The venture capital industry is hardly a poster child for diversity. Only 8% of VC investors are women, 2% are Hispanic, and fewer than 1% are black. All three groups have significantly higher representation in other highly compensated business fields, according to research by Paul A. Gompers and Sophie Q. Wang of Harvard University. They are also more represented in advanced professional and scientific degree programs that typically feed VC firms.
Gompers and Wang found similar patterns among startup entrepreneurs who receive VC funding. Both sectors are dominated by white and Asian males. In short, the capital provision and idea generation sides of the innovation economy are both oddly homogeneous, especially when you consider that VCs are funding startups that aspire to reach diverse global markets.
One important reason for this discrepancy is that humans are wired to trust people who look like them. The scholarly term for this is “homophily,” and it clearly influences hiring and investment decisions in the VC industry. Shared ethnicity increases the propensity for VC investors to work together by 39.2%. Having a degree from the same school increases it by 34.4%.
Ethnic and gender diversity correlate strongly with business success.
The authors note: “Not only is the likelihood of collaborating on any one deal greater, but VCs tend to keep teaming up with those who share their traits.”
In homogeneity we trust
Our species developed an instinct for homophily because it helped us survive in a dangerous world. “It’s easier to see potential in someone who reminds you of yourself,” says Julia Taylor Kennedy, executive vice president at the Center for Talent Innovation, a think tank that has published extensive research on the relationship between diversity and business performance.
Yet a growing body of research suggests that homophily is bad for business. In the VC sector, investor teams that share the same ethnicity and school backgrounds perform worse than more diverse teams. Gompers and Wang found that shared ethnicity reduces the success rate of acquisitions and IPOs by 26.4% to 32.2%.
On the flip side, ethnic and gender diversity correlate strongly with business success. Beyond the VC sector, teams that rank in the top quartile for gender diversity are 21% more likely to achieve above-average profitability than teams in the bottom quartile, according to a 2018 McKinsey study of more than 1,000 companies across 12 countries.
Companies that don’t recruit for diversity are missing out on a major talent opportunity, given that diverse talent is increasingly coming into the workforce. And diverse teams are more likely to understand the needs of diverse customers. A 2013 study by the Center for Talent Innovation found teams are 158% more likely to understand their target customer when one or more team members share traits with that customer, including gender, culture, ethnicity, age, and sexual orientation.
For all these reasons, you might expect market forces would inexorably push companies to be less discriminatory in their hiring and investing practices. In fact, discrimination is “persistent and long lasting in market-based economies,” according to research by William Darity Jr. of the University of North Carolina.
Darity identifies several reasons for this trend, including the material benefits that dominant groups experience from maintaining their privilege. Examples include white privilege in the U.S., high-caste Hindu privilege in India, and Protestant privilege in Northern Ireland. He concludes that “discriminatory practices to preserve privilege are likely to persist rather than fade out, even in market-based economies, in the absence of conscious policy intervention to address them.”
Which is not to suggest that companies should simply rely on regulators to eliminate discrimination. Instead they should set clear diversity targets and hold leaders accountable for reaching them. As important, companies need to create environments where everyone feels welcome and appreciated as unique individuals, regardless of their gender, ethnicity, age, or sexual orientation.
I’m pleased that Workflow’s publisher, ServiceNow, appears on the 2019 Best Workplaces for Diversity list, presented by Fortune magazine and the Best Places to Work Institute. Diversity is both a moral and business imperative. Simply put, companies that foster diverse, welcoming employee cultures will tend to outperform competitors that do not.