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Market Implication of Human Capital Investment in Training

INTRODUCTION Intangible assets of major publicly held corporations are recognized as important determinants of firm value and economic prosperity. However, there are significant concerns about the deficiencies of information in corporate financial reports and inadequate treatment of these assets under traditional accounting principles (Lev, 2001). The failure of financial statements to fully recognize these intangibles leads to an increasing gap between firms' market values and book values. Many studies attribute this gap to the omitted value of what they call intellectual capital (e.g., Stewart, 1994; Roos et al., 1998). Some examples include employee competence, brand names, supplier relationships, production process, and organizational culture. Although there is no consensus on everything that contributes to intellectual capital, the human capital embedded in employee competence is one of the core components agreed upon by many researchers (e.g., Brooking, 1996; Edvinsson and Malone, 1997; Roos and Roos, 1997). According to Blundell et al. (1999), human capital is generated when an individual or a firm decides to invest resources in the development of people who work in the business. This decision is not essentially different from other investment decisions. Similar to other investment choices, human capital investment is intended to generate higher returns. In today's technology-dependent global economy, knowledge and competence of employees become the most important sources of firms' competitive advantages (Drucker, 1999). In fact, the concept of human capital originated in the 1960s, when economists focused on the economic benefits from investments in education and training. Investments in human capital have been shown to explain a country's economic growth (e.g., Psacharopoulos, 1973), an individual's earnings growth (e.g., Becker, 1964) and a firm's employee productivity (e.g., Bartel, 1994). Researchers in the management field are also concerned about the use of human resource practices and their impact on organizational performance. Studies document that a human resource system focused on human capital enhancement is directly related to multiple dimensions of firms' operational performance, such as employee productivity, machine efficiency and customer satisfaction (e.g., Youndt et al., 1996). There is also evidence supporting a significantly positive relationship between human capital investments and corporate financial performance, using both accounting-based measures such as return on assets and market-based measures such as Tobin's q (e.g., Huselid, 1995). Accounting research in the 1970s mainly focused on establishing techniques in measuring the cost and value of employees (e.g., Flamholz, 1974; Friedman and Lev, 1974). Although there is some evidence of differential decision-making effect on investors (e.g., Elias, 1972; Hendricks, 1976), the failure to achieve a consensus about the measurement and reporting methods impeded further development of issues related to human capital accounting. A recent paper by Amir and Livne (2005) uses a sample of football companies in the U.K. to examine the relationship between investment in player contracts and future economic benefits, and documents that the capital market values investment in player contracts, even though the economic benefits of the contracts last no more than two years. The purpose of this paper is to assess the economic benefits as well as the valuation effect of a specific type of human capital investment--employee training. Investment in human capital can be broadly categorized into investment in employee skills and investment in employee motivation (Huselid, 1995). The former includes practices such as personnel selection, job design and employee training, which are intended to enhance employee's knowledge, skills and abilities; the latter includes practices such as performance appraisals, promotion systems and incentive compensation, which are designed to recognize and reinforce desired employee behaviors. …