Why gender diversity in the boardroom won't always please investors

Dr Eric Crampton
The Dominion Post
25 November, 2019

It is too easy to convince ourselves of things that are not true.

We all do it and it is hard to avoid. Some beliefs, from religion to sport, are just comforting. And when some comforting beliefs are very popular, being the one to say otherwise can be a bit risky.

But, at least in business, believing things that are not so can eventually get you into trouble. Businesses face the market test. And, for publicly listed companies, share prices can provide a quick signal that you may have made a bad decision.

The latest issue of Organisation Science, a top academic management journal, provides a wonderful case study

Isabelle Solal and Kaisa Snellman, researchers at European graduate business school INSEAD, wanted to see what happened to company share prices after new corporate board appointments.

They found no effect of increasing boardroom gender diversity on share market performance – with an exception.

Firms that had taken greater efforts to promote diversity, as evidenced by their ratings on the KLD corporate social performance index, saw decreases in share prices when making appointments that increased gender diversity. 

The result sounds rather puzzling.

After all, in 2015, Treasury Secretary Gabriel Makhlouf wrote in the National Business Review that "international research shows companies that have a balanced representation of women and men on their boards perform better."

In last week's Dominion Post, Simplicity's Sam Stubbs similarly told us that "the vast majority of academic research shows that company returns are increased with gender diversity"

So why would share market investors punish firms for increasing boardroom diversity, but only those firms recognised in the KLD indices for their laudable efforts to improve workplace gender balance?

If increasing diversity improves company performance, surely investors should reward it rather than ignore or punish it. 

To figure it out, we need to step back and look a little more closely at the international literature and the received wisdom.

Unfortunately, the best studies out there do not really say what everyone would like to believe. Gender diversity in the corporate boardroom is laudable for many obvious reasons. But it has no particular effect on company performance.

It is easy to find consultants' reports claiming that companies with more diverse boards have stronger performance.

But companies with more diverse boards differ from other companies in all kinds of ways rarely counted in consultants' analyses: they can differ in capitalisation, in employment, in industry or sector, and in prior performance. 

Proper academic studies will statistically adjust for these kinds of differences to see whether boardroom diversity relates to company performance. 

Wharton Business School's Katherine Klein provided an excellent review of the academic literature in 2017. She noted that meta-analyses of work on boardroom gender diversity – studies that summarise the results of dozens of other studies – "suggest that the relationship between board gender diversity and company performance is either non-existant (effectively zero) or very weakly positive."

She also warned there is no evidence at all to suggest that boardroom gender diversity causes changes in performance; causation is much harder to establish than correlation. 

And that helps us to understand why investors might respond in the way that Solal and Snellman discovered. 

It may now be a bit passé to say it but improving shareholder value is a company's ultimate responsibility. There are plenty of wonderful things that companies do to help the communities they serve, but shareholder value is a hard bottom line. It is part of the market test.

Companies that keep that sharp focus on the bottom-line will make board appointments that they think will do the most to improve the company's performance.

When investors have little worry that the latest board appointment was made for any reason other than improving the company's performance, the gender of the latest board appointment has no effect on share prices. Investors simply expect that the best candidate was chosen. 

But among firms highly rated for their commitment to gender diversity, an additional female appointment to the board reduced the firm's market value relative to the value of the company's physical assets (Tobin's q) by almost 6 per cent.

Solal and Snellman suggest that investors infer, in those cases, that the company is less worried about shareholder value than about other objectives. And that can be a worry if you care about your portfolio's returns.

While the literature showing no particular effect of boardroom gender on corporate performance is rather substantial, Solal and Snellman's results are still just one study. Others could yet overturn it. 

But it does provide a bit of a warning for companies that put substantial effort into advertising their corporate social responsibility credentials.

If Solal and Snellman are right, then investors can be quick to infer that companies demonstrating their commitment to popular but mistaken beliefs have taken their eye off the ball.

The market test matters. And mistaken beliefs can be costly. 

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