Do Pro‐Diversity Policies Improve Corporate Innovation?

• Date: 01 September 2018
• Author: Roger C. Mayer,Jing Zhao,Richard S. Warr
• DOI: http://doi.org/10.1111/fima.12205
• Published date: 01 September 2018

Do Pro-Diversity Policies Improve

Corporate Innovation?

Roger C. Mayer, Richard S. Warr, and Jing Zhao∗

Using new product announcements, patents, and patent citations as measures of corporate in-

novation, we find that corporate policies that promote more pro-diversity cultures, specifically

treatment of women and minorities, enhance future innovative efficiency. This positive effect is

stronger during economic downturns and in firms that are more innovative, value intangibles

and human capital more highly, have greater growth options, have higher cash flow, and have

stronger governance. Pro-diversity policies also increase firm value via this stimulating effect

on innovative efficiency. Our results suggest a channel through which workforce diversity may

enhance firm value.

Even though the mantra that firms “value diversity” is frequently heard both in business and

academia, surprisingly little work exists in the academic literature that examines how diversity

(defined as race, sex, and sexual orientation) impacts financial outcomes and f irm value. In this

paper, we explore whether firms that promote diversity within their organizations are rewarded

with tangible outcomes in the form of new innovations and new product announcements, along

with patents and citations on patents.

Wehypothesize that f irms that develop a diverse workforce and a culture of inclusion will have

greater innovative efficiency, ultimately leading to greater innovation output. Pro-diversity prac-

tices enhance innovative efficiency because a more diverse hiring policy increases the potential

pool from which a firm is able to recruit talented and creative employees. In addition, a wider

range of views, backgrounds, and expertise can help innovative problem solving, and a culture

of inclusion may help attract and retain talent. We propose that through the channel of corporate

innovation, pro-diversitypolicies can impact f irm value. Our null hypothesis is that pro-diversity

policies are merely designed to make the company look better to the outside world, or worse, that

such policies are a managerial indulgence and predicts that investment in such policies will result

in the destruction of shareholder value (Jensen, 1986).

Our exploration is motivated in part by Hirshleifer, Hsu, and Li (2013), who document a

link between the ability of the firm to develop and create new technologies and the subsequent

financial performance of the f irm. They measure technologicalinnovation as patents and citations

generated per research and development (R&D) dollar.This measure of “innovative efficiency” is

positively related to future stock returns. Our paper is also motivated bywork in the management

We wish to thank Raghu Rau (Editor) and an anonymous referee, whose comments and suggestions have substantially

improvedthis paper. Wealso thank Antje Berndt, Seong Byun (discussant), Jesse Ellis, Srini Krishnamurthy, Mark Walker,

and participants at Eastern Finance Association Annual Meeting, Financial ManagementAssociation Annual Meeting,

Southern Finance Association Annual Meeting, and North Carolina State University Brown Bag for helpful comments.

Jing Zhao gratefully acknowledgesf inancial support fromthe Cameron Research Fellowship in Financeat the School of

Business, Portland State University.

∗Roger C. Mayer is a Professor of Management, Innovation & Entrepreneurship in the Poole College of Management

at North Carolina State University in Raleigh, NC. Richard S. Warr is a Professor of Finance in the Poole College of

Management at North Carolina State University in Raleigh, NC. Jing Zhao is an Assistant Professorof Finance in the

School of Business at PortlandState University in Portland, OR.

Financial Management •Fall 2018 •pages 617 – 650

618 Financial Management rFall 2018

literature that shows that diverse teams and organizations tend to be more innovative (see, e.g.,

Talke, Salomo, and Rost, 2010; Østergaard, Timmermans, and Kristinsson, 2011).

Our primary measure of innovation is new product announcements from the Capital IQ’s

Key Developments database, which capture innovation that does not necessarily lead to patents.

Prior research links new product development to positive firm financial outcomes (see, e.g.,

Chaney, Devinney, and Winer, 1991, for an early study). As a robustness check, we also use the

National Bureau of Economic Research (NBER) patent and citation database to create measures

of innovative efficiency.1We scale the patent and citation measures by the time series of R&D

expense and repeat our main tests. All of our tests are subject to extensive controls.

Weuse the MSCI ESG STATS database to create measures of a firm’spro-diversity policies. The

MSCI ESG STATS data record whetherf irms have a range of policies and characteristics that are

either “strengths” in diversity or “concerns.” Such measures include whether the Chief Executive

Officer (CEO) is a woman, whether women or minorities are promoted to key positions, whether

minority groups and women are represented on the board, the presence of benefits aimed at work-

life balance, hiring programs aimed at disabled workers, and whether the firm has progressive

policies toward lesbian, gay, bisexual, and transgender (LGBT) employees.

We find that pro-diversity policies are positively related to the number of new product an-

nouncements per R&D dollar spent by a firm. Our results are robust to addressing endogeneity

using Granger (1969) causality tests. More specifically, we find that lagged changes in diversity

policies positively and significantly predict future changes in innovative efficiency but not the

other way around.2Further tests show that the positiveeffect of pro-diversity policies on innova-

tive efficiency is stronger during recessions, including the 2008 financial crisis, suggesting that

building a reputation of pro-diversity and a culture of inclusion pays offespecially when investors

and the economy at large suffer extraordinary uncertainty and risk and a severe crisis of trust and

confidence, and when the reward for being trustworthy substantially increases.3

Weaddress potential concerns that our results are a “Silicon Valley” effect by explicitlyexclud-

ing California-based firms and still f inding that our main results are qualitativelyunaffected. The

positive effect of pro-diversity policies is also more pronounced in more innovative firms; firms

where intangibles including human capital and employees are more valuable; firms with greater

growth options; firms in industries with fewer women in the labor force and thus have more

to gain from attracting and retaining (talented) women and other minorities; firms with lower

leverage, higher cash flow, and less financial constraints; and firms with stronger governance.

We find that pro-diversity policies enhance firm value (as measured by Tobin’s Q) via their

positive effect on innovative efficiency, in particular for a sample of firms that actively and

frequently engage in new product innovation. Therefore, we suggest that the effect of diversity

on innovation represents a channel through which such policies can create firm value. Our results

are robust to alternative measures of innovative efficiency and to firm-, industry-, and year-f ixed

effects, and to various model specifications. In addition, when we replace the dependent variable,

new product announcements, with innovative efficiency measures based on patents and citations,

our major findings remain qualitatively unchanged. Our results provide an explanation for why

promoting diverse workforces can result in greater productivity and innovative efficiency from

those employees, which in turn leads to greater shareholder value.

1Prior literature has documented a positive relation between patent innovationand f irm value (Pakes 1985; Hall, Jaffe,

and Trajtenberg, 2005).

2Wethank the referee for suggesting this impor tant test to control for endogeneity.

3Wethank the editor for suggesting this test.

Mayer, Warr, & Zhao rDo Pro-Diversity Policies Improve 619

Our study makes three major contributions. First, we document a positive effect of diversity-

related policies on corporate innovation. Second, we show that more favorable diversity-related

policies enhance the positive effect that innovation has on firm value.4Finally, we demonstrate

the positive value of corporate diversity policies during a financial crisis period.

The remainder of our paper is organized as follows. In the next section, wereview the literature

on workforce diversity and corporate innovative eff iciency and develop testable hypotheses.

In Section II, we describe the data, variable construction, and research methods. Section III

examines the effects of pro-diversity policies on a firm’s innovative eff iciency using the new

product announcements, while Section IV summarizes our robustness tests using patent and

citation data. We conclude in Section V.

I. Literature Review and Hypothesis Development

A. Diversity Policies

Evidence exists that diversity and pro-diversity policies may improve corporate performance.

First, a more pro-diversity hiring policy increases the depth of the potential employee pool from

which the firm can hire talent. Second, a wider range of views, backgrounds, and experiences

may contribute directly to more innovative problem solving (Horwitz and Horwitz, 2007). Finally,

by being more pro-diversity, a f irm may attract and retain talent even if this talent is not among

the groups that are typically the focus of diversity policies. Being seen to be pro-diversity may

create a halo effect for the firm and its brands.

Addressing the role of diversity in organizations, Richard (2000) finds that in a study of the

banking industry, racial diversity appeared to add value as measured by productivity, retur n on

equity, and market value. Blazovich et al. (2013) consider LGBT measures and corporate per-

formance and find that LGBT-friendly policies lead to higher fir m value and productivity, and

furthermore, these relations are stronger for firms that demand more highly skilled labor.5In

a recent working paper, Gao and Zhang (2015) find a significant increase in patent production

for firms located in states that enact antidiscrimination laws. In a meta-analysis, Horwitz and

Horwitz (2007) report that more diverse workforces are likely to result in more creative solutions

to problems. This finding is supported by Talke et al. (2010) who find evidence that top manage-

ment diversity increases firm performance by increasing the innovativeness of the new product

portfolio. Østergaard et al. (2011) show, using survey data, a relation between employeediversity

and innovation, while Bantel and Jackson (1989) show that more diverse top management teams

lead to greater innovation in banks.

At the team level, Van der Vegt and Janssen (2003) show that more heterogeneous teams lead

to greater levels of innovation. Hewlett, Marshall, and Sherbin (2013), using a combination of

surveys and case studies, report a correlation between diversity and market share growth. Faems,

4Previous research has examined the relation between innovationor innovative efficiency and various factors, including

aggregate stock returns (Hsu, 2009), market liquidity (Fang, Tian, and Tice, 2014), state antitakeover laws (Atanassov,

2013), corporate governance (Chemmanur and Tian,2014), cor porate philanthropy(Bereskin, Campbell, and Hsu, 2016),

analyst coverage (He and Tian, 2013), institutional ownership (Aghion, van Reenen, and Zingales, 2013), hedge fund

ownership and activism (Brav et al., 2015; Wang and Zhao, 2015), bank loan contracting (Francis et al., 2012), bank

competition (Cornaggia et al., 2015), CEO overconfidence (Hirshleifer, Low, and Teoh, 2012), and board interlocks

(Helmers, Patnam, and Rau, 2017), among others. See Chemmanur and Fulghieri (2014) for a comprehensive survey of

this literature.

5The Blazovich et al. (2013) paper contains a very thorough reviewof other literature that examines the relation between

LGBT policies and firm performance. Many of these previous studies rely on employee-level survey data.