Public firms in the United States have seen a significant push towards increasing racial diversity on corporate boards, spurred by a combination of legislative action, listing requirements and shareholder pressure. In 2019, California’s Assembly Bill No. 979 was proposed in the legislature, mandating that publicly traded companies headquartered in the state include racial-ethnic minorities on their boards. The bill became law in September 2020, following the rise of the Black Lives Matter (BLM) movement, which sparked a nationwide call for racial equity and placed additional social pressure on companies to diversify their leadership.  In December of 2020, the Nasdaq introduced a listing requirement for firms to include women and racial-ethnic minorities on their boards, a proposal that was approved by the Securities and Exchange Commission (SEC) in August of 2021.

These developments have sparked considerable debate and several legal battles. Proponents argue that board diversity brings fresh perspectives, mitigates groupthink, and ultimately benefits shareholders—a concept known as “the business case for diversity.” Opponents not only question the legality of these mandates but also contend that requiring diversity could lead to suboptimal board selections, potentially reducing firm performance and ultimately harming shareholders.

In our recent study, we empirically test whether there is a business case for racial diversity on corporate boards. We analyze a large sample of over 2,400 U.S. public firms, using the California legislation and the BLM movement as key demand shocks to assess the causal impact of increased board racial diversity on firm performance, value, and risk. Our findings are available in our new working paper, Is There a Business Case for Racial Diversity on Corporate Boards?, and offer novel insights into this ongoing debate.

Establishing a Causal Link

California’s Assembly Bill No. 979 was a landmark piece of legislation, requiring that publicly traded companies based in the state have at least one director from an underrepresented community by the end of 2021and increasing numbers based on board size by the end of 2022. This mandate significantly increased the racial diversity of corporate boards among California firms that were not already compliant with the law. Notably, however, the law was eventually ruled unconstitutional in 2022, raising questions about its long-term impact.

Around the same time, the murder of George Floyd and the rise of the BLM movement led to a surge in the appointment of Black directors across U.S. firms. This social movement became an informal yet powerful catalyst for increasing board racial diversity, particularly in companies that previously lacked Black representation.

The California law and the BLM movement together provide a rare opportunity to explore the causal impact of board racial diversity on corporate outcomes. However, measuring this impact is tricky due to what economists call “endogeneity,” which can take different forms. One common issue is omitted variables bias. For instance, if we observe that firms with more diverse boards perform better, we cannot automatically assume diversity is driving this success. It could be that higher-performing companies are more likely to attract racial-ethnic minorities to their boards, rather than diversity itself improving performance.

To address this, we can track changes within individual firms over time, asking how performance shifts when board diversity increases. But this approach still faces a challenge known as reverse causality—the “chicken or egg” problem. Firms might bring on diverse directors when they are already doing well, or those directors might join companies only when superior performance is expected. To truly measure the effect of board diversity, we need external events—like the California law and the BLM movement—that independently push firms to diversify, regardless of their current performance.

In our study, we use what econometricians call a triple difference model to capture this effect. The California law required publicly traded firms to meet certain racial diversity standards, but not all were affected the same way. Some were already compliant when the law was enacted, while others had to add racially diverse directors. Our model compares the performance changes between these two groups around the time of the law’s implementation—these are the first two differences.

The third difference, which is crucial, accounts for how the performance differences between compliant and non-compliant firms in California would have evolved in the absence of the law. To create this “counterfactual,” we analyze firms outside of California that were not subject to the law but had similar board compositions to the non-compliant and compliant firms in California. This approach helps to control for the factors that initially determined whether firms were affected by the law, which could also impact future performance differences, allowing us to more precisely isolate the effect of mandated diversity on firm performance.

We conduct a secondary test by leveraging the surge of the BLM movement as external pressure on firms without Black directors to appoint them. This analysis employs an instrumental variables regression to estimate the impact of racial diversity on boards. For a more in-depth explanation of this methodology, including its assumptions and limitations, we encourage you to read our full research article.

Does Racial Diversity Impact Firm Performance?

Our analysis begins by examining correlations between board racial diversity and various measures of firm performance, including sales, return on assets (ROA), Tobin’s Q (a measure of the firm’s valuation by investors), and idiosyncratic volatility (a measure of risk). Initially, we find positive correlations: firms with more racially diverse boards tend to have better performance, higher valuations, and lower risk. These findings align with reports from prominent management consulting firms, which have often touted the benefits of Diversity, Equity, and Inclusion (DEI) in enhancing firm performance.

However, once we account for omitted variable bias by examining how changes in firm outcomes align with changes in board racial diversity, these positive correlations largely disappear. The only relationship that remains significant is between board racial diversity and lower risk.

To address the issue of endogenous timing—where firms might recruit minority directors based on expected future performance—we conduct causal tests using the external shocks discussed earlier. Our findings reveal that the forced increases in racial diversity driven by the California mandate and the BLM movement did not have a significant effect on firm performance, valuation, or risk.

Why Did Forced Diversity Have Little Impact?

One might ask why increasing board racial diversity did not lead to significant changes in firm outcomes. Our study provides suggestive evidence that the pool of minority directors was sufficiently qualified to meet the increased demand without causing disruptions to board effectiveness. One potential explanation is that racial minorities in California make up a larger share of managers compared to other states. In California, firms tended to select minority directors who were already serving on other boards, resulting in minimal changes to overall board characteristics beyond racial diversity.

These findings challenge the notion that racial diversity alone can drive meaningful changes in board decisions. It is possible that directors of different races who reach the board level share more similarities than differences, particularly in terms of their education, experience, and perspectives on key corporate issues. As a result, increasing racial diversity may not lead to the substantial changes in traditional firm policies or performance that some advocates might expect.

Implications for Policy and Future Research

Our study offers valuable insights for policymakers and business leaders considering board diversity initiatives. The null results indicate that while forced racial diversity did not negatively impact firms, it also did not deliver the significant benefits often expected by advocates of the business case for diversity. However, research consistently shows that racial-ethnic minorities remain underrepresented on boards, and both mandates and social pressure have proven effective in reducing these disparities (Bogan, Potemkina, & Yonker, 2024).

These findings highlight the complexity of the issue and emphasize the need for further research to investigate other potential advantages of board diversity, such as its effects on corporate social responsibility initiatives or broader workforce diversity.

While our study focused on racial diversity at the board level, future research could also examine whether similar dynamics play out in other levels of the corporate hierarchy. Additionally, the long-term effects of increased board diversity, particularly in terms of fostering more inclusive corporate cultures, warrant further investigation.

Our study offers a nuanced perspective on the business case for racial diversity on corporate boards. While the initial correlations between diversity and firm performance are positive and statistically significant, the causal evidence suggests that simply mandating diversity may not be enough to drive meaningful changes in firm outcomes. As the debate over board diversity continues, it is essential to consider both the potential benefits and the limitations of such initiatives.

Our complete paper available for download here.