June 25, 2018

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Interview: Baruch Lev On HR and Wall Street

Baruch Lev has researched putting a value on intangibles. We wondered what HR intangibles would be of interest to Wall Street.

David Creelman spoke to Dr. Lev.

DC- I'd like to talk about the things that HR does that are relevant to the market.

BL- Let me start by saying that people in the markets such as financial analysts and institutional investors are very hard-nosed. They are usually not impressed by stories about high employee morale and things like that. I believe that when people feel better they work better, but this is not something that is going to impress people in the markets.

When investors are asked what things are most important, good human resources doesn't come very high on the list. They like to hear about profits, see better accounting data, learn about new lines of business or hear about business plans.

I strongly believe that human resource practices and issues are very, very important. However, evidence of input/output linkages is wanted not stories. For example, if you can establish the link from an investment in human resources to low employee turnover then that interests people. If you can establish a link from an HR practice to higher employee productivity, that is even better. Even on the microeconomic level employee productivity is one of the most important gauges that people look at.

To make an impact with financial people you need to establish quantitative linkages from investments in human resources to outputs. One of the important HR investments is incentive payments. This is a large investment and the question is what do these incentives buy you? If you can show a linkage, for example increases in incentives drive increases in productivity, this will no doubt capture the attention of investors.

DC- Let's move back to this issue of the kinds of things that Wall Street would be interested in. We have talked about productivity measures, we have talked about the fact that they are not interested in just hearing some nice story, they are more interested in something concrete like incentives.

BL- The kind of things they are interested in are the things that factor into valuation models. They are going to appreciate HR information that they can factor into valuation models.

DC- I presume this is literally a mathematical model so that even if they very much liked an organization for a variety of intangible reasons, if those intangibles didn't fit into the model it probably wouldn't show up much in their actual recommendation.

BL- We have to be very careful in presenting statistical results to investors and managers. In many cases I see simple statistical correlations between an HR investment, say training, and an outcome like sales or profits. This is not good enough.

In many cases, the causation is the opposite. What happens is the companies that are successful and have high earnings invest more in both tangible and intangible investments. This is something that many investors know and they question the simple statements of correlation. That is why I emphasize the linkages.

What you want to show is that an improvement in some human resource factor really caused something of value to the corporation. For example, training is a significant expense in human resources. Investors want to know if this is a good investment. They want to see a linkage: An increase in training leading to some measurable outcome such as lower turnover or higher productivity.

This is true for any investment in human resources, better hiring practices and so on. I think the two issues of most interest to investors are the outcomes of incentives and training because that is where the biggest costs are.

DC- If I am a top HR person do you think it reasonable that I work with the CFO to come up with the evidence that Wall Street needs showing our human resource practices are good investments so that our company valuation reflects our true importance of these interventions?

BL- That is a great idea because it will work on two dimensions. It will work with Wall Street and it will also work to elevate your stature within your organization.

I was working with a very large company and was talking about these things, and one of the executives said, "If this works, we will elevate the HR people from the cellar to the fifth floor." You know that in many organizations the HR people are not held in the highest esteem. However, once they get into the overall measurement system they will do much better. I will say, at the outset, that there are many things that can't be measured but the fact is when you can come up with the good measures, it makes a big difference.

Let me give you an example from an entirely different area. I just finished a big consulting job measuring the rate of return on three different types of R&D and brands for a leading chemical company. This is a company that has been in existence for more than 100 years and spent hundreds of millions on R&D and brands but no one systematically looked at return on investment. I did a systematic analysis of what they got from a dollar investment in various types of R&D and brands. I was scheduled to present to the board for an hour and a half but we went on for four or five hours. The reason is I came up with very interesting numbers that one type of R&D has a rate of return which is three times larger than the others. This led immediately to interesting discussions of whether we should shift resources from this side to the other.

DC- I've recently spoken both to Gallup and Watson Wyatt about their research on how HR measures are causally related to company performance. If I get good numbers on the kinds of HR factors these companies say are predictive of future performance, could I take this story to Wall Street?

BL- I am not very familiar with Gallup's or Watson Wyatt's research. I have heard good things about this research. I was told about Gallup's work by a person in Scandinavia and that investment analysts pay attention to this information.

The one thing I re-emphasize for any of this research is that they must relate human resource measures to output taking into account the other things that the company is doing. This is the key, not just correlations but accounting for other things like investments in research. If after that careful research the human resource practices still show up as important then it is a very important result.

DC- We've spoken from the view of the HR manager. On the flip side, if you were managing a mutual fund what HR issues would you be looking at?

BL- I would look for evidence that specific investments in human resources can improve my prediction of earnings in the future. This brings us back to valuation models. The backbone of valuation models is the prediction of future earnings. If you can show for HR, what I have shown for R&D and brands, that certain practices predict future earnings or cash flow, then that is what I want to look at.

I haven't done this research for human resources yet because I don't have the data.

DC- I've spoken to academics like Jeffrey Pfeffer and Mark Huselid, and consultants like Gallup and Watson Wyatt, and they all say there is good evidence that good HR practices predict good company performance. Why doesn't Wall Street talk about HR practices?

BL- Wall Street is incredibly quick to adopt new methodologies. There is nothing too sophisticated or complicated for Wall Street. When good things come out like the Black Scholes options model, it was adopted within months despite the fact it was extremely complicated.

There are thousands of people who are looking for new methodologies. Maybe many people are using these things, I just don't know of anybody who is.

DC- Do you have a closing message for HR managers?

BL- I am sometimes attacked on the grounds that I am a "measures" person and there are things that cannot be measured. Of course that is true but as I said before the fact is that inside and outside corporations people value things that are measured quantitatively. The more you can factor what you do into the models people use, the better off you are.

I consulted 2 years ago to a major global company and the main thing they asked me to do was value the effectiveness of their training program. They had all their middle managers going through a very extensive training program and at the end of the day, they wanted to know if it was effective or not. They meant in terms of value measurement.

This is really my message. I don't think it is a very new message but I am always surprised that people don't think in terms of the linkages of an input to an output. I hear stories like "We invest a lot in training". I would like to see evidence that this investment generated higher productivity or enhanced sales. I don't want stories! I want to see a linkage. A dollar here has an effect there. This will make an impact both within organizations and outside.

-David Creelman