The Financial Case for Board Diversity

It’s been a year since BlackRock chairman Larry Fink issued a letter to CEOs fervently urging them to make boardroom diversity a top priority. Since then there’s been an avalanche of thought pieces telling you why Fink got it right—or wrong.

Most arguments for increased board diversity appeal to its moral and cultural implications. “Boards with a diverse mix of genders, ethnicities, career experiences and ways of thinking have, as a result, a more diverse and aware mindset... They are less likely to succumb to groupthink or miss new threats to a company’s business model,” Fink wrote.

That’s nice, but for board members concerned with a company’s performance and little else, diversity in the governance ranks may be seen more as a nod to social good than as something that relates to dollars and cents. But an emerging body of research points to board diversity as a driver of bottom-line returns, although not always in ways that seem obvious.

Here, five reasons why board diversity is paramount to a successful future for any company:

IT’S A GROWING DEMAND FROM INVESTORS.

The analytics revolution in investing has been underway for decades. But today, a new wave of metrics is driving investor traffic, metrics which heavily take into account the level of boardroom diversity in companies. A growing number of exchange-traded funds, such as the Mackenzie Global Leadership Impact ETF, guide everyday investors toward firms that outperform their competitors in terms of the gender diversity of their boards. Better metrics for tracking racial diversity at the boardroom level are also under development by companies like LedBetter.

Simply put, you don’t want your company to get on the wrong side of the growing horde of socially responsible investors who care deeply about inclusion. In 2018, more than $12 trillion was invested under socially responsible-investing criteria. Trillion. That translates into one in every four American dollars under professional management.

CONSUMERS ARE PAYING ATTENTION.

Less than 4 percent of all Fortune 500 boards are held by Latinx people in America, despite the group accounting for more than 18 percent of the population and more than $2 trillion in purchasing power, according to the Latino Corporate Directors Association. “Boards are finally realizing that public perception matters,” says Wendy Sturley, vice president of communications of LCDA. This is particularly true for consumer-dependent companies, such as Target.

DIVERSITY CREATES A MARKETPLACE FOR BOLD IDEAS.

The more homogenous the group, the more likely it is to exhibit overconfidence, a lack of objectivity and fewer debates over tough decisions.

Emergent research suggests that more diverse boards lead to a healthier rate of turnover on said boards, which reduces group think and ushers in fresh new perspectives. “Usually what happens is CEOs appoint the CEOs of other companies onto their boards, so they’re still appointing people from the same networks,” says Akshaya Kamalnath of the Auckland University of Technology, who recently published a study making the case for board diversity. “The more turnover there is, the more they have to look outside their networks to fill those seats.”

IT FOSTERS C-SUITE DIVERSITY.

C-Suite diversity is still moving at a glacial pace: Only 6.7 percent of the nation’s corporate management jobs at small companies are held by African-Americans, according to the latest figures from the Bureau of Labor Statistics. Only three CEOs in the entire Fortune 500 are African-American men.

This flies in the face of a 2018 McKinsey report, “Why Diversity Matters,” which reported that “for every 10 percent increase in racial and ethnic diversity on the senior executive team, earnings before interest and taxes rise 0.8 percent.” If diversity positively affects corporate decision-making, then injecting diversity into the management ranks, even more than the boardroom, should be a top priority for companies. But it starts with the board.

READY OR NOT, HERE THEY COME.

Following in the footsteps of Sweden, Finland, and France, last year, California governor Jerry Brown signed into law a first-of-its-kind bill in the U.S. that requires publicly traded companies headquartered in the state to meet a threshold of gender diversity on their boards or pay a fine. Illinois is poised to enact similar legislation. Laws of this kind are in their infancy. However, the acceleration of government enforcement of boardroom diversity clearly wouldn’t be possible without a broader public consensus that it’s an issue. Fines may be insignificantly low right now, but in a decade they won’t be.