Published in The National Business Review (Auckland), 11 December 2015
Some things are worth doing even if they do not directly improve the company’s bottom line. Other things that could improve a firm’s profitability could nevertheless be wrong to do.
A firm that knew it could cheat its customers in a way that could never be detected still should not do so: considerations other than profits are also important.
At the same time, it is also important to be realistic in sorting out which policies are worth doing for their own sake and which let companies do well while doing good.
Recently, on NBR ONLINE, there was a bit of a debate between Treasury secretary Gabriel Makhlouf and the New Zealand Initiative’s head of research Eric Crampton.
Mr Makhlouf pointed to the numerous benefits of diversity and also claimed that the business case for greater diversity was clear – that international research showed stronger performance by firms with more balanced board representation.
Dr Crampton, meanwhile, pointed to substantive literature in academic finance journals showing those measures did not improve profitability and may even hurt the bottom line, while not questioning there could be other good reasons for pursuing diversity.
To declare my personal interests, Mr Mahklouf and I get on well and I do not doubt his good intentions in highlighting the benefits of diversity. Dr Crampton is, of course, a colleague for whom I hold the greatest professional respect as an economist. And I was for a while a member of Diverse NZ’s working group.
I find it strange to hold the case for greater diversity hostage to empirical fortune. The academic literature seems reasonably clear: any link between board diversity and firm performance is, at best, shaky. But should that matter? As mentioned earlier, some things may not be right even if they are efficient. And others may not be wrong even if they do not yield an economic return. The debate on board diversity is a case in point.
For the sake of the argument, just imagine there was conclusive evidence that boards made up exclusively of white, middle-aged men resulted in the highest levels of profitability on average. Would this provide a justification for a government policy intervention banning women on boards?
If your answer is yes, then you are committing several logical and ethical mistakes at once.
First, an average result across different companies does not tell you anything about individual performance. Circumstances in each individual company are necessarily diverse so you would need to be courageous to infer a general rule from such an analysis – though the literature Dr Crampton cited was rather careful to control for the ways companies can differ.
More importantly though, on what basis should anyone prescribe to the owners of a private company what kind of people they would like to see on their boards? From a property-rights perspective, a company board acts as an agent of shareholders.
It is the shareholders who ultimately have to bear the risk of poor governance. And so shareholders, who appoint boards, should have realistic expectations about which measures improve profitability, and which are simply the right thing to do.
So far, so conventional. This is why most free-marketers reject diversity quotas. But there is a more philosophical objection, too.
If a company only selected some of its directors to fulfil the desire for a certain pattern of gender, ethnicity or age composition, would this be morally acceptable? It depends on whether you follow Robert Nozick on theories of justice.
Nozick distinguishes between patterned theories of justice, which hold that outcomes are just if they conform to particular patterns, and process-based theories of justice, which argue that many different outcomes can be justifiable if the process leading to them was fair.
Freedom of the individual
Applied to the appointment of company directors, if you are selecting directors based on who will do the most good in helping the company achieve its objectives, boards consisting entirely of women, or entirely of men, or anywhere in between could be eminently reasonable. But your company’s background processes would need to be fair.
Therefore I find the debate about linking diversity and profitability only marginally interesting at best. Whether diversity on our boards has an impact on average profits matters less than ensuring fair and equitable processes for appointing people to boards.
If you base your argument for diversity on the notion that diversity increases profits, you have already lost. If the academic literature showed strong harms from board diversity rather than little real effect, would that make you an advocate for systematic discrimination? Of course not, I hope.
We believe in diversity because we believe in the freedom of the individual. We believe in diversity because everyone, regardless of his or her background, should enjoy equal rights. We believe in diversity because we know that talents are widely distributed around society.
Fundamentally, the reasons why we believe in diversity are the same reasons we favour market solutions. Markets manage to bring a diversity of people together regardless of their backgrounds. They allow them to find out what their comparative advantages are and let them engage in mutually beneficial exchange.
In this way, markets are a discovery mechanism for talent. That is their utilitarian aspect. At the same time, markets are the only way to give people the freedom to act for themselves rather than being somebody else’s means to an end. That is the moral case for markets.
If talents are distributed widely, then companies would be foolish to restrict their search for talent to just one subset of society. This is perhaps even more important for the executive level of companies rather than their boards, and this is where more efforts could be made.
Boards are typically recruited from former top executives anyway. If you facilitate greater diversity there, greater non-executive diversity should follow almost automatically. So let’s rather focus our attention on executive diversity.
Women still sometimes find it hard to combine having children with a professional career. Companies offering assistance in this respect will not only retain their talent but also enjoy greater staff satisfaction and loyalty as a result. And these companies would be helping to ensure a fair process down the track.
Then there is the issue of unconscious bias, which might mean that candidates with foreign-sounding names do not have the same chance of being invited for job interviews. Companies engaging in such practices are behaving morally questionably while limiting their ability to attract talent.
Again, it is only right for companies to monitor their diversity performance in this respect.
In all of this, diversity should never be a box-ticking exercise. Nor should it be undertaken with just a narrow focus on profit maximisation. Nor should diverse outcomes be an end in itself.
We are committed to diversity because we are human beings who believe in personal freedom, human dignity and equal rights under the law.
So if your company has a diversity policy and culture, if you are trying to do what is right and if you believe in diversity because it matches your company’s values, congratulations. That it might not automatically strengthen the bottom line does not make it any less morally worthy.