CAPABILITY 1
Human Capital & the Finance Industry

The case for assessment of management quality:

1 Competitive edge

• management quality insights complement financial data
• Robert Wood (2004) states that 'being good at trading is not just a matter of being smart.
• You also need some level of cognitive ability to be able to process the information required to make trading decisions
• What information gives traders/sales/analysts a competitive edge?

2 Trend to commoditisation

• Much of the contemporary information and sources that traders and equity sales people use is trending towards commoditisation, with traders/analysts/media across the finance sector working with similar data, presented at similar times, using similar analytical tools and resulting in similar trading decisions.
• Under a regime of continuous disclosure there is a trend to commoditisation of financial data.
• Human capital analysis creates the potential for differentiation of analysis products in the market.

Increased pressure from clients and traders/sales professionals to understand more complex company issues such as:

• management quality,
• leadership,
• remuneration,
• corporate governance,
• succession, and
• organizational culture,

all of which are likely to have an impact on share price and trading decisions.

Research by Bassi et al (2001) suggests that in response to this, fund managers are making a large proportion of their investment decisions based on non-financial data.

• This provides an opportunity for traders/sales and analysts to use alternative sources of information to differentiate themselves, their services and their products to gain additional competitive advantage and to meet the pressure for high performance at an individual level in broking houses.
• Trend to double degrees in universities which incorporate behavioural finance is likely to create
  a new breed of traders/sales/analysts/fund managers, who can work quantitatively and qualitatively.  

3 Human capital as a lead indicator

• Management quality, leadership, remuneration and corporate governance can all be
  classified under the general term of human capital.
• Key themes from research on human capital as a lead indicator of future financial
  performance are:
  • Human capital can be analysed in a systematic way.
  • Watson Wyatt and Collins and Porras and Hewitt research on human capital demonstrate
    it is a lead indicator of future financial performance.

4 Operationalising human capital insights

• How are these insights able to be made operational on the primary and secondary markets
  of a contemporary Investment Bank so that investment banking professionals can benefit?
  Can it help investment bankers gain additional insights into clients/and or firms?
• Options available include:
• Rating systems for investment bankers on Management Quality of ASX20/50
• Alert systems for traders/sales, incorporating electronic data sources, using CCH as generic example, which examine short term changes in human capital e.g. corporate governance, training issues, organizational change projects, OH&S data.
• Seminars/lunchtime briefings for traders/sales/securities analysts/primary markets investment banking professionals and their clients, on these insights and recommendations on
  management quality of ASX top 20/50.
• Customised reports as per Lend Lease case (See UNSW Faculty of Commerce,
  IROB Working Paper 146).
• Seminars for investment bankers and their clients, for professional development within the industry.
• SWOT human capital analysis product, showing the relative strengths and weaknesses of
  human capital of a firm.
• On a larger scale is there potential for a qualitative data mining system, using existing electronic resources, covering selected stocks?
• A qualitative data mining service covering selected stocks may cover not the whole ASX 300 but more likely the ASX top 50 as these comprise the majority of holdings of major fund managers.

5 Investor confidence

There are costs incurred if available data is not being systematically embedded in current trading techniques. For instance, this would help manage the cynicism in the shareholder community that major flaws in management systems in NAB, HIH and, in the US, Enron, were not picked up in time by traders/sales professionals and their clients to be able to make informed trading/ investment decisions. Authentic insights into lead indicators of future financial performance of firms may help restore shareholder confidence.

Parallels with military intelligence and its failure to predict the big issues (e.g. September 11).
Similar to Bernstein (2000) in Navigate the Noise . We drown in data, but we crave insight and essentially we desire an element of predictability even in complex systems.

Impost of Financial Services Reform to the finance community creates pressures on accountability
and transparency in the finance sector, just as there is on corporates. Human capital analysis, if the methodology is appropriate and is documented, can be an objective and complementary form of analysis. There has been an increasing trend to independent research houses in the US (e.g. Bassi)
to overcome perceptions of lack of independence.

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