Published in General
'Diversity' is a loaded term pregnant with notions of fairness and as a consequence has traditionally courted a great deal of controversy. Who can forget the publication of Lu Hong and Scott Page's 'Diversity Trumps Ability' theorem in 2004 which seemed to offer mathematical proof that in situations where groups of agents had to work together to solve a problem, groups comprising of 'diverse' agents of varying ability would out-perform groups made up solely of 'experts'. The theorem has since been roundly criticised in academic circles as a salutory example of bad maths and lacking any 'real world' application.
Twelve years on, some interesting research from global Consulting firm McKinsey's suggests that if the nexus between diversity and problem solving capability remains unproven, then one certainly seems to exist between diverse leadership and corporate financial performance.
By adapting the Herfindahl-Hirschman Index (HHI), a tool that has been used by economists for decades to determine the level of competitiveness within markets and industries, McKinsey's have been able to better evaluate companies with the same proportion of majority representation on their executive teams using the range of ethnic backgrounds outside the majority. The size of the dataset allowed for results that were statistically significant and also allowed for the qualification of the value of the relationship in terms of the observed uplift in earnings before tax and interest (EBIT) relative to the diversity of the leadership teams analysed.
The research found that companies in the top quartile for gender or racial and ethnic diversity were more likely to have financial returns above their national industry medians. Companies in the bottom quartile in these dimensions were statistically less likely to achieve above average returns. Additionally, diversity was probably a competitive differentiator that shifted market share towards more diverse companies over time.
While correlation does not equal causation (a greater gender and ethnic diversity in corporate leadership doesn't automatically translate into more profit), the correlation does indicate that when companies commit themselves to diverse leadership, they are more successful.
According to the research, more diverse companies are better able to win top talent and improve their customer orientation, employee satisfaction and decision-making, and all this leads to a virtuous cycle of increasing returns. This in turn suggests that other kinds of diversity - for example, age, sexual orientation and experience (such as global mind-set and cultural fluency) are also likely to bring some level of competitive advantage for companies that can attract and retain such diverse talent.
McKinsey's have been examining diversity in the workplace for several years and in the 'Diversity Matters' report, they reviewed proprietary data sets for 366 public companies across a range of industries in Canada, Latin America, the United Kingdom and the USA, examining metrics such as financial results and the composition of top management and boards. The findings were clear:
- Companies in the top quartile for racial and ethnic diversity are 35 percent more likely to have financial returns above their respective national industry medians.
- Companies in the top quartile for gender diversity are 15 percent more likely to have financial returns above their respective national industry medians.
- Companies in the bottom quartile both for gender and for ethnicity and race are statistically less likely to achieve above average financial returns than the average companies in the data set.
- In the United States, there is a linear relationship between racial and ethnic diversity and better financial performance: for every 10 percent increase in racial and ethnic diversity on the senior executive team, EBIT rose by 0.8 percent.
- Racial and ethnic diversity has a stronger impact on financial performance in the United States than gender diversity, perhaps because earlier efforts to increase women's representation in the top levels of businesses have already yielded positive results.
- In the United Kingdom, greater gender diversity on the executive team corresponded to the highest performance uplift in the data set: for every 10 percent increase in gender diversity, EBIT rose by 3.5 percent.
- While certain industries perform better on gender diversity and other industries on racial and ethnic diversity, no industry or company is in the top quartile on both dimensions.
- The unequal performance of companies within the same industry and same country implies that diversity is a competitive differentiator, shifting market share towards more diverse companies.
About the author
Taken from 'Diversity Matters'. Vivian Hunt is a Director at McKinsey's London Office along with Dennis Layton, who is a Principal. Susan Price is a Principal at the Atlanta Office.