Press Releases

Watson Wyatt's Human Capital Index identifies practices that
drive a 47 percent increase in shareholder returns

WASHINGTON, D.C., October 29, 2001 — Results of a new study by Watson Wyatt prove for the first time that there is a cause and effect relationship between human capital management and financial performance.

Watson Wyatt's 2002 Human Capital Index^® (HCI) study shows that superior human resources practices are not only correlated with improved financial returns, they are, in fact, a leading indicator of increased shareholder value. The year-long study, a follow-up to the firm’s landmark HCI study in 1999, reports that companies with the best HR practices provided a 64 percent total return to shareholders (TRS) over a five-year period, more than three times the 21 percent TRS for companies with the weakest HR practices.

"Our 1999 study confirmed a positive correlation between the quality of a company’s HR practices and its economic results. But it left unanswered the question whether effective HR practices drive positive financial results — or whether successful companies simply have more resources to invest in HR programs," says Bruce Pfau, head of organization effectiveness consulting at Watson Wyatt and author of the study. "Evidence from this new research clearly favors superior human capital management as a leading — rather than lagging — indicator of improved financial outcomes."

The HCI study is based on a comprehensive survey of human resources practices at 750 North American and European companies with a track record of at least three years of total returns to shareholders (TRS), 1,000 or more employees and a minimum of $100 million in revenues or market value. The survey data is matched to objective financial measures of a company’s worth, including its market value, three- and five-year TRS, and its Tobin’s Q, which measures a company’s ability to create economic value beyond its physical assets. Based on this analysis, each company is given a Human Capital Index score on a scale of 0 (low) to 100 (high).

Leading or Lagging Indicator?

To determine which way the relationship between HR practices and financial performance truly runs, Watson Wyatt compared two different correlations using HCI scores and financial data for 51 companies that participated in both the 1999 and 2001 HCI studies.

• The study first looked at the correlation between 1999 HCI scores and 2001 financial performance. This correlation suggests the degree to which human capital management is a "leading" indicator of future financial success.
• The study also looked at the opposite effect — that is, the correlation between 1999 financial outcomes and 2001 HCI scores. This correlation looks at the degree to which good human capital practices are simply a function of financial success — in other words, a "lagging" indicator.

The analysis shows that the first, or "leading," correlation is very significant (.41) from a statistical perspective. Moreover, the "leading" correlation is twice as great as the "lagging" correlation (.19).

"The difference between the two correlations is comparable to the difference between a batting average of .410 and an average of .190," says Pfau. "The bottom line is that effective human capital practices drive business outcomes more than business outcomes lead to good HR practices."

The HCI study also shows precisely which HR practices find their way to the bottom line, identifying 43 specific HR practices that play the greatest role in creating shareholder value. According to the study, a significant improvement in all practices is associated with a 47 percent increase in market value. The 43 practices are divided into five key areas, and the research quantifies exactly how much an improvement in each area is expected to increase a company’s market value.

HCI Dimension		Expected Change in Market Value Associated with a Significant Improvement in HCI Dimension
Total Rewards and Accountability		16.5%
Collegial, Flexible Workplace		9.0%
Recruiting and Retention Excellence		7.9%
Communications Integrity		7.1%
Focused HR Service Technologies		6.5%
		Total = 47.0%

Counterintuitive Findings

In addition to identifying the most financially rewarding human capital practices, the research throws a cautionary flag in front of some HR practices that are applauded by conventional wisdom. Three practices in particular — 360-degree review, developmental training and implementing HR technologies with "softer" goals in mind, such as culture change — were associated with a decrease in financial performance. The study notes that while nothing is inherently wrong with these practices, many organizations implement them in misguided ways.

"These types of complex, process-driven programs can actually destroy value if they aren’t aligned with strategy and executed properly," says Pfau. "For example, implementing multi-source feedback in a company that does not operate in an open environment will likely yield negative results, especially if the employer doesn’t follow up by acting on employee opinions.

"On the technology front, many companies have failed to master the basic operations that create operating efficiencies and help control costs before they try to use technology for fuzzier goals," says Pfau. "But companies have to start with the basics and build up. A beginning golfer can’t expect to master all of the complexities of Tiger Woods’ golf swing the first time he picks up a club — he has to learn the simple mechanics first."

Other study highlights

• Making a stronger effort to link pay to performance — i.e., through stock programs, incentive/profit sharing plans, or higher pay for top performers — is associated with a 6.3 percent increase in market value overall.
  
• Capitalizing on basic communication technology holds tremendous potential for financial payoff — companies that give employees easy access to these technologies see a 4.2 percent gain in market value.
  
• Companies that support flexible work arrangements such as flextime, telecommuting and job sharing have 3.5 percent higher market value.

 

"This research helps us quantify what we’ve believed for a long time," notes Pfau. "If you hire the right people, create an environment that supports creative thinking and increased productivity and leverages technology, you and your shareholders will reap the rewards."

Copies of the report, Human Capital Index: Human Capital As a Lead Indicator of Shareholder Value, will be available for purchase in mid-November. To read a summary of the report click here. Organizations that want to determine their own Human Capital Index can complete a diagnostic questionnaire and receive customized results.

Pfau and Ira Kay, Ph.D. of Watson Wyatt are co-authors of a forthcoming book, The Human Capital Edge, which shows readers what works when it comes to leveraging human capital to improve the bottom line — from recruiting to retention to compensation to leadership. The book, published by McGraw-Hill, will be available in January 2002.

Watson Wyatt is a global consulting firm specializing in human capital and financial management. The firm offers services in three areas: employee benefits, eHR^™ and human capital strategies. Watson Wyatt has more than 6,100 associates in 87 offices in 29 countries. For more information visit www.watsonwyatt.com.

For more information contact Tricia Alvarez at (202) 715-7094 or Ed Emerman at (609) 452-5967.