Is greenwashing old news? The latest component of ESG to be subject to a good scrubbing is diversity: specifically, “diversity washing.”  What’s that? According to this paper authored by academics from several institutions, including Chicago Booth and the Rock Center for Corporate Governance at Stanford, there are a number of companies that actively promote their commitments to diversity, equity and inclusion in their public communications but, in actuality, their hiring practices, well, don’t quite measure up.  The authors label companies with significant discrepancies—companies that “discuss diversity more than their actual employee gender and racial diversity warrants—as ‘diversity washers.’” What’s more, the authors found, companies that engaged in diversity washing received better ratings from ESG rating firms and were often financed by ESG-focused funds, even though these companies were “more likely to incur discrimination violations and pay larger fines for these actions.” The authors cautioned companies that getting a handle on the level of misrepresentation in this area is important because “a failure to adequately address deficiencies in DEI has real effects on firms, including costly ESG audits initiated by activist shareholders, increased scrutiny from regulators, and bad publicity that can negatively affect customer loyalty.” Not to mention the “social and economic loss” for ESG investors.

The paper searched through disclosures about commitments to diversity in SEC filings for “nearly all U.S. public corporations” from 2008 through 2021, using a dictionary constructed of terms related to DEI—such as “gender discrimination,” “unconscious bias,” “people of color,” “being an ally,” “white privilege”  or “pay equity.”  The authors then compared the disclosures with a set of “novel data” measuring the companies’ actual employee diversity. The result: a “significant disconnect.” Where workplace diversity was out of line with the expected level of  discussion of DEI, the authors treated the deviations as misrepresentations. The authors found increased prevalence of DEI-related terms over time, suggesting both an increased interest in DEI generally as well as increased potential for “opportunistic DEI disclosures.” The study also found similar misrepresentations in voluntary corporate social responsibility reports and on social media.

The authors found that companies identified as diversity washers were, on average,  “larger with worse financial performance. These findings are consistent with large, high-profile companies attempting to boost their ESG profiles to lessen shareholder focus on poor financial performance.” Moreover, the study found that these companies had less workplace diversity, lost more diverse employees, and were more likely to incur higher diversity-related EEOC penalties. To the concern that companies identified as diversity washers may in fact simply be behind on their DEI commitments, the authors found that “diversity washing is not associated with subsequent improvements in underlying diversity.”

Finally, the authors found that these DEI-related disclosures—which shareholders and stakeholders may have trouble validating—did have an impact on investors. The study showed a “positive association between diversity washers’ overall ESG and social ratings,” with one ESG rating firm awarding diversity washers an approximately 13% higher ESG score relative to non-diversity washers.  In addition, the study demonstrated that diversity washers had approximately 9.4% more socially responsible investment fund ownership than non-diversity washers, highlighting the possibility that the flow of sustainable assets could be “distorted” by these misrepresentations. “This potential manipulation” the authors conclude, “is an economic benefit to diversity-washing companies and an economic and social loss for investors with an ESG focus.”

Posted by Cydney Posner