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High job security undermines shareholder value

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An overly-comfortable working environment with low levels of employee turnover may actually drain a company's shareholder value, according to a study of over 200 European employers by Watson Wyatt Worldwide, the global actuarial, benefits and human resources consulting firm.

The study shows that a paternalistic working environment has a significant negative impact on shareholder value. "The traditional paternalistic employment practices of European employers are directly correlated with lower shareholder returns," says Doug Ross, a Watson Wyatt partner and co-author of the firm's European Human Capital Index™ study.

"Europe's comparatively high job security and low staff turnover can lead to complacency and an undermotivated workforce, which is hurting our ability to compete with North America," says Ross. "Companies producing higher market valuations are focusing their resources on retaining their most talented employees with performance-based rewards, rather than rewarding people for their tenure."

Watson Wyatt's European Human Capital Index shows a direct statistical correlation between European companies' shareholder value and the quality of their human resources (HR) practices. The study shows a significant improvement in key HR practices is associated with an increase of 26% in a company's market value.

The Human Capital Index (HCI), based on a study of over 200 companies across 16 European countries, follows on from the landmark Watson Wyatt study undertaken in North America in 1999. The study condenses a vast range of management information into a single score for each organisation, expressed on a scale of 1 to 100. An HCI score of 100 represents the best practice found in the study.

The study shows there is a strong relationship between human capital and shareholder value creation over both the short and long term. Companies with high HCI scores were shown to deliver more than eight times the shareholder value (34%) over the past year compared with those with low HCI scores (4%). This pattern holds true over a five-year period, where total return to shareholders was nearly twice as much for high HCI companies (183%) compared with companies with low a HCI (107%).

"The strongest growth in shareholder value is among companies that have moved away from paternalistic cultures," says Steven Dicker, a Watson Wyatt partner and co-author of the HCI study. "Treating employees like adults leads to grown-up financial results."

Aspects of HR management which clearly stood out in the study for high HCI scoring companies include:

  • Well integrated leadership practices
  • Recruiting excellence
  • Extensive use of "knowledge workers"
  • Provision of upper quartile incentive/stock schemes · Consistency in pan-European HR practices
  • Sharing information with employees

"At a time when virtually all companies say that people are their most important asset, this study begins the process of helping them quantify that importance," says Dicker. We found a clear relationship between the effectiveness of a company's human capital and shareholder value creation. Companies with a high index had high shareholder value; those with a low index had low shareholder value."

Other HR programmes identified in the study that are directly related to improved financial returns include the use of "knowledge workers", sharing financial and other business information with employees, and using company shares in employee pay packages. "Employee share ownership in the US has grown as rapidly as their economy," says Dicker. "Share ownership plans may be just the tool European employers need to compete in the war for talent".

Ross says: "Human capital is increasingly a company's main asset and frequently worth several times the physical assets reflected in traditional financial accounts. This makes HCI a key measure for investment analysts – the human capital is one of the major assets investors are buying and they need to know what return management are delivering with it."

"Human capital is a critical and growing part of the value of companies across the world", says Dicker. "The companies that leverage their human capital effectively are the ones which will succeed best in the future, whatever investment markets have in store. The Human Capital Index provides a benchmark for companies to measure themselves against. It makes it possible for companies to identify areas where management action could deliver enhanced shareholder value, prioritised on a return on investment basis."

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