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Study Identifies Gap Between Demographic Diversity and Perceptions of Inclusion

Alex EdmansThis study of Diversity, Equity, and Inclusion (DEI) finds little connection between the actual demographics of management and employees and expressed feelings of diversity, equity, and inclusion in the workplace. By distinguishing between demographic factors and how people feel about DEI in the workplace, the authors turn some conventional thinking about DEI on its head.

Best Companies Do Better in the Stock Market
Companies With High DEI Have Higher Profits But Little Share Price Advantage
Having More Women in Senior Management Correlated With DEI
“DEI is only weakly correlated with traditional measures of demographic diversity.” This is one of many key findings in the paper, “Diversity, Equity, and Inclusion,” by Alex EdmansProfessor of Finance, London Business SchoolCaroline Flammer, Professor of International and Public affairs at Columbia University, and Simon GlossnerFederal Reserve Board. They find that “companies can hit the target but miss the point – improve diversity statistics without improving DEI.”
The paper aims to take “a first step towards measuring the DEI of a company, employing proprietary data used by the Great Places to Work® (GPTW) to compile the list of the 100 Best Companies to Work For in America. Two thirds of the score that determines list inclusion stems from employee responses to the Trust Index™, a 58-question survey on various dimensions of employee satisfaction; the remaining one-third arises from a Culture Audit™ on a company’s demographic makeup, pay and benefits programs, and culture.” To create the DEI score for organizations studied, the researchers identified 13 of the metrics that correlate with feelings of diversity, equity, and inclusion, as opposed to using only numerical demographic percentages by job type. 

Best Companies Do Better in the Stock Market

This analysis is relevant, the authors say, because “Edmans (2011, 2012) finds that the Best Companies enjoyed superior long-term shareholder returns and earnings surprises over a 28-year period from 1984-2011, suggesting that the dimensions captured by the list are financially material.” The findings have been supported by Boustanifar and Kang (2022), who demonstrate that this outperformance continues to hold through to 2020, and Edmans et al (2023), who extend find similar results in GPTW companies outside the US. 
Based on their definition of what DEI really means in an organization, “We find that DEI is positively associated with one- and three-year sales growth, positively associated with three-year but not one-year stock returns, negatively associated with leverage (debt), and positively associated with dividends. This suggests that a strong financial position frees a company from having to focus on short-term pressures and instead allows it to address longer-term challenges such as DEI. Small and growth (low book-to-market) firms are associated with higher DEI, consistent with their greater ability to increase DEI, given management’s proximity to workers, and their greater incentives to do so, given the importance of human capital in such firms.”
The study finds that using their definition based on perceived inclusivess rather than percentage of employees, “DEI is positively associated with seven out of eight measures of future profitability, such as return on assets, return on sales, profits divided by employees, and sales divided by employees. For example, a one standard deviation increase in DEI is associated with a 0.8 percentage point increase in return on assets (9.6% of the sample standard deviation). These results are after controlling for the percentages of female and minority employees; indeed, these variables are insignificantly related to almost all performance measures.”

Companies With High DEI Have Higher Profits But Little Share Price Advantage

“Somewhat surprisingly,” the authors find, “given prior results on profitability, innovation, and earnings surprises, we find no link between DEI and stock returns, after controlling for either firm characteristics in firm-level regressions or risk in portfolio regressions.”
On the other hand, “We also find that DEI is positively associated with valuation measures, such as Tobin’s Q, suggesting that the market at least partially incorporates the value of DEI. However, we also find that DEI is positively linked to future earnings surprises, indicating that the market does not fully incorporate the performance benefits of DEI. We also study future innovation performance, since one of the main financial arguments for DEI is that it allows for a broader consideration of perspectives and stimulation of ideas which, in turn, may be driving increased innovativeness and financial performance. We find that DEI is unrelated to either the number of future patents or patent citations. However, the granular nature of our data allows us to stratify the survey responses by job category. We find that DEI perceptions of professionals, a job category that includes R&D (research and development) staff, are positively and significantly correlated with both innovation measures. But there is no positive link with the responses from the three other categories: executives, managers, and hourly workers. This is consistent with the fact that innovation is most likely to stem from professionals.”
The study finds that DEI exhibits only a modest correlation with the Culture Audit of diversity metrics, such as percentages of women and ethnic minorities in both senior management and the wider workforce. “For example, its correlation with the percentage of female (minority) employees is 0.16 (-0.04). We supplement the Culture Audit by gathering information on the gender and minority status of the CEO and board of directors, which also have a weak correlation with DEI. Thus, our DEI measure contains incremental information that would be missed by standard metrics that focus more narrowly on demographic diversity. This has implications for the significant attention paid to diversity metrics by companies, investors, employees, the public, the media, policymakers, regulation, and ESG rating agencies – they omit a big piece of the picture.”

Having More Women in Senior Management Correlated With DEI

The study does find that “the proportion of women in senior management is positively and significantly associated with DEI across all specifications. In terms of economic magnitude, a one standard deviation increase in the percentage of female senior managers is associated with a 0.03 increase in DEI (16.2% of the sample standard deviation). One interpretation is that female senior managers are more attuned to DEI issues and directly improve DEI within an organization. A second, non-mutually-exclusive explanation is that women in senior management play a figurehead role, affecting employees’ perceptions of DEI or their pursuit of DEI initiatives.”
On the other hand, “there is no link between DEI and the presence of a female CEO and a negative association with the percentage of women on the board. Since female CEOs and directors are likely to have a particularly strong figurehead effect, this result suggests that the link between DEI and the proportion of women in senior management does not stem from a purely figurehead channel. We also find that DEI is unrelated or negatively related to ethnic diversity in senior management, at the CEO level, or in the boardroom.”
The authors assert that “The insignificance of most demographic diversity variables suggests that an ‘add diversity and stir’ approach is insufficient to improve DEI.  We also explore workplace policies, such as childcare, unpaid parental leave days, sabbaticals, and flextime, to test whether DEI can be easily increased by implementing simple policies. In contrast to this hypothesis, all workplace policies are insignificantly associated with DEI. In addition to policies, we also show that voluntary turnover has no link with DEI, and the percentage of unionized workers is negatively linked. This suggests that DEI cannot be increased by general efforts to improve the workplace.”

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