How company diversity can help performance

Katherine Collins, CFA, MTS

Katherine Collins, CFA, MTS
Head of Sustainable Investing, 11/08/18

  • Diversity within a company has more dimensions than can be captured in simple metrics
  • The benefits of diversity may positively impact company performance and strategic agility
  • Investors can analyze a company’s diversity by studying data, communications, and progress over time

There is ample evidence that diverse teams have the potential to generate higher performance with lower risk, especially when the tasks at hand are complex or shifting over time. But assessing company diversity is often reduced to a simple counting exercise, noting the number of women on a board or the age ranges of an executive team, for example. These measures are useful reference points, but they yield little insight about whether a team is benefiting from diversity or hampered by a monoculture. How can investors consider diversity in a more complete way?

Why strive for a diverse workplace?

When we survey the landscape, we find three main reasons executives cite for focusing on diversity:

  • Moral reasons. Actively promoting diversity helps to offset inherent and often unconscious social bias that exists in many of our systems.
  • Supply of talent. Encouraging company diversity widens the pool of qualified candidates for any given role.
  • Performance improvement. Diversity has both risk-mitigating and value-generating potential.

Diving into performance: Cognitive diversity

The potential to improve work performance is perhaps the most intriguing and least understood argument for diversity, so it is worth examining in more depth. Understanding this topic requires focusing on a particular form of diversity: cognitive diversity. This refers to a mix of skills, experiences, and perspectives brought to bear on a problem or task.

Cognitive diversity is necessary for any group that is making strategic decisions in a dynamic, complex environment. When we’re working on simple, repetitive tasks, it is often best to have a narrow range of relevant expertise and to focus on efficiency. But for complex questions that involve incomplete information and a shifting landscape, you need the greatest range of relevant skills, inputs, and insights.

A good analogy is navigation. If you have a flat, straight, empty road between you and your destination, you simply need the fastest mode of transportation. But if that path is a narrow, branching trail up a mountainside, you need more than speed; you need agility and flexibility. Extend this idea further to an ocean, where the surface itself is constantly moving, and you need even more inputs and insights to navigate effectively. Though we might wish that our business environments were smooth and linear like that straight open road, most of them are closer to the tumultuous ocean.

Investment implications

It is hard to assess diversity from a distance, but as fundamental investors we have several tools at our disposal to begin this analysis:

  • Conventional diversity metrics. Though demographic categories don’t always link to cognitive diversity, there is compelling evidence that the two often go hand in hand (for a review of these connections, I recommend The Diversity Bonus by Scott Page (September 2017). Understanding the mix of gender, age, race, and other demographics within companies can be a useful starting point.
  • Company communications. Companies release a wide range of commentary, from annual reports and quarterly conference calls to proxy and annual meeting information. Investors can analyze where diversity shows up in these communications and, just as importantly, how it shows up. Does management use legal language, strategic language, or personal language when discussing diversity? Does the CEO mention it without being prompted, and if so, in what context? Can we see the links between a company’s diversity focus and its core business strategy?
  • Changes over time. Companies are evolving organisms, yet most of our diversity data is static. It is useful to review how the people who make up a company have changed over time in areas such as educational expertise, age ranges, geographic mix, and ethnic composition.

Asking these deeper questions is more labor intensive than screening for basic diversity statistics, but the reward for that extra effort is increased insight into a company’s strategy and culture — crucial issues for any long-term investor.

For more thoughts about sustainable investing, read my posts about how to assess different sustainability choices and how we combine fundamental research with ESG data.