Diversity, Inclusion, and Firm Performance: The Corporate Innovation Channel

ABSTRACT This paper examines whether corporate innovation—measured both as general innovative output and as environmental innovation—mediates the relationship between diversity and inclusion (D&I) and corporate financial performance (CFP). Prior research has documented positive, negative, and null associations between D&I and financial outcomes, but has yet to identify the mechanism through which D&I may generate economic value. We hypothesize that the diversity of executive governance roles and the inclusiveness of workplace practices jointly foster corporate innovation, which, in turn, drives corporate financial performance. Using a sample of 47,212 firm‐year observations from 55 countries between 2010 and 2021, we find that corporate innovation mediates a notable portion of the D&I‐CFP relationship. We further observe that inclusion is the more influential component and that the diversity‐inclusion interaction exhibits a nonlinear boundary: at extreme levels of executive gender diversity, the innovation benefits of inclusion diminish. Our findings suggest that the contradictory evidence in the diversity‐performance literature may reflect an omitted mediating variable: namely, the corporate innovation facilitated by D&I. Moreover, our results underscore the importance of pursuing balanced governance over numerically maximizing diversity for symbolic or compliance purposes.