Are Firms Sacrificing Flexibility for Diversity and Inclusion?

Abstract

This paper examines the impact of workforce diversity and inclusion (D&I) on a firm's flexibility – its ability to adapt to changes. I extrapolate a novel employee rating of D&I introduced in 2020 back to 2008 for thousands of companies, using a machine learning model that surpasses humans. I find that diverse and inclusive firms (D&I firms) exhibit lower flexibility. Moreover, an improvement in D&I due to an novel court ruling results in a decrease in a firm's flexibility, suggesting a causal effect of D&I. I explore why D&I firms have lower flexibility by studying firms' response to a major economic shock and find evidence that D&I creates adjustment frictions in operating efficiency rather than workforce management.