Diversity on Corporate Boards: How Much Difference Does “Difference” Make?

The following post comes to us from Deborah L. Rhode, the Ernest W. McFarland Professor of Law and Director of the Center on the Legal Profession at Stanford University, and Amanda K. Packel, the Deputy Director of the Arthur and Toni Rembe Rock Center for Corporate Governance, a joint initiative of Stanford Law School and the Stanford Graduate School of Business.

In recent years, increasing attention has focused on the influence of gender and racial diversity on boards of directors. More than a dozen countries now require some form of quotas to increase women’s representation on boards, and many more have voluntary quotas in 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.

In our article, Diversity on Corporate Boards: How Much Difference Does “Difference” Make?, which was recently published in Delaware Journal of Corporate Law, 39, no. 2, Fall 2014, we evaluate the case for diversity on corporate boards of directors in light of competing research findings. An overview of recent studies reveals that the relationship between diversity and financial performance has not been convincingly established. There is, however, some theoretical and empirical basis for believing that when diversity is well managed, it can improve decision-making and enhance a corporation’s public image by conveying commitments to equal opportunity and inclusion. We believe 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. Our article explores the rationale for diversity and strategies designed to address it.

By some measures, progress toward greater diversity on corporate boards—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 has grown from 16% in 2004 to only 19% in 2014. And the proportion of board seats held by minorities in the largest 200 S&P 500 companies has remained at approximately 15% for the last several years. Recent data, however, suggest that progress, at least for female directors, may be accelerating; in 2014, a record 30% of newly appointed independent directors in the S&P 500 were women.

The growing consensus within the corporate community is that diversity is an important goal. The case for diversity rests on two primary claims. First, 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 the discussion here.

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; it could be that better financial performance leads to increased board diversity rather than the reverse.

In addition, with so many different measures of performance from which to choose, 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 focusing on short-term accounting measures of financial performance is the best way to measure diversity’s impact. 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.

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. A common assertion, drawing on research on small-group dynamics and studies of board process, is that diversity enhances board decision-making and monitoring functions. The basic premise is that diversity—whether through representation of different strengths, consideration of different concerns and questions based on varying life experiences, or signaling that enhances a group’s ability to handle conflict—may lessen the tendency for boards to engage in groupthink, a phenomenon in which members’ efforts to achieve consensus override their ability to assess alternative courses of action realistically.

Yet the extent to which demographic diversity produces diversity in perspectives is by no means clear. Women and minority directors tend to have educational, socioeconomic, and occupational backgrounds similar to those of other directors. Studies on the influence of gender on leadership behavior are mixed, but some suggest that men and women who occupy the same role tend to behave similarly. Even when women and minorities have a different view, they may lack sufficient leverage to influence the discussion if they are represented at only token levels. Moreover, some studies suggest that demographic diversity leads to increased conflict and poor communication, which tend to counteract or dominate the benefit of broader perspectives.

Given the competing findings and methodological limitations of these studies, the potential benefits of board diversity on firm performance should not be overstated. But neither should boards understate other justifications for diversity, including values such as fairness, justice, and equal opportunity, as well as the symbolic message it sends to corporate stakeholders. A diverse board signals that women’s and minorities’ perspectives 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.

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.

The full paper is available for download here.

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