Is McKinsey wrong about the financial benefits of diversity?

A woman uses her mobile phone at an office building in Tokyo July 21, 2015. Two in five Japanese firms plan to boost capital spending…
A woman uses her mobile phone at an office building in Tokyo July 21, 2015. Two in five Japanese firms plan to boost capital spending…
Image: Reuters/Toru Hanai
We may earn a commission from links on this page.

If you’ve read an article about the importance of diversity in the workplace in the past few years, chances are you’ve come across the assertion that more diverse companies turn out higher profits.

Key to the popularization of this idea are three McKinsey studies, released in 2015, 2018, and 2020, which showed that companies with greater racial, ethnic, and gender diversity in their leadership tended to perform better financially. The Wall Street Journal, the New York Times, the World Economic Forum, and the women’s leadership nonprofit Catalyst have all cited McKinsey’s findings, along with work from the Boston Consulting Group and other consultancies, to support the idea that investing in diversity is in companies’ best interests.

Academic research, however, is less clear on whether there is any relationship between diverse leadership and company profits—let alone a causal one. A new paper, posted on the open-access research platform SSRN, offers one more reason to be cautious in making claims about the business case for diversity. The authors applied McKinsey’s approach to companies in the S&P 500 index, and did not find a link between racial and ethnic diversity and financial performance.

“I’m a big believer in responsible diversity, and I’m a minority myself—I would love [the McKinsey] studies to be true,” says Alex Edmans, a professor of finance at London Business School who was not affiliated with either the McKinsey papers or the new study. “But it’s important to make sure anything we say is based on rigorous research.”

Testing out McKinsey’s methodology

McKinsey arrives at its findings by ranking large public firms by their executive diversity. It then examines the most diverse quartile of firms and the least diverse quartile to see whether they were above or below their industry’s median EBIT (earnings before interest and taxes) margin over a certain period of time.

For example, McKinsey reported that in 2019, “companies in the top quartile for gender diversity on executive teams were 25 percent more likely to have above-average profitability than companies in the fourth quartile—up from 21 percent in 2017 and 15 percent in 2014.” It found similarly impressive-sounding results with respect to racial and ethnic diversity.

The studies are careful to note that “greater gender and ethnic diversity in corporate leadership doesn’t automatically translate into more profit.” That is, they’re establishing correlation rather than causation, and acknowledging the importance of an inclusive, fair environment in determining a company’s success.

The paper on SSRN, which has not yet been peer-reviewed, applied McKinsey’s approach on a sample set of large firms in the S&P 500 as of December 2019. Worth noting is that this is a different (and smaller) data set than McKinsey’s, and that the study looked only at US firms, while McKinsey’s includes international companies as well. The new study was authored by John Hand, an accounting professor at the University of North Carolina Kenan-Flagler Business School, and Jeremiah Green, an associate professor of accounting at Mays Business School at Texas A&M University.

When Hand and Green followed the McKinsey model, measuring firms’ financial performance between 2015 and 2019, they found “statistically insignificant relations” between the racial and ethnic diversity of a given executive team and that company’s financial success. This applied both to EBIT margins and to a number of other measures of financial performance, including industry-adjusted sales growth, gross margin, return on assets, and return on equity. McKinsey declined to comment on the study’s findings.

When a study’s findings are too good to be true

The authors emphasize that this isn’t definitive proof that there is no connection between racial and ethnic diversity and profits—more research is needed on that front. They also note several other important caveats, including that S&P 500 companies are not a random sample of public US firms, and that their method of identifying race and ethnicity among executives (using faces and names) is likely to overestimate the number of white executives. But they criticize McKinsey’s methodology, including its metric for measuring diversity among executives. They conclude that “caution is warranted in relying on McKinsey’s findings to support the view that US publicly traded firms can deliver improved financial performance if they increase the racial/ethnic diversity of their executives.”

Among the additional research that Green and Hand call for is a way to better examine whether there is any causal relationship between a firm’s diversity and its financial performance. McKinsey, by its own admission, is only looking at correlation. Green and Hand are working on a longitudinal study that will look at causation by gathering historical data on the racial and ethnic makeup of firms’ leadership teams in different years, then looking at the companies’ financial performance before, during, and after those years.

Edmans, the London Business School professor who is also the director of its center for corporate governance, says there are a number of other possible issues with the design of McKinsey’s diversity studies.

From an academic researcher’s perspective, he says, it’s unclear why McKinsey looks only at companies in the top and bottom quartile on diversity, as opposed to the top third or bottom third or not splitting them up at all. Also unclear is why the McKinsey studies focus on whether the most- and least-diverse companies beat the industry average of profitability. “The most standard way to do it is to say what’s the average profitability of diverse versus the average profitability of non-diverse” companies, he says.

In general, when reviewing a study, as Edmans explains in his 2017 TEDx talk “What to trust in a post-truth world,” it’s always worth asking whether the authors would have published it had they found the opposite result. “It’s really easy to get away with sloppy research if it confirms what we’d like to be true because we’ll accept it uncritically,” he says.

Does diversity pay?

While the paper by Hand and Green has not yet been peer-reviewed, its findings are consistent with a larger academic body of work on diversity and financial performance.

Wharton management professor Katherine Klein, for example, penned a 2017 post exploring two meta-analyses of peer-reviewed research on the effect of board gender diversity. Both, she says, “suggest that the relationship between board gender diversity and company performance is either non-existent (effectively zero) or very weakly positive.”

Similarly skeptical of the financial benefits of diversity are Robin Ely, a professor of business administration at Harvard Business School and faculty chair of the school’s Gender Initiative, and David Thomas, president of Morehouse College (a historically Black college) and professor emeritus at Harvard Business School.

“Scholarly researchers have rarely found that increased diversity leads to improved financial outcomes,” Ely and Thomas explain in a 2020 article for the Harvard Business Review. “They have found that it leads to higher-quality work, better decision-making, greater team satisfaction, and more equality—under certain circumstances. Although those outcomes could conceivably make some aspects of the business more profitable, they would need to be extraordinarily consequential to affect a firm’s bottom line.”

So while it’s possible that future academic research may provide strong evidence that diversity helps companies deliver better returns, that doesn’t seem to be true so far. The question is, does that matter?

A better case for diversity

It would certainly be convenient if more diversity led to higher profits. Historically speaking, businesses are a lot more willing to make changes when money is a motivator. So it makes sense that so many organizations want to make a business case for diversity.

There are downsides to using profits as a tool of persuasion, though. For one thing, as Ely and Thomas point out, “when diversity initiatives promise financial gains but fail to deliver, people are likely to withdraw their support for them.” In addition, Edmans says that if establishing the financial benefits of diversity is the baseline for getting companies to pursue it, identity groups that are less common subjects of diversity studies (for example, physically disabled people) are bound to get left out.

But McKinsey’s studies aren’t suggesting that profits are the only reason to invest in diversity. A 2020 opinion piece by the firm, tied to its most recent diversity report, highlighted the ways in which companies that prioritize diversity are likely to benefit from better decision-making, more innovation, and higher employee satisfaction.

In any case, there may be less need to demonstrate the financial upside to diversity these days as the ideals of shareholder capitalism (which holds that a businesses’ sole concern is creating value for their shareholders) make way for stakeholder capitalism, which says the purpose of companies is to serve not only shareholders but employees, customers, and society at large.

“There are many companies that do things for intrinsic reasons,” says Edmans. “For example, purpose at work is something people are taking really seriously.” Fifteen years ago, he says, his MBA students were chasing after the most lucrative possible careers; now they’re looking for meaning. And diversifying companies as a means of furthering racial justice and gender equality is an extremely meaningful cause.

Even setting aside the matter of profits, companies still may have selfish reasons for prioritizing diversity: positive press, say, or the need to meet regulations. But the most effective tactic for getting them to make changes may be to simply explain why it’s the right thing to do.