Analysts and Investors Penalize Diversity

THE FORECAST OF EARNINGS PER SHARE AND THE MONEY PROVIDED BY INSTITUTIONAL INVESTORS ARE SYSTEMATICALLY LOWER FOR TARGET COMPANIES WITH MORE DIVERSIFIED TOP MANAGEMENT

by Alberto Manconi, Bocconi Department of Finance

Stock market investors are becoming increasingly vocal about the diversity of corporate leadership; Institutional Shareholder Services (ISS) lists diversity as the number one item on their list of the “Top 10 Corporate Governance Topics to Watch in 2019”. In a paper with Antonino Rizzo e Oliver Spalt, we propose a new approach to studying how diversity among top managers matters for firms in the stock market.

Most academic work on diversity is concerned with what firms with diverse leadership do and whether diversity, via its impact on corporate decision making, relates to firm performance. In contrast, we study how diverse top management teams are perceived in the stock market. That is important, because stock prices reflect expectations, and because perceptions of diversity can potentially color expectations, even if there is no difference in what firms with diverse managers do. We ask whether biases in investor expectations exist for diversity, whether such biases are quantitatively meaningful, and whether they are in favor of or against diverse teams.

Following a long tradition among management scholars emphasizing the multi-dimensional nature of diversity, we develop a new text-based measure that can capture many dimensions of diversity simultaneously and apply it to the US market. Our novel approach is to measure the diversity of a top management team’s biographies of the team’s members, which all U.S. listed firms are required to file with the SEC. That allows us to assemble what is, to our knowledge, the largest and most comprehensive database on corporate diversity to date.

We study investor expectations and how they relate to diversity by looking at earnings per share forecasts by financial analysts. Our main finding is that analyst forecasts on firms with more diverse top management teams are more pessimistic than forecasts for otherwise similar homogeneous firms. That is consistent with analysts believing that the costs of more diversity in a top management team outweigh the benefits. We also find that analyst experience with a given firm substantially reduces the bias in expectations due to diversity, suggesting that inexperienced analysts make systematic mistakes in incorporating the diversity attribute into their forecasts and, on a more positive note, that learning may help reduce the bias.

We also find a similar effect among institutional investors, who tend to under-invest in diverse firms. This is attenuated, on the other hand, for investors headquartered in states with greater minority populations, more votes for the Democratic party, and states that rank lower on an index of racial animus, i.e. where diversity may plausibly have a less negative connotation.

In sum, the results of our study argue strongly in favor of the view that a substantial fraction of analysts and stock market investors are biased against firms with diverse top management teams. This raises many new questions – and opportunities – for firms, analysts, investors, researchers, and lawmakers.