Does Diversity On Boards Of Directors Improve Corporate Performance?

Does board diversity affect corporate performance? Panelists at a recent Stanford Law School conference made a case for diversity on corporate boards, citing data, anecdotal evidence, and principle based arguments in support.

The Case For Diversity On Corporate Boards

The Rock Center for Corporate Governance, CalPERS and CalSTRS co-sponsored this event. Since the election of California Controller John Chiang in 2006, CalPERS, one of the largest and most influential public pension funds, has stepped up its efforts to address diversity on corporate boards. While the most obvious type is race and gender, the panels addressed diversity of all types, including individuals with knowledge of different geographical markets. In a recent whitepaper, CalPERS recommended that the concept of diversity be expanded beyond race and gender.

Panelists made several arguments in favor of diversity on corporate boards.

1. To open up new business opportunities.

Ginger Lew, senior advisor to the White House's National Economic Council, argued that having a diverse board gives a company a better of understanding of demographic and geographic markets. In addition, diverse board members can provide access to connections and business opportunities in new demographic and geographic markets. Diversity can provide a competitive edge to global companies.

2. To improve board processes.

Deborah Soon of Catalyst stated that having women on the board makes men prepare better for board meetings because the men do not want to be "shown up" by the women.

That would be an indirect benefit, not a direct benefit. Further, this does not mean that the women per se enhance board performance, only that the efforts of the men increases.

To be clear, I am not saying women do not enhance board processes or corporate governance more generally. All I am saying is that the idea that women spur the men to greater heights does not speak to what the women themselves are doing.

3. To show respect.

Stanford law professor and former SEC commissioner Joseph Grundfest argued that having a homogenous board shows disrespect to those being excluded. In contrast, having a diverse board shows that the company keeps up with societal changes and wants to be tune with such changes.

4. It is good business.

Former SEC commissioner Aulana Peters observed that board diversity is important to suppliers, customers, and employees. These stakeholders appreciate this characteristic on the board.

The Evidence -- Or Lack Thereof -- Of An Effect On Corporate Performance

Virtcom Consulting concludes that financial performance improved after a company's board diversity increased. However, several factors limit the generalizability and robustness of the results.

1. This is a small set of case studies, not a large sample.

The hypothesis that diversity increases corporate performance must be rigorously tested through statistical analysis of a large sample.

2. The time period is too short.

The data covers only a few years. Further, the data covers only the first several years after board composition is altered. But it is certainly possible that corporate performance improves after any substantial change in board composition, regardless of whether its diversity increases.

3. Alternate explanations are not examined.

The study did not control for the effects of other explanatory or control variables. Thus, we have no idea whether the results would hold after other factorsare considered.

The Challenges Of Showing A Connection To Better Financial Performance

Professor Grundfest offered additional observations on the problem of finding an effect on corporate performance.

• The ultimate test is whether the data shows an improvement in a company's stock price or other measures of financial performance (e.g., ROI). It is also possible that there is an effect, but that the effect is not statistically significant. Princeton sociologist Marta Tienda also mentioned that it may be difficult to find a statistically significant effect on financial performance in particular.

• Exogenous variables such as other explanatory factors must be adequately controlled and tested. Diversity might have an effect that disappears once other relevant variables are included in the statistical analysis.

• There is an endogeneity problem. Correlation does not prove causation. To support an inference of causality, the data and the analysis must be dynamic. The independent variable for diversity must be lagged relative to the dependent variables. Further, the analysis must account for the possibility that other types of diversity besides the board affect financial performance.

At this point, the body of research on this topic is insufficient and inadequate. Further study is needed to determine whether board diversity can be shown to have a positive, statistically significant effect on corporate performance.

Douglas Y. Park
Twitter: @DougYPark