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This article is an extract from GTDT Practice Guide Diversity and Inclusion 2023. Click here for the full guide
Introduction
The bottom line: diversity and inclusion are good for business. While diversity and inclusion efforts in the corporate world have often been spurred by a commitment to social justice and corporate social responsibility, or by the necessity of regulatory compliance, companies should also regard diversity and inclusion as a competitive advantage and source of growth. Empirical data shows that diverse companies tend to be more successful – they perform measurably better financially than their non-diverse peers. This chapter describes the current state of corporate diversity, the correlation between diversity and company financial performance – why companies should prioritise diversity and inclusion – and legislative and regulatory efforts to increase corporate diversity – why companies may have to do so.
The state of corporate diversity
As at June 2023, only 52 Fortune 500 companies – just over 10 per cent – were helmed by women, and only two by Black women.2 Only one major US bank has a woman chief executive3 and only 0.8 per cent of Fortune 500 CEOs are openly LGBTQ.4 In contrast, according to the most recent Census information, 50.5 per cent of Americans are women.5
Further, as of June 2023, Black Americans, who account for 13.6 per cent of the US population, held just 1.6 per cent of Fortune 500 CEO positions.6 Similarly, Hispanics, who account for 18.4 of the population, held just 4 per cent of Fortune 500 CEO positions and Asian Americans, who account for 6.1 per cent of the population, held just 5.4 per cent of Fortune 500 CEO positions.7
These numbers, low as they are, are all-time highs. According to a 2023 report by Deloitte and the Alliance for Board Diversity, nearly 44.7 per cent of all board seats in Fortune 500 companies are held by women and underrepresented minorities, up from 38 per cent in 2020.8 Specifically, from 2020 to 2022, the percentage of Black board members grew from 8.7 to 11.9, the percentage of Asian and Pacific Islander board members grew from 4.6 to 5.4 and the percentage of Hispanic and Latino board members grew from 4.1 to 4.7.9 Even with this growth, the pace of change is still inconsistent across demographics, and boards are far from being fully representative.10 Deloitte and the Alliance for Board Diversity’s report concludes that ‘at the current pace, it would take the boards of Fortune 500 companies more than two decades for board representation to match the current level of representation of individuals from underrepresented racial and ethnic groups in the population.’11
The competitive advantage of diversity
Against this backdrop, those companies that have embraced diversity in leadership find themselves ahead of the curve: empirical data demonstrates that a correlation exists between diversity and a company’s financial performance.
A series of reports shows the impact of diverse workplaces. In its 2012 ‘Gender Diversity and Corporate Performance’ study, the Credit Suisse Research Institute found that companies with at least one woman on the board outperformed those with all-male boards in terms of share price performance.12 Tracking the performance of 2,360 companies on the MSCI AC World Index beginning in 2005,13 Credit Suisse found that companies with women board members ‘delivered higher average returns on equity, lower gearing, better average growth and higher price/book value multiples’.14 Credit Suisse proposed seven reasons for this finding:
- the positive signal the appointment of women sends to the market;
- greater effort and attention to detail;
- a better balance of leadership skills;
- access to a larger pool of talent;
- a better reflection of the consumer decision-maker;
- improved corporate governance; and
- risk aversion.15
Similarly, according to the 2017 McKinsey study ‘Women Matter: Time to Accelerate’, companies in which women are more strongly represented in management are also companies that perform best.16 Following an analysis of 300 companies in 10 countries from 2007 to 2009, McKinsey identified a 47 per cent difference in return on equity between companies with the most women on their executive committees and companies with none, as well a 55 per cent difference in average EBIT margin or operating results.17 The 2018 McKinsey study ‘Delivering through Diversity’ reinforced these results, finding that companies with greater gender diversity on executive teams perform better.18 Companies in the top 25 per cent for gender diversity on executive teams, McKinsey found, were 21 per cent more likely to outperform on profitability and 27 per cent more likely to have superior value creation, measured using average profit as a percentage of revenues over a period of five years.19 The 2020 McKinsey study ‘Diversity Wins’ shows that the business case is growing stronger.20 From its 2019 data set, following analysis of over 1,000 companies in 15 countries, McKinsey found that the most diverse companies are now 25 per cent more likely to outperform on profitability.21
These findings, McKinsey proposed, reveal that leadership behaviours applied more frequently by women ‘strengthen organisational performance’.22 Drawing upon research into behavioural psychology, McKinsey identified nine positive leadership behaviours often displayed by managers in corporations, five of which women tend to use more frequently than men: ‘people development, expressing expectations and rewarding success, role-modelling, inspiration, and participative decision-making’.23
In its 2021 report ‘Gender 3000 in 2021: Broadening the Diversity Discussion’, Credit Suisse expanded on its conclusions regarding gender diversity and corporate performance by focusing on the LGBT community.24 Based on performance data from a ‘market-cap weighted and sector adjusted basket of around 400 LGBT-inclusive companies’,25 Credit Suisse concluded that ’investors seeking to maximise returns should focus on companies that put both women and diversity more broadly at the heart of their corporate strategy.’26
As with gender and LGBT diversity, ethnic and cultural diversity in corporate leadership has been shown to correlate with increased profitability. In its ‘Delivering through Diversity’ study, McKinsey also examined minority representation at the executive level, finding that companies in the top 25 per cent for ethnic or cultural diversity on executive teams were ‘33 [per cent] more likely to outperform their peers on profitability.’27 Based on data from the US, the UK, Brazil, Mexico, Singapore and South Africa,28 McKinsey determined that ‘companies with the most ethnically/culturally diverse boards worldwide are 43 [per cent] more likely to experience higher profits.’29
This study also demonstrates a penalty for low gender and ethnic diversity: companies in the bottom quarter for both gender and ethnic diversity were ‘29 [per cent] less likely to achieve above-average profitability than were all other companies in [the] data set’.30 The 2020 McKinsey study ‘Diversity Wins’ found that this penalty remains – companies in the bottom quarter for both gender and ethnic diversity on executive teams were 27 per cent more likely to underperform.31
According to McKinsey, the correlation between diversity and financial performance is likely to result from ‘improved access to talent, enhanced decision-making and depth of consumer insight, and strengthened employee engagement and license to operate’.32 Diversity can change the behaviour of a social majority in a way that improves thinking, decision-making and employee satisfaction.33 When diverse perspectives, perceptions and beliefs are represented, shared and considered, diverse teams make higher-quality decisions and ‘tend to be more creative and innovative than homogenous groups’.34
These conclusions are consistent with those of earlier research into the effect of diversity on decision-making. In ‘Ethnic Diversity Deflates Price Bubbles’, a 2014 study in the Proceedings of the National Academy of Sciences, academic researchers found that, in a stock-trading simulation, ethnically diverse groups assessed prices more accurately than ethnically homogenous groups.35 The researchers concluded that ‘ethnic diversity was valuable not necessarily because minority traders contributed unique information or skills, but [because] their mere presence changed the tenor of decision-making among all traders.’36 This study, though not designed with corporate diversity specifically in mind, has important implications for the workplace. It reveals that greater ethnic diversity leads to greater scrutiny of one another among group members, which can produce ‘better outcomes’, whereas ethnic homogeneity may lead to overreliance on others’ decisions.37
Of course, diversity is not, by itself, a panacea, as explored in the 2014 Harvard Business Review article ‘Getting Serious about Diversity: Enough Already with the Business Case’.38 Increasing diversity while otherwise business continues as usual, the authors suggest, will not suddenly increase a firm’s effectiveness or financial performance.39 In enhancing diversity, businesses must accept and support a broader definition of success that incorporates ‘learning, innovation, creativity, flexibility, equity, and human dignity’.40 Additionally, leaders must acknowledge that increasing demographic diversity does not on its own increase effectiveness.41 They must learn how to manage and utilise diversity and be willing to reshape a company’s organisational structure.42 Diversity has no impact when diverse members’ perspectives are not elicited or valued.43
Corporate diversity legislation and regulation
Empirical research confirms that diversity is good for a company’s bottom line. It might well be argued, then, that the increasing legislative and regulatory efforts to increase corporate diversity are, too, good for business. Indeed, states have explicitly pointed to this research in enacting legislation intended to enhance corporate diversity – and, ultimately, the local economy. However, efforts and initiatives to promote diversity and inclusion in the workplace are also facing legal challenges.
Two recent lawsuits, for example, have defeated California statutes mandating board seats for women and individuals from underrepresented communities for violating the equal protection clause of the California Constitution.44 The first ruling, in April 2022, involved California’s Underrepresented Communities on Boards law (AB 979). In 2020, California relied on empirical data regarding the benefits of ethnic and LGBT diversity in expanding board diversity requirements with AB 979.45 AB 979 required publicly held corporations with principal executive offices in California to have at least one director from an underrepresented community – a category that includes both ethnic minorities and LGBT individuals.46 Corporations with more than four but fewer than nine directors were required to have at least two such directors; those with nine or more directors, at least three.47 Non-compliance was to be met with fines.48
The second ruling, in May 2022, involved California’s 2018 Women on Boards law (SB 826). The California legislature relied on independent studies, including McKinsey’s ‘Women Matter’ study and Credit Suisse’s ‘Gender Diversity and Corporate Performance’ study, in passing SB 826 in 2018.49 SB 826 required all publicly held corporations with principal executive offices in California to attain minimum numbers of women on their boards.50 All such corporations were required to have at least one woman director; corporations with five directors were required to have at least two; those with six or more directors, at least three.51 As with AB 979, fines could be imposed for failure to meet those requirements.52
In both instances, California courts concluded that the statutes treated similarly situated individuals differently based on their membership in certain groups, and that the state failed to show that the laws furthered a compelling state interest, were necessary to satisfy that interest and were narrowly tailored to achieve that interest.53 Thus, they rendered the statutes unlawful.54 If these rulings stand, California-based public companies will no longer be mandated to appoint board members based on race or gender.
In light of these legal challenges, diversity on corporate boards of directors is likely to move forward with disclosure-only rules rather than specific quotas.55 Notably, while California’s legislation strictly mandated board diversity, some other states have taken a softer approach, enacting laws designed merely to encourage board diversity, often through the imposition of reporting obligations.56
Illinois, for example, in 2019 amended its Business Corporation Act to impose such obligations.57 Publicly held corporations with principal executive offices in the state must include information about the gender and ethnic composition of their boards, as well as their policies and procedures for promoting diversity in their boards and executive officers, in annual reports to the Secretary of State.58 The University of Illinois is to review this information and publish a report rating each corporation’s level of diversity in leadership.59
New York imposed similar reporting requirements, and sanctioned a similar study, with its 2019 Women on Corporate Boards Study Act.60 Corporations authorised to do business in New York must biennially report the representation of women on their boards to the New York Department of State.61 State agencies, in turn, are to conduct and publish a study containing ‘the number of women directors, total number of directors that constitute boards of directors, analysis of the change in number of women directors from previous years, and the aggregate percentage of women directors on all boards’.62
Similarly, in 2020, Washington amended the Washington Business Corporation Act to impose new board of directors gender diversity requirements on public companies organised under Washington law.63 For purposes of this law, a gender-diverse board of directors is composed of at least 25 per cent of individuals whom self-identify as women.64 If a public company does not meet this requirement, it is required to provide its shareholders with ‘a board diversity discussion and analysis’ regarding its approach to developing and maintaining board diversity in advance of the annual meeting.65
Under these laws, candidates are not facing differing treatment. Instead, these disclosure rules make companies’ actions public, allowing individuals to decide where to work and which companies to support.66 Therefore, despite the legal challenges to California’s mandated board diversity requirements, efforts to encourage diversification in leadership will likely continue. Thought should be given, however, to how diversity and inclusion goals are implemented.
In recent years, there has also been a wave of anti-diversity legislation being passed in a number of states, including Iowa, Missouri, Texas and Florida. Although most of this anti-diversity legislation has targeted public employers and higher education,67 it signals a possible trend that has already begun to affect some private sector companies that have either implemented diversity and inclusion initiatives or are seeking to do so in the near future.
As a notable example, in 2022, Florida Governor Ron DeSantis signed into law HB7, otherwise known as the ‘Stop W.O.K.E.’ Act. The ‘Stop W.O.K.E.’ Act places limits on the topics that employers (with 15 or more employees) may discuss in the workplace when conducting diversity training. Specifically, the law allows employees to sue their employers for discrimination under the Florida Civil Rights Act if the employer ‘subject[s] an employee’ to diversity training that ‘espouses, promotes, advances, inculcates or compels such individuals to believe’ certain enumerated topics dealing with race, discrimination, inequality and other related issues.68 The law allows discussion of such topics only if done in an ‘objective manner without endorsement of such concepts’.69 Although this law is the first and only one of its kind, companies should be aware of the shifting parameters of diversity legislation in their states to ensure their programmes are compliant.
Moreover, states are not the only entities regulating corporate diversity. The US Securities and Exchange Commission and market players including the Nasdaq Stock Market have adopted a data-driven approach to board diversity. In August 2020, the SEC adopted disclosure requirements on the human capital of public companies.70 Under this rule, public companies must identify the number of persons employed and any human capital measures or objectives, such as gender and ethnic diversity and inclusion, which it focuses on in managing the business.71 And in August 2021, the SEC voted to approve new listing rules, submitted by Nasdaq, to advance board diversity through a ‘comply or explain’ framework and enhance transparency of board diversity statistics.72
Conclusion
There is a clear business case for seeking and achieving diversity: simply put, diverse companies perform measurably better financially than their non-diverse peers. Empirical evidence demonstrates that an emphasis on diverse leadership, whether or not required by legislation or regulation, provides entities with a competitive edge. When diversity becomes part of the corporate fabric beyond mere tokenism or minimum compliance, viewpoints expand, opportunities surface and doing the right thing drives the right results.
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