An 18th Century Solution to Human Capital Reporting Standards

“Bayes’ Theorem” on probability offers a bridge between two schools of thought about whether proposed standards are a good idea.

Ever hear of Thomas Bayes? He was a “nonconformist” minister in the 1700s who developed a theory of probability that became a pillar of modern statistics. “Bayes’ Theorem” held, in part, that the value of information is greater when it is more likely to change a decision, when being wrong has large consequences, and when the decision maker is capable of acting on it and willing to do so. Failing any one of those conditions, information has little value.

These musings of an 18th century “nonconformist” also offer insights to the present-day debate over financial-reporting standards for human capital.

In Draft American National Standard of Investor Metrics for HR, the Society for Human Resource Management (SHRM) states that companies should report or “indicate their reasons for not doing so” in six areas: (1) spending on human capital, (2) ability to retain talent, (3) leadership depth, (4) leadership quality, (5) employee engagement, and (6) human-capital discussion and analysis. Yet members of the Human Resources Policy Assn. (HRPA) produced a letter and accompanying web page opposing the standards. The letter said the proposed standards add to an already-excessive reporting burden, few investors request such information or find it material to decisions, the standards cannot be compared across companies, and their costs outweigh their benefits.

Both the SHRM and HRPA include smart, well-meaning, and dedicated professionals. Can their conflict be resolved?

Back to Bayes’ Theorem. Suppose you own an ice cream stand, and you must decide each day whether to open it or not. If it rains you should be closed, and if it doesn’t you should open. You also might want to decide whether to pay for a location-specific weather forecast, and if so, how much you should pay for it. There is a way to calculate that value, but the decision about whether to open boils down to this: if you have no weather forecast, the best decision is to open, so you will open every day and take your lumps when it rains. A weather forecast is valuable only when it correctly forecasts rain, and if you always close the stand when it predicts rain. (By the way, if you think it’s far-fetched to pay for a weather forecast, consider your next big family reunion or wedding. There are fee-based services, such as weathermedic.com, that sell pinpoint location weather forecasts for such events.)

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