As California Goes, So Goes the Nation? The Impact of Board Gender Quotas on Firm Performance and the Director Labor Market

Steven Davidoff Solomon is Professor of Law at UC Berkeley School of Law. This post is based on a recent paper authored by Professor Davidoff Solomon; Felix von Meyerinck, Assistant Professor at the University of St. Gallen; Alexandra Niessen-Ruenzi, Chair of Corporate Governance at the University of Mannheim; and Markus M. Schmid, Professor of Corporate Finance at the University of St. Gallen.

Women are still heavily underrepresented in leadership positions in the U.S. corporate sector. According to the Corporate Women Directors International 2018 report, women hold 21.4% of director positions on the boards of the Fortune Global 200 companies. In As California Goes, So Goes the Nation? The Impact of Board Gender Quotas on Firm Performance and the Director Labor Market we examine the consequences of California’s adoption of SB 826, a law attempting to cure this disparity. SB 826 mandates that a minimum number of female directors serve on public companies headquartered in California.

The first question we explore is how the introduction of a mandatory gender quota affects Californian firms’ valuations. We compute abnormal stock returns for firms headquartered in California and a matched group of control firms for different event windows surrounding the days of the gender quota’s adoption and announcement in California. We observe a robust and significantly negative valuation effect of firms affected by the quota. Specifically, firms headquartered in California have a 0.45% lower announcement return on the first day after the quota announcement than a group of control firms headquartered in other U.S. states or the D.C. matched on size and industry. These results translate into a value loss of around 57.2 million USD on average (median: 3.7 million USD) per California-headquartered firm relative to non-California-headquartered firms. The large gap between the mean and median wealth effects is indicative of a skewed distribution, with some firms showing very large effects.

We also find that the market reaction to the quota is more positive (or less negative) the higher the firm’s sustainability score. This positive relationship between sustainability and abnormal returns to the quota’s announcement applies to both California-headquartered and non-California-headquartered firms, but is stronger for the latter. One conclusion that could be drawn from these results is that part of the market reaction around the quota announcement is caused by investors’ disapproval of California’s willingness to legislate non-economic values on California firms.

We further examine whether there are negative spillover effects to firms that are headquartered in states that are likely to follow California’s lead. First, we examine firms headquartered in democratic states, which are arguably more likely to follow Californian legislation than republican states. Indeed, we find negative spillover effects to firms headquartered in Democratic states. This finding can be interpreted as investors assessing a higher likelihood of mandatory gender quotas being enacted in democratic states. Similarly, we find that firms headquartered in states that followed California in legalizing cannabis to react more negatively to the quota’s introduction, a result that is also consistent with the perception of these firms being more likely to face such a quota themselves. Moreover, we find more negative spillover effects of firms headquartered in states that followed California in adopting a minimum wage that exceeds the U.S. federal minimum wage. Hence, we find evidence that firms headquartered in states that are more likely to follow California, and even more so in states that have signaled willingness to legislate non-economic values on firms, show stronger spillover effects. Finally, we document negative spillover effects for firms that operate in industries in which Californian firms need to appoint a large number of female directors to comply with the quota. This finding supports the view that the gender quota is value-reducing because it increases the competition for scarce, experienced female directors.

Finally, we examine whether the board composition of Californian firms has changed in response to the new gender quota. We observe that, relative to control firms, California-headquartered firms significantly increased female board representation by 0.45 percentage points three months after the introduction of the quota law (i.e., as of month-end December 2018). Californian firms that are under more pressure to fulfill the quota, i.e., those that require one (two) female director(s) to comply with the quota, have reacted more quickly to appoint female directors than a sample of control firms headquartered in other states. On average, these firms increased female board representation by 0.58 (0.69) percentage points three months after the introduction of the quota. Some preliminary evidence on the skill set and experience of the newly appointed female directors indicates that they are younger, significantly less likely to possess industry experience or experience as (an outside) director of another listed firm, and less likely to be independent than incumbent female and male directors.

Our results are subject to varying interpretations. One is directly related to the gender quota itself. The value reductions we find may be attributable to investor assessment that the law will lead to the appointment of less-qualified directors and subsequent firm underperformance. In our tests, we find evidence that this may indeed be the case: We document negative spillover effects for firms in industries where competition for female directors is likely to be more intense. We also find that Californian firms appoint younger and less experienced female directors to corporate boards in response to the mandatory quota.

On the other hand, the strong negative valuation results we find are remarkable in that the law only requires the appointment of additional directors, not the removal of male directors. Thus, it is surprising that the simple addition of one to three directors would change firm value so substantially. A second interpretation of the results more in line with this skepticism is that the investor reaction is related to an assessment of the willingness of California (and other similarly politically aligned states) to impose non-economic legislation on firms headquartered in that state. Our results on the effect of this law on smaller firms, those with low corporate governance standards, and those with low sustainability scores imply that firms which might be most affected by future legislation react more strongly, which gives credence to this hypothesis. However, our findings on spillover effects highlight that the gender quota itself has had some effect and that perhaps both effects are at work here.

Under either hypothesis, our findings suggest that non-economic laws concerning the corporation have economic effects. In the case of gender equality, studies have found that proactive measures to increase female representation on all management levels within a firm seem to be crucial to achieving a sustainable increase of the fraction of women in leadership. Gender quotas at the board level do not find this evidential support and appear to be beneficial only to those women that are directly promoted to a board seat due to the quota, but not to all other women in business who were not appointed to boards.

The complete paper is available for download here.

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