Diversity and Meritocracy: What Tradeoff?

As of January 2015, most publicly listed companies on the Toronto Stock Exchange are required to disclose details of their board diversity policy or to explain why they do not have a policy. The ‘comply or explain’ regulation reflects the latest in a spate of regulations introduced across global financial markets to encourage gender diversity in the boardroom. As the proxy circulars came filing in this spring, it became quickly apparent that many companies are held back by the perceived trade-off between selecting qualified candidates and incorporating diversity criteria.

To be sure, some companies, particularly in the finance, real estate and utilities sectors, have made great strides on board diversity. But outside of these sectors, companies could easily be mistaken for relics of the Feminine Mystique era of the 1950s. One sector that stands out in particular as a laggard is oil and gas. According to the 2014 Canadian Board Diversity Council survey, of the 608 directors in the sector, 9.7% or 65 are women. To be fair, the limited number of female candidates with experience in the sector presents a challenge for recruitment, as many companies explain. But a closer look at the explanations provided in proxy circulars reveals a much deeper form of resistance to diversity.

In particular, several companies cite the trade-off between meritocracy and diversity as a primary reason for not having a diversity policy.

The explanation goes something like this: “Company X is committed to meritocracy. We believe that considering the broadest group of individuals who have the skills, knowledge, experience and character required to provide leadership needed to achieve our business objectives, without reference to their gender, race, ethnicity or religion, is in the best interests of all our stakeholders. As such, we do not have a policy with respect to diversity of our board.”

What then are we to make of the proclaimed benefits of diversity demonstrated in several academic studies, including better risk management and better decision-making, ultimately translating into improved corporate financial performance? Perhaps the differences can be explained by the benefits of diversity are themselves diversely distributed.  That is, some companies benefit from diverse boards, while others must only concern themselves with mitigating litigation risks associated with discrimination. Put another way, it is possible that the trade-off of between meritocracy and diversity may hold for some companies but not for others.

For all the attention the trade-off question attracts, it is an irrelevant one. Meritocracy and diversity cannot be traded off against each other. As Scott Page, Director of the Sante Fe Institute explains, it is like trying to compare apples to a fruit basket. An apple, like a director candidate, may be evaluated as desirable based on his or her individual characteristics. In contrast, the fruit basket is evaluated on the basis of how the arrangement of fruits complement each other as a whole. Both factors should be considered when selecting the board.

Indeed, no company would want a board full of directors with identical educational backgrounds. Imagine all directors took the same financial accounting course from the same professor, who taught the wrong method for calculating present value. When it came time to review accounting statements, there would be no one to call a flawed statement into question. While extreme, this example begs the question why have eight directors when one would suffice when it comes to making decisions? Just as diverse skills and education can complement each other, so too can diverse genders, geographic backgrounds, sexual orientation and nationalities.

The question that all boards must ask themselves is how much diversity they need to be effective? Indeed, we can imagine a point where too much diversity might undermine the ability of a board to function effectively. But governance can go a long way to ensure that the benefits of diversity outweigh the increased costs of coordination that is necessary for effective decision-making among diverse groups.

In increasingly complex and interdependent global markets, there is a premium on diversity. It is no longer enough for an oil company’s board to understand the technical details of drilling and production and other market-specific factors related to the company’s competitive position. Risks of infrastructure breakdown that prevent a product from getting to market are intricately linked to risks of environmental degradation and labour market disputes. Boards require local knowledge, such as insight into the interests and cultural attitudes of aboriginal communities, and global knowledge, such as an understanding of new technologies and drivers of emerging market demand. Diverse board members bring access to new networks, specialized local and global knowledge and insights that are critical to corporate success in this new risk environment.

Still, many complain that the comply or explain approach adopted by the Ontario Securities Commission does not go far enough when compared with countries like Norway, which has adopted a hardline approach by setting mandatory gender quotas. But comply or explain does give investors and other stakeholders insight into the attitudes of corporate boards toward diversity. This is  a good starting point for investors to engage with issuers to dispel the myth of a trade-off between diversity and meritocracy.