Boardspan Library

How Much Difference Does "Difference" Make

by Deborah L. Rhode and Amanda K. Packel

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In recent years, increasing attention has focused on the influence of gender and racial diversity on boards of directors. More than a dozen countries have implemented quotas to increase women’s representation on boards, and many more have adopted voluntary quotas in their corporate governance codes. In the United States, support for diversity has grown in principle, but progress has lagged in practice, and controversy has centered on whether and why diversity matters. We believe that increasing diversity should be a social priority, but not for the reasons often assumed. The “business case for diversity” is less compelling than other reasons rooted in social justice, equal opportunity, and corporate reputation. This article explores the rationale for diversity and strategies designed to address it. 

The lack of diversity on corporate boards
Nearly three quarters of members of corporate boards of the largest American companies are white men.  According to the most recent data, women hold 19 percent of the seats on S&P 500 boards, and only 13 percent of board seats among Russell 3000 companies.  Among the S&P 200, 15 percent of companies have no minorities on their boards.

By some measures, progress—especially in the past decade—seems to have stalled. According to Spencer Stuart, the share of S&P 500 company board seats held by women grew from 16 percent in 2004 to only 19 percent in 2014. The share of board seats held by minorities in the largest 200 S&P 500 companies has remained at approximately 15 percent for the last several years. At current rates of change, it would take almost 70 years before women’s representation on corporate boards reached parity with that of men. Recent data, however, suggest that the rate could increase somewhat; in 2014, a record 30 percent of newly appointed independent directors in the S&P 500 were women. 

The case for diversity
The growing consensus within the corporate community is that diversity is an important goal. The case for diversity rests on two primary claims. The first is that diversity provides equal opportunity to groups historically excluded from positions of power and enables full use of the pool of available talent. The second claim is that diversity will improve organizational processes and performance. This “business case for diversity” tends to dominate debates, in part because it appeals to a culture steeped in shareholder value as the metric for corporate decision making. This is also the claim on which controversy centers, so it is the primary focus of this discussion.

Diversity and financial performance
Despite increasing acceptance of the business case for diversity, empirical evidence on the issue is mixed and highly dependent on methodology. While some studies have found positive correlations between board diversity and various measures of firm performance, others have found the opposite or no significant relationship.  Moreover, correlations do not demonstrate causation. In studies showing a positive relationship, it could be that better financial performance leads to increased board diversity rather than the reverse. More successful firms may be better positioned to attract the female and minority candidates who are in high demand for board service. Larger and better-performing organizations may have more resources to devote to pursuing diversity and may face more pressure from the public and large institutional investors to increase board diversity. 

Some researchers attribute the varied findings to the methodological shortcomings in many of the studies, including small sample size, short-term observations of performance, and the difficulty of controlling for reverse causation and other omitted factors that may affect both board diversity and financial performance. Moreover, with so many different measures of firm performance, researchers are likely to find some values that show a positive relationship with board diversity and others that show a negative relationship. Scholars also question whether short-term accounting measures of financial performance are the best way to measure the impact of diversity. Research is lacking on the relationship between board diversity and long-term stock price performance, which is the “gold standard” measure of shareholder value.

Perhaps it should not be surprising that studies of the complex relationship between board diversity and financial performance are inconclusive, given that a direct relationship between various other aspects of board composition and performance has been similarly difficult to establish. Diversity may affect the various functions performed by boards in different ways, making it difficult to establish any consistent relationship between board diversity and firm performance.

Given the limitations of these studies, many commentators believe that the business case for diversity rests on other grounds, particularly its effects on board decision-making processes, corporate reputation, and governance capacities. 

Diversity and board process, reputation, and governance
A common argument is that diversity enhances board decision-making and monitoring functions. This assertion draws on social science research on small-group decision making, as well as studies of board process and members’ experiences. The basic premise is that diversity may lessen the tendency for boards to engage in groupthink—a phenomenon in which efforts to achieve consensus override the board’s ability to “realistically appraise alternative courses of action.”

The literature on board decision making reflects three main theories about the process through which diversity enhances performance. The first theory is that women and men have different strengths, and that greater inclusion can ensure representation of valuable capabilities. For instance, some empirical evidence suggests that women generally are more financially risk averse than men. For that reason, many commentators have speculated that women’s increased participation in corporate financial decision making could have helped to curb tendencies that caused the most recent financial crisis. 

Participants in a widely discussed panel at a World Economic Forum in Davos questioned whether “the world [would] be in this financial mess if it had been Lehman Sisters?” Many believed that the answer was no, citing evidence suggesting that women were “more prudent” and less “ego driven” than men in financial management contexts. Some commentators also cited evidence that indicated that women have higher levels of trustworthiness or collaborative styles that can improve board dynamics.

A second theory of how diversity enhances performance is that women and minorities have different life experiences than white men, bringing different concerns and questions to the table that enable the board to consider “a wider range of options and solutions to corporate issues.” This theory contends that diversity is productive by generating cognitive conflict: “conflicting opinions, knowledge, and perspectives that result in a more thorough consideration of a wide range of interpretations, alternatives, and consequences.”

Some scholars have also suggested that diverse boards can help prevent corporate corruption because they are “bold enough to ask management the tough questions.” According to one study, female directors expanded the content of board discussions and were more likely than their male counterparts to raise issues concerning multiple stakeholders.

A third theory on how diversity enhances performance is based on a belief that the very existence of diversity alters board dynamics in ultimately positive ways. 

Some scholars argue that the presence of visibly diverse members enhances a group’s ability to handle conflict by signaling that differences of opinion are likely. Yet the extent to which demographic diversity produces diversity in perspectives is by no means clear. The educational, socioeconomic, and occupational backgrounds of women and minority directors tend to be quite similar to those of other directors. Even when women and minorities have a different view, if they are represented at only token levels, they may lack sufficient leverage to influence the discussion. Studies on the influence of gender on leadership behavior are mixed, but some suggest that men and women who occupy the same roles tend to behave similarly. Moreover, in some studies, demographic diversity leads to increased conflict and poor communication, which tend to counteract or reduce the benefit of broader perspectives.

Given the competing findings and methodological limitations of these studies, the financial benefits of board diversity should not be overstated. Nor should boards understate other justifications for diversity, including fairness, justice, and equal opportunity, as well as the symbolic message diversity sends to corporate stakeholders. A diverse board signals that the perspectives of women and minorities are important to the organization, and that the organization is committed to inclusion, not only in principle but also in practice. Further, corporations with a commitment to diversity have access to a wider pool of talent and a broader mix of leadership skills than corporations that lack such a commitment.

Strategies for change
Strategies to increase board diversity operate at both the individual and institutional level. For individuals, formal mentoring programs, leadership workshops, diversity advisors or coaches, and related strategies can help interested applicants shape their career paths, refine their resumes, develop networking strategies, and overcome barriers to self-promotion.

Corporations can intensify their diversity efforts, both at the board level and in their internal policies, to help build the pipeline of women and minorities qualified for future appointments. One option is for companies to set their own goals or requirements for new appointments to ensure a critical mass of women and minorities. Some commentators advocate a “structured search” that starts with an analysis of the board’s functional needs and then identifies female and minority candidates who could fill them. Corporations could also adopt a version of the National Football League’s “Rooney Rule,” which requires teams to interview a minority candidate for each coaching and general manager position—an idea suggested by commissioner Luis Aguilar of the US Securities and Exchange Commission. If existing female seats are retained and Fortune 500 corporations adopt a target of recruiting women for one of every two board seat openings due to normal retirements, then 30 percent participation could be achieved by 2018.

Whatever the process, companies should aspire to establish an inclusive nominating committee that is sensitive to the value of diversity. They can also expand their searches beyondthe traditional pool of active and retired CEOs, to consider other corporate executives, nonprofit directors and officers, as well as academic presidents and experts. Many commentators believe the current pool of potential directors is large enough to achieve board diversity if the director qualifications are appropriately broadened. Professional consultants, who now conduct approximately half of board searches, can help identify promising candidates from outside of the board’s network or from less traditional backgrounds.

Companies could also institute age limits or term restrictions, which would open up seats for women and minorities. Despite the thousands of board seats within large public companies, relatively few seats turn over on a yearly basis. Even if women were to receive the majority of new board appointments, the progress in increasing women’s representation on corporate boards will continue to be slow unless the number of seats becoming available significantly increases. As one commentator put it, “What’s holding women back isn’t bias. It’s the fact that no one ever leaves the boards.”

Another institutional initiative could focus on making board diversity (or its absence) more visible and enlisting pressure from stakeholder groups to hold organizations accountable. Some empirical research has demonstrated a significant increase in women and minority directors when companies include pictures of board members in annual reports.28 Several companies in Silicon Valley, including Hewlett-Packard, Intel, Google, Yahoo, Facebook, and LinkedIn, have released information about the diversity of their employees and leaders. Voluntary disclosure efforts such as these can help bring more attention to the issue of diversity and may increase pressure on companies to make more diverse board appointments.

Large institutional investors could also demand disclosure on diversity and use their leverage to advance inclusion among their portfolio companies. The Thirty Percent Coalition—formed in 2011 by leading women’s organizations, institutional investors, executives, elected officials, and concerned individuals—has set a goal of achieving 30 percent representation of women on US public company boards by 2015. The coalition has reported some success using letterwriting campaigns and shareholder resolutions to engage companies with no women serving on their boards. 30 US Stock exchanges, such as NASDAQ and NYSE, could follow the example of exchanges in Australia and New Zealand, which require their listed companies to provide greater disclosure regarding their board composition and search processes. All of these strategies could help narrow the distance between the rhetoric and reality of corporate commitments to diversity.

Conclusion
As recent initiatives make clear, board membership remains a significant issue in the struggle for more equitable leadership structures. In this context, it matters to get the arguments right, and to make the case for diversity on the basis of strong equitable and reputational arguments rather than more contested links between board membership and financial performance.

 

Republished courtesy of The Conference Board. For more, visit ConferenceBoard.org.

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