Private equity can’t afford to give up on recruiting from a broader talent pool or baking diversity into performance metrics.
Can the private equity industry’s diversity drive survive a market downturn? Non-financial initiatives that started in boom times can be vulnerable when economic conditions turn for the worse. This is one effort that needs to persist.
There’s been mounting pressure on this lucrative corner of the financial world, which has long been predominantly White and male, to tap a wider talent pool. Today’s tighter labor market only intensifies the need to act. Having diversity in the senior ranks helps attract talent at the entry level. The money is talking too, as scrutiny increases from ESG-minded limited partners who invest in buyouts and from shareholders who invest in the publicly traded private equity firms.
The impetus is also coming from within — there’s fear that groupthink will befall partners if they all come from the same demographic, went to the same schools and live in the same neighborhoods. That homogeneity could lead firms to miss both risks and opportunities.
Hence the continuing array of initiatives both at buyout firms and at their investments. Carlyle Group Inc. recently formed a network for its portfolio-company bosses to share insights on what works to promote diversity and inclusion. Advent International demands that the boards of its investments set a diversity and inclusion policy for which they’re accountable, while Blackstone Inc. has set a target for boardroom diversity in new investments made from 2021 (where these firms have controlling stakes).
In turn, there’s an awareness that the benefits of buyouts need to be shared more widely. KKR & Co. has been granting equity to rank-and-file staff in some portfolio companies. It’s also invited workers at one of its investments to decide how $1 million could be spent each year to improve their day-to-day experience.
Applying private equity’s “what gets measured gets done” philosophy to equality means expanding the key performance indicators by which the management teams of leveraged buyouts are assessed — for example, requiring that candidate slates include women and minorities, that advancement through an organization is audited and that employees receive training to raise awareness of bias.
This may add additional process and operating cost, but it comes with financial and reputational returns. A 2018 study of venture capital investments since 1990 by Paul Gompers and Silpa Kovvali of Harvard Business School found that the more similar investment partners were in terms of educational background, the lower the performance of their investments. Shared ethnicity had an even more powerful effect on reducing investment gains. Differences emerged in the quality of decision-making around recruitment and strategic development of the target company.
It’s the same story in private equity. Carlyle reviewed its US portfolio companies in 2020 and found that the average three-year earnings growth of those with two or more female, Black, Hispanic or Asian board members was faster than firms with no diversity.
A 2006 study by the late Katherine W. Phillips of Columbia University and her colleagues offers one explanation for why. They set up a murder-mystery game to be played by racially diverse and non-diverse teams. Each participant had a set of clues, some of which were common to their team and some of which were unique. The diverse teams significantly outperformed the homogenous teams, spending more time in discussion and sharing more of the information they held.
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