‘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