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Ethnically Diverse Boards Drive Profits in Talent-led Sectors

New Calvert research finds consumer-focused firms most likely to value human capital and support ethnic diversity at senior levels.

A new study has found a strong relationship between executive-level ethnic diversity and large-cap company performance, particularly in sectors leading the shift in enterprise value from natural to human capital.

Yijia Chen, Quantitative Research Analyst and Index Manager at Calvert Research and Management, showed that metrics around ethnic diversity are still lagging behind gender equality.

However, Chen’s study – titled ‘Does an Ethnically Diverse Board Mean Better Stock Performance?’ – indicated that ethnic diversity can equal higher revenues, especially in consumer-facing sectors where human capital is recognised as a key differentiator.

“We have seen the key driver of the global economy shift from natural resources to human talent,” said Chen. “This trend now impacts economies as companies place the focus on intellectual capital and a diverse workforce as material, competitive factors for business success.”

There have been only a handful of studies on the subject of ethnic diversity. One often-cited study conducted by McKinsey in 2015, suffered from a small sample size.

McKinsey released a study in 2020 that showed the business and investment case for executive team diversity remained strong for diversity.

Chen says more data is now available due to more companies reporting to the US Federal Equal Employment Opportunity Commission, as well as equivalents in other countries, which was not the case even just five years ago. She also states that despite this data being optional, it is provided by a sufficient proportion of employees to be considered reliable.

Due to this, Calvert was able to use a larger data set, focusing on the period from December 2012 to December 2020 and including 845 large companies – 65 Australian, 83 Canadian, 87 British and 610 US firms – to explore recent trends in ethnic diversity at corporate boards as well as its relationship to equity performance.

The countries were chosen because of their larger data sets, the ease of gathering this data, and cultural similarities, which meant they were more comparative, Chen told ESG Investor.

To differentiate among underrepresented groups and compare across countries Calvert set up a framework of seven ethnic groups, based on the latest data from each country’s national census. The metric, referred to as ethnic fractionalisation, measures the likelihood that two randomly chosen people have different ethnicities. According to Chen, it offers a more nuanced approach than a binary metric, such as ‘white versus non-white’.

The study found that, on average, large-cap Australian, Canadian, British, and American corporate boards have become more ethnically diverse, with American boards being the standouts.

While the US has the largest percentage of diverse ethnicities in its population, Chen says part of the reason for its outperformance was that two of the countries – Australia and Canada – are much more resource-based economies.

“The service-based economies are consumer discretionary and more consumer-facing,” says Chen. These industries rely more on talent, which is why, Chen adds, they focus more on ethnic diversity when they manage the company’s risks. “Because human capital management will be a key factor for those companies,” she added.

“We found a significant relationship between the degree of corporate board ethnic diversity relative to country demographics and monthly equity performance,” said Chen. “Our research suggests that using ethnic diversity factors can improve US large-cap equity stock selection. There may be additional benefit in tilting toward more ethnically diverse companies across all four markets,” Chen said.

According to a recent Cerulli Associates and Russell Investments study, asset owners see diversity and inclusion (D&I) as the most critical component of ESG measurement among asset managers. It said, about one-third (34%) of asset owners view D&I as the most important criteria used to evaluate managers on ESG matters.

Change in the market

Chen found a significant link between monthly equity returns and the level of board ethnic diversity factors relative to the company’s home country demographics. In particular, two factors showed a statistically significant positive correlation with monthly equity returns and meaningful differences in return between the top and bottom quintiles: the percentage of people of colour on the corporate board relative to the country demographic and the ethnic fractionalisation of the corporate board, relative to the country demographic.

However, the overall results were more complicated. “We found no evidence of a significant relationship between the monthly equity returns and absolute levels of board ethnic diversity factors,” said Chen.

While more research is needed for evidence, investors are increasing pressure on companies to improve diversity at senior levels. Goldman Sachs Asset Management announced an update to its proxy voting policies to increase diversity expectations for public company boards in December.

“From March 2022, Goldman Sachs Asset Management will expect companies in the S&P 500 and FTSE 100 to have at least one diverse director from an underrepresented ethnic minority on their board,” it said in a statement. Goldman Sachs added that it expected public companies to have at least two women on the board unless the board has fewer than ten members or where local requirements are already higher than this. “[Goldman Sachs] will vote against members of the nominating committees that do not meet these expectations, and in the US it will vote against all members of the boards that do not include any women.”

This is similar to the requirements of the UK’s Parker Review, which expects FTSE 100 companies to appoint at least one ethnically diverse board member by the end of this year.

Goldman Sachs directly linked diversity to good performance: “The increased diversity requirements sit alongside broader engagement efforts that our stewardship team undertakes to encourage inclusive corporate behaviour that it believes drives strong performance for shareholders.”

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