Value, Size… & Groupthink?

Public company leadership with varied career backgrounds have persistently and substantially outperformed stocks from homogenous C-suites, according to the largest study to date on management diversity.  

The link was most pronounced in large-cap stocks, contrary to the majority of accepted equity-market performance anomalies. 

‘Diversity’ in this study concerned professional attributes only—prior roles and specialities, tenure, industry affiliations, education, etc.—as opposed to demographics such as gender and ethnicity. 

The sample included 53,743 executives from 5,391 listed companies, spanning 2002 to 2014. 

“Investors may be more confident assessing the quality of a homogenous team, because they feel that team is easier to understand.” Authors Alberto Manconi, Emanuele Rizzo, and Oliver Spalt—all finance specialists at Tilburg University in the Netherlands—relied on the executive biographies required by the US Securities and Exchange Commission from any public company. Automated textual analysis tools derived the study’s basic dataset from these profiles. 

Their findings suggested that harmony among higher-ups may signal a shorting opportunity for investors, rather than a good buy. 

“Firms with diverse management teams have up to 57 basis points higher risk-adjusted returns per month than firms with homogenous management teams, which is larger than effects obtained from most other leading asset pricing anomalies over our sample period,” wrote Manconi, Rizzo, and Spalt. 

By going long on the top quintile of diverse stocks and shorting the bottom quintile, a diversity-tiled portfolio would outperform a classic Fama-French three-factor strategy by a monthly 42 basis points, and a size and value tilt by 57 basis points over the 12-year sample horizon.

Highly diverse teams accounted for most of the alpha; shorting uniform managers contributed “some action.”   

“That diversity returns are concentrated in large stocks, and that most of the returns can be reaped without going short, means diversity investing may be profitable for investors even after transaction costs,” the authors argued. 

Portfolio turnover was slightly higher for this approach than size and value tilts, but substantially lower than momentum investing. 

Manconi, Rizzo, and Spalt posited three potential drivers of the diversity anomaly. 

First, varied expertise among executives could be correlated with an omitted risk factor, although they noted standard risk adjustments failed to produce a likely candidate. 

Second, and more likely in the researchers’ view, was a link between diverse management and “quality” stocks. “An attractive feature of this explanation is that a part of the related management literature emphasizes the potential of diverse teams to make better, less biased, decisions,” according to the authors.

Finally, investors could simply undervalue well-rounded leadership, producing persistent mispricing of securities under such teams, or even find them repellent. 

“Investors may be more confident assessing the quality of a homogenous team,” the authors wrote—a biotech firm led by biotech veterans inspires optimism. Or allocators and analysts could be put off by “higher perceived ambiguity in the expected performance of a diverse team.”    

Source: “Diversity Investing,” by Alberto Manconi, Emanuele Rizzo, and Oliver Spalt.

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