Santiago Íñiguez. Dean. IE Business School
19 May 2015
The importance of diversity is a discussion that needs to be approached from an ethical, moral and social perspective, rather than being based on the search for irrefutable evidence of its impact on bottom-line results.
Recent literature on diversity policies in business has tended to focus on the benefits in terms of innovation, creativity, a better working environment, lower staff turnover rates, access to a broader cross-section of potential employees, and reaching out to more stakeholders. One oft-cited source is a 2007 survey by consultants McKinsey (1) which showed that publicly traded companies with a higher number of women on their boards had better ROE (11.4 percent) than the average in their respective sectors (10.3 percent).
Nevertheless, some analysts have questioned the science behind these conclusions, suggesting that the cause and effect between adopting diversity practices and ROE has not been fully established. For example, perhaps there is more direct causal relationship between the size of a company and its growth rate and concomitant ROE. As it happens, there is a higher percentage of women in medium-sized companies than in large corporations: we might perhaps conclude therefore that the relationship between ROE in medium-sized companies and greater gender diversity is circumstantial rather than causal. (2)
I raise these points because it is important to understand the reasons for implementing diversity policies in a company. In most cases, there are two main arguments for doing so:
The business case: in short, diversity policies are beneficial for companies both in economic terms and in less tangible areas. This approach is supposedly more “scientific”, given that it is based on empirical evidence of the impact of diversity on companies’ financial results.
The moral case: This line of reasoning argues that directors should encourage diversity in their companies as a way of promoting greater equality in the business and wider worlds. In other words, such policies are the outcome of moral and ethical decisions, regardless of what the economic impact on a company might be, although obviously, the hope is that it will be positive.
Most of the CEOs and CLOs I know subscribe both to the moral and business cases, using them to validate their diversity initiatives. They try to find evidence of the profitability of such measures and need to show their shareholders that they have direct positive influences on their companies’ activities. If they couldn’t justify these positive outcomes they would find it very hard to impose diversity policies.
But as said, hard evidence of the relationship between implementing diversity policies and a healthier bottom line is elusive, and studies supporting this tend to be anecdotal or circumstantial.
Something similar happens when we try to establish links between corporate social responsibility (CSR) policies and a company’s annual financial results. The problem, as several surveys have highlighted, is that it simply isn’t possible to establish a definitive causal relationship between the two because most of the time, it is precisely the most profitable companies that tend to implement CSR programs, rather than the other way round. In other words, it might be argued that adopting CSR measures is actually an effect of a company’s profitability rather than the cause.
Maria Riaz Hamdani and M. Ronald Buckley, two US-based researchers, have recently written about the impact of diversity on organizations, drawing the conclusion that: “What we have now is a morass of conflicting data, both anecdotal and empirical, which has failed to enable us to come to unequivocal conclusions regarding this important issue”. (3) They point out that most studies on how diversity policies affect companies’ bottom lines are not carried out over sufficiently long periods of time, while using relatively superficial diversity variables, or that they fail to take into account other factors that might play a bigger role in how the company performs.
To further confuse matters, studies on diversity provide both negative and positive empirical evidence as to the effects of diversity policies. There are cases where greater diversity sparks innovation, experimentation, a more global vision of the challenges facing the business, as well as boosting its reputation with different stakeholders. At the same time, diversity can also provoke interpersonal conflict, make it harder to recruit, train, and integrate new hirings, as well as sometimes inhibiting or demotivating some members of the workforce.
Two recent pieces of research with very different conclusions about diversity illustrate the complexity of the question. (4) A survey by Virtom Consulting associated greater racial and gender diversity on corporate boards with a ROE 16.2 percent higher than the average for other publicly traded companies. Yet another study carried out in Norway between 2003 and 2008 into the impact of legislation there that at least 40 percent of the members of boards must be made up of women concluded that those companies with the largest number of women directors saw their share price fall, as did their operating profits. The researchers also noted that these companies’ boards tended to be made up of younger, less experienced people.
Are the conclusions of either of these studies sufficiently conclusive as to base a decision on whether to implement diversity policies? In my opinion, while they obviously provide insight into the way that real companies have tried to improve diversity on their boards and the impact in the medium term, of quotas, neither provides evidence that can be extrapolated for all companies, in all environments, or circumstances.
When it comes down to it, the key factors that determine whether measures to promote diversity have a positive outcome are how they are implemented in the long run, how integration and communication is carried out, and how such practices are incorporated into the company’s culture.
Growing numbers of businesses now find themselves on the horns of a dilemma: nobody could reasonable oppose implementing diversity measures on either moral or practical grounds. But how might they overcome the problem that the empirical evidence as to the economic benefits of doing so just doesn’t seem to be strong enough?
Faced with a shortfall of empirical evidence, Hamdani and Buckler decided to look at the question from a different angle. In reality, it is successful companies that adopt diversity practices, and they do so in response to social demands and at the behest of their shareholders and other stakeholders. Businesses are social institutions whose activities are influenced by their environment and that in turn contribute to the nature of that environment. As social institutions they are obliged to change any practices that are out of step with the times, while at the same time they are expected to lead change that has a meaningful impact on society.
Irrefutable evidence about the positive economic impact of diversity has yet to be presented, but I would still argue strongly in favor of pursuing such policies, being absolutely convinced as a result of my own experience as to the tangible and intangible benefits to companies from implementing these kinds of measures.
To conclude: the reasons companies implement diversity policies are institutional, not economic, and are the result of businesses relationship with the rest of society. If a company is going to pursue diversity, it should do so on ethical, moral, or social grounds rather than for economic reason. In any event, it is likely that the correct application of these kinds of measures will result in a more efficient, better-run company.
Furthermore, it is not enough to simply take measures that generate greater diversity in a company in terms of gender, ethnicity, or background, for example. They must be accompanied by integration and training, as well as evaluation as to how diversity is being aligned with the strategy of the company and with its objectives.
And finally: diversity is a mindset and a process, rather than the achievement of a cause in terms of recruitment and promotion, and its impact can only be fully appreciated in the long term. Short-term pressure that ties diversity to improved financial results will only cloud the issue.
Management should be considered many times more as an art than as a science, and decisions should be often based on firm intuitions and convictions, rather than on irrefutable evidence. I recall here a maxim written by British leader Winston Churchill in one of his early works: “I pass with relief from the tossing sea of Cause and Theory to the firm ground of Result and Fact.” (5) This may be also applied to the domain of diversity.
Photo: A group of students of IE Business School's MBA on their opening day, 2013.
(1) Desvaux, G., Devillard-Hoellinger, S. and Baumgarten, P. (2007), Women Matter: Gender Diversity, a Corporate Performance Driver, New York: McKinsey and Company
(2) UK Government, Deaprtment for Business Innovation & Skills: The Business Case for Equality and Diversity: Survey of the academic literatura; BIS Occasional Paper No. 4; January 2013.
(3) Maria Riaz Hamdani, M. Ronald Buckley: Diversity Goals. Reframing the debate and enabling a fair evaluation; Elsevier: Business Horizons (2011) 54, p. 37.
(4) Quoted in UK Government, op. cit., p. 28.
(5) Winston Churchill, The Story of The Malakand Field Force, Chapter III, 1.2