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To Understand HR Standards, Look to GAAP and FASB

Should human-capital standards look and feel more like generally accepted accounting principles, or FASB’s financial-reporting standards?

John Boudreau

John Boudreau

In finance and accounting, “practice standards” (like GAAP) serve a different purpose from “decision standards” like those for financial reporting, with very different requirements.

Independent auditors opine as to whether the companies’ financial statements “present fairly, in all material respects, an entity’s financial position, results of operations, and cash flows in conformity with generally accepted accounting principles,” according to the Public Company Accounting Oversight Board.

A FASB Statement of Accounting Concepts (No. 8, September 2010, page 1, section OB2) defines financial reporting standards a bit differently: “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.”

“Practice” standards (like GAAP) describe common and generally used practices that are “feasible at scale” across a wide variety of organizations. It would do little good to set a standard that could be applied only by organizations with the most sophisticated information systems. Indeed, a significant purpose of such practice standards is to encourage all organizations to use common processes and measures, so that they can be compared to each other. Practice standards do not, in themselves, claim to predict organizational performance or assist investor decisions.

“Decision” standards (like financial reporting) go much further. They aspire to describe measures that help predict future performance. For that reason such standards are recommended as guides for investors. These standards would ideally be based on evidence, theory or frameworks that connect them to future performance. They need not be flawless predictors of organizational performance, but they should offer decision value beyond their cost.

With HR standards these distinctions are less clear, and that explains some confusion and controversy.

Consider the published HR standards from the U.S. Society for Human Resource Management (SHRM) in conjunction with the American National Standards Institute (ANSI). These are all practice standards, such as how to calculate cost-per-hire and elements of a performance management system. These standards neither claim to predict organizational performance nor set a requirement that organizations must meet.

In contrast, SHRM last year withdrew a decision standard — called “human resource indices for investors” — from its proposal for new HR standards, amid significant controversy. It had aspired to something akin to the goal of financial-reporting standards: to “represent the effectiveness, quality, and value of human capital in investor instruments.” That goal ultimately set the bar too high. Opposing groups asserted that investors were not asking for such a standard, and that it might be misinterpreted or have very different effects on organizational performance, depending on the situation.

The controversial standard actually included elements (such as total spending on human capital” and “ability to retain talent”) similar to HR scorecard and employee turnover metrics that SHRM says are still being developed and that are being promoted as a practice standard rather than a decision standard for investors. HR metrics seem have more success when promoted as practice standards rather than decision standards.

That seems logical, because the indices-for-investors standard appears actually to have been more like practice standards. It described measures commonly reported by HR, but did not provide evidence that they predict future performance, nor that investors know how to use them, as I noted in an earlier column. The lack of such evidence may be a reason they were so vehemently opposed.

It is vital that the distinction between practice and decision standards be as clear in the world of human capital as it is in the world of finance and accounting.

Like GAAP standards, emerging HR standards should describe typical practices or measurements that are “feasible at scale” for most organizations. As more organizations adopt them, we will see more common approaches to measuring things like employee turnover and cost-per-hire, and the resulting data will be more easily compared and analyzed. As research uncovers links with organizational performance, we may in the future see a better case for a set of decision standards that can justifiably be connected to organizational performance. Practice standards are a prerequisite to decision standards in HR, just as they were in finance and accounting.

Finance leaders and HR leaders should collaborate in the standard-setting process in order to exploit a golden opportunity to create truly useful human capital standards. Human capital standard-setting can learn much from the frameworks of accounting and finance standards.

The greatest value may be in shared logic, not shared numbers. Even clarifying the definition of “standard” can make a big difference.

John Boudreau is professor and research director at the University of Southern California’s Marshall School of Business and Center for Effective Organizations, and author of Retooling HR: Using Proven Business Tools to Make Better Decisions About Talent. He can be reached at editor@talentmgt.com.

4 thoughts on “To Understand HR Standards, Look to GAAP and FASB

  1. I find it hard to understand the central thesis of this article because the distinction between GAAP (presumably the author is referring to US GAAP) and FASB financial-reporting standards is not at all clear. These two concepts are not alternatives; the latter is a subset of the former.

    There may be such things as “practice standards” that describe common and generally used practices that are “feasible at scale” across a wide variety of organizations but it is not at all clear that this description applies to US GAAP in a way that enables a contrast of any significance to be drawn with FASB standards.

  2. The point of a standard is to set a standard–not provide evidence that elements of the standard predict future performance. And while, “the lack of such evidence may be a reason they were so vehemently opposed” there are certainly other possible reasons why the proposed investor metrics standard was so vehemently opposed. For example, a resistance to change, and perhaps accountability and transparency, comes to mind.

    The argument that investors would (currently) not know how to use the information that the standard would provide seems to me to be a red herring. Without standard information, how would it be possible for even the most sophisticated investors to know how to use it? To be sure, if such standardized information were magically to appear, there would be many (perhaps most) who would continue to not know what to do with it. But change would occur when innovation (and money) is made by those who figure out how to use such information.

    The stakes are high. Firms’s human capital decisions have a critical impact on people’s lives and ultimately the society in which we live. Providing better information in this regard could help ameliorate the pervasive and pernicious short-termism that dominates decision making. If we wait until we have a sufficiently high standard of evidence to convince the academic community that we should proceed, I fear that progress will never be made.

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