Embracing Diversity
Do Companies that Embrace Diversity Achieve Improvements in Performance?
For more than a decade, empirical studies, observations, and simple logic have provided support for the argument that corporate boardroom diversity is good for long term corporate performance and shareholder value. Over the past year, however, the social justice movement has brought heightened attention to the commitment of public companies to diversity and inclusion. Accordingly, the benefits of increased board diversity, some of which are outlined below, are becoming more apparent.
In addition to the ethical arguments that boardroom diversity is the right thing to do, there is also overwhelming support for the proposition that board diversity enhances firm performance and shareholder value. Indeed, Nasdaq has cited numerous studies that explicitly link board diversity to company performance and shareholder value, among other benefits. As stated by Nasdaq Chairman Michael Splinter, “Diversity of experience, gender, race, knowledge, and perspective means that a company is more capable of seeing the full picture, assessing risk and overcoming challenges with forward-looking innovative solutions.” 1
Diversity Improves Decision Making and Oversight
Evidence suggests that corporate boards of directors lacking diversity can suffer from “groupthink,” which is “a dysfunctional mode of group decision making characterized by a reduction in independent critical thinking and a relentless striving for unanimity among members.”2 Board diversity, therefore, can enhance a company’s ability to monitor management by reducing “groupthink” and improving decision making. For example, a 2017 study found that “diversity in the board of directors reduces stock return volatility, which is consistent with diverse backgrounds working as a governance mechanism, moderating decisions, and alleviating problems associated with ‘groupthink.’”3
Investors have also emphasized the importance of diversity in decision making. A group of institutional investors proposing an amendment to the proxy disclosure rule regarding board nominee disclosure asserted that “board members who possess a variety of viewpoints may raise different ideas and encourage a full airing of dissenting views. Such a broad pool of talent can be assembled when potential board candidates are not limited by gender, race, or ethnicity.”4
Even the presence of female directors can help to broaden a board’s perspective, objectify discussions, and provide mediation among other board members.5 Modern research on management and economics suggests that homogenous groups can make poor decisions about economic risk and ethical risk, so women can have a significant impact on board governance. Studies have found, for instance, that gender diverse boards are more likely to hold CEOs accountable for poor stock price performance and that directors on gender-diverse boards receive relatively more equity-based compensation.
While additional evaluation is needed, it appears that, at a minimum, “gender diversity on corporate boards has a neutral effect on governance quality, and at best, it has positive consequences for boards’ ability to monitor firm management.”6
Diversity Strengthens Investor Protections
There is also substantial evidence that board diversity enhances the quality of companies’ financial reporting, internal controls, public disclosures, and management oversight. Indeed, studies have found that companies with gender-diverse boards or audit committees are associated with, among other things: (i) more transparent public disclosures and less information asymmetry; (ii) better reporting discipline by management; (iii) a lower likelihood of manipulated earnings; (iv) an increased likelihood of voluntarily disclosing forward-looking information; (v) a lower likelihood of receiving audit qualifications due to errors, non-compliance, or omission of information; and (vi) a lower likelihood of securities fraud.
A 2016 study, for instance, concluded that gender diversity on the audit committee specifically “improves the quality of financial information.”7 The study found that “the percentage of females on [audit committees] reduces the probability of [audit] qualifications due to errors, non-compliance or the omission of information,” and found a positive association between gender diverse audit committees and disclosing audit reports with uncertainties and scope limitations.8 This suggests that gender diverse audit committees are more likely to oversee managers to ensure that they do not “pressure auditors into issuing a clean opinion instead of a qualified opinion” when any uncertainties or scope limitations are identified.9
Other studies have noted similarly positive effects on corporate governance when women serve on the board but are not part of the audit committee. For example, a 2017 study concluded that “gender-diverse boards commit fewer financial reporting mistakes and engage in less fraud.”10 Indeed, even having one woman on the board is associated with a lower likelihood of material weaknesses in internal control over financial reporting and a lower likelihood of material financial restatements. Specifically, companies with female directors have “fewer irregularity-type [financial] restatements, which tend to be indicative of financial manipulation.”11 One study even concluded that female directors were effective at reducing securities fraud,12 and another found that women directors were particularly helpful in improving corporate performance in times of crisis, such as the 2008 financial collapse.13
Relatedly, board gender diversity has been found to be positively associated with enhanced oversight of management and the issuance of more transparent public disclosures. For example, a 2011 study concluded that “gender diversity improves stock price informativeness by increasing voluntary public disclosures in large firms and increasing the incentives for private information collection in small firms.”14 A 2014 study noted a positive association between board gender diversity and compensation plans that link executive pay to company performance, which may be an effective mechanism to deter opportunistic behavior by management and align their interests with shareholders.15 A 2019 study published in the Harvard Business Review found that the presence of “female board members helps temper the overconfidence of male CEOs, improving overall decision making for the company.”16
Diversity Enhances Investor Confidence
As corporate efforts to foster diversity and inclusion remain in the spotlight, investors lacking access to material information about board diversity might divest from companies that fail to take into consideration the demographics of their corporate stakeholders when they refresh their boards. Accordingly, investors are calling in greater numbers for diversification of boardrooms, and institutions such as Vanguard, State Street Advisors, BlackRock, and the NYC Comptroller’s Office now include board diversity expectations in their engagement and proxy voting guidelines.17
Investors’ heightened focus on corporate board diversity demonstrates that investor confidence is undermined when data on board diversity is not readily available and when companies do not explain the reasons for the apparent absence of diversity on their boards. While this information itself is critical to investors, investor confidence is further enhanced by boards comprised of directors from diverse backgrounds, which ensure that board deliberations include the perspectives of more than one demographic group, leading to more robust dialogue and better decision making.
Diverse boards may also improve investor confidence by increasing the value of a company’s social and political good will within the broader community. Over time, this good will can translate into economic value for both the company and its shareholders.
Diversity Boosts Shareholder Value
There is a significant body of research suggesting a positive association between board diversity and shareholder value. While there are studies drawing different conclusions, the overwhelming majority of studies on the association between economic performance and board diversity present a compelling case that board diversity is positively associated with financial performance. Indeed, studies have identified a positive relationship between board diversity and commonly used financial metrics, including higher returns on invested capital, returns on equity, earnings per share, earnings before interest and taxation margin, asset valuation multiples, and credit ratings.18
For example, The Carlyle Group recently found that its portfolio companies with two or more diverse directors had average earnings growth of 12.3% over the previous three years, compared to 0.5% among portfolio companies with no diverse directors.19 The study also found that, “[a]fter controlling for industry, fund, and vintage year, companies with diverse boards generate earnings growth that’s five times faster, on average, with each diverse board member associated with a 5% increase in annualized earnings growth.”20
Several other studies also noted a positive association between diverse boards and company performance. A non-profit research association found that “the most diverse boards (top 20 percent) added 3.3 percentage points to [return on invested capital], as compared to their least diverse peers (bottom 20 percent).”21 Another study found that greater diversity on boards—including gender, ethnicity, educational background, age, financial expertise, and board experience—is associated with increased operating performance, higher asset valuation multiples, lower stock return volatility, reduced financial leverage, increased dividend payouts to shareholders, higher investment in R&D, and better innovation.22 Finally, McKinsey & Company found “a positive, statistically significant correlation between company financial outperformance and [board] diversity, on the dimensions of both gender and ethnicity,” noting that companies in the top quartile for board gender diversity are “28 percent more likely than their peers to outperform significantly,” and finding a statistically significant correlation between board gender diversity and outperformance on EBIT.23
In the words of SEC Commissioner Allison Herren Lee: “to the extent one seeks economic support for diversity and inclusion…, the evidence is in.”24
Authored by:
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Correy A. Kamin
Associate Levi & Korsinsky LLP Correy A. Kamin is an experienced litigator with a focus on shareholder derivative suits, class actions, and complex commercial litigation. Ms. Kamin began her career with the Investor Protection Bureau of the Office of the New York State Attorney General and spent four years prosecuting shareholder derivative actions and securities fraud litigation at one of the oldest firms in the country. Prior to joining Levi & Korsinsky, Ms. Kamin represented both individuals and corporations in complex business disputes at a New York litigation boutique. Ms. Kamin’s unflappable disposition and composure reflect a pragmatic approach to both litigation and negotiation. She thrives under pressure and serves as an aggressive advocate for her clients in the most high-stakes situations. Ms. Kamin has been recognized as a Super Lawyers Rising Star every year since 2017. |
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1.Nasdaq Press Release, December 1, 2020, https://www.nasdaq.com/press-release/nasdaq-to-advance-diversity-through-new-proposed-listing-requirements-2020-12-01.
2. See Daniel P. Forbes and Frances J. Milliken, Cognition and Corporate Governance: Understanding Boards of Directors as Strategic Decision-Making Groups, 24(3) Acad. Mgmt. Rev. 489, 496 (Jul. 1999).
3. See Gennaro Bernile et al., Board Diversity, Firm Risk, and Corporate Policies 38 (Mar. 6, 2017), available at https://ssrn.com/abstract=2733394
4. See Petition for Amendment of Proxy Rule (Mar. 31, 2015), available at https://www.sec.gov/rules/petitions/2015/petn4-682.pdf.
5. Joecks, Jasmin and Pull, Kerstin and Scharfenkamp, Katrin, Women Directors’ Roles on Corporate Boards: Insights from a Qualitative Study (May 4, 2017), available at https://ssrn.com/abstract=2962947.
6. See Kevin Campbell and Antonio Minguez-Vera, Gender Diversity in the Boardroom and Firm Financial Performance, 83(3) J. Bus. Ethics 13 (Feb. 2008).
7. See Maria Consuelo Pucheta-Martínez et al., Corporate governance, female directors and quality of financial information, 25(4) Bus. Ethics: A European Rev. 363, 378 (2016).
8. Id. at 363.
9. Id. at 368.
10. See Aida Sijamic Wahid, The Effects and the Mechanisms of Board Gender Diversity: Evidence from Financial manipulation, J. Bus. Ethics (Dec. 2017) Rotman School of Management Working Paper No. 2930132 at 1, available at https://ssrn.com/abstract=2930132.
11. Id. at 23.
12. Cumming, Douglas J. and Leung, T.Y. and Rui, Oliver M., Gender Diversity and Securities Fraud (July 24, 2014). Available at https://ssrn.com/abstract=2471081
13. Papangkorn, Suwongrat and Chatjuthamard, Pattanaporn and Jiraporn, Pornsit and Chueykamhang, Sirisak, The Effect of Female Directors on Firm Performance: Evidence from the Great Recession (Apr. 21, 2019).
14. See Ferdinand A. Gul et al., Does board gender diversity improve the informativeness of stock prices?, 51(3) J. Acct. & Econ. 314 (April 2011).
15. See Maria Encarnacion Lucas-Perez et al., Women on the Board and Managers’ Pay: Evidence from Spain, 129 J. Bus. Ethics 285 (Apr. 2014).
16. Chen, Jie, and Sau Leung, Woon, and Song, Wei, and Goergen, Marc, When women are on boards, male CEOs are less overconfident, Harvard Business Review (Sept. 12, 2019).
17. See BlackRock Investment Stewardship, Our approach to engagement on board diversity, noting that “we encourage companies to have at least two women on their boards.” March 2021. Available at https://www.blackrock.com/corporate/literature/publication/blk-commentary-engaging-on-diversity.pdf; State Street Global Advisors, Proxy Voting and Engagement Guidelines, noting that “we expect boards of Russell 3000 and TSX listed companies to have at least one female board member.” March 2021. Available at https://www.ssga.com/library-content/pdfs/ic/proxy-voting-and-engagement-guidelines-us-canada.pdf
18. Nasdaq Proposed Diversity Rule, 85 Fed. Reg. 80, 473 (Dec. 11, 2020), Notice of Filing of Proposed Rule Change to Adopt Listing Rule IM-5900-9 to Offer Certain Listed Companies Access to a Complimentary Board Recruiting Solution to Help Advance Diversity on Company Boards, Exchange Act Release No. 34-90571.
19. See Jason M. Thomas and Megan Starr, The Carlyle Group, Global Insights: From Impact Investing to Investing for Impact 5 (Feb. 24, 2020), available at https://www.carlyle.com/sites/default/files2020-02/From%20Impact%20Investing%20to%20Investing%20for%20Impact_022420.pdf.
20. Id.
21. See FCLTGlobal, The Long-term Habits of a Highly Effective Corporate Board 11 (March 2019), available at https://www.fcltglobal.org/wp-content/uploads/long-term-habits-of-highly-effective-corporate-boards.pdf.
22. See Gennaro Bernile et al., Board Diversity, Firm Risk, and Corporate Policies (Mar. 6, 2017), available at https://ssrn.com/abstract=2733394.
23. See McKinsey & Company, Diversity wins: How inclusion matters 13 (May 2020), available at https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/Diversity%20and%20Inclusion/Diversity%20wins%20How%20inclusion%20matters/Diversity-wins-How-inclusion-matters-vF.pdf.