The Return of Skepticism

McKinsey & Company, the famous management consulting firm, has published a number of wildly popular reports during the Great Awokening—such as 2015’s “Diversity Matters,” 2018’s “Delivering Through Diversity,” 2020’s “Diversity Wins,” and 2023’s “Diversity Matters Even More”—asserting that gender and ethnic diversity in corporate management is a magic bullet for making money.

McKinsey is a (highly) for-profit entity not otherwise known for doing disinterested scientific research just to advance the frontiers of knowledge. Then again, neither is McKinsey an investor trying to pick undervalued stocks. Instead, it makes its money telling the C-suite what the bosses want to hear.

But all that didn’t induce much news media skepticism about McKinsey’s reports…until recently as DEI has slightly receded in fashion.

Now, however, the conservative press is finally starting to publicize the old doubts of the business school researchers who live to find ways to outsmart the stock market.

For a summary of why the greatest concentration of outspoken skeptics about McKinsey’s epochal discoveries have been concentrated in B-School faculties, see London Business School professor of finance Alex Edmans’ blog May Contain Lies. Here are some highlights of his critique of McKinsey’s latest:

The paper is remarkably non-transparent about its methodology. The body of the paper never describes the sample of firms included in the study, what their dependent and independent variables are, and so on. This may be to stop people replicating their study as their prior research was found to be irreplicable. It is as if they hope that people will accept the results because they want them to be true, and not ask any questions (again, the opposite of diversity of thought).

The single most fundamental rule of thumb for thinking about causality is that X couldn’t likely have caused Y if Y happened before X. But not in McKinsey’s world:

But the McKinsey study makes an even more basic error absent from the other studies: they measure diversity after they measure financial performance! In their own words, “The analysis of this report is based on 2022 data on diversity in leadership teams and 2017-2021 data on financial performance.”

To draw a baseball analogy, were the Los Angeles Dodgers the highest-revenue franchise from 2017 to 2021 because in the 2023–2024 offseason they invested over $1 billion dollars in two Japanese stars, Shohei Ohtani and Yoshinobu Yamamoto? Or is Los Angeles already being the richest franchise why Dodgers were, as expected, able to afford the top two Japanese players? (Japanese players are more expensive for American teams than, say, comparable Dominican players: The Dodgers had to pay a $50 million fee to Yamamoto’s Japanese club for the right to pay him $325 million over 12 years.)

The answer to the baseball question is obvious, but then we tend to think more clearly about sport than about society. Edmans observes:

This makes it very likely that any relationship is due to reverse causality: it is financial performance that allows companies to invest in diversity, rather than diversity causing financial performance. (Indeed, my own work finds that financial strength is associated with superior future diversity, equity, and inclusion).

Competent executives and board members who check the currently preferred sex and race boxes are much in demand these days. High-quality People of Diversity are a luxury item more affordable by profitable corporations (and low-quality PoDs are less of a risk to strong firms to drive them into bankruptcy).

Also, McKinsey reports only one measure of profitability, Earnings Before Income and Taxes:

McKinsey’s earlier results were earlier shown to be untrue for all of these alternative profitability measures, leading to concerns about cherry picking the one measure that worked.

And why not report what really matters?

Moreover, it is not clear whether you should be measuring profitability at all. The most relevant performance is (long-term) Total Shareholder Return. TSR is what investors actually receive. TSR is far more comprehensive than EBIT (or any profitability measure). If a company announces a new patent or wins a big customer contract, it will boost the stock price but not immediately lift EBIT. More importantly, TSR is forward looking. Many tech companies have enjoyed soaring TSR despite modest profits due to their long-term potential.

Tech companies have of course driven much of the growth of stock indices over recent generations. (Six of the top seven firms on earth in market capitalization at the beginning of this month are American tech companies.)

If Asians like Jensen Huang of Nvidia, the graphics processing unit chipmaker that is the third most valuable publicly traded firm in the world, are redefined as white-adjacent, then the founders of tech companies are notoriously nondiverse. A legendary Silicon Valley investor once told me he’d analyzed the founding teams of over 150 “unicorn” start-ups with valuations of at least one billion dollars. Only three had female founders, and they were part of husband-wife pairs.

So, McKinsey’s choice to report profitability rather than stock performance biases their results.

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