Board Action on DEI
The arc of social justice, much like the stock market, trends toward progress but rarely follows a straight line. Both are characterized by periods of optimism, overextension, and inevitable corrections that bring balance and reflection.
Since the George Floyd tragedy of 2020, a new stakeholder has dominated the landscape of the Boardroom. Approximately 38% of Fortune 500 companies have established a dedicated Diversity, Equity, and Inclusion (DEI) committee as part of their board's governance structure. Almost every member of the Fortune 500 has a Chief Diversity Officer, most have formal DEI programs in place, and 20% link executive compensation to DEI metrics.
The highly sensitive nature of this subject has made it difficult for boards to engage in critical discussions. A recent survey shows that 50% of directors don’t see a link between these issues and firm strategy. While we all share a desire to work toward a more just and equal society, boards have a fiduciary responsibility to evaluate the claims of the role DEI programs play in corporate performance.
Boardrooms are high stakes environments where well known psychological dynamics come into play; risk aversion, the status quo bias, and intense peer pressure complicate the discussion on this very polarizing issue. But outside the boardroom, the cultural tide is turning. There is an increasing realization that in our rush to ‘meet the moment’, a well-intentioned response to racial injustice and social inequality has led to bureaucratic overreach. As with the ‘replication crisis’ in social science research, there is a growing uneasiness about the claims linking DEI to profitability. Unfortunately, the sensitive nature of even asking this question puts the individual director in a difficult position. It’s time for Boards to lead in terms of finding the balance.
A critical wave in this tide was the 2023 Supreme Court ruling in Students for Fair Admissions v. Harvard which held that the universities’ consideration of race in admissions systems — “however well-intentioned and implemented in good faith” — violated the equal protection clause. Harvard, Yale, MIT, and CalTech have reinstated the SAT for 2025. A review of 10-k’s filed since the Supreme court ruling shows that 24 Fortune 500 companies now mention DEI as a ‘risk factor’. One senior labor and employment attorney says, “I’m not sure which fear is greater right now: the fear of getting sued for having a program or the fear of getting sort of taken to task by eliminating the program”.
Over a dozen US companies including Uber have removed DEI terms like “anti-racist” and “unconscious bias” from their corporate filings this year. Morningstar reports that in the first nine months of 2023, investors pulled more than $14 million from ESG funds. FactSet reports that by the second quarter of last year, only 61 companies in the S&P 500 mentioned ESG initiatives on earnings calls (the lowest level since 2020) — a decrease from 151 in the fourth quarter of 2021.
Boards can lead this realignment in two ways. The first is to recognize the toxic consequences of centralizing the DEI initiative, which led to bureaucratic overstaffing and a muddying of the waters of what were originally good intentions. Combining oversight for diversity, equity, and inclusion into one role blurs the meaning of each of these critically important issues. It’s time to unbundle each of the components of this practice, pushing responsibility for it down into the organizational units where it properly belongs.
Specifically, the responsibility for diversity initiatives naturally belong to recruiters, who must be held accountable for ensuring the company’s outreach, sourcing, and hiring functions meet the highest standards of fairness. Recruiters must continue to implement DEI policies designed to eliminate bias, cultivate a diverse pipeline of talent and promote equal opportunity in hiring, promotion and procurement. Legal has a role in ensuring compliance with the tangled set of very different international regulatory standards in this area.
Pay equity is the natural focus of every firm’s compensation and benefits team, and they should have a direct reporting line to the board’s compensation committee. Complex compensation and benefits data loses nuance when clustered with other priorities, and compensation committees should not dilute the direct accountability of these teams through a DEI head who has multiple and sometimes conflicting objectives.
Finally, inclusion is critical. Providing a sense of belonging, feeling valued and respected, and creating access to opportunities and a sense of psychological safety has to be part of the culture. And that means it can’t be delegated; CEO’s have to lead by example. Every Fortune 100 firm has training, leadership development and talent management teams to create a culture of inclusion, but Boards must hold the CEO accountable for communicating a vision living these values.
In addition to unbundling DEI, Compensation Committees should mandate a top-down DEI audit, providing a clear understanding of the true costs, including head count and training expenses. Not a self-reporting generated by HR program providers, but a performance audit delivered by the internal audit function, to determine if resources invested are delivering as promised. The C-Suite needs a clear understanding of the actual investment firms are making. There’s a legitimate debate to be to be had between stakeholder and shareholder capitalism, and boards may decide to support DEI initiatives as a part of their corporate social responsibility program. But the assumption that it’s measurably driving performance should be put to the test.
Firms are rolling back their diversity initiatives. Boards should give executives support for the necessary realignment.