 126. The company contracted IT work to Deloitte Consulting Consortium (Telstra, 2000d) and even used agency labour inside its own call centres to perform the same work as its own staff (Barton, 2004)pg 139.

235 Creativity competencies: In terms of creativity competencies, companies that encourage new idea generation are considered to be professional organisations under the Royal model, according to a continuum ranging from low to high. In company rhetoric, Telstra claims to place importance on innovation, but there is no evidence the company has promoted a creativity-generating environment. Therefore, Telstra is found to be located at the lower end of the continuum. b. Management Control Companies with low levels of management control and high levels of employee discretion and control are considered to be at the higher end of the continuum for professionalism. Due to the high levels of control within the organisation, Telstra can be considered to be at the lower end of this continuum. During the process of restructuring, Telstra has reshaped its business model from one large single entity to a network-like organisation built around a core business. It has supported the core business by maintaining an arms-length relationship with external partners. Among these partners are suppliers, subsidiaries, subcontractors, joint-ventures and strategic partners (Ross, 2003). For instance, Telstra has created subsidiaries for fixed-term project work such as Visionstream and partnered with Microsoft, Cisco, Siemens and Internet Security Systems (ISS). Initially, Telstra maintained control over partners by having a close relationship with them or with joint-ventures by holding a controlling interest. For example, (Ross, 2003) quotes Telstra’s high degree of corporate control over Multimedia and On Australia. However, this model did not always work very smoothly. For instance, in 2003 Telstra’s wholly owned network design and construction subsidiary, Network Design & Construction Limited (NDC), had to be integrated back into Telstra because the company reported that “it was no longer commercially prudent to maintain it as an external entity”(Telstra, 2000d). Further, there have been cases in which Telstra could not maintain control over partners. In the late 1990s, Telstra started to outsource higher skilled work in addition to non-core work but Telstra managers later admitted that “outsourcing of technical work was not always done well” (Ross & Bamber, 2009). Telstra transformed its workforce relationship approach from a participative approach, in which there was cooperation between the corporation, unions and employees, to a more unitarist approach, in which Telstra management was the single controller (Ross & Bamber, 2009). The high involvement model Telstra utilised during the initial stages of the transformation later created a strain between the company and unions and employees, as it was applied parallel to downsizing and the introduction of AWAs (Shadur, et al., 2003).

236 There have also been complaints about Telstra’s close monitoring of employees’ daily activities in the workplace; in particular, call centre staff performance, in the form of “daily output” (Diane van den Broek, 2003)and breach of employee privacy. Telstra admitted that “employees may be monitored if it is authorised by a senior manager” but it “denied keeping secret dossiers on its staff” (Jolliff, 2005). However, The Australian newspaper has claimed the existence of an internal document authorising the collection of personal staff files, including information on sexual orientation, race and religious and political beliefs, which was later confirmed by management (Jackson, 2005). c. Co-worker Relations/ Work Organisation/ Teamwork/ Communication In the Royal template, companies that maintain high levels of vertical and horizontal communication, co- worker interdependency and team-based structures with flatter hierarchy are regarded as being on the higher end of the continuum for professionalism. The publicly available data suggest that even though Telstra has flattened the organisational structure, communication networks and daily work organisation have not yet supported this new structure. The restructuring process at Telstra included changing the “paternalistic and bureaucratic model of management with a rigid hierarchy” (Rice, 1998)p. 542; (Chu, 2001) into a leaner organisation with flatter management structures. The company aimed to improve decision making and increase accountability by simplifying roles and regulations and reducing management levels (Telstra, 1996) 17; (Telstra, 2001). Using Elliot Jaques' stratified systems model, Telstra reduced ten management layers to six (D. van den Broek & Barton, 2005) (Shadur, et al., 2003), aiming to clear all layers of inefficient employees. In 2000/2001, a 22% reduction was made in executive numbers (Telstra, 2001). Telstra demonstrated potential for continuous change and aligning internal practices with the external environment. From 1999–2004, the company incrementally changed its organisational structure to fit with changing customer needs and the external environment (Telstra, 2001, 2002, 2003). In 2003, Telstra was rearranged into eight strategic business units organised around customer groups (Telstra, 2003e). The company maintained close contact with rural and remote Australia through an organisational network led by 28 regionally based area general managers and networks. Telstra often promoted teamwork-based work organisation in its company rhetoric; for instance, in the 2002 Annual Report the company’s success was attributed to teamwork, as “Teamwork combined with strength in leadership ensured that Telstra continuously improves service to our customers”; further, the company motto in 2003 was “One Company.

237 One Team” (Telstra, 2002a, 2003e). Regardless, the data suggest the teamwork structure was more often used for customer service representatives at call centres (Diane van den Broek, 2003) (Shadur, et al., 2003), while at the corporate centre the work was designed mostly on an individual basis and teams were used only ad-hoc basis; for instance, “an energy management team” (Telstra, 2001), “a project team to manage convergence to IFRS” (Telstra, 2003e). Generally, Australian telecommunications sector organisations promoted multi- skilling and flexible job arrangements, but Telstra lagged behind its competitors (Shadur, et al., 2003). Nevertheless, there is evidence suggesting the company started to develop strategies for flexible work arrangements and work/life balance needs of the employees, with an employee in a risk-management and assurance-management role at Telstra in Melbourne stating: I do a lot of the IT audit work for one of the Telstra business lines. I come into the office early, around 7.15, but at the same time, I'm out of the door at five-to- five…There are people here that make it a point to give 110 per cent to their work but also 110 per cent to their family. ((Beer, 2004) 2)

Maintaining open vertical and horizontal communication is essential for a network organisation. Various methods and channels are required to ensure the flow of information between Telstra headquarters and a diverse workforce of 40,000 employees and suppliers, contractors, subsidiaries and outlets. There is very little information about how this is maintained throughout the organisation, besides the extensive use of teleconferencing and videoconferencing for internal communications. d. Power/Decision Making/Leadership The Royal template describes an active consent relationship as one in which decision making and leadership are participative and employee- oriented. At the other end of the continuum lies the autocratic relationship; in this kind of relationship, employees do not internalise company goals and there is little participation in decision making. Based on the publicly available information, Telstra uses an autocratic relationship. The data suggest that Telstra, in comparison to its previous stance, flattened the hierarchical business structure and simplified decision-making processes. However, it kept strategy and policy making centralised and chose to decentralise only implementation methods. During the transformation process, CEO Blount stressed the themes of “involvement”, “trust-based relationships”, “shared umbrella” and a “participative approach”

238 but these practices never realized. Blount’s leadership style fostered a single voice rather than multiple voices (Rifkin & Fulop, 1997), confirming an autocratic leadership style. Unfortunately, subsequent company leaders used the same leadership style. Employees voiced their opinions in the media and union websites regarding the transformation of Telstra, with most of their complaints relating to bullying and harassment by management (CEPU, 2007), stress created by the new training programs and “intrusive monitoring of both call centre workers and field staff” (CEPU, 2007). The ABC’s Four Corners program conducted several interviews with Telstra employees, eliciting statements like: “I’ve never in all the time I’ve been with Telstra…..felt so much pressure” and “[we’ve seen] a worrying authoritarian trend in staff relations” ("The ABC News: Four Corners programme ", 2007). Generally, the evidence suggested an authoritarian management style.

2. Recruitment The Royal template suggests the professionalism set of human resource practices are those that encourage an employment relationship in which recruitment and career progression occur at all levels of the firm. Organisations in which positions are filled through both internal and external resources and qualifications and experience are the major criteria for selection fall within the professionalism definition. In terms of recruitment practices, Telstra has moved from a structure that displays attributes of traditionalism to one of professionalism. Since its establishment, Telstra has internally recruited and developed managers up the career ladder. However, during the 1990s this trend began to change. Privatisation and deregulation required the company to become more competitive, meaning managers needed leadership, sales and marketing experience (van den Broek 2001, p. 88 cited in (Diane van den Broek, 2003). While the company continued to hire graduates at entry level194 (Telstra, 2000a), following the 1990s the intake of external recruits increased. For example, Frank Blount and several other senior managers were recruited from privatised United States telecommunications firms Bell Atlantic and AT&T195 (D. van den Broek & Barton, 2005). Previously, the company had recruited through a central system (Diane van den Broek, 2003), but due to the changing organisational structure the company began to use recruitment agencies and online recruitment systems196(Telstra, 2004c). Formerly, the

194 Telstra had a graduate recruitment program that provided 18 months training. 195 Other external manager recruits were: Recruited former OzEmail CEO, Justin Milne, to head up its broadband business, Ted Pretty, former director of Optus Communications and adviser to BellSouth Corporation as Director for Telstra Retail and Bill Scales as Group Managing Director of Human Resources (Telstra, 2000b). 196 Telstra started to use Internet-based Human Capital Management systems by Personic Asia Pacific ("Telstra chooses personic for the

239 company had hired people with technical skills such as electrical/electronic engineers (Turpin, et al., 1996), and later sought individuals with managerial skills to aid the corporate culture in becoming more competitive and “dynamic”(Diane van den Broek, 2003). For Telstra, attracting and retaining leaders and managers was important for the sustained advantage of the company. During the 1990s, Telstra’s recruitment/de-recruitment practices showed vulnerabilities at several levels. Firstly, from 1992–1996197, Telstra lost many experienced senior executives (Ross, 2003) 98) and had difficulty replacing them. Yet the process of finding a replacement for CEO Frank Blount, the transformational leader that had helped Telstra make the transition to a private institution, was very drawn out and made investors uneasy 198 (Mathieson, 1998). Even after 2000 this remained a prominent issue; a commentator noted in 2005 that finding a new CEO was the most important issue for Telstra (Durie, 2005). Secondly, the media had been critical of Telstra’s choices for senior executive recruitment, signalling that the company needed to be more open about its selection processes. For instance, the media questioned the appointment of Switkowski as CEO in 1999199 based on of his controversial departure from Optus in 1997 (a competitor telecommunications company) (Craig, 1999; Ridder, 1999). Further, following speculation in the media about mass sackings of management (Kitney, 2002), the company should perhaps be more open about its de-recruitment activities as well. Thirdly, there were instances in which the human resources department skipped background checks during the selection process200 This pointed to the weaknesses of its human resources management systems. Finally, a study exploring the recruitment practices of two Australian telecommunication companies found that Telstra applied pressure on recruits to sign individual non-union contracts and internal job vacancies advertised by the company indicated that preference would be given to those employed on an individual contract basis (Diane van den Broek, 2003). These pointed to Telstra’s aims to de- unionize the workplace, which put more stress on the workplace relations and effect productivity.

supply and management of an enterprise recruitment system ", 2000). 197 According to Ross between 1992 and 1996 the corporation experienced between 60 and 80 percent senior management turnover. 198 It took nine months to find a replacement in 1998/1999. 199 Share price has fallen after the appointment was announced. 200 In 1993 Bruno Sorrentino, head of Telstra’s IT arm and research laboratories had not attended London's Imperial College, or completed a claimed PhD in physics (Tabakoff, 2000). In 2000 Chris Tyler, CEO of Telstra subsidiary Solution 6 convicted of marijuana possession, involved with a North American company, Lessonware, that had collapsed and with a series of blunders as head of New Zealand Telecom's internet operations. Telstra did not know about Lessonware or the drug conviction. Queried why he had not told the boards of Solution 6 and Telstra about his past, Tyler commented that he was "never asked" . (Tabakoff, 2000) In 2002 Telstra appointed former OzEmail chief executive Justin Milne to lead the broadband arm. Milne has been highly critical of Telstra a year ago about a competition notice by the Australian Competition and Consumer Commission against Telstra (Spencer, 2002).

240 3. Training According to the Royal template, organisations that are classified under professionalism tend to adopt an internal/external training philosophy. In these organisations internal training occurs on-the-job from colleagues and peers and external training is acquired from a tertiary or professional institution, providing a formal degree or diploma. The publicly available information suggests Telstra employs both internal and external forms of training, which fits within the occupational category. The company has adopted a short-term approach to skills upgrading, which may endanger the future of the company. Traditionally, learning at Telstra progressed through “an extensive system of structured trade and technical training” (Ewer, 2000). Technicians attained high levels of skills through a long apprentice training program. After the 1990s, the reliance on internal training lessened and the in-house training program was cancelled, which was attributed to several reasons. Among them “the corporatisation and part privatisation of Telstra, technological change” (Ewer, 2000) and “productivity increases and high staff turnover” (Ross, 2003) were listed. The company began to recruit from TAFE colleges, in which employees had gained generic skills and later trained them in job-specific skills (Ross, 2003). In-house training had become primarily computer-based and the scope had changed to communicating company values and mission and the development of interpersonal and leadership skills as well as emotional intelligence (Ewer, 2000), (Nader, 2003) (Telstra, 2004b). A study examining learning in organisations noted that former CEO Blount had created a learning culture that promoted a “shared site of power rather than diffuse sites, specifically harmonious rather than indeterminate outcomes, one voice rather than multiple voices, and a shared perspective rather than diverse perspectives” (Rifkin & Fulop, 1997). The same study observed that this type of learning environment did not fit with the rapidly changing external environment of Telstra and would fail to foster innovation and creativity. As technology enables the telecommunications industry to offer new products and services to the market frequently, the range of skills required is expanding rapidly; for instance, from 1999–2004 there was great demand for technicians with knowledge of internet applications. Telstra's network and technology group managing director, Gerry Moriarty, admitted that there was a need for "dramatic change in skills" (Cochrane, 1999), which could be achieved through re-training as well as recruiting new and trained staff. Commentators cautioned that lack of technical skills within the company could become critical in the future (Ross, 2003).

241 Telstra managed its skills shortage in several ways. Firstly, through the Telstra Learning Program the company cooperated with universities by communicating industry needs and integrating in-house training into university degree programs (Turpin, et al., 1996). Telstra staff became involved both in the design and delivery of these programs. Secondly, the company developed The Data Skills Academy to re-skill technical staff. It also introduced the Telstra Learning Institute program for its mobile phone retailers (Factiva, 2002), which was an industry first and was developed through industry-wide consultation (Factiva, 2002). Thirdly, Telstra continued its corporate graduate program and traineeship programs201(Telstra, 2004c). Lastly, Telstra became the founding member of the IT Skills Hub, a not-for-profit organisation bringing together employers, employees, educators and government and aiming to foster the development of information and communication skills and innovation (Telstra, 2003a). Although the training and experience gained at Telstra means employees are highly employable in other companies, Telstra needs to continue to upgrade its training programs, especially in an environment in which there is extensive downsizing and outsourcing.

4. Career Opportunities Internal career ladders offer opportunities for promotion and employment security. Opportunities for both internal and external careers occur in organisations that have occupational specialists. Public data suggest managerial career structures in Telstra are becoming blurred, as most executives joined the company only recently. In 2000, only one senior executive had more than 6 years’ experience with the company202. Traditionally, Telstra had “a public sector culture“ and offered “long-term career paths” (Ross, 2003). However, after competition was introduced into the industry, the culture changed. There was a need for leaders and managers to transform the state-owned monopoly into a competitive organisation that would ultimately be privatised. In 1992, Telstra hired an experienced international executive, Frank Blount (CEO 1992–1998), an American formerly working for AT&T, to lead the company. Then the company hired externally Ziggy Switkowski, former CEO of Optus, as group managing director in 1997 (CEO 1999–2005). Then, Telstra chose to hire an external recruit Solomon Trujillo (CEO 2005–2009) instead of promoting David Moffatt (CFO 2002) to replace Switkowski (Marsh, 2003).

201 Telstra traineeship program: 300 telecommunications trainees have gained official industry-recognised qualifications thorough working side-by-side with Telstra's very highly skilled and customer-focused technical staff. 202 John Stanhope (CFO 2004) has been with Telstra and its earlier identities for 37 years, his entire career.(Walters, 2004b).

242 When Blount took over in 1992, he began the transformation by reshaping the overstaffed workforce. In 1996 alone, Telstra shed over 10,000 employees203 (Bromby, 1997). Telstra used downsizing not only for cost-cutting but also for removing staff without the requisite skills and experience (Ross, 2003). The work locations of remaining skilled staff were centralised and jobs performed by less-skilled staff were outsourced (Ross and Bamber 1999, pp. 15–16, cited in (Chu, 2001). Some of the staff were moved to subsidiary or partner companies204. Blount also changed top management by hiring experienced executives to assist him in carrying out the transformation. Unfortunately, within a year of his departure, many of those executives also left Telstra205. The task of leading Telstra is particularly challenging because balancing the “commercial needs of Telstra and the social policy needs of Canberra” is highly demanding and at times a conservative leadership is preferred ("GE executive will fix Telstra vacuum," 2001; Mathieson, 1998). The high turnover among successful senior managers has attracted the attention of the media and analysts (Otoo, 2001) and at times it has even caused a drop in the share price206. In general, technicians and managers trained in Telstra are highly preferred in the industry, which may attract staff to career opportunities in other companies. Among the reasons for their departure are the continuing bureaucratic procedures of Telstra, the lag in becoming competitive ("MyPrice, plus options, nets Telstra big gun," 2000) and lack of further career opportunities (Lacy, 2000b). Opportunities provided for minorities and the resulting diversity are significant indicators for evaluating sustainable human resource practices. Telstra’s efforts in providing career opportunities for minorities have been recognised externally. For instance, in 1995 Telstra won a gold award for career advancement for women at the Corporate Work and Family Awards (Telstra, 1995) and in 2003 won the National Corporation category in the Awards for its commitment to providing genuine employment opportunities and career advancement for people with disabilities ("Vision and a fair go - PM's employer of the year awards: A special advertising report," 2003). While the overall representation of women in

203 Between 1990 and 1999 Telstra's workforce was cut from 87,000 to 52,800 (Otoo, 2001). 204 For instance: In 1997, 2,100 Telstra staff and contractors were moved to the joint venture company IBM Global Services Australia (IBMGSA), in 1998, 300 staff members were moved to the network services joint venture Advantra, ,in 1999, 5,000 workers moved to the new subsidiary, Network, Design and Construction (ND&C), and 2,000 accepted redundancy payments (Chu, 2001; Telstra, 1997). 205 Peter Shore (1993-2000) has left for a job running online retailer MyPrice in 2000 ("MyPrice, plus options, nets Telstra big gun," 2000) Paul Rizzo (1993-2000) has left without a known replacement in 2000 (Lacy, 2000b) T he head of networks and infrastructure, Mr Gerry Moriarty (1993-2002) resigned in 2002 (Press, 2002) . The only remaining senior executives that also served under Blount were, the head of Telstra CountryWide Mr Doug Campbell and group general counsel Mr Bruce Akhurst. Mr Andrew Day, Sensis CEO (1999-2004), resigned on Oct 2004. 206 Mr Rizzo's highly-publicised departure in November last year wiped about 5% off the value of Telstra shares ("GE executive will fix Telstra vacuum," 2001).

243 the company is still moderately low (around 32%), there were increases recorded in the representation of women at managerial levels in 2003207 (Telstra, 2003a) 13).

5. Rewards The Royal template indicates that organisations in which employees are occupational specialists and dual career ladders exist, highly variable and performance-related remuneration exists. An examination of the data indicates that in terms of rewards provided, Telstra is closer to a traditional organisation and with some recent changes to professional organisation. Telstra’s Annual Reports provide detailed information about remuneration packages offered to executives to a greater extent than that required by law. However, there is little explanation about the financial or non-financial rewards offered to the rest of the workforce. During its transformation from a state-owned monopoly to a semi-privatised organisation, certain human resource practices had to change to accommodate the external and internal needs of the organisation. Notable changes occurred, particularly in the rewards offered to employees. A study exploring industrial relations in the telecom sector (interview data collected between 1992 and 2009) noted that “Telstra had moved dramatically toward anti-union ER approaches, with a shift away from collective bargaining toward individual employment contracts in the late 90s” (Ross & Bamber, 2009). The company had started to sign AWAs right after their introduction into the Australian labour market208 and implemented wage freezes (Davison, 2000; Ross & Bamber, 2009). By 2000, Telstra had offered AWAs from the top to the supervisory level, with 35% of employees accepting an individual contract (Barton, 2002). While these strategies have been heavily criticised by both unions and employees, as a public-sector organisation the company had a tradition of offering higher wages, in which unions have played a role. A study comparing the Australian and British telecommunications sectors noted that “Telstra employees tended to be happy with their remuneration, and according to the employee opinion surveys, satisfaction with pay and benefits has risen every year between 1992 and 1999” (Otoo, 2001). Overall, Telstra was trying to catch up to the market by lowering its operational costs and the above-average industry wage structure was seen as an obstacle by management:

207 Women employees at management levels: Around 28% for level 2 and level 3 managers in 2003 208 10% of Telstra workers were covered by individual contracts (AWAs) in 1997 and ten years after, 50% of Telstra workers were covered by individual contracts, much above Australian average 8%.

244 There are clear commercial imperatives that this company has to address and we are going to keep working on that. ……In some cases it would have taken about three to five years for the market to catch up to the current salary rates in Telstra (Davison, 2000).

Some managers stated that with low salaries it was difficult for Telstra to compete in the labour market209. On the other hand, the media was also critical of the pay rises senior executives were receiving despite the drop in the share price210. For instance, CEO Switkowski could, if he achieved all his performance targets, earn almost $7 million in a year, of which more than half would be cash (even higher than BHP’s CEO) (Bartholomeusz, 2003). Telstra gradually altered the remuneration system of the semi-privatised company and aimed to better align senior manager and shareholder interests (Telstra, 1999)p. 111), with the T2 offer document announcing the new Senior Manager Equity Participation Plan (SMEPP). According to this document, since 1994 senior executives had been receiving cash as a part of long-term incentives based on internal measures211. However, under the SMEPP senior managers would be allocated shares and options vesting over five years212. The performance hurdle213 for receiving these incentives aimed to reinforce a long-term focus of the company. The new remuneration plan was progressively applied after 2000 (Telstra, 2000b, 2001), with short-term incentives offered for meeting or exceeding specific key business objectives at the corporate, business unit and individual level. The measures included financial, customer service, employee opinion and individual measures that supported key business objectives (Telstra, 2003e). Further, long-term incentives were offered based on equity under the name of Telstra Growthshare. The mix was 18%–25% of the total remuneration package for short- term incentives (fiscal year 2000) and 21%–34% for long-term incentives (Telstra, 2002a), (Telstra, 2003e). The total at-risk pay of 40% in 2000 was aimed to reach approximately 45%–65% in the following years (Telstra, 2000b). To reinforce this long-term focus among the managers, the company introduced a restricted share plan (Telstra OwnShare) after 2001. The new Total Remuneration Package approach aims to focus managers on performance based on company objectives. In 2003, half of the short-term incentives were

209 Mr Yelland, whose salary at Telstra in 1999 totalled $926,000, said he was leaving in favour of a more attractive package. (Lacy, 2000a). 210 Telstra shares have dropped 43% since its offering 2001-2002 , however Switkowski’s salary increased 2.1% in 2002 to $2.4 million (Way & Heathcote, 2003). Ted Pretty, earned an extra $A300,000 in bonus payments and salary to take his earnings to $A1.7m. (Owen, 2002). 211 It was conditional upon the company exceeding over three years the return on investment target agreed by the board. 212 Under Telstra Corporations Act Telstra cannot issue new shares, the company will need to buy shares from the market. 213 Performance hurdle: The performance hurdle is achieved if the 30 day average of the Telstra accumulation index exceeds the 30 day average of the All Industrials Accumulation index between the third and fifth anniversary of allocation Options are then exercisable up to 10 years after the original date of allocation. The exercise price is the market price at the time of grant of the options (Telstra, 2001).

245 based on the achievement of company objectives and Telstra introduced a Deferred Remuneration Plan whereby the CEO and senior executives are provided part of their annual fixed remuneration in the form of rights to Telstra shares through the Telstra Growthshare Trust (Telstra, 2003e). All employees, including senior managers of Telstra, are eligible to participate in the Telstra Employee Share Ownership Plans.

6. Professional Identity and Culture The Royal model specifies that organisations in which employees identify with the organisation itself rather than the profession are those in which there is a strong dominant culture and where networks are top down. Prior to the 1990s, Telstra’s culture was known to be “bureaucratic and driven by technical and engineering imperatives” (Rice 1998, p. 537). The patriotic relationship that Telstra maintained with the workforce214 ensured high commitment and a high level of corporate identification with the company. According to Ross (2003), after the 1990s worker commitment was no longer as important, particularly within a high staff turnover environment. After the introduction of competition, opportunities in the external labour market became attractive for Telstra employees. Moreover, the new workforce had education degrees received from TAFE colleges and higher education institutions rather than through internal company training. This made them identify themselves more with the profession than with the organisation and made it easier to transfer their skills from one organisation to another. When CEO Blount initiated the transformation, the aim was to gain a competitive advantage through better customer service and higher levels of customer satisfaction. For instance, the 1994 Annual Report adopted the theme of “Creating the future with customers” and the first item on the company’s new value set was “the customer comes first” (Telstra, 1994). This theme developed and extended beyond 2000, with Telstra defining its new culture as more commercially oriented, more customer focused, and forward looking215 (Mathieson, 1998). However, after 2000 the customer service focus of the telecommunications industry gradually moved to a sales-oriented focus due to shareholder expectations of higher profits, increased competition from local and foreign-owned firms, and the use of technological and

214 The company provided housing, social and sporting life and vocational education (Rice 1998) Pg 537. 215 The new set of values included service, respect for the Individual, integrity, commitment and accountability, trust, leadership and teamwork ((Telstra, 2002a).

246 alternative services for customer service, which reduced the emphasis on customer-facing staff, as was the case in other service-sector organisations such as NAB. The journey of culture change that had started in the early 1990s and continued through 2000 was by no means a smooth ride for Telstra’s management or workforce. Firstly, according to (D. van den Broek & Barton, 2005), the change process was “not accepted unilaterally by managers”, “received mixed support” and at times rather than internalising the new value set, the managers accepted the initiatives merely for the sake of keeping their jobs. Further, some elected to find jobs elsewhere, such as Lindsay Yelland, head of Telstra's $6 billion-a-year business solutions unit (Wood, 2000). Secondly, the change program was conducted mostly in a top-down manner, with appointed leaders entrusted with readying the company for privatisation, which meant making Telstra an attractive investment. CEO Blount and the subsequent CEOs were impatient to achieve immediate results and had neither the time nor the patience to adopt a more participative management approach. Telstra Chief Operations Officer Greg Winn put forth the approach as follows: We run an absolute dictatorship and that’s what’s going to drive this transformation and deliver results… If you can’t get the people to go there and you try once and you try twice… then you just shoot ‘em and get them out of the way… (McDermott, 2007).

Lastly, the change process impacted the remaining workforce the most profoundly, as they experienced job insecurity and higher workloads. Combined with the introduction of the sales culture and the new sales targets, the conditions undermined employee morale216. The pressure of achieving sales targets and “the intimidating recruitment and redundancy policies” was felt by all employees, even senior managers. According to one view, CEO Switkowski’s failure for achieving revenue growth of 4% by 2006 cost him his contract (Greenwood, 2004). Overall, publicly available data indicates that Telstra is more closely matched with an organisation in which employees identify more with the profession rather than with the organisation. Employees at the company originate from many different professions, such as engineers from various disciplines (electrical/electronic/instrument, computers, mechanical, maintenance, technical design), business specialists (account managers, presales consultants, communication consultants) and skilled and semi-skilled workers(Telstra, 2004b). Further, lower-level managers experience career mobility to a lesser degree than higher-level

216 During 2007 Sally Sandic, a young Melbourne woman who worked at a Telstra call centre, took her life (McDermott, 2007)

247 managers, who “see great opportunities for themselves wherever their work might take them” (Otoo, 2001). It is difficult to say that all of the employee groups strongly identify with the new customer-oriented and sales culture, despite Telstra's employee opinion surveys indicating that since 1998 the job satisfaction of Telstra group employees rises each year (Telstra, 2004b)

8.5 Research Question 2 Is there a knowledge gap between the analyst reports and reporting of Sustainable Human Resource Practices by companies?

In order to understand the contents and recommendations of analysts, this study draws on reports prepared by two investment banks and independent research covering Telstra from 1999–2004. A random selection was made from each set for each year, with 56 reports used overall. These reports display analysts’ valuations of Telstra’s stock value, which are calculated based on information available in the public domain. A common trend in the 1990s in the telecommunications market was the deregulation of the sector and the privatisation of state-owned telephony companies. During that period, computer and internet technologies advanced, resulting in greater use of these technologies both by individuals and businesses. OECD experts Lenain and Pathridge note that these developments resulted in high expectations for future revenues and earnings, thus boosting share prices and borrowing rates. From 1999–2000, US and European telecommunications company share prices peaked (Lenain & Pathridge, 2003) and it is noteworthy that Telstra was partially privatised under these market conditions, in which similar promises to investors were given. While the first two Telstra share offerings were regarded as overpriced, analysts strongly recommend a buy-and-hold strategy for the shares, based on the belief of its future potential. From 1996–2001, telecommunications companies in the OECD grew at an average of 7.2% annually, and the growth rate was forecast to reach the double digits (Lenain & Pathridge, 2003). Only when the growth rate dropped to 1.6% annually, analysts revised their approach and wrote more realistic reviews, downgrading the outlook for telecom stocks. During that period it also became evident that Telstra was losing its market share, growing at a slower pace than the sector average. As a result, it had to write-down some of its Asian investments. Accordingly, the “outperform” and “market perform” ratings of Telstra before and after its privatization by sell-side analysts were replaced with “hold” and “under-

248 perform” in 2003. These confirm the differences between fundamental Human Capital analysis (analysing how growth will be achieved, rather than accepting the company rhetoric) and security reports’ understanding of Human Capital. Generally, in comparison to the other two case companies, analysts referred to very little qualitative data when writing equity recommendations for Telstra. In the selected reports, much attention was paid to market analysis (price/ product/cost comparisons) and cost-reduction programs, as was the case for analyst briefings and conferences. The questions put to company officials centred around “cost-cutting programs and revenue expectations”. With the exception of training and incentives information, analysts showed no interest in qualitative information. Following the bankruptcy of the US telecommunications company WorldCom, corporate governance concerns in the sector became prominent. However, in Australia briefings and reports do not indicate any concern about governance issues for Telstra, which may to a degree be the result of its ownership structure and the role of the government in its corporate governance mechanisms. The selected investment recommendations of two different investment banks for 2004 are given below. Each recommendation report has been written following significant company announcements. Figure 8.1. Investment Recommendations 1

Jan Feb. April July Nov. Market Market Market Outperform Neutral perform perform perform

Figure 8.2. Investment Recommendations Set 2

Feb. April July Nov. Dec. Neutral Outperform Neutral Neutral Neutral

The announcement in January explained that the IT cost-reduction program was on target. The first analyst report (Figure 8.1) raised the question, “Does Telstra have sufficient IT capability to match growth aspirations?” which is a pertinent question related to

249 capabilities then continued with, “Is Telstra prepared to spend in new IT areas in order to enhance service capability?” Unfortunately, the concern only links capability to financial investments, not at all to human capital that will make these investments become value creators. In July 2004, when Telstra announced its future technology roadmap, the recommendation changed from “market reform” to “outperform”. Telstra had forecast that the upgrading of its network to be IP/packed would result in future cost savings and a potential increase in its sales to corporations and government due to the convergence of ICT- and IP-based applications. Further, on a short-term basis, promised improvements in margins are assumed to ensure increased future earnings. In April 2004, Telstra’s chairman resigned and the share price rose by 17 cents. Consequently, the second investment bank (Figure 8.2) changed its recommendation to “outperform”. In December 2004, when the CEO resigned the recommendation stayed neutral, stating that a CEO change would not impact the management of the company in the short term. In neither instance did the second investment bank address the implications of a chairman resigning, corporate governance or succession-planning issues. In summary, answers to Research Question 1b for Telstra has shown that the company goes beyond its mandatory regulations in reporting information about its Sustainable People Management Practices. Similar to NAB this information is much less in the annual and sustainability reports and more in the other sources for Telstra. Nonetheless, there is also some missing Human Capital data in the public domain, which can not be obtained as this research replicates the regulatory environment that the analyst find themselves in and uses only publicly available data. On the other hand, the analysis of the security analyst reports show that analyst include market related information but no Human Capital information other than top management remuneration. In conclusion, there is a knowledge gap between the analysts reports and their understanding of companies in their reports from a Human Capital perspective and what is understood in the field of Human Capital

250 8.6 Research Question 3

How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making predictions about the future financial performance of ASX-listed companies?

The review of the information asymmetry in the capital markets have shown that not disclosing Human Capital information may cause investors to misjudge company value, lead to mispricing of shares and eventually create inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack good information access. There were several examples for the information asymmetry that the Human Capital Analysis depicted at Telstra. Firstly, the data collection and analysis of Telstra have highlighted that “leadership, training and workplace relations” are significant Human Capital related indicators for Telstra that need to be evaluated over time as a part of the Human Capital. Non of these items were reported or evaluated in the analyst reports. The follow up of significant Human Capital information such as “training” and “industrial relations” gave insights for the future financial performance of Telstra. Skilled and committed workforce is essential for strategy execution. Human Capital Analysis points that if Telstra employees continue to feel disgruntled because of their work conditions it will slow down Telstra’s ability to execute strategy in a few ways. Employees will continue to express their anger in the media; TV programs, union websites, newspapers, industry magazines and blogs. Telstra’s reputation as a desired employer will be tarnished and chances to attract a qualified workforce is going to lessen. Labor turnover, particularly at call centers, will be costly and lower the service quality and sales. Human Capital Analysis also points that the decreasing in-house training might result in network maintenance to slow down, causing many dissatisfied customers, particularly in rural areas. A workforce that is not committed and accepting organizational goals might not cooperate in change programs, slowing down the execution of strategy. These were only some of the workforce related issues that had to be addressed before recommending the stock. It is not only market forces, such as the booming telecommunications industry during 1997-2001, that has to be considered, but internal forces that can impact the performance of a company. Even during a booming market investors have a right to know which company has the potential to perform better within its industry.

251 Considering the differences in understanding of Human Capital in analyst reports and what Human Capital analysis have depicted it is highly important to close this gap for improving the investment recommendation process.

8.7 Company Rhetoric vs Reality Compared Through Secondary Sources

This section suggests to sift “company reality” from “company rhetoric” through triangulating “company originated data” with “other sources”. “Company-originated documents” are obtained through annual reports, analyst briefings, presentations, sustainability reports and websites and “other sources” are obtained through academic articles, books, magazine and newspaper articles and industry reports. And through the process of comparing and contrasting the section demonstrates how Human Capital Analysis can overcome the inaccuracy/ reliability problems associated with voluntary company reports. The comparison is conducted at three sub-stages; policy framework, implementation of policies and public accountability. Telstra has adopted a values-based approach for conducting businesses, aiming to go beyond its legal obligations in fulfilling its responsibilities to stakeholders217. The values statement “Living our Telstra Values in every decision we make, every day” is an indication of this aim (Telstra, 2004e). In defining stakeholders, the company takes a very wide approach, as it considers all Australians as stakeholders; it lists key stakeholders as customers, industry, society, employees, suppliers, and shareholders.

1.PolicyFramework Based on the data gathered from publicly available sources, Telstra can be considered to be operating at a very high level in terms of policy development for organisational sustainability and monitoring for high levels of corporate governance.

Negative environmental and health effects arise from the installation, maintenance and use of telecommunications equipment and products, attracting much scrutiny from regulatory bodies and society in general. As such, Telstra's operations are subject to environmental regulation under Commonwealth, State and Territory laws218 and the company

217 For Telstra the corporate social responsibility is defined as “how we do business, leading us beyond legal compliance to make a positive contribution to the industries and communities in which we participate” (Telstra, 2003a). 218 Some of the related laws are s299(f) of the Corporations Act , Section 516A(b) of the Environment Protection and Biodiversity Conservation act 1999 (the EPBC Act), environmental planning approval requirements of the Telecommunications Act and State and Territory legislation.

252 is required to document its actions on the environment and identify measures to minimise the effects of and to report on these activities (Telstra, 2001) (Telstra, 2003e). In regards to these issues, Telstra has externally and internally initiated multiple policies and programs to demonstrate its aims to develop sustainable practices. The Telstra board of directors is comprised of independent and highly experienced professionals and is balanced in terms of experience and areas of interest. An examination of the directors’ backgrounds indicates the pool includes experiences in telecom, retail, banking, accounting, auditing and information-management sectors. In general, the board’s approach can be defined as conservative, as it includes a member of the Reserve Bank of Australia, and forward looking, one member being the Chairman of the Sustainable Research Institution. The board also includes two female members in a male-dominated sector, which is rare not only in Australia but worldwide. Internally, Telstra has developed a number of compliance programs to address specific legal and regulatory obligations, with the annual reports and company website explicitly detailing these programs. The internal programs include health, safety and environment, equal employment opportunity, privacy, trade practices and industry regulation (Telstra, 2004e). In 2003 Telstra began to integrate the environmental management system with the health and safety management system, confirming that the organisation is moving towards higher levels of sustainability. The internal standards use externally developed general and industry-specific principles as a guideline219. The programs applied from top to bottom structurally are strengthened by a corporate-wide legal and regulatory compliance framework and a network of compliance managers (Telstra, 2003a). Telstra’s regulatory group provides advice and assistance on regulatory issues facing the company. At the operational level, focus is placed on following through on policies, procedures and work instructions. Further, some procedures are externally audited by third parties. Data confirm that management for sustainability for Telstra is not mere rhetoric but is planned and practised throughout the organisation. For instance, suppliers are regarded as an important stakeholder group for Telstra and policies and practices confirm this. Like BHP Billiton, Telstra encourages its 20,000 suppliers and contractors to use the same set of environmental and health standards that are used in its operations, with rewards like Telstra

219 For instance; the principles of the Australian Standard on Compliance Programs, AS 3806, have been incorporated to the company-wide compliance program, the internal environmental management system is based on the Australian/New Zealand Standard on Environmental Management Systems (AS/NZS ISO 14001) and the internal health and safety management system is based on the Australian/New Zealand Standard (AS/NZS 4804:2001 Occupational Health and Safety Management Systems) (Telstra, 2000, 2001, 2003, 2004b).

253 Vendor Awards supporting such initiatives (Telstra, 2002b). Customers are another important stakeholder group for Telstra, which adopted a Customer Service Charter in 1999 with consultation from Telstra Consumer Consultative Council, which is updated every year after consultation with customers, staff and external stakeholders (Telstra, 2001) (Telstra, 2003a)16). As Telstra receives 130,000 customer enquires per day, employees working in call centres and other customer-facing staff have a significant role in the achievement of Telstra’s goal to provide “Outstanding customer service” (Telstra, 2004a). Thus, Telstra should extend its policy development and workplace improvements to include these employees and increase its best-practice cases to share with the overly concerned public.

Externally, Telstra is an industry leader in initiating self-regulation. As a member of the Australian Communications Industry Forum (ACIF), Telstra helps develop codes for issues like complaint handling, billing and mobile number portability, participates in external safety activities including development of call centre guidelines with Worksafe, Western Australia, and reviews Health and Safety Representative training with Comcare, the Federal Occupational Health and Safety Regulator (Telstra, 2004e).

2.Implementation Working through the evidence collected from sources produced by the company (e.g., annual reports, media announcements, sustainability reports, briefings, website) and comparing and contrasting it with secondary sources (newspapers, magazines, academic articles, interviews, observations by third parties), the following conclusions are reached. a. Approach: The previous section demonstrated that Telstra has an excellent policy and systems-development capacity. Further, renewal is activated through incremental improvements in policies and practices. Telstra’s approach is one of self-regulation, whereby it sets targets and aims to exceed them. However, there are instances where externally imposed standards have resulted in correction of Telstra’s services, such as in 2003, after the Regional Telecommunications Services Inquiry made 19 recommendations relating to Telstra services; the company had to upgrade the telephone services of 1400 customers living in remote areas, which had been relying on out-dated radio concentrator systems, at a cost of $19.1 million (Telstra, 2003c). There are no data indicating that managers or employees have input in setting Telstra’s performance standards. However, each business unit is free to decide how best to

254 implement and develop them. From top to bottom, the standards are passed through the compliance program, which requires each business unit to plan out how they intend to achieve legal and regulatory compliance in their operations through initiatives such as training, dissemination of information and monitoring of compliance outcomes. Further, each business unit has accountability for its own CSR activities (Telstra, 2004e).

b. Performance Targets: An examination of Telstra’s policy and management standards implementation process has shown that achievement of performance targets is given a great deal of importance, and thus is monitored very closely at Telstra. The monitoring of performance against standards begins at the top, for instance, the board engages an external consultant to conduct interviews with each of the directors to assist in evaluating the performance of the board and the consultant's report is then provided to each director (Telstra, 2004e). Telstra conducts frequent audits to monitor the implementation of performance targets, the results of which are made public220. The company also reports on how it rates in achieving performance targets. For instance, the OH&S Committee reports monthly to the board and externally its accomplishments are published in the annual report. An examination of the charts and data confirm that Telstra’s vigorous efforts in improving OH&S conditions have been highly effective221. Human resource practices are also aligned with the achievement of performance criteria; contractors’ safety performance is used as part of contractor selection criteria and performance assessment (Telstra, 2003a); reinforcement of standards is provided through special training programs such as ethics training and safety behaviour training (Telstra, 2000b); socialisation aimed at raising the awareness of safety among staff and their partners is provided; and wellbeing programs, an on-line community services directory and forums are offered for assisting staff in managing lifestyle factors that affect their health and wellbeing. Management standards are incorporated into Telstra’s operations. For instance, environmental aspects covering the handling and storage of dangerous goods, noise from the fixed plant, visual amenity and disposal of waste, are required to be managed as part of operating and maintaining plant and equipment on occupied sites (Telstra, 2002a).

220 The results of the external health and safety audits that are conducted since 1997 are reported in the annual reports .The company reported that it had conducted 90 audits during 2002/03 and 70 audits during 2003/2004 (Telstra, 2003a), (Telstra, 2004e). 221 Lost Time Incidents have dropped dramatically during 1999-2003.During 2003/ 2004 Lost-Time Incidents reduced by 26% to 265 (Telstra, 2003a) (Telstra, 2004e).

255 c. Internalisation of Values: It is important for organisations to show that they live up to their stated values. For Telstra, “service” is listed first among company values. Company leaders have been influential in developing the Customer Services Charter and encouraging service levels to improve, which compels employees to internalise the values. While it is difficult to judge whether employees have internalised Telstra values, the contribution of employees in certain aspects of business such as community involvement and environmental improvements can be observed externally. Telstra has made great efforts to minimise its effects on the environment. Initiatives such as the Green Office Program and a water re-cycling program were developed as a result of these initiatives222. According to a series of studies called the Corp Rate Project, from 2000 to 2003, Telstra has recorded an improvement in environmental performance ("Corp Rate: An Assessment of Australia's Top Listed Companies in 2003," 2004). This resulted in Telstra being rated the top environmental performer and second overall performer in the Project. d. Community involvement: Telstra not only sponsors special events but also participates in the community through community education; formed the Telstra Country Wide business unit, and has developed rural traineeships to encourage young people to join the industry, while living and working in their local community (Telstra, 2000b).

3.Accountability It is certain that Telstra is committed to long-term relationships with the communities in which it operates, and that it is very open in communications that help to build trust with stakeholders. In annual reports the company announces that it is here to stay. a. Consultation and Dialogue with Stakeholders: There is evidence to suggest that Telstra is involved with its stakeholders in an open dialogue. The company works with stakeholders in improving the management of environmental issues as well as community enhancement. For instance, Telstra collaborated with the Tasmanian Department of Primary Industries, to rectify damage caused by contractors when locating a power supply to a mobile telecommunications tower on Flinders Island (Telstra, 2004e); it worked with communities to minimise the visual impact of base station sites; and it worked with suppliers to adopt Telstra’s Green Purchasing policy(Telstra, 2003a). Consultation with consumer groups is maintained through Telstra

222 These were a national Green Office Program aimed at reducing the environmental impacts of office activities and the establishment (with a number of partners) of a system to collect and treat water from pits for re-use in council parks and sports fields, recycling an increasingly precious resource (Telstra, 2004e)

256 Consumer Consultative Council. Groups meet with senior Telstra managers three times a year, plus state/territory consultation and information events223 (Telstra, 2003a). Telstra Friends, an employee-driven volunteer program, has become Australia's largest corporate volunteer program 224 (Telstra, 2003b). b. Transparency: Telstra is found to be the most open and transparent company among the three case companies. This is due partially to Telstra’s record in responding to externally developed standards and codes. For instance, the Federal Government’s Greenhouse Challenge Program required Telstra to report on its performance in reducing greenhouse gasses 225; the company has received Australasian Reporting Awards for its continuous disclosure in this regard. Telstra has strengthened its internal and external reporting systems at several levels. Internally, it has developed a strong reporting and accountability structure. For instance, in regards to the environment, relevant business units report against environmental performance criteria biannually, with a consolidated company-wide performance report submitted to the Audit Committee for executive oversight and endorsement of environmental initiatives (Telstra, 2001). The company has developed a continuous disclosure procedure, which is reinforced by human resource practices such as training and formal communication networks. The Continuous Disclosure Committee chaired by the Group General Counsel advises the CFO and the CEO on disclosure matters. Internally, the information that may be disclosed is identified and reviewed by the Committee. Senior management undertakes training in relation to Telstra's continuous disclosure obligations. Externally, proposed media releases and external speeches and presentations to be made by senior management are reviewed by internal legal counsel to determine whether they may be disclosed (Telstra, 2003e). Further, the company website is very interactive, including the Annual Review, information on share prices, media releases and shareholder details. The recognition of Telstra’s efforts as “Best use of virtual conferencing” and “Best ongoing management continuous disclosure” by third parties confirms these findings (IR Magazine, 2004). Since 2001 the company has published the Public Environment Report, which outlines key environmental program, targets to be met and actual performance. The

223 Fifteen community organisations such as Australian Financial Counselling and Credit Reform Association, Indigenous Remote Communication Association, National Council of Women and the Australian Council of Social Service 224 The program has been in place since 1993, and has over 4,000 registered members who include staff, family and friends, and employs three full-time staff to manage the program. 225 Only the environmental reports: In 2004 Telstra’s environmental reports included Public Environment Report, the National Packaging Covenant Annual Report, the Greenhouse Challenge Progress Report and the National Environmental Protection Measures Report (Telstra, 2004e)

257 newly established Corporate Social Responsibility Steering Group helped produce the first stand-alone Corporate Social Responsibility report in 2003 utilising stakeholder input. The first two reports prepared in reference to the Global Reporting Initiative should be improved to include a checklist showing performance in relation to targets and specific data on employee satisfaction surveys, employee breakdown and training costs (Telstra, 2004e). The above section describes the strategies, policies and processes implemented and reported at Telstra in achieving sustainability. The section analytically streams through Telstra’s governance for stakeholder management and progress in social, environmental and communal performance.

8.8 Human Capital Classification Process

The first tool suggested by the Royal and O’Donnell (Royal and O’Donnell 2005) model is the historical context of a listed firm to be studied. Based on the data gathered from publicly available sources, the historical context and macro analysis of Telstra’s environment are given below.

8.8.1 Macro Analysis of Telstra’s Environment

In this section, changes in the information, computers and telecommunications sector226 (ICT) from 1999–2004, the significance of ICT as a part of both the world and Australian economy, and the elements of the strategic environment of the company such as regulations, competition, technology and labour markets, will be explored. For this research it is essential to understand how these external factors affect Telstra. There are more than 200 telecom companies worldwide, primarily national or regional operators (Telstra, 2002a). All OECD countries have committed to competitive markets and most state-owned telecom companies in OECD countries were fully or partially privatised by 2001 (Lenain & Pathridge, 2003; Mahboobi, 2002). In 2002, the combined market capitalisation of telecom companies reached US$1.4 trillion (Telstra, 2002a) and telecom companies maintain extensive infrastructure in the regions they serve, requiring large financial resources. The communications infrastructure investments are highly important to countries, both for households and for businesses, hence the average household spends 2.2%

226 In Australia telecommunications is set within the Information, Computers and Telecommunications industry. In USA telecom is within Telecom, Media, Technology industry.

258 of their budget on communications (OECD, 2009). From 1990 the market witnessed the continuous introduction of technological innovations, expanding on average by 6% annually, despite an economic and industrial crisis (OECD, 2009). The rapid expansion of internet and related businesses from 1995–2000 led telecommunications companies to borrow money to invest heavily in building new infrastructure. However, the bursting of the internet bubble (dot-com bubble) in 2000 and the financial crisis that followed negatively affected the industry, causing some operators to go bankrupt227 and the remaining ones to cut on investments (OECD, 2009). Share prices dropped and through cost-cutting initiatives creditors and investors sought recovery, which was “patchy and uneven” (Curwen & Whalley, 2009). Telstra emerged from this period relatively unharmed. The recovery started after 2003/2004, with companies reorganising their liabilities, fuelled by the continuing growth in demand for telecommunications services, particularly for mobile services and broadband (Lenain & Pathridge, 2003). In Australia, the government supported the ICT sector through numerous initiatives228. Communications industry in Australia: Generally, the communications industry has a low impact on national economies, representing between 2%–4% of GDP in OECD countries (avg: 3.01% in 2004 (OECD, 2007)). However, it has greater upstream effects on equipment suppliers and supports the development of other industries (Lenain & Pathridge, 2003). In Australia, in 2002/2003 the industry contributed to 2.2% of GDP, generating revenues over $31.8 billion while employing about 44,000 people (ABS, 2006b), (ABS, 2003). However, combined with ICT, communications is considered to be an important industry for the Australian economy in the future. For instance, the Reserve Bank of Australia has found a direct link between expenditure on ICT and strong productivity growth in Australia (Department of Foreign Affairs and Trade, 2009). From 1997–2007, communications was the highest-performing sector in the Australian economy, with an annual growth rate of 6.8% (Austrade, 2008). The communications industry alone makes a greater contribution to the Australian economy than agriculture, forestry and fishing, defence and utilities (Austrade, 2008). Australian investment in ICT as a percentage of GDP has become the third-highest among OECD countries and by 2008 Australian ICT had become the fifth-largest market in the Asia-Pacific region (Austrade, 2009), (Department of Foreign Affairs and Trade, 2009). In terms of equities, the telecommunication sector is relatively small, compromising 5.31% of

227 WorldCom and Global Crossing in the USA and AT&T in Canada among many others asked for bankruptcy (Lenain & Pathridge, 2003). 228 The Government initiatives included Backing Australia’s Abilities (2001), providing support for ongoing research (allocation of funds), providing funding to universities for research, helping technology diffusion to individuals, households and businesses and working on policies related to building ICT skills (OECD, 2001).

259 total ASX market capitalisation (July 2008 data) and the sector is mostly compromised of a few large corporations and many SMEs (Austrade, 2008), (ASX, 2010b). Regulatory Environment: Most OECD countries have laws specific to the telecommunications sector, enforced by a separate national regulatory agency, as well as a specific competition law applying to the sector (ICT, 2009). Agencies like the Federal Communications Commission in the USA and the Office of Communications in the UK regulate the communications environment, which has a significant effect on the pricing and future profits of telecom companies. For instance, in 2004 in the US the removal of the exemption of all internet telephony services from the access charge regime cast doubt on the future earnings of telecom companies AT&T and MCI (A. Ferguson, 2004a). In Australia, a number of different laws and policies affect the structure of media and communications, making the regulatory environment highly controlling and complex. The Communications Minister and the Communications Minister's Department are primarily responsible for telecommunications industry policy and legislation. The ACCC229 and ACMA (formerly ACA) together control different aspects of the market and can introduce new industry codes, set standards, require new record-keeping rules or control retail and wholesale business pricing (Telstra, 2001). For instance, in 2004, the ACCC suggested that Telstra halve access charges to its copper wires, cut mobile termination charges230 and give it control over Telstra’s pricing of broadband to wholesale customers (A. Ferguson, 2004a). As borders between media, telecommunications and internet service companies become blurry and subscribers use internet and voice services both from local providers and from abroad, the current regulations will need to change to accommodate the needs of the industry and continue to protect consumers. Telstra was also subject to a raft of Commonwealth legislation (administrative law, environmental law and employment-related law), some of which did not apply to competitors (Telstra, 2002a). For instance, Telstra was the only carrier subject to Environment Protection Legislation231 and the Australian Heritage Commission and the Endangered Species

229 The Australian Competition & Consumer Commission (ACCC) administers the Trade Practices Act 1974, regulates competition, protects consumers and also includes specific provisions governing the telecommunications industry. The Australian Communications Authority (ACA) is responsible for regulating the non-competition aspects of the telecommunications industry under the Telecommunications Act 1997 and the Telecommunications (Consumer Protection and Service Standards) Act 1999 (Telstra, 2000b). The ACMA was established on 1 July 2005 by the merger of the Australian Broadcasting Authority and the ACA. The ACMA is responsible for the regulation of broadcasting, the internet, radio communications and telecommunications (ACMA, 2009). 230 The fees carriers charge each other when a fixed line call from one is terminated on another mobile network(A. Ferguson, 2004a). 231 After Commonwealth became minority, Telstra’s obligations have ceased. For instance, in October 2001 the regulations have amended the Environment Protection and Biodiversity Conservation Regulations 2000 (No. 181) to remove Telstra from the definition of Commonwealth Agency in the EPBC Act.

260 Protection Act 1995 (DEWHA, 2001), (Senate Environment Recreation Communications and the Arts References Committee, 1996)148). Industry associations such as the Australian Communications Industry Forum (ACIF) and Australian Mobile Telecommunication Association (AMTA) lead the industry to self- regulate through codes and standards (Schulz & Held, 2001). The Telecommunications Access Forum (TAF), which is concerned with connections, and the Telecommunications Industry Ombudsman (TIO), which deals with customer complaints, are also influential in the industry. Telstra is very much involved in the development of voluntary codes and initiatives. The telecommunications regulatory system in Australia developed primarily as a result of customer complaints (Schulz & Held, 2001). For instance, the Australian Radiation Protection and Nuclear Safety Agency conducted an extensive study following customer complaints about base station emissions and decided to develop a new national emissions safety standard, which was to be later adopted by ACIF (Telstra, 2000b). As technological innovations multiply, the trends indicate that environmental sensitivity will also increase, resulting in either government-imposed regulations or voluntary codes and standards. Competition: Following the duopolistic structure of the telecommunications industry in 1997, the market became overcrowded with new entrants. The market can be grouped into three interconnected sub sectors; telecommunications carriers, mobile services and internet suppliers. The fixed-lines industry comprises carriers, which own and operate network infrastructure, and carriage service providers (CSPs), which deliver a range of telecommunications services through these networks (ACMA, 2005/2006). By 2004–2005, there were over 130 licensed telecommunications carriers and more than a thousand CSPs in the industry. While the growth of the fixed-line sector was flat between 1999–2004, the competition was intense, as more CSPs were using Telstra’s wholesale services for providing fixed-line services232 (ACMA, 2005/2006). During this time, demand for Telstra’s fixed-line services for retail and business dropped. In the mobile services market there were more than 25 providers in 2000, but only four of them owned and operated their networks. Between 1999–2004, the total number of mobile subscribers more than doubled and by 2004 the penetration rate in Australia reached 81.4% , which was high in comparison to other OECD countries (avg: 71.8%) (OECD, 2007). Telstra had the leadership, with 44% market share, followed by Optus at 33%. While

232 1999-2000: Mobile phone subscriptions 8,010 thousand, Fixed Line 10,600 thousand, Internet 3,410 thousand. 2003-2004: Mobile phone subscriptions 16,480 thousand, Fixed Line 11,460 thousand, Internet 5,220 thousand.

261 Telstra maintained the majority of mobile market revenues (42%), Optus, Vodaphone and Hutchison experienced higher revenue growth (ACMA, 2005/2006). As the second- generation mobile market approached saturation, there was a new expectation of more third- generation services (3G). While nearly 1000 internet service providers (ISPs) supplied access to the internet via telecommunications network in 2004, the market was dominated by the 10 largest providers. Australia had the third-highest penetration rate among OECD countries, with subscriptions growing by 53% between 1999–2004 (ACMA, 2005/2006; OECD, 2007). However, broadband access was low (17.4% in 2006) and the speed was slower than the OECD average (OECD, 2007). Nevertheless, the trend was for dial-up services to be replaced by broadband services, since they provided the opportunity to use alternative means of communication such as VOIP, e-mail and text messaging. During that period, both Telstra’s (48.3% in 2004) and Optus’s market share dropped, while the reseller market share grew. Subscription TV was available in Australia after 1995 but the penetration rate stayed low compared to similar nations233 (ACMA, 2005/2006). FOXTEL, the joint venture between Telstra and two other media companies, was the strongest in the market, with over one million subscriptions, followed by Austar and Optus (reseller of FOXTEL content). Labour Market: The need for a skilled workforce can fluctuate in the ICT market, as the market changes very quickly, with greater demand for skilled labour during market upturns. For instance, in 1998 during the rise of the ICT market, Telstra Managing Director Gerry Moriarty stated: On current analysis, Australia doesn't have the skill levels to meet the needs of the new information economy……Telstra alone will need to recruit and/or provide highly specialised training for 2,000 people with deep data technology capability, and another 7,000 will be required with intermediate to deep skill levels. (Gale, 1998)

Government agencies and industry officials had differing views regarding a possible skills shortage in the industry (Philipson, 2003). While the Department of Employment and Workplace Relations (DEWR) stated there were no skills shortages("No shortage of ICT skills: DEWR," 2004), even after the internet bubble burst the media analysis showed that general public believed that employment opportunities in the ICT sector would expand and Australia would face skills shortages, particularly for the high end of the market. The ICT sector is a relatively small employing sector within the Australian economy, with over 336,000 employees (3.4% of total employees in 2004), of which 13% were

233 Pay TV penetration rate: Australia 24%, UK 44%, NZ 45%, US 70%.

262 employed by the communications services industry) (ABS, 2006a). Within the information media/telecommunications sector, 32.8% of the workforce had tertiary education and higher, illustrating the importance of professional qualifications in the sector (Austrade, 2008). The occupations within the sector can be grouped as computing professionals and technicians, electronic engineers/technicians and communication technicians. While having a formal education is important, there are also workers without a qualification, which points to the wide range of occupations in the sector. According to ABS records, the workforce is primarily full time (91.4% in 2005/2006), young (higher percentage between 25–34 years of age) and male (85% in 2005/2006) (ABS, 2006a). The Department of Communication Information technology and the Arts (DCITA) estimates the highest growth in the telecommunications industry to arise from infrastructure technologies for broadband networks and wireless systems (ACMA, 2005/2006). The growth trends indicate that mobile services will surpass fixed lines or that the services will have to merge. Although the dominant communications media still occurred over voice transfer, data transfer is becoming more important and increasingly practicable through improved broadband and mobile services speeds. As service levels improve, prices for all services decrease, with a trend toward flat-rate packages such as “unlimited calling for mobile subscriptions to pre-selected numbers” (OECD, 2007). The price competition is expected to continue as it is now possible to make calls over an internet connection using voice over internet protocol (VOIP). The above information summarises the changing nature of the telecommunications industry, while citing the important external influences as a part of the “Human Capital Drivers of the Value of the Firm” (Royal 2000). The macro analysis underlines the below trends for Telstra.

Future Trends and Telstra: Telstra management previously complained of excessive regulations and feared the introduction of new ones. Current trends indicate that in the short term the regulations could remain stable or even increase. For Telstra there may be skills shortages in the high end of the market. Pressures for lower prices will continue and competition will arise both locally and abroad. Consumers will demand higher-speed connections and data transfers, requiring Telstra to replace its copper wires with fibre optics, as has been done in many leading OECD countries. Most importantly is the speed at which Telstra launches new services to the market; for instance, Telstra was highly successful in

263 2004 when it introduced I-mode234 into the Australian market together with other leading OECD countries. The Australian market is relatively small and is not expanding rapidly, with already high penetration rates, with the exception of broadband. Therefore, providing alternative communications solutions such as 3G mobile services or voice, data and video bundling will bring a competitive advantage to telecommunications companies.

Applying the tool enables an historical contextual evaluation of Telstra. The company was privatised directly prior to the rise of the internet market. During its first two offerings the share price performed very well, with many Australians wanting a piece of the telecommunications giant. However, after the 2000/2001 global financial crisis, the company did not achieve the expected growth rate, and the increasing competition caused Telstra’s market share to decline. This, combined with slowness in bringing new products into the market, a couple of bad investments, and board disagreements, caused the stock to underperform in the market. The second tool evaluates the strategic “rhetoric”, with reference to Telstra’s human resource practices, versus the “reality”, based on other published company information. The tool uses the insights provided by the Human Capital Indicators and Management for Sustainability to explore the differences between what Telstra espouses as HR strategy and the execution of these strategies.

8.8.2 Sustainable Human Capital Practices

The alignment of human resource management systems with the stated corporate strategy is significant for achieving a sustainable competitive advantage. In the literature, the existence of a large pool of skills or the alignment of existing skills with the strategic direction, behavioural training and human resource practices as a system are stated to contribute to the success of the organisation (P. M. Wright, et al., 2005) Huselid 1995). The Royal and O’Donnell model suggests the study of the human capital systems that comprise recruitment, training, career planning, rewards, job characteristics and professional identity will give a better insight to the functioning of the management systems of the organisation and help better anticipate future events within the organisation. For strategy

234 One mode of mobile internet access

264 execution, specific systems of leadership, job characteristics and training appear to be significant for the telecommunications industry. Management makes certain choices regarding the vision, goals and strategy of the organisation as a reaction to changes in the external environment and in anticipation of the industry’s future. These decisions shape the way the organisation is managed to provide value to the stakeholders. The new Telstra vision was defined as “Telstra – Australia’s connection to the future”, demonstrating how Telstra positions itself in the market and can be read as “we will serve Australia with the latest technologies and the most innovative products that will enable them to become the future itself”. This socially correct vision was very promising for the Australian public and a welcome statement from its national telecommunications carrier. In contrast, the new Telstra corporate strategic goal was defined as, “Grow the company profitably and provide attractive returns to shareholders”, which contradicted the vision in that it made promises only to the shareholders. These contradicting statements represent the duality Telstra underwent, which was to some extent a result of the initially partial privatisation of the company. Telstra’s management was caught in between satisfying the “commercial needs of Telstra and the social policy needs of Canberra” ((Mathieson, 1998) 1). Providing services to every corner of Australia (in rural and remote areas), extensive sponsorships and volunteer programs such as Telstra Friends, and above-average dividend payments can be regarded as attempts by Telstra to fulfil its public duties235. Conversely, acquisitions in the domestic and international markets, organisational restructuring and cost-cutting initiatives and technological improvements can be viewed as Telstra’s attempts to accomplish growth and higher returns. Telstra CEOs Blount and Switkowski acted as change agents in transforming the company into its current incarnation. The privatisation improved organisational performance, evidenced in increased profitability, efficiency, leverage and taxation (Domney, 2009 ). However, as the company’s leaders were constantly in the public eye, their decisions were analysed stringently both by the public and the board. The unions strongly opposed Telstra’s decisions about workplace relations, particularly after the company abandoned its participative approach. However, the new owners of Telstra, comprising institutional investors and retail investors, supported operational cost improvements and aimed for greater rationalisation. Overall, many instances have illustrate the conflicting interests of various parties in relation to the company, even in the case of the early departure of Switkowski in

235 Telstra Corporations Act precludes any reduction in Commonwealth Government’s stake reduction, which limits the introduction of a dividend reinvestment plan (DRP). It will be considered it is fully privatised.

265 2004. The uncovering of these interests and the possiblity of new regulations through analysis of the company history, combined with the study of leadership roles, has pointed to the need to select leaders that can manage healthy and mutually beneficial relations with government and regulating agencies. Further, the capabilities of leaders should extend to include organisational transformation and aligning the company’s vision and goals with the changing telecommunications and information environment. The fact that selection of successive CEOs was a drawn-out process points to a weakness in the succession planning of the company and damages the value of the company. As part of the Human Capital system, this process should be better managed in the future. An examination of the macro environment of Telstra has indicated that the distinction between computer and information technologies, telecommunications, and media sectors has become blurred and the market is moving toward technologies that service fixed lines and mobile services interchangeably and provide multiple data over the same access line. Despite its small direct contribution to the Australian economy, the communications and information services sector has an enabling role for the development of other industries, particularly the fast-growing finance sector. These environmental factors require Telstra to have a clear vision of its future capabilities and a high degree of adaptability. The new strategies will require intensive marketing efforts, the introduction of new technologies and services and higher levels of sales efforts. The study of the knowledge competencies of the company, as part of the HC systems, demonstrates that Telstra is a leader in technology acquisition and adoption in its industry, indicating that its products will continue to be in line with the latest developments globally. However, the systems for supporting creativity, innovation and delivery are not very strong, as the autocratic and high-controlling management style hampers creativity and a lack of support for a learning environment prevents tacit knowledge from accumulating and being shared. While the company emphasises the importance of people in achieving its goals through its value statement236, it views training as an expense rather than an investment. Although years of outsourcing, downsizing and technological changes require skills upgrading, Telstra’s training investments have decreased; it has started to rely more on external sources, and internal training consists mostly of short computer- based courses. This issue points to possible service quality problems in the near future, particularly in the maintenance function.

236 Telstra’s value statement reads as “We will achieve this (growth and profits) by employing terrific people who work together, in an operationally excellent way to deliver innovative products and outstanding service to our customers” (Telstra, 2004e).

266 The macro analysis highlights a potential skills shortage for engineers, technicians and communications specialists in Telstra. The expansion of the ICT industry and an increased demand for technicians will make recruitment more difficult, especially as Telstra has abandoned its apprenticeship and other internal training programs. Together with a skilled workforce, commitment is critical for Telstra’s overall performance. In terms of commitment, the existing workforce is divided as a result of witnessing the ongoing downsizing and outsourcing. Employment security will continue to be a problem in the company as rationalisation continues, and the high turnover among professionals and executives will not cease unless Telstra can offer better internal career opportunities. The transition to performance-based pay at Telstra is in the pipeline, and down to the supervisor level employees have accepted AWAs. Telstra did not publish employee satisfaction data as the two other case companies did, so it is difficult to judge whether or not it is positive. Nonetheless, the integration of long-term focus into the executive remuneration system is aligned with the long-term goals of the company. In terms of stakeholder management and working towards organisational sustainability, Telstra has a very inclusive approach, partially because of its background as a state-owned entity; the company considers all Australians as stakeholders and operates at a very high level for policy generation and compliance network establishment. It ensures internal systems are aligned with external regulations and its approach is one of greater self- regulation. Telstra also exhibits a capacity for renewal and correction of internal standards and sets performance targets, implements strategies, measures them and discloses performance results. The company also began to merge environmental and OH&S programs, demonstrating a more integrated approach which should be expanded to other programs that aid the company to work towards organisational sustainability. Telstra has been in an open dialogue with communities and has displayed high levels of transparency. Regarding Telstra’s accomplishments, its readiness for organisational sustainability can be evaluated at two different levels. The company is moving towards “strategic sustainability” (Dunphy’s phases) in terms of environmental and corporate social responsibility, which can be explained as; the organisation sees competitive leadership through enacting proactive strategies for supporting ecological sustainability, developing environmentally sustainable products and is in partnership with the community. The company is in an “efficiency” state in terms of human sustainability, which can be defined as people being viewed as a significant source of

267 expenditure to be used as productively as possible and human resource functions are integrated under these principles. Telstra has many challenges that are waiting to be managed but the company does not view HC as a part of the solution. The third tool seeks to demonstrate the strengths and weaknesses of Telstra’s Human Capital Systems.

8.8.3 Strengths and Weaknesses

The Royal and O’Donnell (2005) model suggests the internal strengths and weaknesses of the company should be taken into consideration when evaluating the investment potential of a company. Telstra has transformed itself from a public monopoly to a partially privatised then a fully privatised commercial entity, and the company has many advantages as a result of its history and positioning in the market. Firstly, it is a full-services communications company, is the second-largest infrastructure provider in the world, has an extensive network structure that covers the whole of Australia, is the market leader in fixed- line telephony services, mobile services and broadband internet services, and owns and operates far-reaching retail outlets. It has accumulated knowledge and experience in the sector in terms of technology and understanding customer needs. Its corporate history and corporate citizenship have created high brand recognition. Secondly, the company has diverse income streams, with no revenue stream comprising more than 17% of the total revenue. Lastly, the company offers the latest technology in mobile and broadband services. On the contrary, after the introduction of competition to the local market, the company lost market share in every product line and trends indicate that competition will continue to come from the local market as well as international service providers. Unfortunately, Telstra has very few prospects for growing internationally, considering its unsuccessful efforts in Asia. The trends also point to increased pressure on pricing and possible regulations that might influence future revenues of the company. Advancements in data-transfer technology that enables transfer of voice, data, images and videos over the same medium require higher broadband speeds and technologies. To position itself as a high- technology telecom and information company, Telstra will need to replace its extensive copper line network with fibre-optics, upgrade its technologies and continue to surprise its customers with latest technologies. Besides capital and technology transfer, Telstra will require Human Capital to deliver these promises.

268 Internally, the company has multiple strengths. Ongoing rationalisation and downsizing have created a leaner organisation with less bureaucracy and fewer management layers. Although some of the experienced employees left during the process, it enabled unproductive employees and managers to be cleaned out. Following privatisation, the company recorded a better organisational performance. Despite criticisms, the new network structure enabling Telstra to be leaner and manage a large number of subsidiaries, joint- ventures and outsourced entities gives Telstra flexibility to change and align itself with the external environment. Telstra’s new recruitment policy has created a good mix of internal and external labour. Initially, external recruitment will bring a new set of skills to Telstra’s workforce. Furthermore, new employees will be more adaptable to the customer-focused culture and more willing to let go of the old bureaucratic culture. As a part of the new recruitment strategy, employing sales people and employees with management qualities (rather than just engineers) will aid the company to improve its marketing and sales functions. Increasing the diversity of the workforce is a good recruitment strategy for a company that considers all Australians as stakeholders. Again, despite much criticism and other side effects (explained in together with Human Capital indicators), by simplifying its relations with the unions, Telstra has obtained greater control of its relations with the workforce. Together with the many strengths of its Human Capital systems, there also exist internal weaknesses and corporate challenges. Among these, the leadership style is the most noticeable; executives and upper management are supportive of the corporate change programs but the ongoing directive style of leadership has left the workforce unwilling to cooperate in corporate change programs, and therefore it is not sustainable. The workplace satisfaction improved to 65% favourable in 2004 but this is still low. The new leaders should change to a more consultative leadership style, supporting top-down strategies with bottom- up initiatives to mobilise the workforce to work around the same goals. The Employee Relations unit should continue to support these programs and company leaders should communicate a clear set of strategies to employees. The company has excellent initiatives for the environment, community and occupational health and safety. Management for sustainability should be broadened and integrated at the top, flowing down to business levels and demanding a higher level of input from employees.

269 The analysis of Telstra’s environment points to several opportunities to be capitalised upon, which can only be achieved with a highly skilled workforce. To become the future of Australia, the company will need to invest more in training and R&D. Managing knowledge is another challenge for Telstra. The examination of corporate-governance practices and a compliance framework indicate very strong management for governance. While it is positive that the governance mechanisms are effective, frequent disputes between the board and executives call into question the fit between the executive management styles and what the board desires. If Telstra continues to grow through new subsidiaries and strategic alliances, it should transfer these good governance and compliance frameworks to its partners.

270

Section Three: Discussion and Conclusions

271 Chapter 9: Discussion

9.1 Introduction

The data analysis chapters (6, 7 and 8) have individually presented the human capital data available in the public domain for the three case companies and answered the research questions. The findings of the chapters indicated that documents other than annual and sustainability reports provide valuable human capital information that is not collected or utilised by security analysts. These findings confirm the existence of a knowledge gap between analyst reports, including their understanding of companies from a human capital perspective, and what is generally understood in the field of human capital. Applying Human Capital Analysis techniques to the data set, the findings also confirm the quality of data that is available to security analysts without breaking regulatory boundaries. The aim of this chapter is to summarise the findings of the research questions and highlight the importance of Human Capital Analysis and the advised framework for understanding the knowledge-management gap in the investment recommendation process. This chapter presents the importance of information and knowledge for investors and describes the various forms of information asymmetry in the financial markets. It goes on to present the findings in relation to the research questions posed in this study. In answering the questions, this section utilises the data set found for each case company using publicly available documentary data-collection methodology and the data found in analyst reports and company briefings. Based on these findings the content derived from Human Capital Analysis data search techniques and analyst reports is compared. The differences reveal a knowledge gap between the two approaches. The chapter continues to discuss how the differences between company rhetoric and reality can be compared through documentary analysis. This section uses data obtained through annual reports, analyst briefings, presentations, sustainability reports and websites as company-originated documents, and academic articles, books, magazine and newspaper articles, industry reports as other resources. Through the process of comparing and contrasting, the section demonstrates how Human Capital Analysis can overcome the inaccuracy/reliability problems associated with voluntary company reports. Later, the chapter presents the findings of Human Capital Analysis for the three case companies, displays the quality of human capital data available in the public domain and

272 stresses the importance of using a qualitative framework for valuing human capital. The conclusions of the thesis are given in the following chapter.

9.2 Information asymmetry in the financial markets

This section will establish the importance of knowledge for investors and define various information asymmetries that exist in the financial markets. While investors require company-specific information to make their investment decisions, stakeholders value information that will aid them in better understanding the organisation. Following the high- profile corporate collapses in the early 2000s, the need to provide timely and reliable information for investors has increased. As early as 1993, Drucker stated. “Increasingly there is less and less return on the traditional resources, labour, land and (money) capital. The only—or at least the main—producers of wealth are information and knowledge” (Drucker, 1993) 166–167). Sharing of knowledge (i.e. knowledge transfer) makes stakeholders more knowledgeable through communication and improves decision making (Dawson, 2000)p. 46). Sveiby (1997) described knowledge as “a capacity to act”, which is dynamic and different from data and information (K. E. Sveiby, 1997). Creation, capturing and sharing of knowledge in an organisational setting requires dedication and extensive effort on behalf of management. Despite the initial inconvenience involved, organisations that measure and report their intellectual capital will have better control of this valuable asset, which will aid them in making more informed decisions, such as during strategy formulation (Grant, 1991), strategy execution (R. S. Kaplan & Norton, 1996) and investment decisions. As Nonaka, Krogh, and Voelpel have noted, organisational knowledge creation primarily benefits employees in performing their jobs and eventually the organisation as a whole (Nonaka, et al., 2006). Sharing of knowledge necessitates the creation and expansion of knowledge through social interaction between tacit and explicit knowledge (Nonaka and Takeuchi 1995), as well as putting it into words, diagrams or other representations (Polanyi, 1966). Not all organisations recognise intellectual capital as an important asset that needs to be captured and shared with others, especially with external stakeholders. Further, while some recognise it as an important value creator, they choose to report on its selective components. Eccles et al (2001, p. 130) called this “the reporting gap”, which occurs when managers make very little effort to report information about measures they find important for running their companies (Eccles, et al., 2001). For instance, the literature review described a study that examined the

273 intellectual capital reporting of South African mining companies and found that even though they rated intellectual capital highly, they were lacking in the measurement and reporting of it and tended to report more of the external intellectual capital indicators (April, Bosma, & Deglon, 2003). BHP has been reporting on selective social and environmental issues, if not intellectual capital, since the early 1900s. The literature review has identified a systematic decline in the usefulness of financial information to investors (B. Lev & Zarowin, 1999) (Amir, et al., 2003). It also pointed to the widening difference between the market value and book value of publicly listed companies, which is explained by the existence of intangible assets, which go mostly unaccounted for in the financial reports. As intellectual capital has become such an important part of company value, failure to disclose intellectual capital information may cause investors to misjudge company value, leading to mispricing and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack adequate information access (John Holland, 2001) and the firm’s cost of capital may increase as assets are undervalued (B. Lev, 2001). Moreover, if management chooses not to disclose this significant information, it might result in an “information asymmetry”, defined as an information gap between what management knows and what is publicly disclosed. The gathering of information, thus closing this gap, can become more difficult when stakeholders are disparate, giving management greater discretionary power (C. W. L. Hill & Jones, 1992). Information asymmetry can arise in different ways; management may keep information to itself or may provide information only to select groups. Furthermore, this asymmetry may be more pronounced when firms possess significant intellectual capital, such as R&D (Aboody & Lev, 2000), or may vary over the life of the firm, such as during new share issues, and increase the chances of insider trading occurring (Aboody & Lev, 2000). Overall, it is highly significant in the knowledge economy for investors to be aware of the contribution of intellectual capital to actual performance and company value prior to making their final investment decisions. New regulations banning insider trading and instituting continuous disclosure requirements can reduce the information asymmetry in markets. Voluntary reporting can also fill the gap between the traditional reporting and external communication needs of listed companies, thus helping reduce the asymmetry. The literature review showed that there is convergence towards greater corporate governance disclosures around the globe and in Australia there has been an increase in regulations and codes for better governance practices

274 and disclosures during 2000–2004. The reporting legislation increased environmental reporting following 1999, but voluntary intellectual capital and sustainability reporting was still low in Australia, while picking up more after the 2002 UN World Summit on Sustainable Development. The literature review also pointed out a lack of human capital information contained in annual and sustainability reports. A second group of actors, in addition to management, causing possible information asymmetry are security analysts and the models they use. The literature review showed that traditionally equities analysts use quantitative data and financial models as the basis for company valuations and future financial earnings estimates. However, current accounting rules and regulations do not recognise human capital as assets, and as a result they are not included on balance sheets. Therefore, the literature review suggests that human capital indicators are not considered in the current recommendation process. However, investors rely on security analysts’ forecasts for earnings estimates, target price and valuations of a company. As early as 1954 Rukeyser recognised security analysts as “wholesalers of financial intelligence” ((Rukeyser, 1954)p. 18). The consistency and accuracy of their recommendations and forecasts are significant for investors and the efficiency of the markets. The accuracy of analysts’ recommendations is also important as a basis for building their own careers and reputations. The role of security analysts (Doukas, Kim, & Pantzalis, 2000; Kothari, 2001) and the efficiency of their research (Z. Gu & Xue, 2005; Zhang, 2006) have been discussed extensively in the literature. Clement and Tse (2005) find that bold237 analyst forecasts are on average more accurate than consensus forecasts and provide new insights for investors (Clement & Tse, 2005). Dawson notes that professional firms in the markets trend towards commoditisation and need to find ways for differentiation (Dawson, 2000) 41). Overall, it can be noted that new sources of information and new tools that will improve the current recommendation process and differentiate analyst forecasts will give equities analysts an edge. There is increasing interest among analysts in including non-financial, intellectual capital-related information (L. J. Bassi, Lev, Low, McMurrer, & Siesfeld, 2000) (F. Gu & Lev, 2001; Narayanan, Pinches, Kelm, & Lander, 2000). Bassi and colleagues demonstrated that one-third of US institutional investors used non-financial data, of which more than half was human capital related. Tasker (1998) showed that analysts requested more analyst meetings in R&D-intensive firms (Tasker, 1998), which indicates their intellectual capital-

237 Herding behaviour is described as forecasts that move away from the analyst’s own prior forecast and toward the consensus. Bold Forecast is described as above the analysts’s own prior forecast and the consensus forecast immediately prior to analyst forecast.

275 related information needs. Findings from a large sample of US companies show that when valuing intangible-intensive enterprises, equities analysts tend to compensate for the lack of intellectual capital information in the financial reports through other sources (Amir, et al., 2003). These other sources include more direct contact with company officials, site visits, management briefings, conference calls and phone calls. A study examining the information needs of telecommunications analysts interviewed 25 analysts and recorded that they ranked “direct contact with company representatives” and “financial statements” as the most significant sources of information as the basis of equities reports (Glaum & Friedrich, 2006). Although to date analysts have used direct contact intensively (G. Breton & Taffler, 1995) (G. Breton & Taffler, 2001), this method will now be limited as many countries, including Australia, have restricted selective disclosures to equities analysts. When Glaum and Friedrich (2006) asked telecommunications analysts which variable is most important to them among non-financial information 48% chose “quality of management”, but explained that these “soft facts” played a role in company valuation only “implicitly”. Similarly, Amir and Lev’s study shows that even if analysts in the 1990s sought more intellectual capital-related information, this could not fully account for intellectual capital’s contribution to future profitability (Amir, et al., 2003). Royal conducted action research into the finance industry, feeding analysts Human Capital Analysis information. Traders indicated that they benefited from the “timeliness of human capital information” and analysts benefited from a framework that enhances sales dialogue and investment recommendations (C. Royal & O'Donnell, 2008a). This section discussed various forms of information asymmetry in the financial markets and addressed the utilisation of qualitative information by analysts during the recommendation process. However, it concludes by saying that both investors and security analysts/fund managers benefit from improvements in the recommendation process, that is, closing the knowledge gap. The next section will answer the research question regarding whether a knowledge gap exists within the investment recommendation process, using actual examples from three publicly listed companies.

9.3 Research Questions Revisited

This section will present the answers to the research questions posed in this thesis. The findings are reported using three case companies (BHP , NAB, Telstra) as samples. The research questions posed in this thesis were:

276 1. a. Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable Human Resource Practices?

1. b. How much more than the mandatory regulations do these companies report or make available to the general public?

2. Is there a knowledge gap between equities analyst reports and reporting of Sustainable Human Resource Practices by companies?

3. How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making forecasts about the future financial performance of ASX-listed companies?

9.3.1 BHP Billiton (BHP)

Research Question 1 a. A disclosure index was constructed for this study using the ASX Listing Rules and AASB Accounting Standards. The disclosure index included the qualitative human capital- related reporting requirements for publicly listed companies on the ASX. The use of the disclosure index on BHP’s annual reports shows that the company complies with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999–2004 and even goes beyond these requirements. However, despite a very careful text search, reporting of the “number of employees” for years 2003 and 2004 (AASB 1034.5.1.d) and “auditor remuneration” (AASB 1034.5.3)238 for 2001 were not found in the annual reports. Although these few items were missing, BHP’s reports were systematically prepared. Furthermore, the company reported on the existence of an Audit Committee239 (ASX, 2004) before it became a requirement to report this, and also fulfilled the requirements of “Additional Reporting on Mining and Exploration Activities”240 (ASX, 2004). While this study only examined whether BHP goes beyond the mandatory regulations on the ASX, after the merger BHP had a “dual-listed company” structure, and was required to comply with the corporate regulations of the UK as well as Australia. At the same time the company also had to comply with the Principles of Good Governance and the

238 AASB 1034.5.3 became operative in 2001. The company reported on this item starting in 2002. 239 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year. 240 ASX Listing Rules 5.1.1 and 5.2: Details of mining production and development activities of the entity or group relating to mining and related operations and a summary of the expenditure incurred on these activities. A summary of the exploration activities and results.

277 Code of Best Practice set out in the Listing Rules of the Financial Services Authority in the UK, as well as the Listing Rules of the ASX. Furthermore, as registrants of the SEC in the US, the company had to comply with the regulatory regime of that country insofar as it applies to foreign companies (e.g. the Sarbanes-Oxley Act 2002). As the quality and variety of data found in the annual reports of BHP improved after the merger and obtaining dual- listing status, the improvements can be partially attributed to these developments.

Research Question 1 b. The analysis of the annual reports, media announcements and website information from 1999–2004 indicates BHP exceeds the mandatory regulations in reporting. The extent of its reporting within the human capital framework will be discussed below. The literature review indicates that prior to 1998 BHP had not been transparent in reporting bad news to stakeholders. However, examination of the reports (annual and HSEC) that BHP produced suggests the company became much more open and transparent in its stakeholder communications after 1998/1999. In fact, it almost became a leader in initiating and adopting new reporting mechanisms, such as forming the Global Mining Initiative (GMI) in 1999. “Corporate Governance” appeared as a subheading in BHP’s annual report for the first time in 1994, the same year as the revolutionary King 1 Report241, before it became mandatory in Australia to report on corporate governance. The length and content of the corporate governance section subsequently improved and had already become very comprehensive prior to the BHP and Billiton merger. Post merger, BHP started to publish a separate corporate governance statement in the annual report. Furthermore, BHP formed a “Disclosure Committee” in 2003 to disclose all the board policies on its website. After the merger in 2001, BHP began to publish a full Health and Safety and Community Report (HSEC). Until then, BHP had not systematically collected non-financial data. However, in the 2001 HSEC Report, BHP underlined the need for collecting “social metrics data” in order to become more transparent. The full HSEC report was prepared in compliance both with BHP’s Management Standards and Australian Minerals Industry Code for Environmental Management. In this report, BHP openly disclosed the consequences of deviation from its targets. A metric with seven levels of severity explains the importance of injury/disease, environmental hazards, social/culture heritage consequences, fines and

241 The King 1 Report was released in 1994 by the King Committee on Corporate Governance in South Africa. 82 reports around the world were modelled after it. (Ping, 2003)

278 community, government, media and reputation damage. In 2003, the company started to report non-financial information against GRI 2002 Sustainability Reporting Guidelines, the Minerals Supplement and ICMM’s Sustainable Development Framework Recommendations (2003). An examination of the annual reports, the HSEC reports prepared under the GRI guidelines and corporate governance reports demonstrated that these can be excellent sources of information regarding BHP’s “corporate strategy,” “corporate governance mechanisms”, “community and environmental performance” as well as “economic performance”. They are not only appropriate for disclosing policies, procedures and management standards, but also their progress and implementation. With regard to human capital information, the literature review of voluntary reporting practices suggested the reports did not include human capital-related data. The data-collection process for this thesis confirms this finding. Collection of human capital data is not straightforward, because annual/sustainability reports do not include much of this information. The social parts of BHP’s HSEC reports have two broad groups of information; “employee-related” and “community-related”. Some of the employee-related information is useful, such as “workforce breakdown”, “average employee turnover”, “trade union representation”, “occupational accidents and deaths”, “discrimination” and “human rights issues”, which are all important measures for evaluating Sustainable Human Resource Practices. In these reports, BHP chose not to report on average hours of training, but if it had, this would reveal little about the type of training and its effectiveness. Further, sections categorised as “consultation with employees”242 added very little to the information pool. The data-collection process confirmed the importance of seeking human capital data in sources other than annual reports and sustainability reports. For instance, the training- related information missing from the 2004 HSEC report was found on a government website and in an academic article. Some short examples of when human capital-related data were found in places other than annual reports and sustainability reports are given below: Knowledge management: strategic alliance with universities (company website), R&D budget (academic article), technology acquisition (academic article), organisational learning program (academic article), knowledge-management system (EOWA statement), knowledge sharing (academic article), existence of CoPs (academic article). Recruitment: company website, magazine articles, newspaper and academic article

242 2004 BHP HSEC Report: “Employee relations arrangements at individual workplaces are required to respect local legislative requirements and other local standards and circumstances”.

279 Rewards: remuneration policies (BHP Remuneration Report), internal award programs (World Business Council for Sustainable Development), investor and public opinion on executive payments (newspapers). During the data search, there was much content in newspapers and magazines and many academic articles used interviews and site observations as their data source. Considering BHP’s size, geographical dispersion and dual listing, the quantity of data sources was not surprising. However, it is important to note that there was still some significant human capital-related information omitted. Some of this data relate to employee satisfaction surveys, the performance appraisal process and the reward mix of the workforce.

Research Question 2. During the data analysis stage, 56 reports covering BHP were analysed when seeking reporting of qualitative data, specifically on human capital. An examination of the narrative sections of the security reports indicated that soft and qualitative information is not systematically sought but is used randomly as information or the need arose. For instance, analysts attributed “long-term success” and “profits” to “better/excellent management” in several cases, but did not define what is meant by “excellent management”. Furthermore, some did not use human capital-related indicators or link it to business results. For instance, after the sudden CEO change at BHP, one analyst argued against the share price being affected by this change:

First, the issue of management change has been a drag on the company’s share price performance over the past 50 or so days since the departure of the former CEO. Whilst this issue is intangible, in the sense that it is not necessarily possible to wrap earnings changes around personnel changes, it is nevertheless important to the perception of future value creation… (CSFB, 24 Feb 2003: First Alert).

In comparison to how the security analyst viewed human capital-related information, the human capital approach differed. Although in a healthy company the change should not negatively affect the business results, these changes should be watched through a human capital lens and followed up for other possible internal reasons, such as lack of succession planning or corporate governance problems. In such instances a watchful eye using the human capital lens can provide an early warning. In their discussions, analysts recorded that their sources of information comes primarily from quarterly, half yearly and annual financial reports and company announcements. However, the literature review suggested annual reports and company

280 announcements provide only part of the qualitative data originated by organisations. Further, this study has shown that as annual/sustainability reports are not sufficient, other sources should be utilised for human capital-related data for collection. Analysts covering BHP confirmed they were not utilising these other resources in their own reports, and thus not using human capital-related data in such reports. Analysts also had opportunity to pose questions at BHP site visits (Samarco Iron Ore Visit), luncheons (i.e. a luncheon/meeting with CEO), analyst briefings and presentations. The second part of the analysis included an examination of these briefings and web-casts. The analysis indicated analysts did not directly request much qualitative data other than “the replacement of the CFO”, “the closure of Ok Tedi Mines (PNG)” and “HBI plant”. However, both pre and post merger, analysts did not tend to ask about how personnel issues would be handled during the merger and did not mention this as an important element in their reports. The answers to Research Question 1b for BHP show that the company goes beyond its mandatory regulations in reporting information about its Sustainable People Management Practices. However, this information is not readily available in annual and sustainability reports and needs to be selectively retrieved from the other sources. Nonetheless, there is also some human capital data missing from the public domain, which cannot be obtained in this study, as this research replicates the regulatory environment in which analysts operate and thus uses only publicly available data. On the other hand, the analysis of security analysts’ reports shows that analysts do not generally use other sources for data collection and do not include human capital-specific information in their reports. When they do, it is only with reference to top management-specific issues, and analysts lack capacity to make meaning of such data within the human capital framework. There exists a knowledge gap between analyst’s reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital.

Research Question 3 The literature review chapters illustrated that human capital is an intangible source of value creation and forms part of the assets that create competitive success. Furthermore, the literature established that investments made in human capital are valuable and need to be pursued and evaluated. The construction and use of a disclosure index of the mandatory reporting requirements for BHP showed that the regulatory framework has not provided for ways to bridge the knowledge gap in human capital, other than mandatory reporting on governance, remuneration of executives, review of operations, review of mining and

281 exploration activities and equal opportunity for women (reported separately to the EOWA, explained in detail in Chapter 5). Most of the human capital knowledge used to analyse the data in this thesis regarding indicators “Job Characteristics, Recruitment, Training, Careers, Rewards and Professional/Identity/Culture” are not systematically part of the mandatory reporting requirements or part of the investment process. The review of the information asymmetry in the capital markets indicates that failure to disclose human capital information may cause investors to misjudge company value, leading to mispricing of shares and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access. Human Capital Analysis identified several examples of information asymmetry at BHP. Firstly, the data collection and analysis of BHP highlighted that “leadership, living up to the values stated, corporate culture, workplace relations that show themselves in labour relations and importance given to improving occupational health and safety” (results of analysis in this thesis) are significant human capital-related indicators for BHP that need to be evaluated over time as part of human capital. None of these items was reported on or evaluated in the analyst reports. Analysis of significant human capital information such as “employee safety” and “industrial relations” revealed insight into the future financial performance of BHP. There have been many instances in which, due to workplace accidents and disagreements with unions, work has stopped at BHP worksites, causing loss of productivity at mines. By contrast, these instances were not included in equities reports. Using the human capital lens, a qualitative analyst can provide an early warning regarding factors affecting the future earnings of the company. The literature suggested that the way in which a merger is managed is critical for its success or failure (Marks & Mirvis, 1992) and creating a common culture and managing the human side of the merger plays an important role in this process (Robbins, 2002). Where this is not done appropriately, the costs can exceed the proposed benefits. The study of equities reports and analyst briefings revealed that although equities analysts posed questions about “the business conditions, profitability, development projects, share structure issues, strategy development, marketing functions and earnings goals” during the merger, they never questioned or evaluated the “human side or the culture management” of the merger. Fortunately, the integration was completed smoothly, even though BHP and Billiton were culturally different, and after the merger in 2001, the cost savings had exceeded the target of $270m. Using the human capital lens, further analysis of the culture integration process would

282 have provided earlier indications of the positive results without needing to wait to see the financial statements. From a human capital perspective, it is also important to see how human capital becomes a partner to the strategy-setting and implementation phases of organisational sustainability. On the other hand, a review of BHP’s corporate history confirmed that continuity of its environmental and social performance is highly significant for BHP’s future earnings. However, the examination of the analyst reports indicates that although some equities reports included corporate governance-related information, none reported on BHP’s environmental or social performance. BHP's vice-president of sustainable development at the time, Ian Wood, confirmed that “mainstream investors and analysts seldom attended the company's briefings on safety, environment and community issues” ((Berger, 2006)1). Organisational sustainability and the way in which leaders and employees contribute to these can provide valuable insights into a company’s future earnings. At this point it is important to note that distinguishing “reality” from the “company rhetoric” is highly significant in following the Sustainable People Management Practices of a company. When BHP was exploiting the environment and having disputes with local communities at its OK Tedi Mines (PNG) during the late 1980s to 1998, the investment community did not see what this could cost the company and continued to follow and report on “company rhetoric”. Mining companies risk their licence operating in mining regions subject to community concerns and governmental regulations, in addition to incurring legal costs and fines. Moreover, if a company is known to exploit its environment, these concerns can have consequences in other parts of the world. Using the human capital lens, a qualitative analyst may provide early indications of factors affecting future financial performance, with regard to the “lack of policies, leadership and employee support” for these highly sensitive issues. Equities analysts asked about the mine and its prospects only when BHP was forced to publicly admit that OK Tedi Mines was an environmental disaster. Naturally, the financials of the company were threatened, as it divested its 52% shareholding to the PNG Sustainable Development Program Ltd in 2002 and in 2007 was sued by 13,000 villagers for civil damages exceeding US$4 billion.

283 9.3.2 National Australia Bank (NAB)

Research Question 1. a. The use of the disclosure index for NAB’s annual reports indicates that the company complied with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999–2004 as well as going beyond these requirements. The only reporting requirement that was not found in the annual reports was “auditor remuneration” (AASB 1034.5.3)243 for the years 2001–2004. Similar to BHP, NAB reported on the existence of its Audit Committee244 (ASX, 2004) before it became a requirement to report this. While Chapter 5 showed that there are relatively more regulations controlling financial institutions than many other industries, the Group's branches and banking subsidiaries in Europe (Great Britain and Ireland), New Zealand and the US are subject to further oversight by the Financial Services Authority, Central Bank of Ireland, Reserve Bank of New Zealand (RBNZ), and the Office of the Comptroller of the Currency, respectively. Furthermore, during the period under study, NAB’s fully paid ordinary shares were quoted on the London Stock Exchange, the Tokyo Stock Exchange, the New York Stock Exchange and the New Zealand Stock Exchange, in addition to the Australian Stock Exchange. Overall, although these external requirements increased the reporting quantity of the Bank, it did not necessarily improve the quality of its reports in regards to human capital reporting. This will be discussed further in the following section.

Research Question 1. b. The analysis of the annual reports, media announcements and website information for the period 1999–2004 indicates that the NAB goes beyond the mandatory regulations in reporting. The extent of reporting within the human capital framework will be discussed below. The analysis of publicly available documents produced by NAB indicates that the company’s disclosures in relation to intellectual capital elements have dramatically increased during the time period examined (1999–2004, 2004–2006). In 2002, NAB established an

243 AASB 1034.5.3 became operative in 2001. The company reported on this item starting 2002. 244 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year.

284 External Stakeholder Forum on its website and in 2003 began to publish a Balanced Stakeholder Card against 30 key performance indicators. In 2004, NAB released its first externally audited, stand-alone Corporate Social Responsibility Report, benchmarking economic, social and environmental performance against the Global Reporting Initiative (National Australia Bank, 2004). Moreover, NAB was reporting on its audit committee and executive remuneration before it became mandatory to do so. The company also disclosed very useful data that is not found in the other case company reports, such as aggregate training costs, details of the training programs for various employee levels and a breakdown of employee numbers. Guthrie’s study, examining voluntary disclosure of intellectual capital attributes for 50 listed entities in Australia and 100 in Hong Kong, found that the second most active firm in terms of intellectual capital reporting was NAB (2002 Annual Reports; (James Guthrie, et al., 2006). Further, the Horwath 2002 Corporate Governance Report analysing the governance structures of Australia's top 250 listed businesses identified NAB as ranking equal first with eight other companies (National Australia Bank, 2002b). The bank was also recognised by Reptex as the top company in Australia in reporting social environment and other information to stakeholders. In contrast to the findings of other studies, a close examination of the indicators used for these studies and ratings showed that NAB reports relatively more on its external capital and organisational restructuring initiatives and much less on its internal capital development and human capital. During data collection for this thesis, it was very difficult to find information about “organisational learning, knowledge management, communications, workplace organisation, team work and reward structure” through company-originated sources; this human capital-specific information was obtained through other sources. For instance, information about “workplace organisation, skill development and downsizing and its effects” was obtained from a research dissertation and the Financial Services Union website (FSU).

Research Question 2. During the data-collection process, 57 reports covering NAB were analysed in the search for qualitative data reporting, specifically of human capital. An examination of the narrative sections of the security reports indicated that analysts have used more qualitative data in writing recommendations for NAB compared to the other two case companies. However, such reporting was more related to strategic and top-level human capital-related

285 data, such as “strategy”, “executive and senior management changes” and “re-structuring programs”. In comparison with the way in which security analysts viewed human capital-related information, the human capital approach differed. Firstly, when applying the human capital lens it is important to follow investments in human capital over time and not regard them as individual incidents. However, analysts tend to question the nature of investments and the recovery plans associated with them when a publicly listed company encounters a crisis. For NAB these were the Homeside Lending writedown and its sale during 2001–2002 and the Foreign Exchange Desk Crisis in early 2004. Secondly, in their reports positive analysts repeat the “company rhetoric” and base their projections on management’s forecasts, which can be overly optimistic. For instance, after listening to the CEO’s announcement about the new “Positioning for Growth” program, in their reports analysts replicated management’s positive expectations from the change program; “there will be clear lines of accountability”, “culture change”, “more community involvement” and “acknowledging broader social responsibility”(CSFB, 2001; Macquire Research Equities, 2002-2003). Only a few were sceptical of such change and early on warned of “premature external assessments of savings” and “downsizing”(CSFB, 2002). Further, all approved the new strategy that promised growth through acquisitions and regionalisation. By contrast, from a human capital perspective, analysts should have asked about “employee satisfaction and engagement, diversity, workplace relations or employee health and safety” when the CEO promised the development of a high-performance work culture, which analysts never questioned. Moreover, none discussed the implications of change from an employee perspective, or potential contributions to improved human resource practices (soft measures), which could ensure the sustained performance of the company. Most importantly, the examination of the reports indicates that analysts rarely followed up on such programs during their implementation stage. However, the literature review found that while investments in human capital are highly critical, they must be monitored over time in order to be included in valuations. The respective approaches of security analysts and Human Capital Analysis differ in the value each attributes to human capital. For instance, when NAB announced its investments in intellectual capital or knowledge management, analysts were unable to place a value on it.

286 While it is important to continue to develop e-commerce initiatives and invest in intellectual capital, cost control remains one of the key drivers in assessing management performance.

The answers to Research Question 1b for NAB indicate that the company exceeds mandatory reporting of information on its Sustainable People Management Practices. Such information, however, is more likely to be found using other sources than the company’s annual and sustainability reports . Regardless, there is also some human capital data missing from the public domain, which cannot be obtained for this study, as this research replicates the regulatory environment in which analysts operate and uses only publicly available data. On the other hand, the analysis of the security analysts’ reports show that while analysts include top management-specific issues, they lack the capacity to attribute meaning to human capital data within the human capital framework. There is a knowledge gap between analysts’ reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital. This gap is partially a result of analysts’ ignorance and acceptance of facts as they are presented and partially a result of the lack of transparency of NAB’s management.

Research Question 3: The construction and use of a disclosure index of the mandatory reporting requirements for NAB indicates the regulatory framework has not provided for ways to bridge the knowledge gap in human capital outside of mandatory reporting on governance, remuneration of executives, review of operations and equal opportunity for women (reported separately to the EOWA, explained in detail in Chapter 5). Most of the human capital knowledge used to analyse the data in this thesis in relation to the indicators “Job Characteristics, Recruitment, Training, Careers, Rewards, and Professional/Identity/Culture” are not systematically a part of the mandatory reporting requirements or part of the investment process. The review of information asymmetry in the capital markets indicates that failure to disclose human capital information may cause investors to misjudge company value, leading to mispricing of shares and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access. Human Capital Analysis identified several examples of information asymmetry at NAB. The data collection and analysis of NAB highlighted that “leadership, accountability, transparency, corporate culture and knowledge management” are significant human capital-

287 related indicators for NAB that need to be evaluated over time as a part of human capital. Only a few of these items were reported on or evaluated in the analyst reports. The literature review posited that the accountability and openness of corporate management may be strong indicators of future growth and sustainability. Prior to 2004, the monitoring of significant human capital information such as “transparency” and “board culture” provided insights into the future financial performance of NAB. The lack of good corporate governance practices resulted in NAB experiencing a corporate scandal in early 2004, which had financial repercussions as well as loss of reputation and market share. By contrast, the findings of this study demonstrate that equities reports include information on only some corporate governance elements, such as “board structure” in the form of “independent vs. dependent directors, transparency and remuneration strategies” but exclude items like “board culture, directors’ relevant experience, risk-management strategies, compliance measures and accountability”, which may help analysts develop a deeper level of understanding of corporate-governance practices. Rather than applying Human Capital Analysis, analysts prefer to repeat the company rhetoric; NAB, like Enron, received widespread recognition for its good corporate- governance practices, even as it suffered internally from excessive risk taking, low-level compliance management and accountability problems. Media and analysts knew of the “Profit is the King Culture” at NAB and were very positive about what this promised for the future—growth. There was evidence to suggest that analysts were unable to evaluate the importance of “leadership, good corporate-governance practices, ethics and culture” as part of the value of a firm. In January 2004, following the announcement of risk-management problems and FX losses, equities analyst recommendations were still outperform or neutral. One of the analysts commented as follows:

Our impression at this stage is that this development will not result in any substantive changes in strategy.... None of the customers are directly affected. Recommendation: Neutral. (CSFB 14 Jan 2004, NAB losses questions credibility)

The discrepancy between Human Capital Analysis and security reports are also evident in terms of reporting timeframes. When monitoring human capital indicators it is possible to glean early warnings, yet security analysts began to question governance and culture issues and downgraded the stock only when APRA and PwC reports pointed to culture problems and the company revised the earnings estimates. This indicates that analysts

288 react very slowly to human capital indicators, as they wait for signs from financial indicators to confirm the projected changes. At the same time, analysts were unable to forecast how customers would lose trust in the company and move their business to competitors. It is worth noting that it took three years for NAB to recover from this minor but revealing financial loss. Overall, the data collection and analysis part of this thesis indicates that “corporate governance, corporate culture and leadership” are significant indicators that need to be evaluated over time as a part of a company’s human capital. Despite these findings, following the data-collection process it is evident that human capital knowledge was not drawn on in analyst recommendation reports, hence creating a knowledge gap in the knowledge-transfer process.

9.3.3. Telstra

Research Question 1. a The use of the disclosure index for Telstra’s annual reports demonstrates that the company complied with the mandatory regulations and the ASX Corporate Governance Recommendations for the period of 1999–2004 and exceeded these requirements. The only reporting requirement that was not found in the annual reports, as in the other two case companies, was “auditor remuneration” (AASB 1034.5.3)245 for the years 2001–2004. Two other items (ASX 4.10.11: Information about Stock Exchanges and AASB 1034.5.1.d: Employee Information Numbers) that were not found in the concise financial reports were found in the full financial reports. Telstra is shown to be the most open and transparent company among the three case companies, which can be partially attributed to the strict controls imposed on the previously state-owned company. The company reported on its “Audit Committee”246, some aspects of “Corporate Governance”247 and “Employee Benefits”248 before it became mandatory to report on these areas (AASB, 2004b; ASX, 2004).

245 AASB 1034.5.3 became operative in 2001. The company reported on this item starting 2002. 246 ASX Listing Rule Condition 13: An entity which will be included in the S&P All Ordinaries Index on admission to the official list must have an audit committee. 1/1/2003 Amended 3/5/2004. ASX listing Rule 12.7 An entity which was included in the S&P All Ordinaries Index at the beginning of its financial year must have an audit committee during that year. 247 ASX listing Rule 4.10.3: A statement disclosing the extent to which the entity has followed the best practice recommendations set by ASX Corporate Governance Council during the reporting period. 1/1/2003. 248 AASB 1028 : Each reporting entity to disclose its equity based instruments/compensation benefits ( for example performance related benefits) in their financial reports. Operative Date: 2002 July.

289 Despite Telstra’s early compliance, changes in reporting requirements certainly improved the quality of the company’s reporting; for instance, the Corporate Governance Section of the Annual Report 2000 included basic information on “board, meetings, committees, business conduct and risk”. However, after the ASX Corporate Governance Recommendations were introduced, the Annual Report 2004 Corporate Governance section included “the roles, membership rules, size, meetings, performance evaluation of BOD, the role of the chairman and audit governance and market disclosure controls”.

Research Question 1. b An analysis of the annual reports, media announcements and website information between 1999–2004 indicates that Telstra goes beyond the mandatory reporting regulations. The extent of Telstra’s reporting within the human capital framework will be discussed below. While Chapter 5 showed that there are relatively more regulations controlling all three industry groups to which the case companies belong in comparison to other industries, within its industry, Telstra has the most reporting requirements, as a partially state-owned entity until it was fully privatised. For instance, the Federal Government’s Greenhouse Challenge Program required Telstra to report on its performance in reducing greenhouse gasses, which explains why Telstra was found to be more open in this regard than other case companies. Moreover, the company took transparency very seriously; it had a Continuous Disclosure Committee chaired by the Group General Counsel and senior management undertook training in relation to Telstra's continuous-disclosure obligations. However, despite the vast quantity of reports published by Telstra, the quality of information found in company-originated reports in relation to human capital data was very low. Secondly, although the historical study of Telstra pointed out that “knowledge management, skill upgrading, employee relations and workplace organisation” are significant indicators for evaluating the company’s sustainable human practices, there was almost no information provided by the company in relation to these topics. Information in company originated data was around “environment”, “occupational health and safety”, “customers” and “community service”. As such, human capital-specific information was obtained through the use of other sources for this thesis. For instance, the information about “industrial relations and training” was obtained through academic articles and dissertations government websites, industry reports and OECD reports.

290 Research Question 2 During the data collection process, fifty-seven reports covering Telstra were analysed in search for reporting of qualitative data. The study of the narrative sections of the security reports have shown that analysts have used very little qualitative data in writing equity recommendations for Telstra in comparison to the other two case companies. In comparison to how the security analyst viewed Human Capital related information, the Human Capital approach differed. Using the Human Capital lens it is important to follow investments in Human Capital. The historical analysis of Telstra displays that “employee relations, training and knowledge management” are significant indicators that need to be evaluated over time as a part of the Human Capital. These can be significant when making forecasts about the future financial performance of Telstra. By contrast, analyst reports placed significant emphasis on “market analysis (price/ product/cost comparisons)” and “cost reduction programs”, and analyst briefings and conferences were not much different. The questions posed to company officials focused on “cost cutting programs” and “revenue expectations”. With the exception of “training” and executive remuneration”, analysts have not shown interest in qualitative information. Following the bankruptcy of the US telecommunications company WorldCom, corporate governance has become an important concern for the sector. Further, the literature review suggested that accountability and openness of the management of corporations can be strong indicators of future growth and sustainability. However, the review of briefings and reports does not reveal much concern about governance issues for Telstra, which may to a degree be a result of its ownership structure and the role of the government in its corporate- governance mechanisms. Answers to Research Question 1b for Telstra show the company exceeds its mandatory regulations in reporting information relating to its Sustainable People Management Practices. As for NAB, this information is more likely to be found in other sources for Telstra than in annual and sustainability reports. Regardless, there is also some human capital data missing from the public domain, which cannot be obtained for this study, as this research replicates the regulatory environment in which analysts operate and uses only publicly available data. On the other hand, an analysis of security analyst reports reveals that analysts include mainly market-related information and very little information on top management remuneration. There is a knowledge gap between the analysts’ reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital.

291 Research Question 3 The construction and application of a disclosure index regarding the mandatory reporting requirements for Telstra showed that the regulatory framework has not provided for ways to bridge the knowledge gap in human capital other than mandatory reporting on governance, remuneration of executives, review of operations, review of mining and exploration activities and equal opportunity for women (reported separately to the EOWA, explained in detail in Chapter 5). Most of the human capital knowledge used to analyse the data in this thesis regarding the indicators “Job Characteristics, Recruitment, Training, Careers, Rewards, and Professional/Identity/Culture” does not systematically form part of the mandatory reporting requirements or the investment process. A review of the information asymmetry in the capital markets shows that failure to disclose human capital information may cause investors to misjudge company value, leading to mispricing of shares and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access. Human Capital Analysis identified several examples of information asymmetry at Telstra. Firstly, the data collection and analysis of Telstra reports highlighted that “leadership, training and workplace relations” are significant human capital-related indicators for Telstra that need to be evaluated over time as a part of human capital. None of these items were reported on or evaluated in the analyst reports. The monitoring of significant human capital information such as “training” and “industrial relations” provided insights into the future financial performance of Telstra; a skilled and committed workforce is essential for strategy execution. Human Capital Analysis points out that if Telstra employees continue to feel disgruntled due to their work conditions, it will slow down Telstra’s ability to execute strategy in several ways. Employees will continue to express anger in the media; TV programs, union websites, newspapers, industry magazines and blogs. If this occurs, Telstra’s reputation as a desired employer will be tarnished and its ability to attract a qualified workforce will lessen. Labour turnover, particularly at call centres, will be costly and reduce service quality and sales. Human Capital Analysis also identifies that the decreasing prevalence of in-house training may result in network maintenance slowing down, creating dissatisfied customers, particularly in rural areas. A workforce that is not committed or accepting of organisational goals may not cooperate in change programs, impeding strategy execution. These are only some of the workforce-related issues that had to be addressed before recommending the stock. It is not only market forces, such as the booming telecommunications industry during

292 1997–2001, that needs to be considered, but internal forces that can impact the performance of a company. Even during a booming market, investors have a right to know which company has the potential to perform better within its industry.

While this section presented the qualitative information found in analyst recommendations, its main aim was to demonstrate how financial analysts, by not using and assessing this qualitative information through a human capital lens, have lagged in understanding the reality of corporations. Voluntary reporting disclosures of companies partially reduce the information asymmetry that exists between management and other stakeholders. More and more frequently, companies are reporting on their environmental, social and governance performance. Yet equity analysts have not systematically included these reports and incorporated other sources of information. Only specialised research providers assess governance, environmental and sustainability reports but none of them use human capital as an indicator for assessing the contribution of human capital and human resource practices for generating company value. There is a need for more extensive human capital reporting on behalf of companies, which is something regulators should consider. In light of the findings of the research questions, it can be stated that there is a knowledge gap in the investment recommendation process. While this gap is smaller for some companies, it is much larger for others. This situation can change firstly depending on the human capital information available in the public domain and secondly on the personal skills of security analysts in collecting and using human capital information. However, like financial analysis, qualitative analysis should be used systematically by qualified analysts utilising models based on theory. The next section will explain the process of distinguishing reality from rhetoric data, and the next section, using these data, will display the findings of the Human Capital Analysis process.

9.4 Company Rhetoric vs. Reality compared through secondary sources

Annual reports, as the main corporate communication mechanism, are important for conveying the intentions of management(Wiseman, 1982). There has been increasing prevalence in narrative reporting (G. Breton & Taffler, 2001) and an upward trend in the reporting of non-financial information in annual reports (Abeysekera & Guthrie, 2004; M.

293 Williams, 2001). When asked, analysts have stated that they doubt the informational value of the “management report” in the annual report, but Glaum and Friedrich (2006) pointed out that this is the most forward-looking element of annual reports. This research has also shown that the narrative sections of the annual report, such as “vision, strategy, goals, value system, code of conduct, management standards and performance targets”, can provide valuable data that is forward looking. However, this reported company rhetoric needs to be closely analysed to determine whether it is set in corporate policies, standards and systems and translates into performance that adds value to the company. On the other hand, an examination of the voluntary reporting practices of companies pointed to several dangers associated with using such reports. The literature review indicated that although over the years there has been an increase in disclosure quantity, the quality of voluntary reports is not uniform. They can be incomplete, biased and fail to reflect reality. GRI Sustainability Guidelines lay a good format for reporting sustainable performance and make comparisons possible, and voluntary reports that use these standards and are externally audited are more valuable. However, these reports give little insight into human capital indicators. Nonetheless, while some of the voluntary reports hold the potential of providing rich and soft data, they need to be approached with caution and the analysis needs to be enhanced using other types of documentary analysis. Therefore, after considering the pitfalls of using solely “company-originated data” for conducting Human Capital Analysis, this section suggests sifting “company reality” from “company rhetoric” through triangulating “company-originated data” with “other sources”. “Company-originated documents” are obtained through annual reports, analyst briefings, presentations, sustainability reports and websites, and “other resources” are obtained through academic articles, books, magazine and newspaper articles and industry reports. Through the process of comparing and contrasting, this section demonstrates how Human Capital Analysis can overcome the inaccuracy/reliability problems associated with voluntary company reports. The comparison is conducted in three sub-stages; policy framework, implementation of policies and public accountability.

9.4.1 BHP Billiton (BHP) It is very difficult to evaluate a company’s actual performance using only publicly available data. A comparison between “company-originated data” and “other sources” can demonstrate the differences between “company rhetoric” and “company reality”. Finding

294 information that closely represents reality will help the researcher evaluate the actual capabilities of the organisation for higher organisational performance. “Safety and environment” will be used to demonstrate this process. The BHP Billiton Annual report reveals that “safety and environment” are key values for the company. HSEC reports state that at the heart of BHP’s relationship with stakeholders are local and indigenous communities and employees (Consultation with communities, Accountability). HSEC reports, from 2001, defines the “safety and environment” related policies, management standards and performance (Policies). Overall, all the information provided by the company through annual reports, HSEC reports and websites confirms that BHP has adopted an integrated approach for managing the “safety of employees and environment”249. Reports lodged at EOWA by BHP reveal both positive and negative news, such as some worksites that have not had adequate policies to attract a more diverse workforce for non-traditional roles as planned. Industry reports have exposed how BHP performed in regards to “safety and environment” within its industry (Policies). The company showed leadership in “employee safety” and has extended standards to include contractors; in the State of NSW, the Government’s Workplace Health and Safety Strategy (2005-2008) followed BHP’s practices, asking for a reduction of 40% in contractor injury rates by 2012 (NSW Department of Primary Industries, 2005). Two other studies have shown that the company has continued to uphold “employee health and safety” outside of Australia (Implementation) 250. In regards to the “environment”, case studies confirm that employees have internalised this value and have made it a part of their daily operations251. On the other hand, a newspaper article indicates that in 2004, the company had to halt operations in Tintaya Mine in Peru as a result of increasing community concerns (R. Gale, 2005). Moreover, other newspaper articles suggest that BHP has been heavily criticised for human rights abuses at some of its operations252. A

249 a. The 2001 HSEC report announced the establishment of a new board committee, called the HSE Committee. b. The HSEC Policy taken from the report states “Continual improvement in performance, efficient use of natural resources and aspiration to zero harm to people and the environment” are essential elements of working Responsibly at BHP Billiton. c. The company website recorded that the company has committed to several voluntary initiatives for improving better environmental performance. d. At the site level, how Environmental Management Standards are reported in the individual HSEC Reports of sites. e. The company announces both achievements in performance and disappointments. For instance, the Classified Injury Frequency Rate has fallen from 6.51 in 2001/2002 to 5.18 in 2002/2003 and 4.95 in 2003/2004. Despite these efforts, the “zero fatalities” target has not been attained during the sample period. 250 Academic studies indicate that BHP manages high risks of HIV/AIDS ratios for employees in countries like South Africa and Mozambique by introducing local support programs to help prevent employees from acquiring the virus and cooperates with local governments, community organisations, NGOs and industry groups (Fast, 2004) (P. B. Lawrence, 2003) 251 At Dendrobium underground coal-mine (NSW, Australia), the ventilation shaft was constructed without one person entering the shaft during the construction period. The project has set new industry standards in safety performance and environmental care (Fast, 2004) 252 BHP’s “involvement in allegedly unlawful exploration for nickel in Pujada Bay in the Philippines”, “failure to address the cases of long suffering communities who were forcibly evicted for the expansion of the El Cerrejon coal mine in Colombia” (Mineral Policy Centre (Australia), 2005) and intentions to mine on Gag Island in Indonesia despite ecological and community concerns.

295 study that examined the implementation of Human Rights Standards at BHP Billiton South Africa’s Bayside Aluminium Smelter pointed to the weak human rights fit between standards and operations (P. B. Lawrence, 2003). A comparison of “company-originated data” with “other data” confirms that the achievement of “safety and environmental” performance targets is attributed much importance and is monitored very closely, despite some inconsistencies between worksites during the implementation process. Further academic studies reveal that human resource management practices253 are also closely aligned with the achievement of “safety and environmental” performance targets. This confirms that BHP displays good/high levels of consistency between “company rhetoric” and “company reality” and has the capacity to develop and renew policies, apply management standards and achieve performance targets for better “safety and environment” performance.

9.4.2 National Australia Bank (NAB) “Corporate Governance” and “Leadership” will be used to demonstrate the process of distinguishing “company reality” from “company rhetoric”. This process also demonstrates why security analysts should not accept leaders’ assertions as their only information source.

In NAB’s Annual Report 2001, CEO Cicutto announced the new restructuring program as “Positioning for Growth”. An examination of investor briefings, speeches given during business luncheons and media announcements shows that CEO Cicutto discussed corporate success only via improvements made to shareholder value through quantitative measures such as increased sales, acquisitions and financial returns (i.e. no of inclusion of stakeholders’ contribution to corporate success and sustainability). He repeatedly sent the message that a transformation would be achieved through “emphasis on growth” (Cicutto, 2000a). In relation to considering stakeholders’ interest in the company’s decisions and activities, a study of company reports as well as public speeches indicates that the approach was rather superficial. This conclusion was reached through following up on the implementation process of management’ promises.

253 The new employee-selection criteria stress the sharing of company values. At BHP Steel, new training programs were initiated to help managers reduce the impact of the mills on the environment and understand technological developments to minimise the degree of dangerous emissions (Kelly & Underhill, 1997), (Poltorzycki, 2002)Parts of executive remuneration are made dependent on the achievement of HSEC Targets. And there is a strong network of environmental professionals (100 engineers) working at the BHP work sites, which help to implement new standards.

296 Cicutto promised that “growth” would be realised through a transformation to a “high performance work culture” (HPWS). Applying the human capital lens to publicly available documents, the study of the culture elements and human resource practices of training, team- based structures, and rewards showed little proof of moving towards HPWS (Implementation). Moreover, from a human capital perspective, for the proper functioning of a “high growth and profit strategy” the corporate culture had to be balanced with a sound value system and good governance practices. However, the study of governance mechanisms gave many warning signals of weak practices for NAB (Policies), even before the 2004 foreign- exchange crisis. A study of the background of the board of directors based on annual reports shows that only two executives (CEO Frank Cicutto and John Steward) had prior banking experience. The company reported very little information in annual reports about governance practices and compliance mechanisms and the Risk Committee was only established in 2003 (Public Accountability), with the board disregarding APRA’s warnings about risk management. Newspaper and online articles have noted that NAB had control issues in several international subsidiaries. The company culture allowed only good news to be released both within and outside of the bank, and there was evidence of a lack of transparency. An examination of media announcements and annual reports following losses at Homeside Lending in 2001 indicates that CEO Cicutto himself failed to provide timely and accurate information to the market; in one interview institutional investors stated that they had questioned bank officials about Homeside Lending losses and received no reply(Arbouw, 2004). Comparing company-originated reports regarding “leadership” and “corporate governance” with other sources, the differences is clear; from a human capital perspective, due to governance problems as well as cultural issues, it is possible to forecast that the leaders would not be able to execute “growth strategies” during 1999–2003.

9.4.3 Telstra “Knowledge Management” and “Training” will be used to demonstrate the process of distinguishing “company reality” from “company rhetoric” at Telstra. The Telstra Annual Report defines the company’s new vision as “Telstra—Australia’s connection to the future” (Policies). To realise this vision and execute supporting strategies,

297 according to the human capital view, Telstra should show the capacity to invest in technology and information management and should foster a creative working environment. Data collected through annual reports and the company website indicated that Telstra had extensive investments in technology acquisition and made continuous incremental investments in R&D (Implementation). The initiatives for developing R&D were plentiful; cooperation with universities, building new research laboratories, creation of a new position as a chief technology officer. These accomplishments have also been recognised by external parties. A survey of company senior executives commissioned by PricewaterhouseCoopers (PwC), BRW and conducted by the research firm Millward Brown, reported that Telstra was found to have the “most effective use of technology” and was ranked third in “coping with the future” (Kavanagh, 2001). Strikingly, an industry analysis conducted by OECD shows that Telstra’s R&D budget was considerably lower than similar telecom companies in OECD countries and showed a downward trend. An examination of company reports and case studies revealed no evidence to suggest that Telstra was promoting a learning environment, in which knowledge acquisition and sharing were fostered through formal and informal organisational processes. The company’s controlling and autocratic management style left little room for fostering creativity and innovation in the workplace. Academic studies note that years of outsourcing, downsizing and changes in technology required re-skilling of the workforce. Unfortunately, Telstra has abandoned its formal internal on-the-job training programs, and relies more on external sources for training. The majority of the remaining internal training programs are computer-based, posing a threat to the quality of the installation and maintenance technicians’ training. The comparison between the company vision and policies (company rhetoric found in the annual reports) and the practices of the company (implementation of policies found through other documents) did not support that leaders and management would be able to execute an innovation strategy. In other words, applying the human capital lens it is possible to say that the stated strategy will not result in improved organisational performance in the near future.

Using examples from the three case companies, this section aimed to demonstrate how company “rhetoric” found in various company reports can be validated/rejected through monitoring company policies, implementation practices and reporting of activities. This new reality that is reached through the former validation process is used to assess human capital systems of the case companies.

298 9.5. The Results of the Human Capital Analysis Process

This section will display the results of the Human Capital Analysis process using the three case companies. Applying the first tool, the Model of Drivers of Sustainable People Management Systems (Royal, 2000), it is possible to identify the historical context of an organisation. The tool reveals facts about the company’s founders, establishment and business cycle. It demonstrates management’s reaction to multiple organisational challenges, crises and changes, and how it overcame them. The macro analysis of an organisation’s environment reveals the external influences in the model. The analysis makes it possible to view product/market information, governmental and industry-specific regulation, demand for labour, technological change and societal forces. It aids in determining how organisations have repositioned themselves in the market, especially in the global economy. Thorough analysis using this tool will point to opportunities and threats in the external environment and help to forecast how they will impact management thinking and strategy. The second tool, Sustainable Human Capital Practices, provides a systematic approach for uncovering how the organisation manages human capital as an intangible asset. It enables qualitative analysts to judge alignment of human resource management systems with corporate strategy. Specific systems of “recruitment, training, careers, rewards and remuneration, leadership, workplace relations and culture” are regarded as important in understanding this fit. The third tool isolates the human capital-specific strengths and weaknesses of the company and evaluates them in light of their future potential.

9.5.1 BHP Billiton (BHP) The macro analysis underlines the changing supply and demand patterns and the new players in the arena. It also identifies that in the near future to stay competitive resource companies will need to be able to forecast supply and demand patterns, manage large diversified portfolios, improve the skills of the workforce through both internal and external training, invest in new technology and manage a variety of stakeholders by being accountable and maintaining a close dialogue. Applying the tool, it is possible to evaluate BHP’s historical context; the company known as a great performer in the ASX stumbled through the 1990s, but managed to realise a great comeback after the changes made to the overall company structure during 1998–2001 and the BHP and Billiton merger. The decision to eliminate unprofitable investments, thereby

299 cutting costs, as well as simplification of the organisation structure, diversification of its product portfolio through globalisation and inorganic growth aided in creating a better company. This all occurred under the visionary leadership BHP had, aided by the new management structure. By 2003, the new BHP Billiton was ready to face the challenges of the changing market. When the resources boom hit the markets, BHP’s profits increased dramatically, as did the share price, and in 2003–2005the company once again became an attractive stock for investors. The analysis of BHP’s Sustainable Human Capital Practices has shown that there is a high level of consistency between the company’s human resource management systems and its stated strategy, as well internal consistency among BHP’s practices. This consistency and the appropriate fit in BHP’s practices will aid the company to execute strategy and hence improve its financial, environmental and social performance. The strengths and weaknesses analysis indicates that BHP’s century-long mining experience, consistent management policies, standards and practices, updated culture, effective succession-planning strategies and internal career opportunities, strong knowledge-management systems, and internal/external training opportunities are some of the internal strengths of the company. In addition to its strong internal management practices, there are also weaknesses that need to be closely monitored by outside parties. The composition of the board, labour-management issues and human rights abuses are some of these weaknesses.

9.5.2 National Australia Bank (NAB) Financial globalisation has become an important determinant for the Australian banking industry’s future profitability. In more concrete terms, changes in the world economy and financial markets will also to some degree affect the profitability of NAB. The cost base for NAB is affected by ongoing investments in technology and innovation, expansion in new markets, training needs of employees and the reporting requirements brought on by new regulations. On the other hand, while revenues may increase as the local market expands, at the same time NAB is restricted by world service fee rates. The macro analysis demonstrates that banking has become a knowledge-intensive industry through the sophisticated products it offers, the utilisation of the latest technology and the employment of knowledge workers. It suggests that in the near future, to stay competitive banks will need to be able to offer low-cost and innovative products and provide a full range of services that aid in cross-selling, balance the use of face-to-face customer interaction with the

300 use of new technologies, be able to manage an increasingly part-time workforce and understand flexibility needs, manage a highly educated professional workforce that has a low commitment to the organisations and monitor and respond to the changing expectations of society. Applying the first tool, it is possible to evaluate NAB’s historical context; the company that had a good share price performance during 1999–2003 in comparison to the GICS Financial Index stumbled in mid 2004. The FX crisis and the subsequent turmoil caused both customers and investors to lose trust in the company. Combined with lower than expected profits, NAB’s shares lost their attractiveness. Fortunately, a successful recruitment effort had put the right leaders in the right places; acceptance of the mistakes made and the readiness of top management to lead a comprehensive culture change program, which investors closely monitored from 2004–2005. If the follow-up of this change process indicates NAB’s capacity to change and transform into a more innovative and knowledge culture, then the bank can defend itself against threats in its external environment and exploit opportunities in order to become an attractive investment once again. The analysis of NAB’s Sustainable Human Capital Practices shows that the level of consistency between NAB’s human resource management systems and its stated strategy during 1999–Jan 2004 was low. However, after this period, the level of consistency improved significantly, which may aid the company in executing strategy and hence improving its financial, environmental and social performance. The strengths and weaknesses analysis shows that NAB’s century-long retail banking experience, its new structure as a full-services bank, strong customer base and accumulated knowledge, high investments in technology, employee participation in community programs, and its commitment to voluntary initiatives, represent internal strengths. Newly hired leaders and higher-level executives showed high potential for taking change initiatives and the new board possessed a balance of skills and experience. In addition to its internal strengths the bank has significant internal weaknesses it needs to work on. These include above-average remuneration packages for senior executives, lack of succession planning and leadership development, lack of communication networks, diversity issues and integration of sustainability measures into human resource systems. Its leaders will need to achieve a balance of the pressures of short-term performance with long-term goals of sustainability and workforce development.

301 9.5.3 Telstra

Current trends indicate that industry-specific regulations will not diminish in the short term and will continue to become more stringent. For Telstra, there may be skills shortages in the high end of the market, pressures for lower prices will continue, and competition will arise both locally and internationally. Consumers will ask for higher-speed connections and data transfers, which will require Telstra to replace its copper wires network with fibre optics, as is the case in many leading OECD countries. Most importantly of all, the speed at which Telstra launches new services to the market will be crucial. The Australian market is relatively small and is not expanding rapidly, and already has high penetration rates, with the exception of broadband. Therefore, providing alternative communications solutions such as 3G mobile services or bundling voice, data and videos will bring competitive advantages to telecom companies. Applying the first tool, it is possible to evaluate Telstra’s historical context; the company was privatised directly before the rise of the internet market. During the first two offerings the share price performed very well, with many Australians wanting a piece of the telecommunications giant. However, after the 2000/2001 global financial crisis the company could not meet the expected growth rate. Furthermore, the increasing competition caused Telstra’s market share to decrease. This, combined with slowness in bringing new products to market, a couple of bad investments, and board disagreements, caused Telstra’s stock to underperform. The third and final sale of the Government’s shares caused supply to exceed demand in the market and they dropped further in value. The analysis of the Sustainable Human Capital Practices shows that the level of consistency between Telstra’s human resource management systems and its stated strategy during 1999–Jan 2004 was low. A number of incidents have illustrated the conflicting interests of parties to the company, thus impeding progress and change. The organisation is divided between satisfying the needs of the Government and its new shareholders. Telstra has established partnerships with the community and is moving in the direction of achieving strategic sustainability, but does not enjoy a similarly positive relationship with its employees, who are regarded as an expense rather than a part of the solution for improved performance. The strengths and weaknesses analysis indicates that Telstra managed to effect a leaner organisation with less bureaucracy and management layers, thereby improving organisational performance. The new organisational structure helped it move closer to

302 customers, enabled it to achieve a good mix of internal and external labour, and established flexible work arrangements. While the workforce remains male dominated, the company has improved diversity and female representation at higher management levels has improved. Despite the many strengths of its human capital systems, there are also some weaknesses and corporate challenges. Among these, Telstra’s leadership style is the most noticeable. Executives and upper management are supportive of the corporate change programs and maintain strong resolve. However, the ongoing directive style of leadership has left the workforce unwilling to cooperate in change programs, and as such it is not sustainable. Workplace satisfaction increased to 65% favourable in 2004 but this is still relatively low. Telstra employees have voiced their dissatisfaction about the autocratic and performance-oriented management style through different media, such as programs like Four Corners on ABC TV. Therefore, relations with the workforce and unions continue to pose a challenge for Telstra.

This section aimed to illustrate the findings of the Human Capital Analysis process and record the possible insights this qualitative analysis can provide to the users of investment recommendations. The use of this framework does not render all other lenses unimportant or invalid but aims to improve the investment recommendation process through using human capital data.

9.6. Conclusion

The literature review chapters showed that human capital is an intangible source of value creation and forms a part of the assets that create competitive success. Furthermore, the literature established that investments in human capital are valuable and need to be pursued and evaluated. The construction and use of a disclosure index for the mandatory reporting requirements for the three case companies demonstrated that the regulatory framework has not provided ways to bridge the knowledge gap in human capital other than mandatory reporting on governance, remuneration of executives, review of operations, review of mining and exploration activities and equal opportunity for women (reported separately to the EOWA, explained in detail in Chapter 5). The majority of human capital knowledge used to analyse the data in this thesis regarding the indicators “Job Characteristics, Recruitment,

303 Training, Careers, Rewards, Professional/Identity/Culture” is not applied systematically as part of the mandatory reporting requirements or the investment process. The review of information asymmetry in the capital markets indicated that failure to disclose human capital information may cause investors to misjudge company value, leading to mispricing of shares and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access. Human Capital Analysis identified numerous examples of information asymmetry for the three case companies. While applying the human capital lens and utilising several kinds of publicly available data, it was possible to provide indications of the future financial performance of the three case companies on several occasions. In contrast, an examination of security reports revealed that they were not able to identify these early signs. If security analysts continue to use reports guided only by mandatory reporting requirements, based on the current quality of these requirements and the resulting reports, it would not be possible for analysts to identify early indications. As this study has demonstrated, to close the knowledge gap there is a need to utilise available data in the human capital space. These data can be obtained through company archival information, media analysis, industry reports, university academic sources such as dissertations, management case studies carried out by academics, professional associations’ newsletters and conferences with guest CEO speakers such as the Australian Institute for Human Resource Management, Australian Institute of Company Directors. However, closing the knowledge gap depends not only on the use of alternative data sources but also on the use of qualitative techniques and frameworks for providing a clearer picture of organisations. The literature review indicated that financial analysts are specialists with degrees in finance and business and are trained to use only financial models and quantitative methodologies. Based on their education, skills and experience, it is not likely they will use this framework, which requires a deep understanding of human resource management, sustainability, knowledge management, organisational change and human capital management. Royal in her article at the Economic and Labour Relations Review points to the difficulties of finding analysts around the world to be skilled up enough to provide human capital expertise given that their training is in modern financial theory and practice and not in qualitative human capital areas of expertise (C. Royal, 2004). She suggests regulators like the Australian Securities and Investment Commission take up responsibility for upgrading the skills of security analysts in this regard. She adds that there is also a need to have human

304 capital experts working in investment banking organisations, stockbroking and funds management organisations to assist on research teams with this kind of specific expertise and/or use external independent human capital service providers. These concerns indicate that the training issues should be considered not only by regulators but also by business schools and academics. The final conclusions of the thesis will be drawn in the following chapter.

305 Chapter 10: Conclusion

Two simultaneous and distinct events occurred at the beginning of the twenty-first century; the technology bubble burst and accounting scandals and corporate collapses emerged worldwide. These had major implications for capital markets. Directly after the end of the boom in the capital markets, investors, the media and regulatory agencies questioned the credibility issues associated with security analysts’ reports. Further, following the corporate scandals and the resulting financial losses, corporate governance and credibility issues associated with the corporate reports emerged. The lack of transparency in company reports and the investment recommendation process caused investors to lose trust in capital markets. In their attempts to redress “perceived governance weaknesses” (J. Hill, 2005) 368), major stock exchanges and regulatory bodies introduced changes to “governance, disclosure, analyst independence, accounting and auditing practices”. In Australia, changes were made to the ASX Listing Rules, specifically Continuous Disclosure Requirements. A rise in the number of socially responsible investment funds and indexes around the world was recorded as investors wanted to invest in companies with appropriate corporate-governance practices and/or companies that were working towards organisational sustainability. Companies that wanted to rebuild trust supported voluntary reporting codes, reported on their progress towards sustainability and even had these reports externally audited. The above actions by capital market actors were aimed at improving the transparency of the investment process and rebuilding trust in capital markets. Building on this base, this thesis asserts that investors would further benefit from more open communication from companies and from more accurate and timely investment recommendations. Improvements in transparency are particularly important for knowledge-intensive companies, as it is more difficult to place a value on their knowledge-based assets. Additionally, this thesis suggests that, as opposed to market-efficiency theory, capital market actors do not collect and use all the soft data available in the public information pool. This results in a knowledge gap between the more traditional investment reports written by financial analysts and the publicly available fundamental human capital information. Furthermore, if this soft, qualitative data is systematically collected, analysed using theory- driven models and the results applied together with traditional financial analysis and included in analyst reports, the investment recommendation process would improve for the benefit of

306 institutional investors as well as small investors. As ascertained by this study, the improvements in closing this knowledge gap would surely increase transparency for the investing public and rebuild trust in capital markets, which has deteriorated over the past decade.

10.1 Findings

This thesis examines the extent to which human capital information is reported publicly by corporations and the extent to which human capital information is analysed by equities analysts in their investment recommendations in the Australian Equities Market. The study consists of three sections, which together attempt to open up new lines of research and interpretation of the human capital paradigm in the investment process.

Section One: Literature and Research Design

The literature review chapters (Chapters 2 and 3) established that there appears to be a knowledge gap between analyst reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital. Chapter 2 recognised human capital as an intangible source for value creation and asserted that it should be evaluated as a part of the value of the firm. It also displayed the existing models for this process. Chapter 3 ascertained that the current investment recommendation process does not systematically include human capital as part of company valuations. Indeed, human capital is not discussed in any detail in financial quantitative fields, as it is a separate field of study and expertise and the links between these disparate fields are not very strong. Chapter 3 showed that annual reports and voluntary reports using GRI Sustainability Reporting Guidelines do not provide much human capital data and there is a need to use other sources to collect this information. Furthermore, the chapter presented the new working environment of security analysts as highly regulatory, in which direct access with company officials is limited. Building on the findings of the two literature chapters, Chapter 4, Research Methods, presented the diverse methodological approach to for this study. The study, which is qualitative in nature, relies on the triangulation of publicly available data sources. In doing so, the study to a large extent replicates the regulatory environment in which analysts operate.

307 It also identifies through a multidisciplinary approach that human capital theory and practice is a leading conceptual framework for exploring the research questions. The Model of Drivers of Sustainable People Management Systems (C. Royal, 2000a) and Human Capital Classification Process (C. Royal & L. O'Donnell, 2002; Carol Royal & Loretta O'Donnell, 2002a) are identified as being suitable frameworks for understanding the human capital value of a company. The three case companies the thesis uses to study human capital reporting practices from 1999–2004 are BHP Billiton, National Australia Bank (NAB) and Telstra. All three case companies are the largest by market capitalisation in their sectors and all are listed on the ASX 20 Index. This period coincides with great changes in the reporting environment of publicly listed companies. It witnessed the boom and the bust of technology stocks, both bull and bear markets, accounting scandals and major corporate collapses, and the subsequent changes in corporate law, disclosure requirements of the ASX and voluntary reporting practices of publicly listed companies. Therefore, it was assumed that a study of this period would incorporate variety in reporting practices and coverage of analyst reports. Lastly, this chapter highlighted the need for constructing a disclosure index for assessing the mandatory reporting requirements for publicly listed companies on the ASX and their reporting of human capital data beyond these requirements. The last chapter of Section One, Chapter 5, presented the regulatory environment for publicly listed companies in Australia. This chapter identified the major mandatory reporting requirements of these entities as Australian Accounting Standards, ASX Listing Rules and the Principles of Good Corporate Governance and Best Practice Recommendations (after 2003). The chapter also identified annual reports as the major medium that companies use to fulfil these requirements. A qualitative disclosure index was constructed using the mandatory reporting requirements for the years 1999–2004. The construction of the disclosure index showed that the regulatory framework does not provide ways to bridge the knowledge gap in human capital other than mandatory reporting on governance, remuneration of executives, review of operations, review of mining and exploration activities and equal opportunity for women. The majority of human capital knowledge used to analyse the data in this thesis regarding the Sustainable People Management indicators “Job Characteristics, Recruitment, Training, Careers, Rewards, and Professional/Identity/Culture” is not systematically used as part of the mandatory reporting requirements. Lastly, Chapter 5 highlighted the problems in relation to using voluntary reports and underlined the need for triangulating data sources with other publicly available documents in this study.

308 Section Two: Case Companies BHP, NAB and Telstra

The three case company chapters, through answering the research questions, confirm the existence of a knowledge gap both in the reporting of human capital information by corporations to the public and the reporting of human capital information by equities analysts in their investment recommendations. Furthermore, the chapters demonstrate how to distinguish “company reality” from “company rhetoric” using supplementary documentary sources. Lastly, the chapters present the findings of the Human Capital Analysis, which demonstrates the quality of human capital data available in the public domain and emphasises the importance of using a qualitative framework for valuing human capital. In answering Research Questions 1 a: “Do publicly listed Australian companies go beyond the mandatory regulations in reporting their Sustainable Human Resource Practices?”, the disclosure index constructed from mandatory reporting requirements was used in analysing the narrative sections of annual reports. The analysis showed that all three case companies comply with mandatory reporting regulations and ASX Corporate Governance Recommendations for the period of 1999–2004 and exceed these requirements. Very few items were found to be missing from the mandatory reporting items, and were later found in full reports or annual reports in later years. Considering BHP is dual listed and the other two companies are listed on stock exchanges in addition to the ASX, their reporting is relatively greater in quantity than that required by Australian regulations and there is evidence these companies reported on some items before they became mandatory. This confirms with previous literature (chapter 5) For answering Research Question 1.a. and Research Question 1. b. “How much more than the mandatory regulations do these companies report or make available to the general public?”, the Sustainable People Management indicators “Job Characteristics, Recruitment, Training, Careers, Rewards, Professional/Identity/Culture” were used to sort and analyse the data found in the narrative parts of annual reports, sustainability reports, other company- originated documents and additional sources. Analysis of annual reports and sustainability reports using the human capital indicators confirmed that reporting of these indicators did not occur in these sources. Annual reports are useful for mandatory reporting on “governance, remuneration of executives and directors and review of operations”, and when companies choose to report on their “vision, strategy, goals, value system, and code of conduct, management standards and performance targets” these can provide valuable data that is forward looking. Thus far, sustainability

309 reports utilising GRI Sustainability Guidelines give very little insight into human capital information. However, they are useful for ascertaining environmental and social policies and performance. In regards to employees, some quantitative data was found in sustainability reports, such as “employee numbers and breakdown”, “diversity numbers” and “occupational health and safety performance” (deaths and injuries). The analysis of other company-originated data using the human capital indicators demonstrated that some valuable data is communicated by management to the public through multiple mediums. Even if the quality of the data is not entirely reliable or complete, these sources still have potential, such as the company archival information (historical analysis), documents found on the website (e.g. careers websites give some clues about “recruitment” and “careers” and outsourcing, documents found on the website demonstrate management sincerity about communicating with stakeholders, presentations by leaders give insights into strategy), reports lodged at Equal Opportunity for the Women in the Workplace Agency (i.e. diversity at all levels, differences among worksites), media reports (i.e. timely follow up of progress on change programs, management changes) and newsletters (i.e. communication with stakeholders). The analysis of the other documents using the human capital indicators demonstrated that there is much data available in the public domain that can be used for Human Capital Analysis. These data can be obtained through media analysis, industry reports, university academic sources such as dissertations, management case studies carried out by academics, professional associations’ newsletters and conferences with guest CEO speakers such as the Australian Institute for Human Resource Management and Australian Institute of Company Directors. These sources give insights into the strategies, policies and standards developed and adopted for investing in human capital, the renewal of these standards and their implementation. By monitoring these investments it would be possible to glean insights into the future potential of human capital. Even when multiple data sources are searched and utilised, some human capital data is still missing in the public domain, which cannot be obtained for this study, as this research replicates the regulatory environment in which analysts operate and uses only publicly available data. The analysis and comparison of reporting practices among the three case companies demonstrated variations in the reporting of human capital. The results show that BHP had the most human capital data in the public domain, in comparison to NAB and Telstra. The literature review, Chapter 5, suggested ways to interpret the voluntary disclosures of

310 companies. Both social contract theory and legitimacy theory connect voluntary disclosures to the approval needs of organisations and the public pressures placed on the organisations. Stakeholder theory adds the expectations of stakeholders to this “organisation–society dialogue” understanding. Therefore, an appropriate explanation for the differences in quantity and quality of BHP’s disclosures could be its desire for approval, specifically after the environmental scandals it experienced in the 1990s. The same conclusion can be made regarding the increase in the quality of NAB’s disclosures after the corporate-governance scandal in early 2004. Another explanation for the observed information asymmetry may be management’s lack of knowledge about the importance of human capital indicators. Eccles, Herz et al. (2001) defined this as the “understanding gap”. As a result, Telstra’s managers may regard human capital information as unimportant and therefore do not report on it. A third explanation draws on the agency theory. As described in the literature review, Chapter 5, agency theory states that managers disclose information only if the benefits of the disclosures outweigh the associated agency costs. Therefore, management may choose to keep this critical and sensitive information to themselves, as they do not see any benefit in reporting them. Eccles, Herz et al. (2001) call this “the reporting gap”, which occurs when managers make very little effort to report information about measures they find important for running their companies(Eccles, et al., 2001) .

In answering Research Question 2, “Is there a knowledge gap between the equities analyst reports and reporting of Sustainable Human Resource Practices by companies?”, once again the Sustainable People Management indicators were used to analyse the security reports written for the three case companies. Additionally, investor briefings were analysed in order to monitor the questions asked by analysts. The study of the narrative sections of the security reports showed that soft and qualitative information was not systematically sought but is used randomly as information or occasions arose. In their discussions, analysts recorded that their sources of information came mostly from quarterly, half yearly and annual financial reports and company announcements. However, these reports contain very restricted human capital information, as the use of the disclosure index verified in this study. According to the human capital approach, reports other than annual and sustainability reports contain much valuable information. Conversely, analysis of the analyst reports confirmed that analysts do not use other sources for data collection and when they had access to specific human capital data they did not link it to business results or put value on these assets.

311 As a result, the analysis showed that security analysts do not generally include human capital-specific information in their reports, and when they do, it is only related to top management-specific issues, and analysts lack the capacity to interpret of these data within the human capital framework. There is a knowledge gap between analysts’ reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital.

In answering Research Question 3, “How important is it for analysts to be able to bridge the knowledge gap within the financial regulatory services framework when making forecasts about the future financial performance of ASX-listed companies?”, this thesis discussed the importance of closing the knowledge gap from the perspective of investors. The human capital approach has indicated several examples of information asymmetry between what the Human Capital Analysis identified among the three case companies and that depicted in analyst reports. If security analysts continue to refer only to reports guided by mandatory reporting requirements, based on the current quality of these requirements, analysts will not be able to draw conclusions as comprehensive as those drawn by Human Capital Analysis. As this study demonstrated, to close the knowledge gap there is a need to utilise the available data in the human capital space. However, closing the knowledge gap is not dependent only on the use of alternative data sources but also on the use of qualitative techniques and frameworks that provide a clearer picture of organisations. The review of information asymmetry in the capital markets indicated that failing to disclose human capital information may cause investors to misjudge company value, leading to mispricing of shares and eventually creating inefficient capital markets. It can also put smaller shareholders at a disadvantage as they lack appropriate information access. Therefore, reporting this information as a part of the investment recommendation process would help rebuild trust in capital markets as well as help create more efficient markets as a result of increased transparency.

312 10. 2 Implications

This thesis showed that there exists a knowledge gap between analyst reports, including their understanding of companies from a human capital perspective, and what is understood in the field of human capital. Applying Human Capital Analysis techniques to the data set, the findings confirmed the quality of data that is within the reach of security analysts without breaking regulatory boundaries. This thesis displayed additional techniques for the purposes of analysing publicly listed companies for investment purposes. Firstly, it set out a roadmap for human capital- related data-collection strategies. Secondly, it demonstrated how to triangulate company- originated data with other sources and distinguish actual practice from company rhetoric. Lastly, through utilisation of the Model of Drivers of Sustainable People Management Systems (C. Royal, 2000a) and Human Capital Classification Process (C. Royal & L. O'Donnell, 2002; Carol Royal & Loretta O'Donnell, 2002a) it demonstrated how the model and framework provide valuable insights into the drivers of future company success. Combined, the model, framework and data-collection techniques suggest an additional means of analysing publicly listed companies for investment purposes. This is not to say that these techniques should replace fundamental financial analysis, but should complement them to improve the investment recommendation process. The results of this thesis should encourage companies to report more human capital- related information. Although the current regulations do not require human capital information, they can improve the quality of their voluntary reports. Moreover, they can volunteer to generate new reporting codes based on the disclosure of human capital information. The resulting transparency could help to rebuild investor trust, which would result in long-term investments in their companies. The results should also remind regulators of the types of human capital indicators that should be mandatory to report on. Alternatively, like the Corporate Governance Recommendations, these indicators could become part of the recommendations based on “comply or explain” principles. The results should also encourage security analysts to use more human capital data- collection and analysis techniques in writing their reports. The framework and indicators establish an appropriate format for the types of data that should be collected. These can be used in designing questions to be forwarded to management at analyst briefings and annual

313 general meetings. While the suggested data sources can be used and the variety of sources can be enhanced, expecting financial analysts to use these qualitative techniques immediately would not be reasonable. As the literature review illustrated, based on analysts’ education, skills and experience, it is unlikely they will use this framework, which requires a deep understanding of human resource management, sustainability, knowledge management, organisational change and human capital management. Royal in her article at the Economic and Labour Relations Review points to the difficulties of finding analysts around the world to be skilled up enough to provide human capital expertise (C. Royal, 2004). She suggests regulators like the Australian Securities and Investment Commission take up responsibility for upgrading the skills of security analysts in this regard. She adds that there is also a need to have human capital experts working in investment banking organisations, stockbroking and funds management organisations to assist on research teams with this kind of specific expertise and/or use external independent human capital service providers. These concerns indicate that the training issues should be considered not only by regulators but also by business schools and academics. The issues addressed in this study will be of interest not only to Human Resource Management but also Schools of Management, Accounting, Finance and Environmental Studies. Further, increased transparency would be interest to society, various regulators (Stock Exchange, Policy Makers, Accounting Standards), employees and company managers, besides the other actors of the capital markets. Lastly, Social Investment Funds would certainly benefit from the increased transparency and the suggested framework.

10.3. Limitations of the Study

Using documentary data-collection methodologies has certain limitations that have influenced the results of this study. In this research, it was the assumption that choosing large, dual-listed companies there would mean there was more valuable qualitative data in the public domain. However, this was not entirely true. The analysis indicated that while some companies reported more on some indicators, others did not report on them at all. This resulted in data overload for one particular case company, BHP, which required extensive

314 time for data sorting and coding 254. On the other hand, the data search for the other two case companies was time-consuming but returned less data. As this study used a paradigm which to a large extent replicates the regulatory environment in which analysts operate, in other words, a very regulated environment where company access is quite limited, the study was restricted to publicly available data. Therefore, this required the researcher to improve the number of data sources and data-search techniques to obtain a more complete data base. This research utilised voluntary disclosures of companies, media reports, and analysis of academics and others to reach its conclusions. As much as this thesis has attempted to improve the measurement validity of the data-collection process through the triangulation of data sources, the power of the analysis is limited to the truthfulness of the subject reports. This research used three case companies to study human capital reporting practices and it was the assumption that this would improve the external validity problems of the research. Conversely, the reporting laws and regulations, ownership structures and other factors change the reporting practices of companies, restricting opportunities to generalise the conclusions of this study to other countries or smaller companies. However, in countries where there are high regulations on corporate disclosures this framework would become more useful. Having stated the findings, implications and the suggested use of this study, I need to conclude with saying that adopting a human-capital perspective does not render all other lenses of analysis as unimportant or invalid, but attempts to open new lines of research and add new meaning to already existing ones.

254 Yin (1984) argues that in multiple case analysis each case should be selected so that it “either a)predicts similar results or b) produces contrary results but for presictable reasons (Yin, 1984)p 48-49). The same author also argues that in multiple case study the researcher should be concerned about “unwanted variations in data collection procedures from case to case” (Yin, 2003)p 54). The ideal case size is recommended as 4-6 cases (Yin, 2003). However the number of case replications is dependent upon the “certainity wanted to be achieved”and the “richness of underlying theoretical prepositions”. The author warns that if the empirical case do not work as predicted modifications must be made to theory (Yin, 1994).

315 APPENDICES

APPENDIX A: Disclosure Index

BHP Billiton Ltd. Research Question 1a

The ASX Listing Rules and AASB Accounting Standards

Name Definition 2000 2001 2002 2003 2004 ASX 1. 1.A Constitution

ASX 1.2.3.a Audit-3 yrs

ASX 1.1.13 Audit -com

ASX 4.3 Audit

ASX 4.3.A App 4E

ASX 4.6 Annual rep

Concise

ASX 4.10 Additional info

ASX 4.10.3 Corp Gov

ASX 4.10.4 Shareholders

ASX 4.10.11 Stock exch.

ASX 4.10.15 Mining tenem.

ASX 4.10.17 Review of

operations

ASX 5.1.1 Mining ASX 5.2 Mining ASX 5.10 Mining ASX 10.17 Payments to directors

ASX 12.17 Audit commit.

AASB Accounting 1001.8.1 policies

316 AASB1002 Events after rep.

AASB Related party

1017 disclosure

Name Definition 2000 2001 2002 2003 2004 AASB Employee benefits

1028

AASB Number of

1034.5.1.d employees

AASB Auditor

1034.5.3 remuneration

AASB Executive

1034.6.1 remuneration

AASB Executive

1046 disclosure

AASB Amendments 1046A

AASB Impacts of

1047 adopting IFAS

Legend:

The regulation for that year does not exist.

There is regulation and the company complies.

The regulation does not exist, but the company complies.

The regulation exists, but company does not comply.

317 APPENDIX B: Checklist Matrix 1

National Australia Bank : 2001 Annual report Research Question 1 a and 1 b: Sustainable People Human Capital Analysis Indicators

Indicator Definition Examples

1. Job Competencies The Group Executive Forum focuses on Characteristics Mngmnt Control leadership development, both as individuals and Co-Worker as a collective. Relations A. Power/Dec. There is an ongoing programme called "leader Making as coach" . B. Leadership 2. Recruitment Selection Criteria No information. Selection Process 3. Training Main Source Talent Review Program: assessed leadership Nature and overall capabilities of managers (top 500) will be extended to the rest of the employees

Service Recovery Training Program: All employees that work with the customers 4. Internal/External Tools and programmes are being developed to Career/Opportunities Employment assist career navigation. Security

5. Reward System Board Members: There is no direct link between director remuneration and the short-term results of the Company. The long-term performance of the Company, relative to other large corporations, is considered among other factors in setting the fee pool, which is periodically proposed to shareholders at the AGM Executives: The Talent Review that started in Review year 2000, has encompassed the most senior 1650 managers in the Company until 2001. It includes a "360-degree" assessment, and is one of the processes that is used to determine remuneration and reward for individual and team performance. The employee share plan has been shifted to a performance-based plan and rewards are linked to EVA. Base or fixed remuneration: This element reflects the scope of the job and the level of skill Fixed/Variable and experience of the individual Salary Short-term incentive: This is paid depending on the annual performance of the Group, the Incentives individual business unit and the individual executive. The weighting of this component varies

318 depending on the nature of the specific executive role. This aspect of the reward program looks back at actual achievements over the past year.

Long-term incentive: This is paid through the is of executive share options and links the reward of executive directly to the growth in the Company's share price. This aspect of the reward program focuses the executive on the future performance of Group over the next three to eight years. Before executive share options can be exercised, a performance hurdle must be met. This hurdle compares the total shareholder return (TSR)

During 2001 share options were granted to 2,525 senior employees.

6. Professional Culture/Teamwork Throughout the organisation teamwork is Identity strongly encouraged, and the Company is seeking to model the characteristics of a high performing team. The change is absorbed in the following statement of a non-executive director:

Mrs Catherine Walter: "The National's move from a traditionally hierarchical culture to a more collaborative one means individual needs of different stakeholders will be heard throughout the organisation."

Diversity: The awareness that the National has insufficient diversity, particularly at senior management levels, directed the management to develop this. A Diversity Guiding Coalition was formed, which is chaired by the CEO and a cross-section of staff. The Coalition will monitor and report on the National's achievement of diversity along a range of demographic variables. They’ve developed strategies for a number of initiatives, such as mentoring programmes to foster greater diversity in employee groups and support employment opportunities for disabled and indigenous people.

319 APPENDIX C: Checklist Matrix 2

Telstra: Database and Library Resources: Newspapers, Magazines Research Question 1 a and 1 b: Sustainable Human Capital Analysis Indicators

Indicator Definition Examples 1. Job Competencies A survey of company senior executives that was Characteristics C. Mngmnt commissioned by PricewaterhouseCoopers (PwC), BRW Control and conducted by the research firm Millward Brown, found Leadership that Telstra has found to be the “most effective use of technology and third in “coping with the future” (Kavanagh, 2001)

Telstra has made changes to its management structure, reorganizing the business into customer-focused segments and putting more emphasis on broadband and online services. Dr Switkowski told analysts Telstra was at a "chapter turn in the history of the industry". Telstra Retail will now be known as Telstra Consumer and Marketing, Telstra Enterprises will focus on small businesses and other corporations, Telstra Country Wide's footprint will be expanded to include nine additional areas, Telstra Technology, which previously was called Telstra Networks and Technology. Dr Switkowski also made changes to what he described as the four points of Telstra's compass: retail, wholesale, international, and applications and content. (Nicholas, 2002)

There is evidence suggesting flexible work arrangements and work/life balance at the company: Ms Lynch, works at a risk management and assurance management role at Telstra in Melbourne. "I do a lot of the IT audit work for one of the Telstra business lines. I come into the office early, around 7.15, but at the same time, I'm out of the door at five-to-five," she says. "There are people here that make it a point to give 110 per cent to their work but also 110 per cent to their family. (Beer, 2004) 2. Recruitment Selection Criteria Both the CEO Mr Blount and the internal candidates Selection Process running for the job, became impatient, when the length of the search for a successor, took more than nine months in 1998.

Mr Blount has been successful in his six years at the top, he has transformed Telstra from a lugubrious government monopoly to a dynamic carrier in a viciously competitive market. The board was looking for a new chief "who is at least as good as, if not better than, Frank Blount". “An American might not understand the balance between the commercial needs of Telstra and the social policy needs of Canberra, particularly as the Government looks to sell a further 16 per cent of Telstra”(Mathieson, 1998) The appointment of Switkowski was well regarded by the

320 market, but there is still a shadow over Switkowski after his sacking at Optus. 16 February 1999 The Evening Standard

Telstra started to use an Enterprise Recruitment System that would utilize both the Internet and Telstra's Intranet to create a robust and active on line job market which managers and individuals (both internally & externally) can use to match vacancies to people with the required skill.

Chooses Personic for the Supply and Management of an Enterprise Recruitment System 16 August 2000 Lack of background checks during the Selection process: Chris Tyler, CEO of Telstra subsidiary Solution 6, was revealed in 2000, convicted of marijuana possession, involved with a North American company, Lessonware, that had collapsed and with a series of blunders as head of New Zealand Telecom's internet operations. Telstra did not know about Lessonware or the drug conviction. Queried why he had not told the boards of Solution 6 and Telstra about his past, Tyler commented that he was "never asked". Telstra had previously been embarrassed by the revelation in 1993 that Bruno Sorrentino, head of its IT arm and research laboratories had not attended London's Imperial College, let alone completed a claimed PhD in physics. (Tabakoff, 2000) Yet another example: Appointment of former OzEmail chief executive Justin Milne to head up the broadband arm. The issue of a competition notice by the Australian Competition and Consumer Commission against Telstra accusing the Big T of stifling competition in the broadband industry to protect its market share. In the article, Telstra's newest hot-shot recruit pulled no punches in his estimation of the Telco. (Spencer, 2002)

“Our policy in Telstra is to tie Aboriginal and Islander employment to their percentage in the population” (Nason, 2000)

Telstra, is taking EQ into consideration as part of its recruitment and training, recognizing that promoting the most skilled person in a team often results in creating a monster(Nader, 2003). The job cuts would include about 220 senior managers - more than 20 per cent of the top 1000 executive roles. Telstra is recognized as a good training ground and a developer of skilled staff. ("Telstra layoffs `help' industry.," 2000) While Telstra vehemently denies any mass sackings of management, there's certainly been some activity with rumors of casualties among the executive ranks. There is speculation some ``Level 3s'', executives from the third rung of Telstra's six-tier management system, have been given notice. (Kitney, 2002)

321 APPENDIX D :Checklist Matrix 3

Analyst Reports for NAB Research Question 2: Sustainable Human Capital Analysis Indicators

Indicator Definition Examples 1. Job Characteristics No information 2. Recruitment Selection It is reported that an internal recruit was sought Criteria for the position of the CEO after Switkowski’s sudden resignation. It is added that this is not Selection going to change the fundamentals (the earnings Process expectations) of the company.

3. Training Coordination between HR policies and the company goals would make the stated goals to be more achievable. Analysts seek to know about training and incentives given to sales staff for achieving fruitful partnerships with customers. 4. Career Opportunities Analysts view the ongoing staff redundancies as part of the larger commercialisation and privatisation program. “The staff redundancies that are part of the cost reduction programmes result in increased redundancy costs and decreased ST earnings. Ultimately Telstra will have a lower cost base and increased LT earnings.” They don’t review the secondary effects like what it does to their reputation, or how these redundancies are handled, which skills are lost…. And as we know some these jobs have been later Career Opportunities outsourced to other organizations. Chairman of the board and the CEO have resigned unexpectedly but the researchers have not detailed these. 5. Reward System Salary No information Benefits 6. Professional Culture No information Identity/Culture/Networks Professional Identity Stakeholders 1.Corporate Governance Federal Government effectively electing all the board members and the resigning chairman mentioning a divided board. 2. Community No information 3. Employees No information

322 APPENDIX E: NVIVO Theme (Tree) and Sub-tree (Node) Listing

The code of the data was facilitated by the use of the qualitative research software NVIVO package(L. Richards, 2005; T. Richards & Richards, 1994, 1995; Silverman, 2000; Tesch, 1990). The documents that are collected from the public domain were reviewed, sorted and analyzed using NVIVO software package. When documents were reviewed, emerging themes and sub-themes were noted. The emerging notes, themes and sub-themes were readjusted many times until the final scheme was reached. The mapping function of the software have also helped in conceptualizing analysis.

Human Capital Indicators Job Characteristics Competencies: Knowledge/information, Technology, Research and Development, Creativity/ Innovation, Skills Management Control Co-Worker Relations, Communication Power/Decision Making Recruitment Selection Criteria Selection Process Training Main Source: Internal training, External training Nature: Investments, Partnerships Careers Internal/ External Employment Security: succession planning, mentoring Rewards Fixed/Variable Pay Incentives/Benefits Executive remuneration/ Directors Performance Appraisal/ Feedback

323 Professional/Identity/Culture: Culture/ Teamwork Leadership

Sustainability Indicators (Stakeholders) Corporate Governance: Accountability, Board (composition, culture, experience), Risk Management, Transparency, Committees Employees: OH&S, Industrial relations, Work/life Balance, Diversity, Flexibility Customers: Partnership, Competition, Standards Suppliers: Standard setting Environment: Regulation, Legal Fines, Codes Community: Dialogue, Consultation

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