Investors Are Committing to Action on Diversity. Now What?

By: Marcela Pinilla, Manager, Financial Services and Impact Investing, BSR and Nandini Hampole, Associate Director, BSR

Amid a wave of societal commitments to action on diversity, equity, and inclusion (DEI) and racial justice, investors are stepping up commitments and vowing to intensify engagement with companies on DEI.  Despite some progress made to reflect a country’s demographics in the corporate office, in the U.S. and around the world, we are now amid a racial reckoning that calls on all of us to reflect on the real progress made and what needs to advance for real change.

So, what does that mean for companies, and how should they prepare to meet the moment?

The business case for diversity in the workplace is crystal clear. The most recent evidence includes a McKinsey report finding that companies with greater gender diversity are 25 percent more likely to experience above-average profitability compared to their counterparts. In the alternatives space, the average earnings growth of portfolio companies with two or more diverse board members has been nearly 12 percent per year greater than the average of companies that lack diversity, according to private equity firm The Carlyle Group.  

Investors Want Transparency from Companies on the Diversity of Their Workforces

Investors, passive and active alike, are more than ever urging companies to go further and to do so transparently as DEI is integrated into investment decisions and corporate engagement activities. There is a clear and unambiguous ask from investors for U.S.-based companies to disclose annual data on the composition of their workforce disaggregated by race and ethnicity, gender, job category, and, as of recently, pay equity, using the U.S. Equal Employment Opportunity Commission’s (EEOC) EEO-1 form. These reports tell a story of the makeup of a company’s workforce over time.

Currently, only a fraction of companies, or 4 percent of companies of the Russell 1000, release the full data they are required to collect each year and disclose through an EEO-1 report. A more recent survey by Bloomberg revealed that in the S&P 100, as many as 25 companies have released their EEO-1 report, many for the first time, and others plan to do so in 2021. First-mover companies that publish their EEO-1 report are likely to be better off for it by holding themselves accountable to the progress they have committed to make and in doing so proactively rather than reactively.

There is a clear and unambiguous ask from investors for U.S.-based companies to disclose annual data on the composition of their workforce disaggregated by race and ethnicity, gender, job category, and pay equity.

Investors also request disclosure beyond the EEO-1 report, including turnover by region, and critically, what the company strategy on DEI is across the enterprise, including its governance. As pressure continues to build around diversity of board and executive leadership, proxy advisor Institutional Shareholder Services (ISS) has directed letters to U.S. companies asking for self-identified race and ethnicity data at the director and senior executive level. Likewise, the Workplace Equity Disclosure Statement—with investor backing of US$1.88 trillion in combined assets under management (AUM)—calls on companies to release meaningful data on policies, practices, and outcomes related to workforce composition, promotion, recruitment, and retention rates, as well as pay practices.

Investment managers are also increasingly requesting privately-held companies to provide data on race, ethnicity, and gender, particularly at the executive and board levels. In addition, some private equity firms are setting targets to improve DEI in their portfolio companies over a three- to five-year timeline. 

Investors Want Companies to Take More Action on DEI

There is clear investor support for broader actions on diversity. Large institutional investors have articulated their expectations on diversity, from disclosure to strategy and implementation, through letters to the board chairs of the public companies in their portfolios, while active investors have filed several proposals on these topics. Investors and advocacy groups making a broader case for a diverse workplace will expect to see evidence of how companies are recruiting, retaining, and promoting diverse talent across corporate functions, including recruitment of board members.

Investor coalitions like the Racial Justice Investing Coalition seek to engage with, amplify, and include Black voices in investor spaces and company engagements, taking direction and guidance from their lived experience. The Thirty Percent Coalition, known as the Coalition for U.S. Board Diversity and representing over US$6 trillion in combined AUM nationally and internationally, has articulated the resolve of institutional investors to continue to press for more board diversity across gender, race, and ethnicity.

Investors and advocacy groups making a broader case for a diverse workplace will expect to see evidence of how companies are recruiting, retaining, and promoting diverse talent across corporate functions, including recruitment of board members.

As investor action on DEI escalates, we may see more investors and stakeholders taking litigious steps to demand action. For instance, earlier in 2020, shareholder derivative lawsuits were filed with the boards of three large technology companies for failing to deliver on diversity in their boards and executive ranks. Complaints have been filed with other companies for breaching their fiduciary duty by making false assertions about their diversity commitments.  

Investors may also:

• Ask for disclosure on additional categories of diversity, including LGBTQ+
• Scrutinize how companies’ products and services can impact DEI, whether they are conducting relevant human rights impact assessments, and how they make DEI part of product design and roll out
• As a result of the point above, diversity as an element of broader human rights company engagements could also take shape

Investors Will Take Action during Proxy Season

Investors want a clear strategy on the role that diversity plays at the management level and on the boards of companies. Outcomes from the past few proxy seasons have demonstrated that these are issues companies will likely hear about in the 2021 proxy season.

Investor requests for additional quantitative and qualitative information, such as the role that diversity plays in the firm’s broader human capital management practices and long-term strategy, will increase. Companies that delay or do not engage with their investors could expect to receive shareholder proposals asking for key metrics such as median gender and racial pay equity and diversity data. Blackrock, State Street, and Vanguard, among others, are going further in seeking to understand company performance across a variety of diversity-related issues. While institutional investors typically do not file shareholder proposals, they will exert their influence through proxy voting.

The impact of the use of mandatory arbitration on companies’ employees and workplace culture in employment policies is becoming a key indicator of policy actions to drive equity and inclusion. Investors and advocates see the use of arbitration as being a facilitator of the prevalence of harassment and discrimination in the workplace and on employees’ ability to seek redress for claims of discrimination.

It is imperative that companies respond to these investor interests by developing clear DEI strategies, integrating them into their core business, developing cross-functional communications between sustainability teams, human resources, investor relations, and the C-suite and board of directors, and, not least, engaging their investors.

How Companies Can Respond to Investors’ DEI Interests

Across the capital structure, we see companies making efforts to reduce the gender and race divide. BSR believes it is imperative that companies respond to these investor interests by developing clear DEI strategies, integrating them into their core business, developing cross-functional communications between sustainability teams, human resources, investor relations, and the C-suite and board of directors, and, not least, engaging their investors.

It is time for a deliberate, thoughtful, and humble reset of the role that the corporate world will play in creating diverse, equitable, and inclusive workplaces. The theme for BSR Conference 2020 is an active sentence: Meet the Moment, Build the Future. If you’re interested in learning more on this topic, please join our conference session, How Can Investors Better Address Diversity, Equity, and Inclusion? and contribute with your thoughts, questions, and ideas to advance DEI in your organization. To learn more about BSR’s work on DEI, please don’t hesitate to reach out to our team.

Originally appeared on BSR.