Commentary: Mind the gap — the connection between gender alignment and performance

A recent court ruling in California struck down a state law mandating female representation at the board level, putting a further spotlight on the discussion around gender diversity in the workplace. In response to the argument that more diverse boards would bolster California's economy by improving business performance, the judge explained that this claim has not yet been proven or quantified in any meaningful way.

This adds to the already spirited discussions in boardrooms and C-suites about the true impact of doing the right thing — in this case enhancing gender diversity — on financial performance as measured, for example, by stock price appreciation.

What would we learn if we surveyed every executive, at every publicly traded company, about the value of gender diversity in the workplace? We suspect the responses would cluster into two broad categories:

1. Gender diversity is a social good worth pursuing regardless of its direct impact on financial performance.
2. Gender diversity is worth pursuing to the extent it improves financial performance.

Regardless of individual opinion, we believe than even the most cynical of executives would strongly support enhanced gender diversity if they had good evidence that such steps would improve future equity performance.

On the other hand, while we hope companies would strive toward increased gender diversity for its obvious and strong social benefits, we understand that social good alone may not be galvanizing enough for executives whose careers and compensation are often affected most directly by measures of financial performance. That is why we aimed to quantitatively capture the lift that gender alignment and equality throughout a corporation has on a company's stock price in an investible way.

Against this backdrop, we argue that many gender diversity efforts have not yet met their goals due to (a) a lack of concrete proof that these efforts can bring about better performance and (b) the utilization of incorrect — or at least imperfect — measurements.

One can easily count the number of diverse members on boards or in the C-suite and then use this measure as an input for an investment strategy. While this approach might seem appealing, it doesn't go far enough.

First, the percentage of women in these key leadership roles does not necessarily guarantee that they would say they are treated equally.

Second, the presence of more women at the top of a company does not necessarily guarantee that women throughout the company experience equality or career advancement.

Consider this as an example: Does the day-to-day experience of a female middle manager, software engineer or accountant change as the result of a new female board member being appointed? Likely not. While we would hope that increased diversity at senior levels will eventually trickle down to improve the experience of female team members, such an impact is far from certain. Basically, adding woman in key roles alone is unlikely to have a meaningful impact on the experience for women throughout the organization.

Several index-based ETFs have launched with the noble objective of investing based on the number of women in various roles, a shorthand for measuring an organization's diversity. The most notable is ticker SHE, which tracks an index focused exclusively on the balance of men and women at the top of organizations. As of June 30, 2022, however, the index SHE tracks has materially underperformed the Russell 1000 (7% annualized) since inception compared to the Russell 1000's total return (from its June 30, 2010, index history). Performance notwithstanding, SHE deserves credit for playing an important role in elevating the visibility and importance of gender equity, and materially moving the needle in advancing women on boards.

Two other products that add data provider Equileap's gender policy scores for things like anti-harassment policies to the basic "counting" approach of SHE's index have delivered mixed results. The index WOMN tracks (a broad composition of 200 women-inclusive stocks), has slightly outperformed since its inception in 2018 while the index tracked by EQUL (a more concentrated portfolio of 75 stocks) has underperformed since its inception in 2021.

How should we interpret the financial performance results of the indexes created for SHE, EQUL and WOMN? Should we take these as evidence that gender inclusion is just not that important? Not so fast. We think that what is needed is different kinds of data, and that with such data, it would be much easier, and far more compelling, to make the case for more equitable gender inclusion.

Over the last five years, we've taken a deep dive into employee sentiment at all levels of a company. We have curated data across thousands of companies where hundreds of thousands of respondents have answered questions about their day-to-day experience. These queries primarily focus on measuring the levels of previously intangible attributes within an organization such as psychological safety, levels of trust, perceived fairness, a sense of appreciation and more.

We codified these findings in what we call the Human Capital Factor. The results were quite profound, showing companies that scored higher on these hard-to-measure characteristics consistently outperformed the market.

We went deeper to look at the responses of these attributes by women and men. The result is a framework to measure the core emotive building blocks of the relationship between employees and their employer through a "gender lens."

These findings gave specific insight into whether women throughout an organization feel they are treated equally. Within outperforming organizations, we found much higher "alignment" (smaller gaps) between the responses given by women and those given by men. Conversely, a material gap between the answers of men and women was a signal suggesting a drag on future company stock performance. Importantly, this analysis tracked gender sentiment across all levels of an organization, not just in the board room or C-suite.

When we compare the market performance of companies that score high on gender alignment (the top 100-plus with the smallest gap between female and male responses across 30-plus key attributes) vs. the Russell 1000, we see meaningful outperformance:

Our research found that companies with stronger gender alignment across a range of intrinsically motivating factors performed better than strategies based on headcount alone. More importantly, this approach represents a more authentic measure of diversity and equality throughout an entire organization. In short, companies that treat women more equally do much better. This is a clear reminder that it's important to make sure that when we measure important things like gender equality that we are measuring the right things.

Tackling an issue as complicated as gender diversity and making meaningful progress is not an easy undertaking. We are excited that our research suggests some firms are already embodying these attributes and are reaping the rewards in a manner not yet fully appreciated — or perhaps even noticed — by the investment community.

We believe if we continue to demonstrate the true impact of strong gender alignment by measuring how women and men actually feel in and throughout the workplace, everyone from employees to executives to shareholders will benefit. When we tangibly show that "doing the right thing pays," the quality and effectiveness of gender diversity efforts will meaningfully improve and the gap will narrow, regardless of what is happening in any given courtroom.

Dan Ariely is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University and a co-founder of Irrational Capital, a company that specializes in measuring human capital. Hannah Grove is an independent board director at abrdn PLC and member of the advisory board for Irrational Capital. Both authors are based outside of Philadelphia. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.