Do rating agencies impound workforce human capital information into default risk assessments?

ABSTRACT

No accounting policy exists to mandate that employee-level human capital (ELHC) must be included on Annual Reports. Because structured ELHC information is rare, the association between ELHC and credit ratings (risk) is not demonstrated in the extant literature. South Korea is a unique instance where ELHC information is included on Annual Reports as a rule. Using a sample of 9,273 Korean listed firm-year observations from 2011-2020, we demonstrate that employee tenure, a ELHC proxy, has a positive association with credit ratings. The results infer that credit rating agencies interpret that employee tenure improves a firm's potential to survive a business cycle. The study also demonstrates that continuous employment has a more positive effect on credit ratings for NonBig4 and smaller clients/firms, compared to Big4 and larger clients/firms. The study contributes to the literature by demonstrating that firms that retain employees are less likely to default, implying that if firms look after employees, there are economic advantages. From a policymaking perspective, the study demonstrates the information advantage of reporting non-financial ELHC information on Annual Reports, on a structured/numerical basis.

KEYWORDS:

• Continuous employment tenure
• credit ratings/risk
• human capital
• non-financial reporting

Acknowledgment

We would like to thank two anonymous reviewers and the handling editors Diogenis Baboukardos, Silvia Gaia, Philippe Lassou and Teerooven Soobaroyen who provided important guidance in improving the quality of the work, with their valuable contributions

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For instance, firm A has two employees, where employee1 (department i) starts working on the 1st of January in 20X0, and resigns on the 31st of December, 20X1. Employee2 (department ii) is hired on the 1st of January in 20X0, but still works for the company as of 5th of July in 20X3, and the most recent date of financial statements is the 31st of December in 20X2. Firm A can compute the employee1 (retiree) tenure by calculating the difference between the 1st of January, 20X0 and the 31st of December, 20X1 (2years). Firm A also needs to compute the employee2 (incumbent) tenure by calculating the difference between the 1st of January, 20X0 and the 31st of December, 20X2 (3years). The firm now can compute the average years of continuous employment by averaging these two numbers (2.5years).