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2 Big Ways Corporate Diversity Can Improve Stock Price

By Matthew Frankel, CFP® – Jul 17, 2020 at 7:07AM

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Workforce diversity is certainly a socially responsible thing to do, but it could also be a great move for investor returns.

Right now, ESG investing -- which stands for environmental, social, and governance -- is growing in popularity for investors. Simply put, more and more investors don't want to put their money into companies that don't take care of the environment, don't hire and treat their employees ethically, and don't have shareholder-friendly governance.

Corporate diversity is a big part of the social and governance aspects. Does a company hire a diverse workforce, and are advancement opportunities equal for all genders and minority groups? Is a company's board of directors made up of a diverse group of women, men, and minorities?

Now, actively striving to achieve corporate diversity is clearly the socially responsible thing to do. But it may also significantly benefit shareholders.

Group of people of different ages, genders, and ethnicities.

Image source: Getty Images.

Investors want to own responsible companies

Investors could be more willing to buy the stocks of companies that do a good job of promoting diversity and inclusion, and this could create more demand for shares than there otherwise would be. In fact, in a Stanford Graduate School of Business study, researchers found that stock prices tend to increase more when corporate announcements reveal a higher level of diversity.

There are tons of factors that can influence stock prices, but at the end of the day, the stock market is governed by supply and demand. If one company's stock has more buyers than another, all other factors being equal, that stock will likely perform better.

An expanded talent pool means better performance

Some research has indeed shown that diversity on corporate boards and within C-suites can be a positive catalyst for business results. And there are several explanations that have been suggested, such as that more diversity means more creativity. But the biggest explanation may boil down to a simple math problem.

Consider this hypothetical scenario. Let's say that you have an applicant pool of 100 qualified prospects and that you need to fill five executive level jobs. And we'll say that these 100 people are representative of the American public-that is, 51 of them are women, 18 of them are Hispanic or Latino, 13 are African American, six are Asian, and one is another minority. So, just 49 are men and if the minority groups are equally distributed by gender, just 30 of those men are white.

Here's the point. If your goal is to choose the five best candidates to fill these positions, you'd be excluding 51% of your available talent pool by only selecting men. Only selecting white men means that you would ignore 70% of the candidates. Statistically, if your goal is to choose the five best candidates out of 100, by limiting your search to just men who aren't minorities, you'd be lucky to end up with just one or two of the top five. On the other hand, by carefully reviewing all 100 candidates, you'll be sure to find the best five for the positions.

In a nutshell, in addition to the fact that inclusion of women and minorities is clearly the right thing to do from a social responsibility standpoint, choosing your leaders from the largest talent pool possible is just good business.

The statistics back this up. A 2011 research report found that companies with three or more women on their board of directors outperform companies with all-male boards in return on equity (ROE) 60% of the time. And in a 2015 report from McKinsey & Company, companies with relatively culturally and ethnically diverse executives achieved above-average profitability 33% more often than non-diverse peers.

The Foolish bottom line

Socially responsible investing isn't only about insisting that companies do the right thing for the environment, their employees, and their shareholders. Companies that actively practice inclusion and diversity could actually have a leg up on their rivals when it comes to the performance of their business as well as their stock price.

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