A Hidden Cost of Corporate Diversity and Inclusion

Lately, diversity and inclusion (D&I) have become buzzwords, capturing the attention of investors, policymakers, and the general public alike. And why not? Promoting D&I could support social justice, align with ethical goals, and, frankly, many consider it surely the right thing to do. But as firms rush to embrace these values – even as recent political backlash has made them more cautious – a crucial question emerges: Could prioritizing diversity and inclusion be limiting companies’ ability to quickly adapt to changes?

Intuitively, a diverse workforce should offer a broad spectrum of perspectives and creative solutions, potentially making a firm more agile in responding to risks and opportunities. However, there’s also a real possibility that investing heavily in D&I practices could slow things down. Communication can get trickier, and integrating diverse backgrounds effectively might require considerable time and resources.

To get a clearer picture, we need accurate, reliable measures of D&I practices, which, until recently, have been pretty scarce. In 2020, Glassdoor provided a breakthrough by allowing employees to anonymously rate their employers’ D&I efforts. Hoa Briscoe-Tran, a finance professor at the University of Alberta, extended these ratings back to 2008 in his paper by analyzing written employee reviews on Glassdoor with Google's powerful BERT language model. In doing so, he created a comprehensive D&I rating system covering over 10 million employee reviews.

Interestingly – and somewhat controversially – Briscoe-Tran finds that firms with higher D&I scores tend to be less flexible. He measures flexibility by looking at how consistently firms can maintain their operating cost margins over time. To understand this intuitively, imagine a flexible firm as one that smoothly adjusts its costs relative to revenues, keeping this ratio stable even as economic conditions fluctuate. On the other hand, a less flexible firm struggles to adapt swiftly, resulting in larger swings in its cost margins. These fluctuations indicate inefficiencies or delays in responding to market changes, reflecting lower overall agility.

It turns out that highly rated D&I firms often experience wider fluctuations in these margins, suggesting they're slower to adapt to economic changes. This was particularly clear after a 2013 court ruling that suddenly increased employer accountability for workplace harassment. Companies impacted by this ruling improved their D&I ratings but also became noticeably less flexible.

Why might this happen? Briscoe-Tran identifies two potential culprits. First, diverse and inclusive hiring and firing practices can complicate workforce management decisions, leading to delays. Second – and perhaps more significantly – maintaining communication across diverse groups can slow decision-making, impacting efficiency.

The COVID-19 crisis of 2020 provided a stark test case. When the pandemic hit, companies had to quickly adjust their operations. Briscoe-Tran’s analysis reveals that firms strong on D&I suffered greater losses in operating efficiency compared to less diverse firms. Notably, their challenges were more related to efficiency issues rather than workforce size adjustments.

Here’s the bottom line: Yes, diversity and inclusion are essential for ethical and social reasons. However, there's some trade-off – firms emphasizing D&I practices might sacrifice some operational agility, especially during major economic shocks.

How about equity, as in the buzz term Diversity, Equity, and Inclusion (DEI) we have heard so much about in the news? While Briscoe-Tran’s measurement approach (the Glassdoor rating) captures diversity and inclusion – but not equity – it’s reasonable to expect a similar trade-off might apply. That is, if firms care about equity – fair access and support tailored to individual needs – on top of diversity and inclusion, they will have to sacrifice even more flexibility. Put simply, the more criteria one wants to satisfy, the more operating frictions there might be.

Does this mean firms should reconsider investing in D&I or DEI? Perhaps not. But they should approach these issues with their eyes wide open, understanding the potential downsides, and actively managing these challenges. After all, true leadership is not about avoiding trade-offs but recognizing and navigating them wisely. Briscoe-Tran’s work offers crucial insights that can help business leaders make better-informed decisions in today's ever-evolving corporate landscape.

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By Hoa Briscoe-Tran (Alberta School of Business, the University of Alberta)

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