Promoting Corporate Diversity: The Uncertain Role of Institutional Investors

On March 7, 2017, the eve of International Women’s Day, State Street Global Advisors initiated its ‘Fearless Girl’ campaign, an effort to increase the number of female directors on the boards of its portfolio companies. According to State Street, at the time the campaign began, approximately a quarter of those companies lacked even a single woman director. State Street was not alone in its efforts; indeed, major public pension funds had spearheaded the initial effort to increase board diversity, and following State Street’s announcement, BlackRock and Vanguard joined in demanding greater female leadership at their portfolio companies. Other institutional investors took similar action. These efforts dramatically increased diverse corporate leadership, at least at the board level. More recent efforts have extended diversity objectives beyond gender to include racial and ethnic diversity and targeted a broader range of diversity practices such as requiring companies to conduct racial equity audits and disclose their results.

In my essay forthcoming in the Seattle University Law Review and available here, I analyze institutional investor efforts to promote corporate diversity and, in particular, the rational for these efforts. While it is tempting simply to applaud institutional investors for their success in promoting more diverse corporate leadership, I suggest that there are reasons for caution.  Although the normative case for greater corporate diversity is powerful, it stems from a range of distinct justifications including economic arguments about the relationship of diversity to firm value and noneconomic arguments about representation, justice and equal opportunity. The rationale for promoting greater diversity has important implications for the form that diversity should take, as well as what types of diversity to prioritize.

Efforts to promote greater diversity can pit the interests of one identity group against another, particularly when, as with board composition, claims for diversity compete for a limited number of positions or opportunities. Broad-based diversity initiatives in the selection of directors may also compete with other economic and societal priorities.

In this debate, the role of institutional investors is complicated by their status as intermediaries who manage other people’s money. While one may plausibly argue that institutional investors act pursuant to delegated authority when they engage with portfolio companies to pursue economic objectives, the claim that beneficiaries delegate to asset managers the authority to pursue ethical or social objectives is less clear. As a result, the debate over corporate diversity has overwhelmingly focused on the business case for diversity. Challenges in empirically analyzing the relationship between diversity and firm economic value, however, make it difficult for institutional investors to defend their initiatives in economic terms.

The case for corporate diversity extends beyond any demonstrable impact on firm economic value, however, and has its roots in both business and societal rationales. As the essay explains, there are powerful arguments that the societal benefits of diversity are more important drivers of diversity, equity and inclusion initiatives than firm-specific economic justifications. The challenge is that these justifications for diversity span a broad range—from remedying past discrimination and increasing representation of a broad range of viewpoints and experiences, to promoting role models. These justifications lead to different conclusions about which groups should be included in diversity efforts and how greater inclusion should be structured and prioritized. The societal justifications for diversity do not provide guidance about how to create categories and navigate trade-offs.

The issue is complicated when these decisions are made by institutional intermediaries. Although such institutions wield considerable influence due to their sizeable shareholdings, they represent the economic interests of their beneficiaries who typically have little or no say in institutional voting or engagement decisions. At the same time, both institutional investors and the fund managers who act on their behalf face political and social pressures that influence their engagement choices and create potential agency problems. In addition, growth and concentration in the asset management industry have produced a small number of institutional investors that exercise substantial power over social policy, raising questions about whether their exercise of that power is legitimate.

Although these concerns present challenges for institutional engagement across a wide range of social and political issues, diversity is distinctive. Different investor perspectives about the rationale for diversity are likely to result in meaningfully different preferences that cannot readily be aggregated.

Rather than reflecting those differences, today’s institutions are promoting their own visions of diversity without seeking to determine whether those visions correspond to the preferences of their beneficiaries. Moreover, there is a societal cost to delegating to investors the responsibility for addressing moral or ethical issues. Implementing corporate diversity through corporate governance takes these deliberations outside the political process, reduces the input of other members of society and, to a degree, may relieve pressure on courts and legislatures.

The essay concludes by identifying two potential corporate governance solutions to this dilemma. The first is to limit the role of institutional intermediaries in addressing corporate diversity. This approach would address concerns about accountability and legitimacy but would sacrifice the powerful impact of institutional engagement with respect to diversity. The second would require institutional intermediaries to ascertain the views of their beneficiaries and incorporate those views into their voting and engagement decisions, an approach that Jeff Schwartz and I term ‘informed intermediation’ and develop further here. With respect to an important and potentially controversial issue such as diversity, informed intermediation offers the potential to retain the important influence of institutional engagement while increasing its accountability and legitimacy.

Jill E Fisch is the Saul A. Fox Distinguished Professor of Business Law at the University of Pennsylvania Law School.

This post was first published on Columbia Law School’s Blue Sky Blog and is based on her essay, ‘Promoting Corporate Diversity: The Uncertain Role of Institutional Investors’ forthcoming in the Seattle University Law Review and available here.