Monday, 8 December 2008

Investing in Bob


   Last week's Talking HR show (006) focused on one 'Bob', but today, I'd like to talk about another: a talented young man who has recently started at University and whose tuition costs are being covered by investors in return for a percentage of the student's future earnings over a fixed period of time.

This form of "human capital contract" has recently been reviewed in a Boston Globe article, 'Betting on Bob'.  The article notes that:

"The concept of human capital contracts was originally the brainchild of economist Milton Friedman. In 1955, he wrote a paper, later reprinted in Capitalism and Freedom, proposing that equity-like instruments, rather than debt, should finance higher education.  For Friedman, equity financing was a way to keep government out of the business of paying for higher education."



Unlike with student loans, repayments on human capital contracts are scaled to salary received after graduation.  This means that graduates are freed of the risk of overwhelming debt and are able to pursue socially valuable but low-paying work such as teaching.  And investors face reduced risks of default then under a more conventional loan.  And if a graduate finds a job with a high salary the investors stand to gain more too.



Of course, there are quite a few problems with the idea too.  I think the main one of many reviewed in the article is one of 'adverse selection': that students who expect to be well paid in the future (tomorrow's doctors and lawyers etc) have less incentive to get involved than those who don't (eg the future artists and nonprofit staffers):

"Why, after all, would students who anticipate fabulous success sign up to subsidize their less go-getting peers? A student who intends to be a high-flying investment analyst might calculate that the payments on a traditional private loan are likely to take a smaller bite out of her salary than those for a human capital contract would."



This and other problems means that there are only a few examples of firms offering HC contracts:

  • The main one is Career Concept, based in Germany, "which finances about 2,000 students at 180 universities in more than 20 countries, mostly in the EU. Typically, students are obliged to repay between 3 percent and 10 percent of their income over a period of between four and six years".
  • And another is Lumni which has financed about 150 students in Chile, Colombia, and Mexico and is starting to look at the US. "Students pay no more than 15 percent of their income, and in some cases as little as 1 percent, for up to seven years".


My perspective -

However, in general terms, I think the idea is sound, and I see it as just one early example of the way in which organisational reward is going to have to change quite significantly over the next decade.

As each individual's human capital continues to become more important, simply paying them a salary and developing their human capital if it aligns with an organisation's own objectives, isn't going to be enough.  People are going to want to ensure their human capital is maximised and that they are rewarded for the human capital they provide.  They may also not trust their employer fully to do this. 

One of the other problems raised in the article was that human capital contracts are a form of indentured servitude. For example, Sandy Baum, a professor of economics at Skidmore College commented, "I don't like the idea of someone owning a piece of someone else".

To me, this is the key benefit that human capital contracts could provide.  Have you noticed how the entrepreneurs on Dragon's Den often value the input of the dragons more than their cash?  Investors in someone's human capital would take care of their tuition fees, but they could be active investors too.

Bob could ensure that his investors are involved in helping him choose his employer, and they will naturally want to ensure he is getting the best possible development, and the right reward.

Organisations may only just be getting used to including helicopter parents in their younger employees' performance reviews.  They may need to get used to the involvement of helicopter investors too.




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