Diversity Washing

Introduction

Diversity washing happens when firms claim they are committed to diversity, equity, and inclusion (DEI), but their hiring practices do not reflect these commitments. This study assesses the prevalence of ‘diversity washing’ in company financial reports and its implications on shareholders and regulators. 

The study evaluated over 1.4 million financial and DEI-related disclosures of U.S. public corporations to examine the extent of diversity washing and its effect on investors as well as regulators. This timely publication illustrates how false DEI disclosures might affect investor choices, like misleading statements from firms about their DEI initiatives which result in higher environmental, social, and governance (ESG) scores and attract more investment from institutional investors with an ESG focus; it also contributes to broader research on corporate transparency and accountability in ESG practices.

The authors include Andrew C. Baker, Associate Professor at Berkeley Law School; David F. Larcker, James Irvin Miller Professor of Accounting at the Graduate School of Business, Stanford University, Senior Faculty at the Hoover Institution, and Research Fellow at the European Corporate Governance Institute; Charles G. McClure, Assistant Professor of Accounting at the Booth School of Business, The University of Chicago; Durgesh Saraph, Independent Scholar; and Edward M. Watts, Assistant Professor of Accounting at Yale School of Management.

Methods and Findings

Methods

For this analysis, almost all U.S. public corporations within 2008 to 2021 are included, and more than 1.4 million documents were evaluated. The researchers gathered firm-level financial and equity data from the Center for Research in Security Prices (CRSP) and Compustat. Environmental, social, and governance (ESG) ownership proxies were obtained from mutual fund holdings data, while Violation Tracker information on firm misconduct (i.e., violations related to DEI hiring practices, including discrimination-related offenses identified by the Equal Employment Opportunity Commission, as well as other adverse human-capital outcomes and negative ESG-related events) was sourced through Goodjobsfirst. The firm misconduct in this study, sourced through Goodjobsfirst’s Violation Tracker, encompasses regulatory violations across various domains, including labor, employment, and environmental issues.

DEI commitment was measured based on the frequency of DEI terms in financial disclosures, identified using a dictionary-based algorithm. The algorithm was derived by creating a list of words related to DEI from different online DEI dictionaries and deleting words that have alternative meanings not linked with DEI. To ensure accuracy, research assistants reviewed sentences containing these terms to confirm their relevance to DEI initiatives. The resulting dataset was analyzed using various statistical methods, including regressions and fixed effects models, to identify links between DEI disclosures, workforce diversity, and market outcomes.

Findings

The study found statistically significant discrepancies between companies’ DEI commitments and the actual levels of diversity within their workforce. Companies with greater frequency of DEI discussions in their financial reports had lower levels of actual workforce diversity (i.e., female and non-white employees) compared to firms who discussed DEI less frequently. These firms also experienced higher turnover of female and non-white employees, more discrimination-related fines, and other adverse human-capital events. Despite these outcomes, diversity-washing firms received higher ESG scores from commercial rating organizations and attracted more investment from ESG-focused investors.

Furthermore, the study uncovered that firms engaging in diversity washing tended to have weaker governance structures, such as boards lacking diversity and independence, and less transparent reporting practices, such as not disclosing detailed DEI metrics or using vague language in DEI reports, when compared to firms that discuss DEI in amounts that are commensurate with their actual diversity levels. Frequently, the diversity-washing companies placed more importance on short-term financial performance rather than long-term sustainability and equity. 

The researchers found that this misalignment between public DEI commitments and actual workforce practices not only undermined trust among employees and investors, but it also posed reputational risks. For instance, many firms, previously lauded for their DEI efforts, were discovered to be engaged in substantial discrimination lawsuits and labor conflicts. The authors highlight a need for establishing more stringent benchmarks and independent verification of DEI claims to hold companies accountable for upholding their DEI promises.

Conclusions

The study’s findings highlight the prevalence and implications of diversity washing in corporate DEI disclosures. The authors recommend enhanced regulatory oversight and enforcement to ensure the accuracy of DEI reporting and to hold firms accountable to their public commitments. They also suggest that investors and stakeholders critically evaluate DEI disclosures and seek independent verification.