UK Edition
It has become a truth universally acknowledged that diverse companies perform better. A much heralded McKinsey report, entitled Diversity Wins, argued that “the business case for gender and ethnic diversity in top teams is stronger than ever”.
Last month, the Financial Reporting Council (FRC) released a study, which concluded that “gender-diverse boards are more effective than those without women”. The evidence is supposedly so compelling that one chairman claimed in the study that “there have been enough reports … statistics and … evidence-based research to stop talking about it and get on with it”.
Another declared that “I don’t want to see any men. I don’t care if they’re Jesus Christ. I don’t want to see them.”
Accordingly, regulators are taking action. The US’s Nasdaq has proposed a requirement for boards of listed companies to contain at least two minority directors. In the UK, the Financial Conduct Authority is consulting on whether to introduce “comply-or-explain” targets for diversity.
Both proposals are based on the belief that diversity improves financial performance. As an ethnic minority and strong supporter of responsible business, I would really like this to be true.
But the business case for diversity is far weaker than commonly claimed. The McKinsey study has been shown to be irreplicable even with their chosen performance measure (EBIT) and preferred methodology. Moreover, there is no link between diversity and other performance measures – gross margin, return on assets, return on equity, sales growth, or total shareholder return – or when using more established methodologies.
The study commissioned by the FRC runs 90 regressions investigating the link between diversity and profitability. Eighty-eight find no relationship, and two find a weak relationship that fails the standard threshold for statistical significance. Yet many articles have been written based on the study’s headline claim, without looking at its actual results.
The foreword to the study (not written by the FRC) proclaims that “the academic rigour with which data was collected and analysed yields new insights … we all stand to learn from the authors’ methodology”.
But making claims unsupported by the evidence is not rigorous, nor a methodology that should be learned from. Beyond these two studies, rigorous academic research, published in the most stringent peer-reviewed journals, either finds no or a negative link between diversity and performance.
Why are we so quick to believe such weak evidence? Because of confirmation bias – the temptation to accept any study that supports what we’d like to be true. We want to live in a world in which diverse companies outperform. But our acceptance of a study should depend on its scientific rigour, not whether we like its findings. This point applies beyond diversity to any research – on business, politics, or health advice.
Importantly, the invalidity of popular diversity research does not invalidate diversity initiatives. Perhaps there is a business case for diversity, but existing studies haven’t found one due to blunt classifications based on only gender and ethnicity. Diversity comprises a myriad of different dimensions, such as socioeconomic, educational, regional, or experiential background, as well as the practices a company puts into place to foster inclusivity.
And even if there is no clear business case for diversity, there are strong moral and ethical cases. Many people – myself included – believe that companies have a responsibility to contribute to a diverse and inclusive society. Perhaps doing so may not maximise profits but many shareholders and stakeholders are willing to accept that trade-off – just as consumers buy organic food, despite its greater cost, due to non-financial considerations.
When I took over as managing editor of the Review of Finance, the leading academic finance journal in Europe, I appointed the first female editors in our 21-year history. I didn’t do so because of evidence that diversity instrumentally improves journal performance, but because diversity is intrinsically desirable and because these candidates were excellent in their own right.
Moreover, study-based arguments for diversity are problematic because they relegate dimensions of diversity for which no study exists. There is no rigorous evidence on the financial benefits of inclusion based on disability or socioeconomic background, but it is desirable for other reasons. This goes beyond diversity to any initiative to serve society.
During the pandemic, many companies paid furloughed workers, gave away free products, or prioritised their most vulnerable customers. They did not do so because studies showed that it would improve their public image and generate more profit in the long term.
Researchers’ mission is to analyse the data in the most careful way possible and let it speak. Sometimes, it will uncover win-wins where social and financial goals coincide. But if there are trade-offs, researchers should be upfront about them. Even if an action sacrifices profits, some companies and investors will be willing to make this sacrifice. But it’s their choice, and the role of evidence is to inform this choice rather than torturing the data to get the result we want.
Alex Edmans is professor of finance at London Business School and author of Grow the Pie: How Great Companies Deliver Both Purpose and Profit
No, boardroom diversity does not mean higher profits
Beware of the temptation to accept research just because it supports a view we would like to be true