Diversity and Company Performance: Window Dressing or Successful Policy?

Achieving gender equity in the corporate world has proved to be a slow and challenging journey. In both developed and emerging markets, women are a minority at both management and board levels. Decades after women began taking on professional and managerial roles, the so-called “glass ceiling” appears to be stubbornly persistent.

Recent McKinsey research shows that over the last decade, the impacts quotas and investor pressure have on improved gender representation became more positive on average. The question that remains is: Has this increase in gender diversity had a meaningful impact on company performance?

Gender Diversity and Firm Characteristics: Correlations

To understand the potential drivers for gender diversity, we turn to firm-level attributes and examine the correlation of gender diversity with a variety of firm-specific characteristics—the type of indicators that we would look for in our quantitative company analysis process.

Table 1 reports the average cross-sectional correlations of the firm gender diversity (as captured by the percentage of females in senior management—senior management gender diversity and the percentage of females on the board—board gender diversity) with several firm characteristics. The highest correlation of 1 is represented in the lightest color, and the lower correlation is shown in the darker colors.

Table 1: Correlation of Gender Diversity Metrics with Other Firm Characteristics: MSCI ACWI

Source: Realindex Investments and FactSet (January 1, 2009-December 31, 2021)

We find that gender-diverse firms (both board and senior management) are typically higher quality firms, where gender diversity has a positive correlation with return on assets (ROA), return on equity (ROE), and profit margins (Gross and Net Profit Margins). They also tend to have higher price returns over the previous year (MOM12M) and lower market volatility, as evidenced by the negative correlation to 12-month price volatility (VOL12M).

We also find that larger capitalized firms (as captured by Size) tend to have higher diversity, especially in the boardroom, while diverse firms also appear to have high valuation multiples, as seen by the negative correlation between the diversity metrics and book yield (BY) and earnings yield (EY).

Diversity and Future Operating Performance

The questions that follow are:

• Has increased female representation made a meaningful impact on firms by improving their operating outcomes?
• Does senior management gender diversity have a more material impact than diversity in the boardroom?

The central proposition behind this is that diversity in management, and more generally, leadership, would lead to greater innovation and, in turn, better financial or operating performance. To answer these questions, we looked at whether there is a link between diversity and the profitability/performance of the firm.

Various studies have examined the link between diversity and company performance, including McKinsey (2015, 2018, and 2020) and Boston Consulting Group (2018).

Those studies conclude that diversity and financial performance are correlated and that firms with above-average diversity scores are more likely to generate increased revenues from research and development (R&D)-related products and services. These studies have, however, relied on smaller, survey-based samples and offered snapshots of diversity at particular points in time.

While previous studies on the correlation of diversity and financial performance have relied on smaller, survey-based samples, our analysis examines a broader cross-section of companies globally.

Our analysis has extended these insights by examining a broader cross-section of companies globally, spanning more than 30 countries and over 2,500 large cap firms and covering an extended time period spanning more than a decade (i.e., from 2009).

Following some of this work, we initially investigated if there is a link between diversity and profitability. For both board and senior management gender diversity, we looked at profitability metrics commonly investigated in other studies, such as gross and net profit (EBIT) margins. Some interesting results emerge over the sample period, as highlighted in Figure 17.

• In any given year, higher-diversity firms (those approximately in the top one-third of all firms) have about 20% higher margins in the following 12 months than lower-diversity firms (those approximately in the bottom one-third of all firms)
• In terms of EBIT margins, diversity in senior management is correlated with approximately 30% higher future profit margins, while diversity at the board level board has a less significant effect

We find that gender diverse firms (both board and senior management) are typically higher quality firms, where gender diversity has positive correlation with return on assets, return on equity, and profit margins.

Figure 17: Gender Diversity and One-Year Ahead Margins

Source: Realindex Investments and FactSet (January 1, 2009-December 31, 2021)

Our analysis then examined future operating performance over multiple years by testing whether a firm’s return on equity (ROE) is impacted positively by gender diversity. To do this, we again ranked firms based on their senior management level or boardroom gender diversity and examined ROE performance over the next five years.

The results for senior management are highlighted in Table 2 and Table 3 for the boardroom. The data shows that for senior management, higher-diversity firms are able to generate cumulative ROEs that are almost 30% higher than lower-diversity firms over a five-year period. Similarly, for boardroom diversity, cumulative ROE for high boardroom gender diversity firms outstrips firms with low diversity, by 20%.

Table 2: Senior Management Gender Diversity and ROE

Source: Realindex Investments and FactSet (January 1, 2009-December 31, 2021)

Table 3: Boardroom Gender Diversity and ROE

Source: Realindex Investments and FactSet (January 1, 2009-December 31, 2021)

To understand whether these results are robust, we examined whether the relationship remains after controlling for a number of other common factors. This will allow us to determine if diversity is essentially just picking up other characteristics of the firm that are known to be related to future operating performance.

We can control for several firm characteristics, such as past profitability (captured by the current level of ROE), valuation (captured by the firm’s book-to-price ratio), price-based momentum (captured by the firm’s previous 12-month price return), and size (captured by the firm’s market capitalization) as well as sector and region effects.

Controlling for Common Factors in the Data

We take the raw diversity values in a given year, for a given firm, and de-mean its value for the average sector and regional effects. Doing so also effectively removes the positive trend in gender diversity that was observed earlier. The diversity scores now represent the firm’s relative diversity score after controlling sectors and regions. This means the firm’s diversity score is now relative to its sector and regional peers.

These relative diversity scores are then used to determine whether diversity can predict the forward profitability of the firm over the next five years. This is achieved by running a regression of forward five-year ROE against the relative diversity score, as well as several controls that are likely to influence future ROE, including the current level of ROE. To facilitate comparability, the relative diversity scores are ranked into deciles, which are in turn used in the regressions.

 This analysis points to the robustness of our earlier results and reveals the following insights:

• Controlling for sector and region effects, as well as other firm-level characteristics, both senior management and board gender diversity are strongly statistically significant in predicting future firm-level profitability
• For either metric, we can see that firms in the top decile of gender diversity are able to generate approximately an additional 5% of ROE over the next five years, compared to firms in the bottom decile of either diversity metric, after controlling for other effects that drive firm performance
• Despite their correlation, the presence of both diversity metrics within the same regression does not invalidate the significance of either metric. In fact, we find that firms in both the top decile of senior management and board diversity generate approximately an additional 10% of ROE over the next five years compared with firms that have low (bottom decile) diversity in both senior management and the board. This suggests the importance of gender diversity for both boards and senior management teams; both can be predictors of financial performance.

This article contains excerpts from “Beyond Lip Service: Tracking the Impact of the Gender Diversity Gap” (Nash, Guido, 2022, 25-30). For a complete analysis of how gender diversity interacts with various company performance and investment indicators, view the research paper in its entirety.

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