The relationship between diversity in the workplace and corporate performance has been put under an empirical microscope for quite some time. Multiple studies have shown that the positive correlation between the two makes for a compelling case for a more diverse workforce.But when the scope is narrowed down to focus on board diversity and its subsequent impact on the firm’s performance, the results are surprisingly mixed.
But before we take a look at the data, a caveat: the word “diversity” is an umbrella under which attributes such as age, gender, ethnicity, tenure, skills, etc. come into play. Most research papers, however, dwell on the elements of gender and ethnicity.
DIVERSITY AND THE LACK OF A BUSINESS CASE
A 2016 Columbia Law School blog post on diversity noted that “greater national cultural diversity in corporate boards leads to lower performance at U.K. firms accounting for more than 95 percent of the market value of London Stock Exchange-listed companies. The negative impact is economically significant, with a reduction in return on equity of 1.43 percent for firms with higher levels of cultural diversity (those at or above the 75th percentile) versus firms with lower levels of cultural diversity (those at or below the 25th percentile).”
As for gender diversity, a 2014 study in The Economic Journal finds no support for the argument that gender-diverse boards in the U.K. enhance corporate performance. It states: “Proposals in favour of greater board diversity may be best structured around the moral value of diversity, rather than with reference to an expectation of improved company performance.”
Two other 2015 peer-reviewed studies (spanning at least 30 countries) cited in this Wharton University article also suggest that “the relationship between board gender diversity and company performance is either non-existent (effectively zero) or very weakly positive.”
DISADVANTAGES OF BOARD DIVERSITY
These studies run counter to the logic that diversity in the entire employee pyramid (from board directors to rank-and-file employees) is inherently a “good thing.” But the reasons for the zero to negative impact of board diversity on a company’s performance are interesting.
A. Less Effective Interpersonal Dynamics
Communication dynamics are often cited as a downside to board diversity as it often becomes more complex. Ethnically and gender diverse boards will have to deal with more varied perspectives, biases, and personal experiences. Diverse boards will have to maneuver around these dynamics. This leads to slower-decision making processes, which can negatively impact the firm in instances when quick action and responses are demanded by the marketplace.
B. Reduced Trust Among Board Members
The Columbia Law School blog post cited above states there is more trust among members of the same culture. Diverse boards have to nurture and build higher trust levels. When trust and value issues permeate board dynamics, this leads to disruption, conflict, and inefficiencies.
These two points make it difficult for leadership to function effectively.
DIVERSITY AND VALUE CREATION
On the other side of the coin, there are more published studies on the positive impact of board diversity on corporate performance – as well as a movement towards it.
McKinsey & Company’s 2015 “Diversity Matters” report, which analysed 366 public companies across the U.K., Canada, U.S., and Latin America, reveals that there is a significant correlation between board diversity and firm performance – indicating that companies who commit to diversity are more successful.
Its 2018 “Delivering Through Diversity” report supports this trend as well. It highlights that at the board of directors level, more diverse companies were 43% more likely to see above-average profits.
Goldman Sachs’ CEO, David Solomon, recently announced that the firm will only take companies public if they have at least one diverse (focus on women) board member effective July 2020.
This decision is rooted in data reflecting that “since 2016, US companies that have gone public with at least one female board director outperformed companies that do not, one year post-IPO….”
Solomon states that those with “at least one diverse board member saw a 44% jump in their average share price within a year of going public, versus 13% at companies with no diverse board members.”
On December 1, 2020, Nasdaq issued a press release stating it “filed a proposal with the U.S. Securities and Exchange Commission (SEC) to adopt new listing rules related to board diversity and disclosure. If approved by the SEC, the new listing rules would require all companies listed on Nasdaq’s U.S. exchange to publicly disclose consistent, transparent diversity statistics regarding their board of directors,. Additionally the rules would require most Nasdaq-listed companies to have, or explain why do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+. Foreign companies and smaller reporting companies would have additional flexibility in satisfying this requirement with two female directors.”
The basis and rationale behind this requirement are the results of a dozen studies that found a positive correlation between diverse boards and better financial performance and corporate governance.
BENEFITS OF BOARD DIVERSITY
The improved overall performance of firms with more diverse boards are attributed to the following:
A. Better Understanding of Customer Orientation
In a global and highly connected economy, a diverse board will likely reflect its diverse customer base and better understand its changing needs. This allows for complex problem-solving in (and for) increasingly complex markets.
B. Higher Employee Satisfaction
When minority groups are represented in board roles, it helps foster an organisational culture of inclusivity. In turn, this creates an environment where employees feel free to voice out innovative ideas and creative solutions. This leads to increased self-confidence and higher self-esteem.
C. Positive Reputation for the Firm
The moral and societal value of diversity cannot be overlooked in today’s socio-political environment. A diverse board signals to the firm’s internal and external stakeholders that it is in sync with their values, preferences, interests, and aspirations. This increases the stature and reputation of the firm, which, some studies tie to better performance.
D. Less “Groupthink” and More Innovative Solutions
A diverse board is less likely to fall into “groupthink”, a term developed by social psychologist Irving Janis in 1972. It is best described as the “…tendency for a group to make bad or poorly thought-out decisions because its members aligned themselves with one other, insulating themselves from outside opinion and reinforcing viewpoints they already share.”
Inherent to a diverse board is a variety of personal experiences, skill sets, values, and convictions. This makes board members less likely to succumb to group pressures because more distinctive, individual characteristics are at play. Because of the wider range of competencies, differing risk-reward orientations and/or approaches to stewardship, diverse boards are more likely to offer multifaceted perspectives that lead to better identification of opportunities and innovative solutions.
All of the abovementioned upsides lead to a cycle of increased returns and better performance.
A FINAL NOTE
While it may seem that implementing diversity practices at the board level is a response to media promotion or mounting pressure from stakeholders and regulators, there is enough evidence to suggest that it is a socially responsible investment.
And yet is important to remember that board diversity is not about the token gesture of appointing individuals to the board because they check off certain boxes on the basis of gender, age, or ethnicity (i.e. “tokenism”). Factors such as competence, professional background, and reputation remain critical and cannot be overlooked. When social and professional diversity intersect, it amplifies the board’s effectiveness – and makes the case for good governance.