Board games aren’t enough — real change on diversity has to happen at all levels in the organization
If the words diversity, equity and inclusion were not already in senior executives’ minds, Nasdaq’s December 2020 proposal that firms would need to disclose hard figures about their board composition to the market will have changed that. Subject to SEC approval, the tech-focused exchange will require listed firms to have a minimum of one woman director, and one person who is from a minority or LGBTQ background on their boards. Companies that can’t meet this requirement will need to explain why.
The next day’s Wall Street Journal condemned Nasdaq’s proposal, saying it would “harm economic growth and job creation”, but the financial paper appears out of touch with the wider mood. Congress is considering legislation requiring each SEC-registered company to provide board diversity statistics, and to disclose whether it has a board diversity policy in place. In September, New York became the latest US state, on a list including California, to take legislative action related to board diversity, meaning there are now 11 states which have either introduced or are considering laws in this area.
Definitions of diversity abound, and one of the more digestible was coined by Netflix’s current VP of inclusion strategy, Vernā Myers, who said in 2015 that, “Diversity is being invited to the party; Inclusion is being asked to dance.” Despite the increased focus on workplace diversity in the time since Myers made her comments, efforts on widening access to parties and encouraging more people onto the dancefloor remain focused on the C-suite. Nasdaq’s move is a good example: it’s explicitly aimed at increasing board diversity and doesn’t cover company-wide implementation of similar goals.
Key to successfully instituting cultural change within organizations is taking action at every level, not just within senior management, and here, the message is less positive. According to the European consortium for internal audit institutes (the ECIIA), diversity challenges barely made it to the top five risks that internal auditors perceived for 2021, and that was under a broader heading titled “Human Capital and Talent Management”. This trend of not involving internal audit in diversity initiatives was reflected in Deloitte’s September 2020 “Board Practices Quarterly Diversity, Equity, and Inclusion” report, in which just 1% of survey respondents said their company’s audit committees have oversight of diversity issues.
This is a missed opportunity; the internal audit function could help diversity and inclusion initiatives by reviewing their outcomes to see if they are in-line with expectations, and reporting on the conclusions to the board. One way to ensure that diversity initiatives are successful would be to appoint a Chief Diversity, Equity and Inclusion Officer, reporting directly to the CEO, whose main goal is to facilitate frank, and potentially uncomfortable, conversations across the whole organization on diversity issues.
While diversity might intuitively be seen as a role for Human Resources, the HR function deals exclusively with a firm’s internal workforce, whereas a chief diversity officer can also look at third-party relationships, such as the company’s key vendors, which sit outside of HR’s responsibilities.
Diversity needs to be discussed across the whole of businesses because its benefits will impact all company functions. In its submission to the SEC, Nasdaq quoted a raft of reports pointing to business advantages gained from recruiting out of a broader pool of candidates. Critically, a number of these advantages applied to all firms, both listed and non-listed, as well as those in the non-profit sector.
The macro case was published by alternative asset specialist, The Carlyle Group. Its 2020 research found that its portfolio companies with two or more diverse directors had an average earnings growth of 12.3% over the previous three years, compared to 0.5% among portfolio companies with no diverse directors.
Positive impacts from increasing diversity also come in less tangible forms; for example, firms with a less homogeneous workforce will better reflect the communities they serve. A 2019 survey by advocacy group, the Greenlining Institute, which looked at the 10 largest depository banks in California found, on average, people of color make up 30% of boards, versus 67% of California’s population. Greenlining’s report observed that if corporate leadership at financial firms better reflected the communities they served, it would enable them “to effectively build trust with consumers and make capital and financial services accessible”, a statement which is also true for firms outside of the report’s core focus area.
This must change and looks like it will: In September 2020, industry standard setters, the Institute of Internal Auditors of North America, put out a statement saying that internal audit functions have to “embed social equity and corporate social responsibility” in their strategy and culture. In recent years, internal audit functions have moved beyond traditional assurance and into areas such as culture risk, giving them the skills to audit an area like diversity. The chief audit executive should bring it to the attention of the firm’s senior management as part of cultural audit recommendations or risk assessments.
Corporate management is also better served by diversity. A 2016 study conducted by Pucheta‐Martínez et al. demonstrated the positive impact of increased diversity had on individual business functions. It concluded that increasing the number of women on firms’ audit committees “improves the quality of financial information”, with greater female representation on audit committees reducing the probability of errors, non-compliance or the omission of information. These issues are of even greater importance than usual with the impact of COVID on working practices leading to fears of higher levels of fraud as we step into 2021.
Whatever approach companies take, one thing is clear: Nasdaq’s move isn’t the only, or last, requirement that firms will face with respect to diversity and inclusion, and it’s vital that audit functions — and other parts of the business — start to focus on it. If they are not already looking at these issues, now would be an excellent time to start.