How Private Equity Firm Boards Can Promote Diversity

The growing Black Lives Matter movement and protests over systemic racism have expanded globally, catalyzing public demand for corporations to take action. While companies of various sizes have ramped up donations to nonprofit organizations and offered public statements in support of the causes millions are marching for, there is a pervasive need to increase the racial diversity of corporate leadership – especially in boardrooms.

Recent reports show that efforts to increase the racial diversity of corporate boards and leadership teams are “moving the needle” too slowly: a 2018 study by Deloitte revealed that 80.7 percent of the 1,033 newly available board seats that year were filled by Caucasian/white directors, with 59.6 percent filled by Caucasian/white men in particular. In part, this is due to board hires being dependent on networking and, to put it simply, “knowing the right people,” a practice that has historically favored white men.

Board directors are uniquely situated to help drive an increase in the racial diversity of corporate leadership, which, in turn, can have a profound impact on the well-being and experience of a company’s employees, customers and other stakeholders. It is time for boards across sectors to start making the board hiring process more transparent, with some industries better positioned to jump-start this effort than others. Private equity firms, for example, are uniquely suited and well-equipped to foster diversity and inclusion at the board level, thanks to their widespread ownership of diverse private companies and their ability to move rapidly and affect change.

That said, the majority of private equity firms are very homogeneous – with predominately white men. So, what could PE firm boards do to promote diversity? If they do act, how can they measure the success of their efforts? To answer these questions, we must first look at why PE firms and their boards, specifically, are in a good position to spur change.

PE Firms Are Uniquely Positioned to Increase the Diversity of Corporate Leadership

PE firms invest in private companies, which don’t face quite the same challenges public companies do around hiring decisions. Private companies are not subject to shareholder pressure around the selection of new board and executive leaders; they have more freedom to choose the candidates they feel best fit their needs without having to gain shareholder approval. They may also add an independent board seat more easily. This gives PE firms an advantage when it comes to being proactive about diversity and inclusion in their portfolio companies’ leadership. PE firms can make diverse leadership a requirement if they so choose, and they can hold their portfolio companies accountable to meeting specific goals within a specific time frame.

Additionally, PE firms can generate power through their investments. As investors, PE firms can apply pressure on those companies to make that change – and quickly. This powerful position could be especially impactful in the tech sector. Having garnered a poor reputation for diversity over the past few years, tech companies are particularly behind on diversity and inclusion initiatives. Here, especially, is an opportunity for PE firms to play a strong role in moving the needle by holding the tech firms in their portfolios to higher standards around diversity hiring.

Lastly, PE firms are well-positioned to establish a deeper partnership between boards and senior management teams, a capability that is usually in their wheelhouse. During the pandemic, signs of both collaboration and blurred lines between management and governance became apparent across industries. Public company directors interviewed by Diligent Institute this spring revealed that they have been collaborating more frequently with management and have been better aligned with day-to-day realities at their companies. This new level of collaboration started due to the need for fast action and agile crisis response, but directors reported their desire to maintain a new level of collaboration beyond the crisis. As the global demand for racial justice accelerates, the same level of speed, agility and collaboration will be an important factor for success. PE firms, which often work in close partnership with the leadership of their portfolio companies, could leverage this practice to drive better alignment and regular updates on diversity efforts.

PE Firms Can Spur Innovation Around Diversity in Corporate Leadership

While promoting racial diversity in every facet of society is important, real change in the corporate space has to begin with a new tone at the top. According to data from Mercer, 64 percent of workers in entry-level positions are white. However, in the top executive ranks, 85 percent of positions are held by Caucasian/white people, demonstrating the promotion gap many minority groups face. Given this stark contrast, it is clear there is a need for the C-suite and board members to work together to execute on diversity initiatives and hold their companies accountable to measurable changes within a specific time frame.

Given this, PE firms can help spur digital innovation around the process of recruiting, selecting, onboarding and supporting diverse hires, and then encourage their portfolio companies to leverage new digital tools as they become available. As more tech and software companies innovate to address present-day challenges (such as the racial diversity gap on boards), PE firms can invest in those digital solutions. Solutions rooted in digital tools and software are able to give boards access to a more diverse host of candidates through a matrix of online databases, which helps further diversify their pool of prospective hires and helps boards track their success quickly and efficiently.

For example, recently a group of 10 PE firms, including Insight Partners, Clearlake Capital Group and Vista Equity Partners, all agreed to create five new board positions to be filled by diverse candidates through Diligent’s Modern Leadership initiative and have used a new tool from Diligent to ensure the process is transparent and that diverse applicants have the opportunity to apply. This type of technology helps leaders use their networks to nominate diverse, board-ready executives to build a database of largely untapped talent. This process will help to address the tradition of homogeneous networking that has favored white executives. Additionally, technology can help organizations post board searches, creating more transparency for diverse candidates to apply for those roles. Both of these actions will widen the pool of applicants to reach more racially diverse candidates.

PE Firms Can Set Benchmarks for Leadership Diversity and Hold Companies Accountable

The most obvious way to begin driving change in corporate leadership is by hiring diverse candidates. Equally important is getting a clear picture of the full scope of the challenge and setting KPIs for diversity in hiring.

That said, there are clearly hurdles to be overcome in measuring the problem and in charting the progress in addressing it. For example, digital tools that help recruiters find diverse candidates based on specific demographics could run afoul of regulations such as the General Data Protection Regulation (GDPR), which requires explicit written permission from data subjects in every instance when their personally identifiable information (PII) is collected or used. Additionally, digital tools that would make it easy to filter and search for candidates based on specific diversity traits also run the risk of being abused – potentially increasing incidents of discrimination in hiring practices, rather than reducing them.

Beyond these technical challenges, there is also the potential of unintended negative consequences coming out of well-meaning efforts. For example, let’s look at California’s recent gender quota law, which requires public companies increase the number of women on their board of directors. While this quota had the effect of increasing the total number of women onboarded to company boards last year, it did not effectively shift the overall gender balance of corporate boards. Why? Because many companies met the quota requirement by adding board seats, rather than doing the harder work of board refreshment.

But PE firms have a unique opportunity to address these issues in several ways.

PE firms can set diversity goals and expect results. Progress has to begin somewhere, and PE firms have a track record of setting ambitious goals and then helping their portfolio companies find or create innovative solutions to meet them. A PE firm can establish the targets they want their portfolio companies (and the PE firm itself) to hit and then hold leaders accountable to making progress. Imagine how quickly the numbers would move if PE firms made diversity targets as important a measure of success as financial targets.

PE firms can create demand for better digital solutions to help increase diversity and inclusion in corporate leadership. There are already tools on the market; by encouraging their numerous portfolio companies to use them, PE firms will accelerate innovation and the improvement of existing approaches. As demand increases, so will the quality of the available solutions.

PE firms can set the pace for diversity in the corporate leadership. Because PE firms have the unique ability to “set the tone at the top” for thousands of companies, their actions can have far-reaching impact. If the majority of PE firms were to set specific targets around diversity in corporate leadership, it could create systemic change across the business landscape.

Conclusion

PE firms are in an extraordinary position to lead the effort on racial diversity at the leadership level in business. While the actions we’ve described here can lead to change, the first step for many corporate leaders is to recognize the value of hiring a diverse board and workforce. Evidence shows companies that reflect the diverse makeup of their customers and stakeholders tend to outperform those with little diversity. As the demographics of the global workforce evolve and as the economy becomes more globalized, it is essential to foster a dynamic environment that welcomes diverse perspectives – particularly those of people who are currently marginalized in society. The companies that embrace a culture of inclusion will ultimately have an advantage over those that don’t.