Buyout barons need to keep diversity in the spreadsheet


Can the diversity dynamics of the private equity industry survive a market downturn? Non-financial initiatives that started in good times can be vulnerable when economic conditions deteriorate. It is an effort that must persist.

There has been growing pressure on this lucrative corner of the financial world, which has long been predominantly white and male, to tap into a wider talent pool. Today’s tight labor market only intensifies the need for action. Having diversity in the upper ranks helps attract entry-level talent. Money talks too, as scrutiny increases from ESG-conscious limited partners investing in buyouts and shareholders investing in publicly traded private equity firms.

The impetus also comes from within – there are fears that groupthink will get to the partners if they all come from the same demographic, went to the same schools and live in the same neighborhoods. This homogeneity could lead companies to miss both risks and opportunities.

Hence the proliferation of initiatives both at the level of buyout companies and at the level of their holdings. Carlyle Group Inc. recently formed a network for CEOs of its portfolio companies to share ideas on what works to promote diversity and inclusion. Advent International requires boards of its investments to establish a diversity and inclusion policy for which they are accountable, while Blackstone Inc. has set a boardroom diversity target in new investments made from 2021 (where these companies have controlling interests).

In turn, there is a realization that the benefits of buyouts need to be shared more widely. KKR & Co. has granted equity to the core staff of certain portfolio companies. He also invited workers at one of his investments to decide how $1 million could be spent each year to improve their day-to-day experience.

Applying the “what gets measured gets done” philosophy of equity private equity means expanding the key performance indicators by which leveraged buyout management teams are assessed – for example, requiring candidate slates to include women and minorities, that advancement in an organization is audited and that employees receive training to make them aware of biases.

This can add additional process and operational costs, 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 background, the poorer their investment performance. Shared ethnicity had an even more powerful effect on reducing investment gains. Differences emerged in the quality of decision-making regarding the recruitment and strategic development of the target company.

It’s the same story in private equity. Carlyle reviewed companies in its U.S. portfolio in 2020 and found that the three-year average earnings growth of those with at least two female, Black, Hispanic or Asian board members was faster than that of corporates. without diversity.

A 2006 study by the late Katherine W. Phillips of Columbia University and her colleagues offers an explanation. 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. Diverse teams significantly outperformed homogeneous teams, spending more time discussing and sharing more information they had.

Phillips concluded that being with similar people fosters a faulty assumption that everyone knows the same things and thinks the same, which hampers collaboration and innovation. Reviewing other research with similar results, she argued that an awareness of difference makes people assume they have to work harder to reach consensus. So while research has shown that social diversity in a group can cause discomfort, there is a compensating behavioral effect.

“They might not like it, but hard work can lead to better results,” Phillips wrote. “The pain associated with diversity…produces the gain.” That’s an argument the buyout barons get.

Of course, the cogs in this industry turn slowly. It will take time for the pipeline to change the dynamics at the highest level. Proof of private equity’s commitment will come when it brings its recent investments to the stock market later this decade. These should be led by much more diverse teams than in the past. We will see.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering the deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.

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