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Just call it corporate karma.

Companies that turn a blind eye to systemic discrimination in their workplaces risk damaging their credit ratings and driving up their cost of borrowing.

Moody’s Investors Service Inc. recently became the first of the Big Three credit-rating agencies to directly assess the ratings ramifications of a large public company’s racial-diversity strategy. It’s a progressive move that portends a broader rethink of corporate credit risk amid a global reckoning on systemic racism.

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New York-based Moody’s established a benchmark for this type of analysis when it reviewed Lloyds Banking Group PLC’s new “Race Action” plan. Moody’s deemed the strategy “credit positive” because it “will improve staff diversity at all levels and reduce Lloyds’ exposure to social risk.”

The British bank set a target to increase Black representation in senior roles to at least 3 per cent by 2025, and vowed to publish an ethnicity pay gap report this year among other initiatives. Black people comprise roughly 3.1 per cent of the British population, but only 1.5 per cent of Lloyds’ employees and 0.6 per cent of its senior management as of July, Moody’s said.

“The underrepresentation in financial services of ethnic minorities, and in particular Black staff, and at senior level, is a social issue that is subject to increasing scrutiny by investors, regulators, and politicians in several countries,” Moody’s wrote in its report.

Systemic racism, of course, isn’t limited to the financial services industry. Indeed a wide range of companies, including those here in Canada, are pledging to combat systemic racism after the police killing of George Floyd in Minneapolis on May 25.

The COVID-19 pandemic has shone a light on anti-Black racism and business leaders were given a stark reminder about its pervasiveness last week when U.S. President Donald Trump made inflammatory comments in Kenosha, Wis. The city became a hotbed of social protest after Jacob Blake, another Black man, was left paralyzed after being shot seven times by police on Aug. 23.

Canada, meanwhile, is confronting its own uncomfortable truths about systemic discrimination, including in the business community.

Although Moody’s has no immediate plans to analyze the credit-ratings implications of Canadian companies’ racial-diversity plans, it’s leaving the door open to doing so in the future. “If there’s interest and enough disclosure in Canada, the team would consider it,” said Moody’s spokeswoman Melissa Mott.

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Given the racial strife we’ve witnessed in recent months, such analysis of North American companies seems inevitable. This is no abstract concept – it’s about managing systemic risk. Moody’s has already established a correlation between gender diversity and higher corporate credit ratings. Last year, it published a study based on a review of 1,109 publicly traded companies in Canada and United States that found businesses with more female directors have higher credit quality.

Credit rating agencies, meanwhile, already take social factors into consideration for sovereign credit ratings. Moody’s, for instance, has flagged racial income and wealth inequality as a threat to America’s credit rating.

“Recent events have highlighted the unequal position of the Black community in particular, which is a salient and persistent feature of the inequality dynamic that exacerbates credit-related social risks in the U.S.,” Moody’s stated in July.

S&P Global Ratings, too, considers social factors when assessing sovereign credit ratings. “Our analysis of social cohesion looks at social mobility, social inclusion, the prevalence of civic organizations, degree of social order, and the capacity of political institutions to respond to societal priorities,” said Daniela Brandazza, senior analytical director of S&P Global.

For all of those reasons, a correlation between racial diversity and corporate credit quality isn’t a stretch. Regulators are already conducting cultural-risk analysis.

For instance, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), is assessing how corporate cultures, including social mores, can create excessive risks for lenders.

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“Our supervision of financial institutions includes assessing their management of reputation risk as reputational events can impact an institution’s financial position,” said OSFI spokesman Michael Toope.

Corporate Canada, though, still has a long way to go on racial inclusion. Although more than 250 businesses signed a pledge to end anti-Black systemic racism as part of the BlackNorth Initiative, diversity experts are urging companies to set more specific staffing targets.

Companies subject to the Canada Business Corporations Act are already required to disclose information about the diversity of their boards and senior management teams to investors. The Trudeau government, however, still needs to make good on a promise in the 2019 federal budget to create parallel requirements for major banks, which are subject to the Bank Act.

Ottawa, along with provincial and territorial governments, must also tweak their respective pay equity laws to close the racial wage gap. For instance, university-educated Canadian-born visible minorities earn, on average, 87.4 cents for every dollar earned by their Caucasian peers, according to The Conference Board of Canada.

That’s precisely why corporate boards should tie a company’s diversity targets to executive compensation. What’s the point of making pledges if the C-suite isn’t held accountable?

Numerous studies, including those by Credit Suisse Group AG, Morgan Stanley and Catalyst Inc., have already established a link between gender diversity and stronger financial results. Racial diversity is next.

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The tide is turning against companies that tolerate systemic racism in their workplaces. It’s only a matter of time before more credit-rating agencies consider the ratings implications of corporate diversity strategies.

Systemic racism is a serious business problem that requires a serious business solution. Canadian companies that fail to act will learn the hard way that racism hurts us all.

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