Companies’ diversity and inclusion (D&I) practices have attracted widespread attention and support from investors, policymakers, and the public. Yet while they may advance social justice, these practices’ impact on a company’s operations remains unclear.

Conventional wisdom is that a diverse and inclusive workforce offers a firm a variety of valuable perspectives and problem-solving approaches, enabling the firm to make better decisions, especially during times of change. If that’s right, a diverse and inclusive firm (henceforth, D&I firm) may exhibit more flexibility in adapting to changing economic conditions. However, focusing on D&I practices could also constrain a firm, making its operations less flexible. For example, diverse teams may encounter communication issues, and the process of integrating differences among employees may require time and resources that hinder swift decisions. Therefore, without concrete data, it is hard to know whether D&I practices hinder or enhance a firm’s flexibility – its ability to adapt to change.

Determining how D&I practices affect a firm’s flexibility requires an accurate measure of corporate D&I practices. Yet commercially available D&I ratings are based on very limited information about workforce diversity and often fail to capture inclusion, i.e., how minority employees are treated inside a firm. Fortunately, in 2020, Glassdoor.com, a career intelligence site, introduced a new rating that allows anonymous employees to evaluate firms’ D&I practices. While this rating is new, in a new paper, I was able to extend it back more than a decade for thousands of companies using written reviews on Glassdoor. The paper uses an advanced language model from Google to understand how written reviews predict the numerical D&I rating back in time, effectively creating a D&I rating for over 10 million employee reviews.

With the D&I rating from employee reviews, I then measured each firm’s D&I practices by averaging the D&I rating across reviews for the firm. Overall, my paper finds that firms with a higher D&I rating (D&I firms) tend to exhibit lower flexibility.

The key to measuring a firm’s flexibility is the idea that if a firm is inflexible, it is less able to adjust its operations to keep its profit and cost margins stable during changing economic conditions.  Therefore, I measured a firm’s flexibility according to the range of the firm’s operating cost margins (cost relative to revenue) over a period, where a wider range indicates a lower flexibility. Consistent with the lower flexibility of D&I firms, I find that D&I firms often have a wider range of operating cost margins. This finding is validated in many settings. For example, when Lambert v. Peri Formworks Sys., Inc., a circuit court ruling about workplace racial and sexual harassment,  gave companies an incentive to improve D&I practices, the affected companies improved their D&I ratings while subsequently experiencing a wider range of cost margins, i.e., less flexibility.

Why may D&I practices constrain a firm’s flexibility? There are potentially two main reasons. One involves the workforce, where D&I introduces hiring and firing frictions that restrict a company’s ability to manage its employees.  The second involves efficiency, where D&I practices lead to communication challenges among diverse employees, slowing down decision-making and hindering adaptability.

To investigate these reasons, I studied how D&I firms responded to the COVID-19 crisis in 2020. This crisis provided an unexpected shock to the economy, allowing me to observe firms’ flexibility in real-time. The results indicate that D&I firms experienced a larger decline in operating efficiency during the crisis, rather than a larger workforce reduction, compared with other firms. Therefore, it seems that D&I practices affected flexibility more through operating efficiency than workforce management.

In short, the data suggests that a firm’s D&I practices on average reduce its operating flexibility. While D&I is widely recognized as important for social and ethical reasons, this finding implies that there is a downside to having effective D&I practices for a company: lower operating flexibility.

Nonetheless, the findings do not mean that having good D&I practices is not optimal for firms, because there could be many potential benefits of D&I that future studies can examine, such as higher innovation and higher efficiency during normal times. Understanding these trade-offs is important for business leaders as they navigate the evolving landscape of diversity and inclusion in the corporate world.

This post comes to us from Professor Hoa Briscoe-Tran at the University of Alberta. It is based on his recent article, “Are Firms Sacrificing Flexibility for Diversity and Inclusion?” available here.