Research Report: the Business Case for Board Diversity

Looking for the markers of a successful company? We delve into research which suggests that one area to investigate is diversity on executive boards. According to many reports we reviewed, company boards that include people with diverse backgrounds, perspectives and experiences are more likely to create innovative, resilient and profitable companies.

"Diversity is broadly one of the top trends dominating CEO concerns," says Karen Brown, founder of the Chicago-based firm Bridge Arrow, which advises companies on diversity and inclusion (D&I). "The conversations in boardrooms are moving today with a greater sense of urgency than ever before, and leaders are being very explicit and frank in their dialogue. Looking ahead, a company's ability to remain competitive will rely on its understanding of domestic and global markets, changing demographics, and investor and customer expectations."

"Who is missing from the conversation? Who is missing from a company's ability to be innovative and creative?" - Karen Brown, founder of the Chicago-based firm Bridge Arrow

As a result, conducting your own research on D&I is worth the effort. "Ask questions, such as what types of perspectives or backgrounds will help in the formulation and fulfillment of a company's strategic objectives," says Brown. "Does the company show that it values diversity? Where does it need different insights and perspectives? Who is missing from the conversation? Who is missing from a company's ability to be innovative and creative?"

To understand the bigger picture, we do a deep dive into the data to find what investors can keep in mind when examining board diversity.

What does board diversity mean?

At its core, board diversity is about embracing different genders, races, ethnicities, ages, disabilities, sexual orientations and religions. Increasingly, governments and organizations are defining what board diversity could and should look like. The Canadian federal government has issued the "50-30 Challenge," which asks organizations to work toward two goals for their boards and senior management: 50 per cent gender parity and 30 per cent representation of underrepresented groups, including racialized persons, people living with disabilities and members of the LGBTQ2+ community. South of the border, in December 2020, Nasdaq proposed comply-or-explain rules. If approved by the U.S. Securities and Exchange Commission, these rules would require all companies listed on Nasdaq's U.S. exchange to publicly disclose "consistent, transparent diversity statistics" about their board of directors, and to have – or explain why they don't have – at least two diverse directors: one who self-identifies as LGBTQ+ or an underrepresented minority, and one who self-identifies as female.

Newer members of the workforce, namely the millennial and Gen Z set (whose birth years collectively span 1981 to 2010), may define diversity more broadly to include differences in personality, as well as more tangible things like education, knowledge base, experience and skill set. In 2019, ISS Analytics reviewed nearly 20,000 directorship positions in the U.S. to determine the characteristics of newly appointed directors. It found that "diversity among new directors goes beyond gender and ethnicity. We observe a change in the skillsets disclosed by companies for new directors compared to incumbent directors."

"When we are looking at this through a true equality or equity lens, the focus remains on groups that we know were historically disadvantaged and excluded from opportunities." - Wendy Cukier, founder and academic director, Diversity Institute at Ryerson University

This broader notion of diversity — diversity of thought, skills and disciplines — is important, says Wendy Cukier, founder and academic director of the Diversity Institute at Ryerson University in Toronto. "But when we are looking at this through a true equality or equity lens, the focus remains on groups that we know were historically disadvantaged and excluded from opportunities in terms of employment, leadership and governance."

Why it matters: the benefits of board diversity

Research from McKinsey, RBC Global Asset Management and Vontobel Asset Management cements board diversity as a predictor of positive financial results and company culture. 

In 2019, McKinsey surveyed 1,000 large companies in 15 countries. It found that those with more than 30 per cent women executives were more likely to outperform those with 10 to 30 per cent, which themselves were more likely to outperform those with fewer or none.

“What you get is better decision-making, because you've got a built-in insurance policy against groupthink." - Susan Black, CEO of the Conference Board of Canada

The trickle effect of gender-diverse boards is palpable, according to RBC Global Asset Management: "Companies with diverse boards tend to have lower volatility, better operating performance and invest more in research and development."

McKinsey also reported that companies with ethnically diverse boards are more likely to outperform: "In 2019, top-quartile companies outperformed those in the fourth one by 36 per cent in profitability" (an increase from 33 per cent in 2017 and 35 per cent in 2014). Also, Vontobel Asset Management studied the 150 largest S&P companies and found that the 25 with the most ethnically diverse boards had a higher average revenue, more revenue from international sales and higher five-year earnings-per-share (EPS) growth compared to the 25 with the least diverse boards.

"What you get is better decision-making, because you've got a built-in insurance policy against groupthink," says Susan Black, CEO of the Conference Board of Canada, adding that this has been demonstrated by a number of studies. "You get more creativity. You get more people developing broader skills because they're exposed to people who are different than them. The benefits of achieving board diversity are consistent with the benefits for any organization that achieves diversity throughout its levels."

"If you get this wrong, the cost to the brand, the cost to the organization can be massive." - Wendy Cukier, founder and academic director, Diversity Institute at Ryerson University

In addition to the stats, board diversity makes intuitive sense to many. "A higher-performing board is one that truly has a holistic understanding of its organization and its industry," says Brown. "This involves understanding every stakeholder, shareholder, consumer, supplier, contractor and more – and understanding that they're all very different by countless characteristics of diversity. They have different expectations, based on their worldview, their desires, where they come from. So a rich discussion, driven in part by diversity, feels necessary for a board to be optimally effective."

Cukier agrees. "I think there's good evidence that the more your board looks like the people the organization is serving, the more likely you are to be effective," she says. "And then, frankly, there's risk avoidance. We've seen examples where organizations really were behind in terms of their understanding of diversity and inclusion and its implications, and they sustained significant damages as a result. If you get this wrong, the cost to the brand, the cost to the organization can be massive."

Understanding the challenges to board diversity

A big challenge to board diversity is the tendency of board members to recruit people in their own circles and to use rigid requirements which disqualify other potential candidates. "Historically, if you look at how boards populate themselves, it's very much through their own personal networks: you invite people onto a board because you know them, or you know them by reputation, and you're very comfortable that they'll integrate well into the board," says Black. "And there's still a heavy reliance on that. The way you overcome that challenge is by doing things like having really good governance practices – having things like term limits and a skills matrix, and being very intentional about the profiles you're looking to fill on a board."

A past approach like limiting board candidates strictly to people who have already been CEOs narrows the pool considerably, says Cukier. "You also need deep knowledge of legal issues, regulatory issues, finance and, increasingly, IT and security and so on. So if you go through the list, you can create a lot of opportunities for people with different backgrounds who may not have been a CEO to participate and contribute."

"It's one thing to get diversity, but boards also need to make sure they're managing that inclusion dynamic." - Susan Black, CEO of the Conference Board of Canada

Simply having a diverse board is not a magic solution, adds Black. "The managing of a board that is diverse requires competency from the chair and from the board members. Make sure you've got a board director who allows everybody to speak and to feel their opinions are valued and considered. So it's one thing to get diversity, but boards also need to make sure they're managing that inclusion dynamic."

COVID-19 has added another layer of challenge. More than a quarter of D&I leaders who responded to an i4cp survey near the end of March 2020 reported that their organizations had put "all or most" diversity initiatives on hold due to the pandemic. Such companies may be putting themselves at a disadvantage, says McKinsey: "They could not only face a backlash from customers and talent now but also, down the line, fail to better position themselves for growth and renewal. Some of the qualities that characterize diverse and inclusive companies — notably innovation and resilience — will be much in need as companies recover from the crisis."

How to research a board's diversity

So how do you find out if a company has a diverse board? You may be able to identify a board's composition by gender, age and in, some cases, ethnicity just by looking at a company's website, but that doesn't go far enough. One step is to check the company's stated D&I approach, suggests Black: "What is the organization's public stance on diversity and inclusion? Do they have it on their websites? Do they talk about diversity and inclusion? Do they have a definition? If they're publicly traded under the comply-or-explain regulation, they must answer whether they've got a policy, and if not, why not? Look at all those things for the positive indicators you'd expect to see."

Brown recommends seeing what research is available from proxy advisor firms with a research arm that looks at D&I, and digging into the research from professional services firms like Deloitte and McKinsey. For Canadian companies, check Osler's annual D&I reports.

Conducting your own research is worth the effort, the experts agree. Find one easy way to get started in How to Find Investments That Matter to You.

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