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Incentivizing Corporate Diversity through Commercial Transactions
-- By BrandonHolt - 13 Mar 2022
Introduction
When the video of Derek Chauvin murdering George Floyd commanded the attention of the world in May 2020, many corporations, particularly in the United States, released statements decrying police brutality, anti-Black racism, and their organization’s systemic failure at employee diversity. Corporations publicly revealed their employee demographic data, which exposed an abysmal lack of diversity attainment across Black, Latinx, queer, and women employee populations. The general sentiment of these data releases and public statements was, “We need to do better. We will do better.” This left a longing question of when those changes would be realized.
Fast forward two years and there is still the same want of diversity. While challenges to a corporation’s lack of diversity are more acceptable in corporate talk, actions that produce meaningful diversity attainment are sparse or do not produce expedient results. This introduces the question to be explored here: how can corporations be incentivized or compelled to expediently diversify their workforce?
Expedience is an important component of this inquiry because demands for diverse workforces by marginalized employees were not new to May 2020. In general, these demands were, and are, met with requests for patience, which punted any meaningful efforts to diversify.
Multiple industries at all levels of seniority continue to be inaccessible to diverse employees. Should demands to diversify be serious, they have to be attached to an incentive structure that compels corporate change. Morality––or the market shame that results from lack of adherence to a moral position––is an unmoving, or at best slow yielding, corporate incentive. Alternatively, financial stipulations that impact a corporation’s strategic ability is more demanding.
A merger, acquisition, or strategic joint venture allows corporations to generate synergies that improve valuation and drive value for various stakeholders. These transactions share common stages, including due diligence, credit and financing, and shareholder and board approvals. What would it mean to incorporate diversity standards in these elements such that transactions could not proceed without adherence?
Due Diligence, ESG, and Shareholder Activism
Through due diligence, acquirers evaluate the risk profile of a target and balance those risks against their own risk appetite. An increasingly popular risk analysis is in ESG, Environmental, Social, and Governance. Climate-conscious investing is on the rise and is one of the most popular operational impacts to scrutinize through ESG. For example, when ExxonMobil? did not commit to a net-zero status goal like its peers BP and Shell, an ESG-activist hedge fund initiated a proxy contest against the company, which received institutional investor support and ultimately led to a shake up on the board of directors. The board is now exploring avenues for climate-friendlier operations.
The rise in ESG based attacks of corporate strategy are expansive and not limited to climate issues or challenges by large investors. Carl Ichan, famous for his serial activism, recently launched a board challenge at McDonald? ’s over animal rights abuse even though his ownership interests are only worth around $50,000. As the Financial Times noted, given the rise in ESG, companies and boards must now be prepared for investors of varying shareholder interests attacking even “squishy matters where blunt profit maximi[z]ation is not the issue.”
While shareholder activism and ESG-based challenges are the more obvious avenues to pressure corporations to pursue genuine workforce diversity, these strategies require continuous engagement, proxy coordination, and motivated shareholders. Further, these strategies are generally limited to public companies and do not solve the important issues of time and expediency.
The Proposal: Bank Financing
In their paper “Corporate Carbon Reduction Pledges: Beyond Greenwashing,” co-authors John Armour, Luca Enriques, and Thom Wetzer present their “green pill” solution to pressure corporations into green compliance. The solution requires corporate borrowers to meet agreed environmental goals. The interest rate on their bank credit is indirectly tied to their environmental goal attainment: the greater the attainment, the lower the interest rate.
A similar idea has been applied in the racial justice context. Napoleon Wallace’s firm, Activest, rates municipalities’ credit worthiness by incorporating police brutality prevalence into traditional municipal credit ratings. When occurrence of police brutality is high and the frequency and amount of lawsuit settlements are also high, the riskier the rating Activest assigns.
This proposal leverages both of the aforementioned concepts to make diversity attainment a measure of access to financing. The lower a company’s employee diversity, the higher the interest rate assigned at the start of the bank credit arrangement. In this way, a company’s existing employee diversity is a metric of its creditworthiness. As an incentive to improve diversity over the course of its term loan, a company’s interest rate improves as the firm’s employee diversity improves in keeping with the Armour, Enriques, and Wetzer model.
In order to glamorize their diversity metrics, companies often overstate their gender diversity at the expense of racial diversity or obfuscate their racial diversity through people of color metrics while specific racial groups remain underrepresented. For this financing model, employee diversity should be defined with specificity (i.e. identifying goals for particular marginalized groups) and the rate-based goal tiers should be ambitious in order to encourage material diversity.
Attaching diversity metrics to financing in this way will importantly drive expediency. Interest rates, particularly in the context of an acquisition or joint venture play an important role in how a target company is valued. If a valuation can become more favorable to an acquirer and borrower over time, multiple corporate parties, from senior leadership to boards and shareholders are motivated to realize the best rate which would be a direct result of diverse hiring and retention practices.
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