Homophily—the social phenomenon of people being more likely to interact and form relationships with others similar to themselves—is a significant contributing factor to racial inequality. It has been well-documented that African-Americans have fewer economic opportunities than non-African-Americans due to this tendency for people to socialize with others who look and think like themselves. However, less is known about race inequality in corporate leadership. My colleagues and I decided to investigate whether African-American corporate executives have the same access to informal networks as their non-African-American counterparts. Our results showed that homophily can, in fact, have a negative impact on access to information for certain racial groups.

Informal social networks and interactions in the workplace are important for building human and organizational capital, as managers often require cooperation and support from those within their social networks but outside their formal reporting hierarchy. If these social and professional networks are, in fact, racially homophilous, then African-American executives will have limited information for decision-making, as pervasive homophily in the workplace can cause informal information networks to be highly localized.

My colleagues and I decided to measure profits from insider trading as a proxy for access to these information networks. Legally speaking, an insider is an officer, director, 10 per cent stock holder or anyone with access to non-public material information about a company. They are allowed to trade stocks so long as those trades are not informed by non-public material information. However, there is a very large grey area where insiders can trade on soft information — e.g. potential growth prospects of the firm and its suppliers. Soft information differs from concrete, private information like an earnings report or a not-yet-public announcement like a merger or a new product.

Soft information is passed along through personal social networks, so an insider is likely to make very profitable trades when they’re regulars at dinner parties and the country club. On the other hand, those excluded from these groups would be at a disadvantage, which we reasoned would be reflected in the profitability of their trades.

To test this, we used the ExecuComp and the Individual Shareholder Services (ISS) databases to identify and categorize 15,598 insiders. We then cross referenced those insiders with insider-trading and stock price data we obtained from the Thomson Reuters Insider Filing Data Feed and Center for Research in Security Prices.

The results support our hypothesis. We found that although there were no differences in the trading frequency between African-American and non-African-American executives, African-American executives did not see a statistically significant return on trades, while their non-African-American counterparts saw a 90-day equal-weighted average return of nearly five per cent. We also found that on average, non-African-American executives purchase when the stock price is at its lowest point within a 100-day window — a pattern indicative of informed trading. We did not see the same pattern for their African-American counterparts.

While the return on investment of a certain group of executives may seem trivial, it's important to remember that trading profits are being used as a proxy for access to information. This deficit has other real-world consequences. Specifically, it can place qualified African-American executives at a disadvantage when competing with their non-African-American counterparts for promotions, raises and job recommendations, which often circulate through word-of-mouth. 

The good news is that evidence indicates a strong corporate emphasis on equity, diversity and inclusion (EDI) can mitigate these differences. Investment in EDI fosters interracial communication and cooperation while suppressing race-based discrimination. While it’s unfortunate that racial inequality extends all the way to the C-suite, there is a clear path forward towards rectifying it through a strong commitment to EDI by companies and organizations.

Deniz Anginer is a professor of finance at the Beedie Business School at Simon Fraser University. He conducts research in banking and capital markets. Prior to joining the SFU's Beedie School of Business, he was an economist at the Development Research Group at the World Bank. Deniz has a Phd in Finance from the Ross School of Business at the University of Michigan. Prior to his graduate studies, Deniz worked as a consultant for Oliver Wyman in their New York office.