I. Geography and the SEC’s New Human Capital Management Disclosure Rule
“We looked at what our employees want, and where they would want to live.”
John Schoettler, Amazon executive. The company ran a widely publicized contest (“HQ2”) to select a second headquarters location.
In 2020, the Commission adopted amendments to Regulation S-K that require more extensive disclosures of the business that relate to ESG, including the strategic management of employees, i.e., HCM. Item 101, which informs the issuer’s description of its business in its annual report on Form 10-K, was amended to require that companies make public certain aspects of their employment arrangements below the executive and board level. In particular, the Rule provides that annual reports filed on or after November 9, 2020, must contain a discussion of the following quantitative and qualitative factors that concern HCM:
A description of the registrant’s human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the development, attraction and retention of personnel).
These disclosures are required to the extent they are material to an understanding of the issuer’s “business taken as a whole” or to a particular segment. SEC leadership has also suggested that the Commission may be interested in intensifying its focus on HCM, which may in turn require richer geographic disclosures.
While public companies may access national or international pools of resources like financial capital and executive and director labor, operations and other critical human capital inputs are typically less mobile, suggesting a closer relationship with place. A recent study by the insurer and consultancy Aon examining disclosures made under the new Rule found evidence that many companies deem the geographic distribution of the workforce to be material. The topic was discussed by 54 percent of sampled companies. Further, of the subset of companies that made quantitative information available under the Rule, 84 percent addressed geography. Disclosure topics on which data exist often gain salience, and in the right circumstances they can be expected to influence the behavior of the public.
ESG objectives may require a human capital strategy that is geographically sensitive. Three areas where ESG, HCM, and geography converge are diversity, housing prices, and political preferences. To recruit a diverse workforce, for instance, some prominent companies have changed their geographic footprint. Airbnb provides one example. The city where the hospitality platform is based, San Francisco, is 5.2 percent Black. Neighboring Silicon Valley, arguably the global headquarters of tech, is roughly 2 percent Black. Airbnb pledged to raise the level of underrepresented minorities in its workforce to 20 percent by 2025, but found “we couldn’t fulfill [that goal] just by having our company headquarters in San Francisco or London. We needed to consider places that looked very different to get the results we needed.” In 2021, it announced that it planned to open an Atlanta location in part “to make manifest our commitment around diversity,” and in 2022 it announced that employees could work remotely, on a permanent basis, from anywhere in the country in which they worked.
The specific movements of Airbnb are emblematic of a general point: a company’s locus of operations influences the identity of its people. Many management concerns connect to that basic fact. At many firms, for example, the cost of housing is a concern for employee recruitment and retention. Location can also merge with political preferences and enterprise risk assessments to catalyze a location decision, with implications for the firm’s workforce even if not driven by its demands. Gunmakers provide a vivid illustration. Smith & Wesson recently joined other gun manufacturers (as well as the National Rifle Association) in moving “from the mid-Atlantic and Northeast to Southern states with less restrictive gun laws.” In explaining the company’s decision to spend $125 million relocating from Massachusetts to Tennessee, the CEO cited the lower cost of living—and thanked the state’s Republican leaders “for their unwavering support of the Second Amendment and for creating a welcoming, business-friendly environment.” Other companies are reported to have considered (or reconsidered) relocations or expansions based on their perceptions of the local or state political climate.
The role of political preferences in corporate relocations is contested. For example, some have speculated that the 2021 Texas Heartbeat Act, which outlaws abortion after six weeks of pregnancy and authorizes enforcement through private civil lawsuits, might negatively influence workforce retention and recruitment and curb the appetite for corporate relocations to or expansions in Texas. Barely a month after the Act went into effect, Tesla became a counterexample when it announced it would relocate its headquarters from California to Texas. The state’s governor raced to portray the move as a vindication of its political choices. CEO Elon Musk was only partly cooperative; he cited the housing shortage in the Bay Area and the difficulty of expanding there (rather than politics per se) as reasons for the move, though he had in the past been critical of a variety of California policies.
But corporate operations location decisions are only one manifestation of the connection between HCM and geography. Location is by nature sticky and path-dependent; job sites are where three classically primary factors of production—human capital, physical capital, and real estate—converge, and may have converged for a firm’s entire history. Yet other corporate policy decisions around location are more adaptable.
While few corporations have announced relocations in response to changes in the availability of abortion, a growing number have declared support for workers affected by them. Amazon, Apple, Citigroup, Yelp, Lyft, Uber, Salesforce, and Levi’s are among the public companies that have pledged a variety of types of support for workers’ reproductive rights, ranging from travel benefits up to $4,000 designed to cover the cost of traveling out of state for abortion-related health care to assistance in relocating out of state in response to abortion bans. Some CEOs have also criticized new restrictions on abortion.
II. How Firms See Geographic Human Capital Management Strategy: Evidence from Fifty Software Firms’ 10-Ks
This Part analyzes geographic characteristics of firms’ human capital strategy during the first year of disclosures under the Rule. Specifically, it examines hand-collected 10-Ks filed in 2021 by fifty unique software firms—the largest twenty-five by book value, and twenty-five randomly selected—for evidence of the way that issuers see geography influencing HCM strategy. Importantly, these disclosures are made subject to the anti-fraud rules of securities law, which distinguishes them from other corporate communications. That discussion is preceded by a brief explanation of the significance of the new Rule and the reasoning behind choice of sample.
A. The Significance of the New Rule
The Rule’s novel contribution is in specifically requiring issuers to provide information on their human capital strategy. Historically, firms shared information on HCM via channels other than the 10-K. To some extent, this included SEC filings on other forms (notably the proxy), but voluntary ESG or corporate social responsibility reports (“voluntary reports”) predominated. These formats—especially voluntary reports, which are not filed with the SEC—afford more flexibility than the required disclosure format of the 10-K. Flexibility has its advantages. However, because these reports are either entirely elective or only indirectly required as part of a disclosure in another area, the information provided therein lacks important assurances of reliability. Because voluntary reports are not policed by the strict anti-fraud rules of securities law, their legal status is more akin to advertising and public relations—puffery—than to a 10-K. In addition, the Rule’s specific and mandatory nature reduces the selection bias inherent in a largely voluntary and standardless disclosure regime.
B. Choice (and Limitations) of Sample
The fifty firms in the sample are all coded 451030 (Software) under the Global Industry Classification Standard (GICS). Software was chosen as the industry of analysis because of the high level of discretion a typical firm in that sector enjoys with respect to the location of its human capital. This discretion flows from several sources, all relating to the industry’s economic characteristics. First, the software industry operates under different geographic labor market constraints than industries where fundamentals require employees to be based at specific locations. This relatively unconstrained dimension of software-company HCM flows from essential qualities of the product:
The [software] industry’s output is intangible intellectual property that sells in the national and global markets. Thus, locational factors such as access to natural resources, local demand, proximate input suppliers, and transportation costs are not particularly relevant. Capital inputs are not typically fixed (beyond the period of the current building lease) or tend to depreciate very rapidly (e.g., computer hardware and software), so past investment decisions in physical plant do not constrain firm location over the medium term.
In addition, software companies “have neither a capital nor a land intensive production. They are highly footloose thanks to portable computers and wireless internet,” in contrast to “class/first nature type location factors” that have traditionally been critical to other industries.
A secondary motivation for the choice of sample was the shift to telework during the COVID-19 pandemic. The same factors that gave rise to a higher degree of theoretical geographic flexibility among technology firms prior to the pandemic might reasonably be expected to manifest in more diffused work and remote work during it. Supporting this intuition is a prominent economics study indicating that technology occupations are the most capable of being performed from home, as well as subsequent modeling bearing this out. These factors might be expected to yield additional disclosure on software firms’ approaches to telework under the Rule.
These methods have a number of limitations. To begin, and notwithstanding the above observations, the tendency of software firms to prioritize location and specifically to agglomerate in close proximity to one another has proven persistent, at least prior to the pandemic. No claim is made that such firms do not consider locational factors in their HCM strategy, only that they face lower costs than firms in most other industries in trading off location against other inputs. But this assumption could be wrong, for example if it understates the spillover benefits of agglomeration, which would imply a higher opportunity cost of relocating. Further, no claim is made that the fifty sample firms are representative, either of software firms specifically or of issuers newly subject to the Rule in general. Finally, since the sampled disclosures were issued under the first year of the Rule, it is possible that their future content will evolve so much—organically, in response to revisions to the Rule, or both—that observations based on sampled disclosures may become obsolete. These limitations are the price of working with a new trove of partial data.
C. Evidence of Human Capital Strategy from Sampled 10-Ks
In the sampled disclosures, three patterns emerged in the way that firms present locational characteristics of their human capital strategy. These are: the geographic distribution of firms’ employees; firms’ perspectives on the nexus between the location of employees, their compensation, and their diversity; and firms’ approaches to remote work.
1. Geographic Distribution of Employees
Disclosure on the geographic distribution of employees is perhaps the most common type of geographic human capital disclosure (present in twenty-four of fifty sampled 10-Ks). Most filings making disclosures of this type identify the number or share of employees who work in the United States or North America as compared with outside that area; others state the number of countries where employees are based. Some of this disclosure is likely held over from a prior reporting obligation now encompassed (and expanded upon) by the Rule. Though perhaps only dubiously material, disclosure of these highly general data points may continue out of inertia, i.e., because they are low-cost boilerplate for management and counsel to produce. It may also reflect uncertainty regarding how best to comply with a new rule.
2. Relationships Among Employee Location, Compensation, and Diversity
Several firms imply or state that they see location as a factor in employee compensation—in other words, they see their labor market as local. Other firms, however, state that they have shifted to a remote or hybrid workforce model. Many in this second set, addressed separately at infra Part II.C.iii, have not explained how they will treat compensation of remote workers, raising questions about whether and how they will take location into account in determining compensation. The assumptions undergirding these disclosures are worth exploring for the different philosophies they embody, and for their relevance to investors. They also plug into larger debates now ongoing among tech and other firms that are allowing greater remote work, i.e., between those “localizing” pay levels and those paying a uniform rate regardless of location.
Let us first examine the disclosures of firms stating that location is a factor in compensation. Among the top twenty-five firms by book value, VM Ware states it is committed to “equitable compensation,” and among the criteria it uses in explaining this concept is geographic location. Notably, this discussion comes under a diversity, equity, and inclusion (DEI) subheading within human capital management, suggesting that the company sees same-location compensation parity as being a facet of DEI. Adobe’s disclosure language is similar but more specific. In explaining that the company (also among the top twenty-five by book value) is committed to fair compensation, its disclosure “defines pay parity as ensuring that employees in the same job and location are paid fairly regardless of their gender or ethnicity.” Language used by Workday (likewise among the top twenty-five) notes the role of location in compensation as well (the company follows “a market-based pay structure that compares our roles to those of our peers in each region.”). Adobe’s discussion, like VM Ware’s, is situated under a DEI subheading of HCM; Workday’s is not, suggesting it sees regional pay parity as a general HCM rather than DEI-specific issue. The disclosure of Splunk, another company among the top twenty-five by book value, follows the same approach as Workday.
The randomly sampled firms generally have less discussion of the compensation-location point. The disclosure of one of them, Citrix, is directionally similar to if more vague than the above firms (its compensation “reflect[s] local market practices”). This statement appears under a “Compensation and Benefits” subheading rather than the DEI subheading (“Diversity, Inclusion and Belonging”) of Citrix’s HCM heading (“Our People”).
A theme that companies talk about elsewhere that may be worth watching for in the HCM section of the 10-K as practices in that area develop is signs of a nexus between firms’ geographic strategies and diversity goals. Language used by Salesforce (one of the twenty-five largest firms) under its DEI subheading (under the HCM heading) is suggestive: “We aim to create a workplace that reflects the diverse communities we serve and empowers our employees.” This language is highly general; “communities” in this sense does not necessarily imply a spatial component. The disclosure language of Digital Turbine, a randomly selected software firm, is clearly locational, however: “We seek a diverse and inclusive work environment and transparently measure our progress to ensure that our employee populations are reflective of the communities in which we reside.” While not a lengthy or frequent component of sampled 10-Ks, this nexus has been noted by companies in the press and elsewhere outside of disclosures and may develop further.
3. Remote Work
A third geographic theme present in the sampled disclosures is the prevalence of remote work, from which inferences can be drawn regarding workforce diffusion. Many firms indicated plans to expand telework and hybrid offerings as part of their HCM strategy, suggesting the potential for a long-term shift in the way firms operate. Microsoft and Oracle, the number one and two firms by book value, respectively, announced in subheadings (“New Ways of Working” at Microsoft, “Flexible Work Options” at Oracle) that they had metabolized lessons from the pandemic and plan to enhance hybrid or remote work options for the long term. Palo Alto Networks, another of the top twenty-five, elaborated, signaling a desire to expand hybrid work through an initiative called FLEXWORK: “our philosophy is simple: place our employees at the center of their working life by providing employees flexibility, personalization, and choice regarding how they work, the benefits they choose, the way they consume learning and, where possible, where they work.” The firm also connected telework and DEI, stating; “FLEXWORK adds even more opportunity to scale our efforts to improve Inclusion and Diversity.”
In emphasizing telework, Citrix (a randomly selected firm) explains that, “[O]ur belief [is] that work is a measure of output and accomplishment—not a place—and flexible work means people are most productive when they match their work environment to the outcomes they are trying to deliver. . . . Starting in 2021, time in the office will no longer be prescribed” but will instead be determined at the team and individual level. Notably, Citrix is not merely a software firm but a company that produces (among other things) telework software, so its description of remote work potential should be read with that in mind.
Finally, a small number of firms mention that location is a way for them to achieve greater diversity. This is more interesting read in context with developments outside this Rule. In recent years, several companies have reportedly moved to or opened up offices in locations that allow them to recruit a more diverse workforce. These disclosures may provide some additional evidence for that proposition.
A widespread permanent dispersal of employees would have significant governance implications, especially in software, whose workforce is geographically concentrated to a higher degree than many industries. Evidence suggests that the geographic location of directors influences directors’ cost of information acquisition (distant directors face higher information costs) and may influence board behavior. Analogously, a permanent expansion of remote work can be expected to influence not only director oversight of managers but manager oversight of line employees, as to whom traditional forms of informal, low-cost supervision would be less feasible.
To facilitate better disclosure and use of information, this article proposes three changes to current practice: (1) the Commission should require more disclosure of geographic dimensions of HCM strategy on the 10-K; (2) proxy advisors and other participants in the market for corporate influence should incorporate geographic HCM into their formal guidance; and (3) large asset managers should be subject to the same requirements of the Rule regardless of whether they are publicly traded.
The Commission has already signaled an interest in expanding disclosure required under the Rule; the first proposal makes a bid for the SEC to require issuers to include more information specifically on their spatial human capital strategy in the 10-K. Right now, these disclosures appear in three places—the 10-K, thanks to the Rule; the proxy; and voluntary reports, for example on corporate social responsibility.
From a policy perspective, there are a number of reasons to prefer disclosure on an SEC filing, ideally the 10-K. One concerns the choice among securities filings: “The annual report on Form 10-K provides a comprehensive overview of the company’s business and financial condition.” HCM disclosure goes to management strategy; it is a natural fit for Item 1, the Business description, of the 10-K. It may indirectly influence director elections and other matters decided at annual meetings, but there is no compelling policy reason to prefer disclosure on the proxy over the 10-K.
Other reasons go to SEC disclosure generally rather than the 10-K vehicle specifically. Embedded in the notion of a choice among filings is, of course, a choice to require a filing with the SEC at all. Voluntary reports lack any kind of standardization and are not subject to securities fraud rules. The disclosures issuers make in such reports may be helpful to them as they craft more robust human capital descriptions on the 10-K, but it is important that there be at least one source of such information that enjoys a high degree of credibility, backed by law. Finally, geographic aspects of HCM should be presumed material, i.e., the default should be shifted such that firms wishing to avoid disclosure on this point should be required to explain the absence of materiality. For reasons of shareholder wealth maximization as well as broader ESG objectives, the investing public would benefit from broader disclosure on how issuers approach their location strategy—especially given the experience of radically expanded telework catalyzed by the pandemic. Given that this proposal calls for merely a presumption, however, if an issuer believes spatial human capital inputs into its business strategy are immaterial to the business or its segments (the test under the current Rule), it can reduce the costs of this presumptively elevated disclosure obligation by explaining why.
Second, proxy advisors and institutional investors should incorporate geographic sensitivity into their engagement, including their voting guidelines. This could be accomplished in a number of ways. For example, issuers whose operations are chiefly based in areas with highly diverse populations could be encouraged to further diversify their workforce. Other issuers may operate in comparatively homogeneous areas and have homogeneous workforces, but may have a diverse customer or shareholder base; this type of gap might suggest a need for disclosure about how the company will address it. Proxy advisors and institutional investors, like passive mutual funds, are in a good position to inquire about these issues. Disclosure (and even academic and market discussion) of these topics is not as mature as on other HCM issues; one reason to opt for a nudge from market participants rather than a mandate from the SEC is to begin developing knowledge, practices, and expectations.
Finally, the Commission’s human capital disclosure Rule should be extended to all large asset managers. Such investors should be required to disclose characteristics of their human capital strategy that are material to the strategy of their funds. These would include but not be limited to those relating to geography. Currently, only public companies are subject to this requirement—and thus it applies to large asset managers only if they are publicly traded.
The outsized and growing role of institutional asset managers in the market for corporate influence, combined with the explosion in ESG assets under management, counsels against locating the trigger for this Rule in the exchange-traded status of an asset manager’s stock. For example, BlackRock, the world’s largest asset manager, notched over 1,000 investor engagements around HCM in 2020 alone, up 139 percent from 2019. BlackRock’s engagements are subject to the Rule because BlackRock happens to be publicly traded, but engagements by its competitor Fidelity, which is privately held despite managing trillions in assets, are not. This public–private distinction is senseless when it comes to HCM disclosure by mutual funds. A minimum reporting threshold would need to be chosen for large funds, but this line-drawing exercise would be fairly straightforward in today’s market structure. Given that a small number of very large asset managers dominate, an inflation-adjusted trigger of, say, $300 billion in assets under management would capture them without unintentionally entangling other types of asset managers, such as university endowments or hedge funds, should such a distinction be deemed desirable. Given the connection of human capital to ESG, reform would also help improve the credibility of disclosure of the latter, where regulators and investors have identified a need for improvement. It might be objected that this expansion duplicates the Rule since the underlying issuers of stock are already subject to its requirements. But the engagement (and business) strategy of funds around HCM matters is not necessarily the same as the HCM business strategy of the issuers of stock they hold.
Despite its fixation on agency problems, the literature has largely overlooked the basic role of place—distance, local characteristics, and so on—as a driver in firm governance. Management strategies that seek to maximize agent output are self-evidently relevant to investment decisions, and are now to some extent required under the Rule. As revealed by the hand-collected disclosures made by GICS-coded Software firms reviewed in this article, the new Rule has increased our understanding of the locational dimensions of public companies and their role in human capital strategy. Moreover, the formal recognition of a nexus between spatial inputs—like the sites where employees work (including telework), whether employee compensation is “localized” or paid on a uniform schedule, and the interaction between operational geography and diversity—represents a step forward for corporate governance disclosure. Reform at the level of three different market institutions would help. First, the Commission should deem geographic aspects of human capital strategy to be presumed material (and thus requiring of disclosure, subject to the presumption being rebutted). Second, proxy advisors and institutional investors should build locational attributes into their engagement policy, including by pushing companies that are located in areas of high diversity but that have lagged on that metric to diversify further. And finally, the Rule should be extended to all large asset managers, not only those that are publicly traded. These interventions would raise the quantity and, optimistically, the quality of human capital disclosure at low cost and have the potential to generate a virtuous cycle that results in better and better information for the public.