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ESG insights for private companies

Diversity, equity, and inclusion: FAQ

Multiple authors
2023-08-31
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

Emerging public companies increasingly want to be leaders on diversity, equity, and inclusion (DEI) issues. This includes understanding evolving disclosure expectations, implementing effective communication approaches, and adopting DEI best practices from their industry peers. Here, with these goals in mind, we answer some of our private portfolio companies’ most frequently asked DEI questions.

Why DEI matters to investors

“We’ve seen a growing trend of investors caring about DEI. Why do you think this is, and do you think it will continue?”

Shawna: As a firm, we believe DEI better enables us to collaborate, solve problems, make decisions, and, ultimately, to deliver better investment results and solutions to our clients. In our view, there are three key reasons why investors’ interest in DEI could continue to grow: potential for improved performance, a differentiated talent pool, and stronger knowledge retention.

  • Potential for improved performance: DEI can mitigate groupthink, increase innovation, and enhance returns. Companies with top-quartile executive team diversity are 25% – 36% more likely than companies with bottom-quartile executive team diversity to have financial returns above their industry medians.1
  • Differentiated talent pool: The composition and expectations of talent are multidimensional and changing. More of the corporate workforce is multiracial/ethnic, multilingual, has unconventional lifestyles, is of various sexual orientations/ identities, has different abilities, and is globally socially conscious. Candidates and employees expect firms to reflect all aspects of DEI. By doing so, firms can access a much larger pool of talent of differentiated and innovative thinkers.
  • Stronger knowledge retention: Firms must both retain proven strategies from an experienced workforce and develop early-career talent to grow the next generation of leaders; otherwise, they run the risk of facing knowledge gaps.

Evolving investor expectations

“What DEI investor expectations should we be prepared to meet?” 

Hillary: A growing number of asset managers are asking companies to disclose their DEI goals and strategies as well as the racial, ethnic, and gender composition of their boards and workforce. Some investors have taken further steps by voting against companies that do not have a minimum number of women and underrepresented individuals on their boards. 

We view DEI practices as a material input to long-term performance and therefore ask our public and private portfolio companies to align with our efforts to increase transparency by disclosing their board and workforce diversity data. For our public company investments, we reserve the right to vote against the reelection of nominating/governance committee chairs at US large cap and FTSE 100 firms that do not meet local market expectations for racial and ethnic board composition, have gender diversity of less than 20%, or have failed to appoint one director from a minority ethnic group. We will also support shareholder proposals asking for improved workforce diversity disclosure, for example EEO-1 reporting for US companies. Full detail on our public company voting policies with respect to board diversity may be found in our 2022 Global Proxy Voting Guidelines. For our private firms, this year, we will begin tracking the racial and ethnic diversity of their boards, as well as engaging with management on these issues where necessary.

Emerging regulations 

“What recent DEI-related laws and regulations are likely to impact my company?”

Drew: There are several regulatory measures that have recently passed or are currently under review that could materially change how companies report on and approach diversity in the future. This is a non-exhaustive list and regulations are quickly evolving.

  • The Securities and Exchange Commission (SEC) approved Nasdaq’s proposal to require companies listed on the exchange to disclose their board diversity annually using a standardized template and meet minimum diversity targets of two diverse board members, including one who identifies as a female, for companies with six or more directors.2 While the rule is not a mandate, companies that do not meet these objectives are expected to explain their reason for not doing so.
  • SEC Amendments to Regulation S-K, which were adopted in August 2020, require US public companies to provide a description of their human capital resources, allowing companies to disclose their diversity data. This is an area that will likely evolve, as the SEC has faced increased pressure from the Asset Management Advisory Committee to require public companies to disclose their diversity data.
  • State laws: California’s legislation (AB979) required covered companies to have at least one director from an underrepresented community by the end of 2021.4 The requirement builds on existing state legislation (SB826) requiring every public company based in California to have at least one female director on its board by 2021. A California judge struck down the AB979 requirement in April of 2022, deeming the law a violation of the state’s constitution. However, the appeal process to reinstate the requirement is ongoing. The State of Washington passed a law in January 2022 requiring covered companies to have at least 25% of their board directors self-identify as women. Other states such as Massachusetts, Michigan, New Jersey, and Oregon are currently considering similar legislation, but have yet to adopt new regulations. 
  • Non-US regulations: In June 2022, the European Union (EU) announced an agreement on a new directive which would require European-listed companies to have at least 40% women in nonexecutive board seats and 33% in all board positions by 2026.6 Many European countries already have mandatory gender board diversity quotas, including Austria, Belgium, France, Germany, Greece, Iceland, Italy, Norway, and Portugal and nonbinding quotas, including Denmark, Finland, Ireland, Luxembourg, the Netherlands, Poland, Spain, Slovenia, Sweden, and the United Kingdom.7 Non-European countries, including India, Israel, and Kenya, have also instituted quotas,8 and we expect the number of countries implementing such quotas to continue to grow.

Strategies and best practices

“How can we improve our DEI profile as a private company? What are some meaningful best practices my company could implement?” 

Shawna: We believe that active leadership and accountability are critical to improving a company’s DEI profile. In our view, companies should aim to:

  • Build the DEI muscle early by understanding there is no right time or size to start focusing on DEI — start today. Making DEI an integral part of company culture only becomes more challenging as companies grow larger.
  • Provide an understanding of DEI terminology to promote a shared awareness, prevent miscommunication, and ensure alignment with action plans and desired outcomes. See Appendix B for our definitions of a few key terms.  
  • Communicate the business case for DEI both internally and externally by explaining why diversity, equity, and inclusion matter to your business. We believe it is crucial to be humble, educate oneself, and engage in dialogue in this process. 
  • Develop a company-wide strategy with progress goals that match your functional action plans. Action plans establish short- and medium-term milestones to monitor progress. This process includes identifying specific initiatives, time frames, roles, and responsibilities and articulating desired results.
  • Identify inclusive leaders and senior management at your organization from a mosaic of backgrounds to help to champion the effort, set direction, advocate for equal opportunity and equitable practices, and demonstrate inclusive behaviors.
  • Leverage the “Build, Buy, or Borrow” approach to grow talent internally, hire externally, and use contingent workers to bring in expertise temporarily — all with DEI in mind. Firms can implement early-career programs, lateral talent training, job shares, and rehire programs to help improve their DEI profile. They can also employ executive recruiters from boutique search firms to hire external talent. Please see Appendix A for more information on this strategy. 
  • Disclose what metrics you measure against and, importantly, select credible data (such as US census or CFA Institute data). Companies can create DEI transparency reports, diversity dashboards, or scorecards to track progress, communicate areas for improvement, and provide consistent disclosure. 
  • Create an accountability process to advance DEI. This is a growing trend among firms as they seek to show their commitment to diversity to investors and employees by holding leadership/decision makers accountable. 

Bottom line

Diversity, equity, and inclusion will likely continue to be increasingly important factors for companies and investors alike. We believe private companies approaching the public markets should understand and adapt to DEI best practices and disclosure expectations. In our view, these efforts are not about meeting a target, but rather seeking to ensure the diversity of boards, management teams, and workforces that can provide multiple perspectives and skill sets to enhance long-term performance.

We believe Wellington can help our portfolio company management teams and boards navigate the DEI landscape by sharing our experience, perspective, and resources. For instance, we’re working to develop a new proprietary director database that will connect private company boards to high-potential, diverse candidates. Once this database is live, we hope it will be one of many resources to help our portfolio companies achieve their DEI goals. Please see further resources below.

Appendix B: DEI terminology9

  • Diversity is about building a mosaic of talent. This includes hiring underrepresented talent, vendors, and brokerage firms to increase team performance.
  • Equality is about providing equal opportunity for all through policies, procedures, and processes (e.g., job posting policies, health care coverage options for everyone, a safe work environment, transparency, etc.).
  • Equity focuses on customized practices, programs, and solutions to meet specialized needs so that identity is not an obstacle and is not predictive of opportunities or workplace outcomes (e.g., closed captioning features, customized development solutions, scholarship programs, coaching services, cultural or religious holiday observances, etc.).
  • Inclusion is a state of being or a deliberate action and is binary. It is granted or not granted by a leader, manager, or peer in a position of power.   
  • Belongingness, in contrast to inclusion, is multidimensional and is a shared responsibility between the individual and organization. The lack of belongingness (disaffiliation) is associated with numerous individual and organizational adverse outcomes. By contrast, increased levels of belongingness are correlated with positive individual-level impact including employee satisfaction, productivity, and growth. Positive organizational impacts include increased retention, collaboration, innovation, and even revenue and profit. Belongingness can be measured through talent engagement practices and pulse surveys to drive elevated and accelerated DEI and organizational KPIs, outcomes, and impact.
  • Intersectionality is the cumulative way in which the effects of multiple forms of discrimination (such as racism, sexism, and classism) combine, overlap, or intersect, especially in the experiences of marginalized individuals or groups.

1Source: McKinsey & Company, “Diversity wins: How inclusion matters,” May 2020. Based on the gender and ethnic diversity of executive teams. Figures are relative to companies with bottom quartile executive team diversity. | 2Companies with five or fewer board members are only required to have one diverse director. | 3Source: NASDAQ Listing Center, “NASDAQ’s Board Diversity Rule,” February 2022. | 4Companies that qualify are those with principal executive offices in the state. Companies with five directors must have a minimum of two females on the board and those with six or more directors must have a minimum of three female directors on the board by 2021. | 5Source: JDSUPRA, “The Push for Corporate Board Diversity Requires Your Attention, Regardless of Legal Challenges,” April 2022. | 6Source: Bloomberg, “EU Set to Approve 40% Quota for Women on Company Boards by 2026,” June 2022. | 7Source: S&P Global, “Gender Equality in the Workplace,” February 2021 | 8Source: Harvard Business Review, “What Happened When India Mandated Gender Diversity on Boards,” February 2021. | 9Source: Caerulean Analytics, a research, data, and analytics firm focused solely on Diversity, Equity, & Inclusion (2021).

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