ESG Leads to Increased Employee and Board Diversity

Issue March/April 2022 April 2022 By Valerie C. Samuels and Kaila D. Clark
Labor & Employment Law Section Review
Article Picture
From left: Valerie C. Samuels and Kaila D. Clark

Environmental, social and governance (ESG) issues have become important to publicly traded companies, and many non-public ones as well. Many socially responsible investors screen companies using ESG criteria, and the number of investment funds that incorporate ESG factors has grown rapidly since the beginning of this century. This trend has not only continued, but exploded during the pandemic, as people were glued to their devices to get real-time global updates. This should have a profound impact on diversity initiatives, the “S” in ESG, as employers realize diverse workforces increase their appeal to investors and employees alike. This is an important issue for employment lawyers, as we are often called upon to advise on diversity best practices and defend employers who failed to heed the call of diversity.

Here is an example of ESG in action: In December 2020, Engine No. 1, an activist and impact investing hedge fund, was founded. That same month, Engine No. 1 challenged Exxon Mobil, the world’s largest publicly traded oil and gas company, to change its ways and bought a stake in ExxonMobil worth $40 million, which equated to about 0.02% of the oil company’s shares. Engine No. 1 garnered international attention when, in less than six months, it successfully led a shareholder revolt in early 2021 to unseat three directors on ExxonMobil’s board and replace them with nominees who would make climate change a central issue. 

After its unprecedented win against ExxonMobil on climate change, Engine No. 1 is widening its work to include diversity issues. Motivated in part by the growing national conversation about race, Engine No. 1 will ask its portfolio companies to explain their obligations to workforce demographics. ESG-centric funds, like Engine No. 1, are responding to the social climate of the nation and broadening their efforts to include social issues such as Black Lives Matter, human rights, gender diversity and worker safety, and to governance issues that encompass board diversity, transparency and reporting, and other issues.

According to a study performed by Calvert Research and Management, a unit of Morgan Stanley Investment Management, over the last several decades, the key driver of the global economy shifted from natural resources to human talent, making diverse talent a social imperative. Just ask the people behind TikTok, a social app used to create and share videos. In the summer of 2020, as protests calling for racial justice and equality swept the country, TikTok experienced a blackout on the app calling for Black creators to be treated more fairly amid accusations of censorship and content suppression. TikTok, whose popularity was significantly helped by Black creatives, apologized, vowing to do better. TikTok vowed it wouldn’t just say it wanted a more diverse platform; it would make it happen. Some steps taken included the creation of an independent advisory board and bringing in more diverse advisers. TikTok is not alone. Many companies are actively promoting diverse and inclusive cultures to attract and retain talent and drive innovation. 

That diverse teams drive better results for companies is not limited to creativity. A recently published study by Calvert Research and Management reveals that using racial and ethnic board diversity factors can improve U.S. large-cap equity stock selection. The Calvert study analyzed over 800 large-cap companies in the United States, United Kingdom, Canada and Australia from 2012 to 2020. Calvert tested the relationship between the ethnic diversity of corporate boards and equity performance, and found that companies with greater board diversity may be better stock picks. For U.S. companies, the study found, racial and ethnic diversity on corporate boards of large-caps had a significant positive impact on stock price: the difference in returns between stocks of companies with the highest number of people of color on their boards and those with the least was 1.5%. 

A 2015 study conducted by McKinsey & Company found that companies in the top quartile for racial and ethnic diversity were 35% more likely to have returns above their national industry medians than less-diverse peers. Although studies on the impact of gender are somewhat limited, research focusing on the relationship between gender diversity and company performance supports the same conclusion that board diversity improves company performance. According to a 2020 article in Forbes, women hold more jobs than men in the United States. Hopefully, we will see women increasing their numbers in senior management and board roles as well.

Companies in the top quartile for gender or racial and ethnic diversity are more likely to have financial returns above their national industry medians (15% and 30%, respectively), whereas companies in the bottom quartile in these dimensions are statistically less likely to achieve above-average returns. Racial and ethnic diversity has a stronger impact on financial performance in the United States than gender diversity and, in the United States, there is a linear relationship between racial and ethnic diversity and better financial performance (for every 10% increase in racial and ethnic diversity on the senior executive team, earnings before interest and taxes rise 0.8%). Thus, the research proves that companies with more diverse workforces perform better financially. Not only should companies use workforce diversity as a strategy to help attract and retain talent, enhance intellectual capital and drive long-term value creation, but diversity improves financial performance.

Companies that commit themselves to diverse employees and leadership will be more successful. Achieving greater diversity may not be a simple task for businesses, but it should not take a social media blackout or a shareholder revolt for companies to recognize the value of diversity, equity and inclusion. As companies pay more attention to diversity, it is important to remember that diversity is not the same thing as inclusion. Diversity is inviting people to the table, but inclusion necessarily involves empowering those diverse voices. Having a diverse corporate board is an important metric and it surely makes for great marketing, as does a diverse workforce, but savvy investors know the difference between window dressing and actual change. 

As companies do this important work, it is equally critical that they take full advantage of the opportunity that diverse leadership teams represent, and realize that the work includes attracting, developing, mentoring, sponsoring and retaining diverse talent at all levels of the organization. As trusted advisers to our clients, management-side employment lawyers are an essential driver of change. So, too, are employee-side attorneys, who work to ensure that companies create and maintain diversity at work.

Valerie C. Samuels is a partner in the nationally recognized Labor and Employment Group at Arent Fox LLP. She focuses on discrimination, sexual harassment, reductions in force, wage and hour, and restrictive covenants. Samuels provides harassment, discrimination and diversity awareness training, and drafts employee handbooks, social media and other policies. Samuels also has substantial expertise in executive advocacy and transition, representing executives and professionals in complex employment issues, including contract negotiation, non-competition and non-solicitation covenants, severance, change of control, deferred compensation, and equity interests.

Kaila D. Clark is an associate at Arent Fox LLP. Clark assists on a variety of complex litigation matters.