SC Connecticut News

In recent years, shareholders have attempted to hold companies accountable in court for failing to uphold commitments to diversity within their workforce or leadership teams. However, these efforts have largely been unsuccessful. For instance, Facebook’s board of directors won dismissal of shareholder claims that it had breached its fiduciary duty by ignoring diversity concerns—a judge described some of the company’s claims about diversity as “non-actionable puffery or aspirational.”

A forthcoming paper co-authored by Yale SOM’s Edward Watts suggests that these litigants may be on to something. The paper, based on data from over 5,000 publicly traded companies, reveals significant discrepancies between firms' statements about their diversity, equity, and inclusion (DEI) efforts and their actual hiring practices. Notably, sharing inaccurate information about DEI hiring appears to help these companies attract capital from ESG investors.

“It does seem like what companies say doesn’t match up with what companies actually do,” Watts states.

The study utilizes data from Revelio Labs, which compiles workplace analytics using public sources such as LinkedIn. Watts and his coauthors created a dictionary of DEI-related words and compared this data with information voluntarily disclosed by companies in three types of financial documents filed with the U.S. Securities and Exchange Commission: annual reports (10-Ks), current reports (8-Ks), and proxy statements. The sample included nearly all U.S. public companies between 2008 and 2021.

The research team focused on the "disconnect" between DEI language and actual diversity—referred to as the "diversity-washing level."

One compelling result was that statements about diversity are almost completely untethered from actual diversity.

“The disclosure regime is very weakly correlated with actual actions,” Watts says. “They are almost two separate things, which is concerning.”

Diversity washing is associated with several negative behaviors. The researchers found that diversity washers were more likely to have been penalized by the Equal Employment Opportunity Commission; provide vague or forward-looking ESG policies; highlight them via other communication platforms; and hire fewer diverse candidates in the future despite those forward-looking policies.

More people are relying on non-financial factors when making investment decisions. If the veracity of statements about those factors is questionable, investments might be misallocated.

Meanwhile, diversity washers received higher ratings from two leading ESG rating providers—with scores 12% and between 1.5% and 1.9% higher than those not engaging in diversity washing. These ratings influence institutional investors who base decisions on supposed ESG commitments. According to the paper, firms engaged in diversity washing have 10.4% more ownership by funds committed to sustainable and responsible investment.

“Trillions of dollars are tracking ESG factors at this point, and companies are responding to it,” Watts says. “More people are relying on these non-financial factors when making their decisions, and if the veracity of statements about those factors is questionable, money might be going into the wrong places.”

The authors advocate for “standardized, mandatory disclosure requirements” regarding ESG-related issues and regulation and enforcement of those requirements.

Watts notes that individuals focused on ESG efforts—including investors and academics—have not been surprised by these results.

“Everybody had a feeling some of this was going on,” he says. “The question in a lot of people’s minds was, ‘How much?’”