Human Diversity: Benefits for CEOs and Their Companies?

Embracing human diversityis not the strongest side of human nature. Plenty of social psychology concepts and research indicate how we tend to prefer people who are like us, form relationships with people who are alike rather than different, and categorize people similar to us into an ‘in-group’ and dissimilar people into an ‘out-group’. Evolutionary psychologists would attribute these tendencies to survival needs, implying that preference for the similar and familiar involved less risk than the different and unfamiliar…

Despite our natural tendencies though, we are called upon embracing human diversity. Within the business realm, there are many suggestions for the benefits of diversity. For example, from an information-processing perspective, more diversity means more sources of information, more perspectives, more solutions, and more creativity. Hence, diversity may be a tool for thinking ‘out of the box’ and innovating, as opposed to the risk of ‘groupthink’ in highly homogenous teams. At the same time, there is also a dark side to diversity. As discussed in one of my previous blog posts, diversity may also result in increased conflict and lower social integration.

Yet, we live in highly diverse societies indeed, and seeing it as an opportunity makes probably more sense. Moreover, recent research gives additional reasons for such an optimistic outlook. Namely, Fang, Francis and Hasan (2018) explored diversity of CEO’s networks, concluding that such diversity creates higher firm value.

Based on a sample of 1,212 CEOs of U.S. firms, the researchers looked into their social networks, specifically documenting school, work and social ties, and estimating the range of diversity according to the six factors — gender, nationality, academic degrees, majors, professional expertise, and global work experience. They found that CEOs with more diverse networks improved their company’s value (measured as Tobin’s Q, a ratio between market value of assets to book value of assets) on average by 1,7%, compared to the ‘averagely connected’ CEO, and that less diversely connected CEOs underperformed the average CEOs by 2,5%. Moreover, the study found that in cases of newly appointed CEOs, those with more diverse networks than their predecessors were again more beneficial to firm value than new CEOs with less diverse networks. Interestingly, within several days after the appointment of a more diversely connected CEOs, firms experienced more stock returns, whereas the appointment of less diversely connected CEOs was followed by several days of lower stock returns.

So, why would diversity of a CEO’s networkbe beneficial for firm value?

The researchers hypothesized that diverse networks provide CEOs with diverse sets of knowledge, which in turn can lead to more innovations. Moreover, diverse networks seem to benefit firms’ growth opportunities, as CEOs with a heterogeneous networkcan more easily obtain foreign contacts and identify cross-border business opportunities. Indeed, checking for this hypothesis, the researchers found that when handling cross-border M&A deals, the diversity of the CEO’s networkwas positively associated with stock market reactions to the deal. As such, the researchers concluded that higher CEO network diversity leads to greater firm value through the channels of better corporate innovation and diversified M&A deals.

More broadly, this is another piece of evidence to support our continued efforts in embracing diversity and doing so with purpose and awareness, as falling back into our ‘comfort zone of sameness’ isn’t that difficult after all 🙂

Further reading: Fang, Y., Francis, B., & Hasan, I. (2018). Differences make a difference: Diversity in social learning and value creation. Journal of Corporate Finance, 48, 474-491.