Using a new dataset on more than 50,000 top executives in U.S. firms from 2002 to 2014, a new study shows that top management team diversity—a new text-based measure of how diverse managers are in terms of personal characteristics and prior experiences—matters for stock returns. Firms with diverse management teams have significantly higher risk-adjusted returns than firms with homogenous management teams, the report shows.
Diversity returns are driven by large-cap stocks and the long leg of the strategy, so diversity investing seems feasible for investors. Additional results suggest the large returns to diversity investing are due to (i) diversity being a new dimension of quality stocks and (ii) mispricing.
The study considered team size, biography length, firm characteristics, variations across industries and single manager firms.
Why does diversity investment work? According to the authors, diversity investing generates large, stable abnormal returns among the largest firms. In addition, they say, it is possible that the diversity characteristic is correlated with some priced risk-factor. If high diversity stocks are riskier, they would naturally command a return premium. While this is a theoretical possibility, the authors used a set of standard risk-adjustments in the literature, so it is not obvious what the omitted risk factor should be.
In conclusion, the authors show that the substantial returns to diversity investing may be driven by a combination of two things. First, diversity of the top management team may be a previously underemphasized dimension of “quality” stocks which is important over and above the quality variables used in the literature. Existing quality measures explain at best about 25% of the diversity returns we observe. Second, we nd evidence for the notion that some of the diversity returns may be due to the market mispricing the diversity of the top management team by showing that returns are, all else equal, coming from stocks with lower analyst coverage and higher idiosyncratic volatility.
The report is written by Alberto Manconi, Emanuele Rizzo, and Oliver Spalt—all finance specialists at Tilburg University in the Netherlands.