Domain 2: Organizational Capability and Human Capital

Besides the quality of the individuals currently holding leadership positions, a firm’s leadership capital includes its investment in cultural development and HR practices designed to build future leaders. Studies have shown a relationship between a firm’s investment in human capital practices and its financial performance. A number of consulting firms have worked to create assessments focusing on basic HR practice areas (staffing, training, compensation, succession planning), generally emphasizing the strengths of their consulting firm. At times these assessments show the relationship between a single practice and financial performance, but more recently efforts have been made to create human capital indices showing how integrated HR investments affect business performance.

APPROACHES TO HUMAN CAPITAL ANALYSIS

It is useful to take a look at some of the human capital analyses currently available, as aspects of what they cover may be included in a leadership capital index. Examples of these studies are summarized in Table 2.2.

What investors want are insights into the organizations in which they invest that help them improve their chances of success. Of course, they could choose to ignore leadership altogether in their firm valuation assessments, or they could continue to assess leadership through a haphazard gut-feeling approach. Conversely, they could choose to use this leadership capital index. The idea and ideal of standards may emerge when investors want to have more replicable and consistent information. At this stage, investors would be happy to have unique information that gives them preferential insights into their choices without taking so long to assemble that the opportunity disappears in the process.

ORGANIZATION CAPABILITY AND HUMAN CAPITAL SUMMARY

As with the personal competencies of effective individual leaders, the domain of human capital is very broad, ranging from specific HR practices like executive compensation and training investments to broader issues like culture. This domain generates a fourth theme for consideration:

Pay more attention to capability than to management structure: An organization’s capability represents what the organization is good at doing and is known for. The capability concept synthesizes work on core competencies, organization systems, culture, archetypes, and resources. Investors can audit both the type of capability and the extent to which the capability is shared both inside and outside the organization.

For human capital to be accurately assessed in valuation discussions, the complex domain of processes, practices, metrics, tools, and ideas must be simplified. These micro views of leadership offer wonderful insights into components of effective leadership, but these micro views have not been combined into a macro-level look at how leadership shapes firm value. Based on human capital studies like the ones listed in this section, I have identified five additional organizational factors for a leadership capital index—one overall, and four devoted to aspects of the human capital practices that drive culture:

1. Cultural capability: To what extent has the leadership created a customer-focused culture that is shared throughout the organization? (See Chapter 8.)

2. Talent management: To what extent has the leadership invested in practices that manage the flow of talent into, through, and out of the organization? (See Chapter 9.)

3. Performance accountability: To what extent has the leadership created performance management practices (such as compensation) that reinforce the right behaviors? (See Chapter 10.)

4. Information processes: To what extent has the leadership managed information flow to gain information asymmetries? (See Chapter 11.)

5. Work processes: To what extent has the leadership created organization and work practices that deal with the increasing pace of change in today’s business setting? (See Chapter 12.)

Investors can assess human capital by determining if leaders wisely invest in these organization practices. These five elements, outlined in Figure 2.3, provide a graphic roadmap for Part 3 (Chapters 8 through 12).

Table 2.3 provides an overview of the leadership capital index assessment that flows from these two domains and ten elements. Using the high-level diagnostic questions in this table, investors (and others) can assess both individual and organization domains to produce an assessment of the quality of leadership. As suggested, the individual and organization domains serve a purpose similar to the principles that Standard & Poor’s uses to guide its assessments. This framework is comprehensive in that it synthesizes the range of leadership capital issues investors should attend to. It is also simple in that the two domains and ten elements both have face validity and are easily understood, and it is disciplined in that investors can examine and codify specific actions and metrics for each of the elements. In Part 2 (Chapters 3 through 7), I offer specific details and indicators for each of the individual factors, and in Part 3 (Chapters 8 through 12), I offer specific indicators for the five organization factors. However, the index in Table 2.3 enables investors to move from simplistic and intuitive opinions of leadership to more comprehensive and rigorous leadership audits.

As noted, these ten factors offer a much more robust and comprehensive way for investors to realize the market value of leadership. How would it work?

Consider the cases I described briefly early in this chapter. Leaders in the energy company could communicate to investors not only how the CEO performs on these ten elements but how potential successors are likely to perform. The company that invites investors into the organization would have visitors who were focused on the ten elements rather than asking haphazard questions and making scattered observations about leadership. The investment firm would not just look at one primary leader in an uncomfortable position; its representative could still take the CEO sailing but would also have a framework for rating a whole cohort of leaders against criteria of leadership readiness. Isolated, haphazard, and unstructured information can be turned into an index that helps investors have more confidence in intangibles and consequently future earnings.

Ultimately, this leadership capital index offers investors a more integrated approach to assessing leadership. For example, the Society for Human Resource Management (SHRM) and American National Standards Institute (ANSI) cost-per-hire metric may be used as a part of factor 7 (people) and become a useful component of an overall leadership capital index, even though in isolation it can’t provide a comprehensive assessment of leadership quality.

In addition to synthesizing this complex literature into the leadership capital index, my colleagues and I sought the insights of thought leaders in leadership and management analytics. They were asked to select the elements they felt would be the most useful information for investors. (See Table 2.4.)

It is interesting that eight of the ten received multiple votes, which implies the importance of all ten elements. It is also interesting how few votes were on the personal proficiency of the leaders, particularly since most of the investor interviews summarized in this chapter report that investors rely heavily on their personal judgment of the leaders. It is also interesting that the personal skills of strategy and talent and the organization capability of culture building are perceived as the most important factors of leadership capital.