1.2.1Human capital and its relationship to value creation

Human capital has been defined at the individual level as the combination of four factors: heredity, training, experience, and attitude [3]. It is the sum of aspects inherent in workers: skills, knowledge, experiences, habits, motivation, and even the energy that workers demonstrate in carrying out their duties, creating a specific culture in each company [4]. Under these conditions, employees are able to learn, innovate, stimulate, and make changes, as well as think creatively, all of which factors are vital for the future success of a company.

The human resource management literature is based on the premise that human resources are vital to an organization’s strategy since, through their behavior, individuals have the potential to lay the foundation for strategy formulation and implementation [5]. In this way, they recognize that individuals’ knowledge, skills, and abilities are insufficient to create value for an organization, unless they are used through individual behavior [6, 7].

The human capital of companies is not precisely the workers, but rather the workers are the owners of their own human capital, and they exhibit said behavior in different areas of their private lives, including their interactions with their families, their communities, their hobbies, their sports, and in their work [1]. In this paper, we accept that a firm does not possess human capital; rather, individuals do. Companies need a higher level of knowledge, skills, and abilities; however, a superior alignment between individual and organizational goals is crucial [8].

Furthermore, many papers and reports relate the management of human resources to a greater generation of business value. The literature on strategic management of human resources has found sufficient evidence supporting the idea that a high commitment practices in human resource management lead to greater organizational performance (e.g., [9–14]). This set of practices, which is aimed at the management and development of human capital in organizations, serves to establish long-term relationships between companies and their employees, thereby promoting the sharing of the same strategic goals as well as the creation of a strong commitment between both parties and their respective objectives. All of this contributes to better performance of the organization [15].

A survey on human capital carried out by IBM Business Consulting Services at more than a thousand companies from 47 different countries demonstrates that a welldesigned and properly implemented human resource strategy can achieve a 35% increase in revenue per employee and a 12% decrease in absenteeism [16]. Conversely, those companies that reduced their workforce by more than 15% saw the price of their shares fall below the average level for their industry [17].

1.2.2Levels of human capital measurement: the value chain of human talent

Both the literature on human resources management and enterprise managers themselves have always recognized the need to establish human capital measurement systems in companies [1, 18].

Traditionally, researchers have measured the quality of human resources management systems using data related to various personnel policies implemented in a company gathered from a single informant [19]. Thus, the impact of human resource practices in business outcomes has been significantly different from what such works suggest and may be even greater than indicated in the literature.

One detected error is located in what is known as the percept–percept inflation, which occurs when the information of both dependent and independent variables originate from the same source [20]. This type of error poses the least threat thanks to the fact that most works obtained information from different sources [19].

Perhaps the more serious issues include those raised by Rush et al. [21], who established that respondents, either owing to faulty memory or because the requested data are unknown to them in their entirety, react by resorting to so-called implicit theories, which act as counsel when gaps in information are filled in a search for consistency among all data that have been produced. Thus, when information is requested by an informant, whether objective or subjective, it would seem logical to think that the respondent will react to information concerning the implementation of human resource policies in a way that is aligned with the same direction as the business results perceived by that informant.

Subsequent studies have supported this theory, demonstrating the need for some caution when it comes to measuring systems and human resource practices in enterprises [19]. For this reason, this work seeks alternative ways to measure the impact of human resource management systems in a company in a more objective way, as well as the impact those systems have on the generation of added value.

Historically, a variety of methods have been used to measure the productivity of the human factor. However, these methods have been mainly oriented toward efficiency in carrying out certain administrative tasks or related to the cost of productive activities [22]. The main problem that we face today is that the type of work carried out by the majority of employees and that generates greater business value is very different from traditional jobs; therefore, new formulas for the measurement, subsequent management, and improvement of value are required [23]. As shown in the latest report on global trends in human capital 2016 performed with more than 7000 business leaders and human resource experts in 100 countries, the great challenges of global impact involve redesigning the workplace, the workforce, and work itself [24].

There is a need for systems that can be used to evaluate the human capital contribution to business value creation and that are focused on more than just the technical efficiency of finished tasks or operations. Bontis and Fitz-Enz [25] suggest that the measurement of human capital is critical and vital to the future success of companies. The environment in which a company is currently functioning and that is becoming increasingly more competitive requires all areas to address the growing demand for better results [26]. Most company CEOs ponder the impact of their training and development, reconciliation of work and family life, improvement of the quality of life at work, work flexibility programs, and other aspects of work. In summary, it is crucial to be aware of the economic impact of investments in human capital development carried out by enterprises as part of their overall productivity and whether this will lead to dramatic improvements in business strategy and generate additional profits [27].

We must be aware that no department is allowed to make an investment without prior analysis of future profitability. However, in the field of human resources, despite the fact that most managers recognize that said resource is the main asset of the company, it is difficult to predict what profitability a given investment will generate owing to the difficulty involved in its measurement.

Therefore, this issue adds to current accounting problems, since the majority of intangible assets go unnoticed with respect to accounting information because they do not appear on balance sheets. As a result, the majority of investments carried out for staff are directly treated as costs. Thus, initially, a company will try to reduce costs, and the first programs to be cut will be those related to human factors since a clear and precise assessment of their impact on business results is unobtainable [1].

At this point, we may hesitate in asserting that human capital is an asset, but the definition given by the Financial Accounting Standards Board [28] leaves no doubt that our theory is correct. The FASB establishes three criteria for such a defintion: it must be an economic resource that is able to generate a cash influx or reduce outflows; the organization should aim to have rights or privileges in connection with it; and that resource as well as the rights of the employees must be listed in the financial statements of the company. In summary, an asset is a resource that is controlled by the company and is used to produce additional future inflows or reduce outflows. As for employees, we cannot regard them as a company asset as such, however, in the case of human capital companies usually establish a series of agreements by which employees put their capacities and abilities at the disposal of companies to generate income flows [1]. Thus, their capacities and abilities become a company asset.

One might wonder whether we can really measure the human capital of a company and analyze employee contributions. To do so, we must recognize the existence of different levels of impact created by human capital in a company. Some authors (i.e., [26]), based on the model of evaluation of capacity established by Kirkpatrick [29], have added an additional level to determine the value chain for the management of human talent. This is represented in the following Figure 1.1.

For each of these levels, we can find different types of measurement. For levels I, II, and III, we have measures that determine the economic benefits associated with a particular program or human resource policy. When compared with the investment made in this program, the degree of contribution can be established. By means of the cost/benefit ratio or the calculation of the profitability of the program or the productivity at work, we can know their total contribution to the company. In the case of levels IV and V, in which scenario we must determine the strategic contribution of human capital, the issue becomes more complex. To this end, we are required to rely on the calculation of various indicators such as the rate of strategic alignment, the ratio of retention of key personnel, employee satisfaction, work environment, and other factors. However, an obstacle arises in that this is not a direct reflection on the effect on business value creation; what really is needed are relevant performance indicators [18].

The indicators that are closer to these functions are considered global indicators, such as the rate of economic productivity of employees or the added value of human capital (human capital added value) [26]. Such indicators are criticized since individual employees do not actually make a proportional contribution to sales revenues, which may lead one to believe that the only way to improve those indicators is through reducing staff or wages [23]. However, these indicators attribute all the added value achieved to human capital, removing from consideration the role of financial capital. In this regard, it should be made clear that the value of an asset depends on its contribution of value to the company; however, in reality, the main assets generate value only in combination with other factors. For this reason, it would be a mistake to think of the value of any intangible asset as coming from outside the context of its function in combination with all other assets [1].

To summarize the preceding information, the result of the relationship between the management of human resources on the basis of human capital will have to include not only already commonly used planning and acquisition activities and programs aimed at obtaining support as well as retaining and developing human resources [30–32], but it should also measure the impact of those behaviors on the productivity and profitability of the company [33–35]. The strategic possibilities of this resource are expected to increase under this method.

Quantifying the ROI of human capital is then produced from the identification of human resource activities as a link in the structure of investment in companies, leading the discussion toward the assumption on human resources in their participation in the production system as an intangible asset [36], instead of its typical adoption as an operating expenditure.

For this reason, among the total operating expenses, the item corresponding to staff costs must be excluded. This is supported by the theory that defends human resources as intangible assets [37]. Thus, we already know the initial component of the calculation of the ROICH. Operating costs would be obtained by subtracting staff costs from the total expenditures in the accounting system. These costs commonly include the total number of payroll items and social benefits, contributions to health and retirement plans, and costs of training, development, safety, satisfaction, confidence, and participation in employee programs [38].

Since everything relating to personnel is considered an investment, it is essential to contemplate the possibility of treating it as an intangible asset. The theory behind the concept of return on assets [39] locates the accounting base of investment in human capital in the denominator of the relationship, giving rise to the return on investment in human capital, much as one would do with any other tangible asset.

Equation 1: Return on investment in human capital. Source: [40]

Although the preceding equation arises from a theoretical analysis and evidence collected by Fintz-Enz over the last 15 years in a consulting practice, there is no way to dismiss the relevance of this model since it mandatorily responds to the requirements implicit in the organizational goal of profitability, as demonstrated in what follows.

It should be noted that, from a mathematical perspective, as an indicator of the return on investment, the ROI can only increase at the expense of a decline in the denominator, implying in this case a reduction in the implementation of the budget for investment in human resources. This may also be done by an increase in income items or a decrease in other operational costs. Nonetheless, it is necessary to consider that the investments and their corresponding returns are dependent on the behavior of the market and economic conditions, apart from human behavior.

Once the analysis that theoretically shows the interaction between investment in human capital and the factors that affect the generation of business value is complete, so that we have the tools to measure it, we put forth our first working hypothesis:

H1: There is a positive relationship between investment in human capital and the generation of business value.

Keeping in mind that the activity sector will significantly impact personnel costs, and considering the above stated relationship, we may establish a priori that companies that devote more economic effort to employees will be those that will make an increased investment in human capital. Therefore, such companies are more oriented toward the development of a particular service than those with a productive focus. As a result, the amount of investment in human capital will be less compared to other investments that the company makes in technology, innovation, and other areas. For this reason, we put forth our second hypothesis as follows:

H2: The sector of activity to which a company belongs will influence the generation of business value.

Finally, we propose our third hypothesis, where the sector of activity of a company will moderate the relationship between investment in human capital and the creation of value in the following way:

H3: The sector of activity of a company moderates the relationship between investment in human capital conducted by the company and the generation of value achieved, being greater for companies in the service sector and lower for companies in the industrial sector.

Thus, our model is represented as follows (Figure 1.2):

Table 1.1: Sector of activity

1.3.1Source of data, study population, and sample

To verify the hypothesis, our study population is composed of enterprises affiliated with ASCORT.

ASCORT is an association recognized in the Colombian business world as an entity that provides services in areas related to the management of human resources in the business field. Additionally, it brings together 331 important companies in the Colombian business community, including, in its database, institutions at different levels in terms of structure by size, as well as representatives of each economic sector of the country: industrial sector, financial sector, commercial sector, chemical industries sector, health services sector, public services sector, cooperatives of associated work, and official institutions. See Tables 1.1, 1.2 and Figure 1.3 to see the composition of the sample used.

To collect the information, we appealed directly to the enterprises, which were asked to provide information on the total value of items for 2009. The required data were obtained from balance sheets as well as the profit and loss accounts. To ensure the accuracy of the information, it was compared to the information contained in financial databases belonging to the chambers of commerce of Colombia.

Although the questionnaire was sent to the entire population, responses were obtained from only 23 companies, a 6.95% response rate. Though this is not a large sample of companies, the data are sufficient to achieve a minimum statistical significance through a normal distribution. In addition, this response rate is in line with that of other works using similar methodologies.

Table 1.2: Sectors and subsectors of activity.

1.3.2Study variables

To determine the profitability of the investment in human capital (ROICH) for each of the companies sampled, data on the total income for the period under study were obtained, as well as the total of operating expenses and investment in human capital, all taken from the accounting item of personnel costs.

It is worth mentioning that total personnel expenditures were complemented by the executed value of items aimed at training, welfare, and development programs, as well as the corresponding factor of social benefits. Thus, as was discussed in the theoretical analysis of the return on investment, personnel costs were excluded from the total of operating costs, and they became part of the index denominator, showing that this was indeed an investment in an intangible asset [37, 41, 42].

The return on investment in human capital estimated using the equation designed by Fitz-Enz [34] shows no economic amount of direct return. Instead, it indicates the number of times a unit of investment made by the company is returned depending on income.

To measure business value generation, we chose to analyze the operating free cash flow. The importance of the free cash flow indicator is based on the recognition it enjoys, making it the best tool to determine the business value or “rod of financial measure that truly shows the value of an organisation” [54, p. 2].

Given the circumstances characterizing the financial analysis of companies, any effort to show the impact on the creation of value caused of the way a factor of production is handled should justify the impact and the force with which such effort influences the generation of liquidity. This is measured by means of the free cash flow [43], given that no company can operate indefinitely with a short-term cost-cutting focus. However, if managers fail to complete their work analyzing cash flow, such that they only focus on profit, many companies will not survive in the long term [44].We ought to consider that the presence of high profits is not necessarily related to the existence of a box to service debt or distribute profit sharing [39].

In addition, it is important to design models that allow one to shape a company’s economic behavior in the return on investment and future free cash flows [45]. To do so, one must take into account that the scope of corporate financial objectives may be better achieved through the use of probabilistic models, which, although at times unprecise, usually offer greater insight as compared to projects carried out blindly in an environment with so much uncertainty.

1.5.1Evaluation of measurement model

The individual reliability of an item need not be measured since it has a variable that has been obtained from financial statements. With respect to both the ROICH and the FCLO, the load assumes the maximum value of 1 (as shown in Table 1.5), which means it exceeds the values recommended by Carmines and Zeller [48]. Regarding the internal consistency, this is computed through composite reliability and convergent validity by applying the average variance extracted (AVE). As we predicted, these values are above those recommended, since they are 1 in both cases.

Table 1.5: Convergent reliability and validity.

Finally, to measure the discriminant validity, we compare the square root of the AVE with correlations between constructs according to Fornell and Larcker’s [49] recommendations. As shown in Table 1.6, the square root of the AVE is higher for all the constructs than the correlations between them, which suggests that each construct is more strongly related to its own measures than with those of others.

Table 1.6: Discriminant validity.

The first approach works well for large sample sizes; however, it is not well suited for samples of smaller scale such as ours. Therefore, to check the discriminant validity, we will analyze the HTMT criterion by intervals, which is based on a comparison of the “heterotrait–heteromethod” and the “monotrait–monomethod” correlations [50]. This will allow us to identify the discriminant validity for samples of any size. As we can see in Table 1.7, none of the intervals is 1, as recommended by the existing literature [50], which again confirms the discriminant validity of the model.

Table 1.7: Discriminant validity.

1.5.2Evaluation of structural model

Once the measuring instrument has been validated, we proceed to contrast our first hypothesis, where the effect of the ROICH in the FCLO is evaluated. In Figure 1.5, we can see that the ROICH has a significant influence on FCLO, with a value of T = 1.567. This fact allows us to corroborate hypothesis 1 (H1: β = 0.55, p = 0.059). Regardless, we cannot confirm that the sector influences in a significant manner the relationship between ROICH and FCLO because, although we find a high value for the statistic (T = 0.966), it does not reach the minimum value recommended to support hypothesis 2 (H2: β = 0.245, p = 0.167).

To test hypothesis 3 and to measure the interaction (moderation) effect that the (industrial or service) sector establishes in the relationship between ROICH and FCLO, the effect of orthogonalization [51, 52] was examined. This method is highly recommended when few observations and few indicators are available, as in our case, and it also mitigates the potential effect of multicollinearity [52]. Although this method accepts the use of small samples, and we have β = 0.637, the significance of this effect has not yet been demonstrated since the value of the statistic T has been 0, not even achieving minimal values accepted in the literature. However, when we look at the power of the sector, we do it through the f square [53]. The value that is reached for this moderating effect is 0.498, indicating a strong moderating effect.

To better understand the strength of this interaction effect, it is represented in Figure 1.6. Even though the effect of ROICH on FCLO is extremely high in the example of the service sector, in the case of the industrial sector, this effect diminishes and even changes direction.