Delegated Gender Diversity

Hao Liang is Associate Professor of Finance at Singapore Management University and Cara Vansteenkiste is a lecturer at the University of New South Wales Business School. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here); Will Nasdaq’s Diversity Rules Harm Investors? by Jesse M. Fried (discussed on the Forum here); and Duty and Diversity by Chris Brummer and Leo E. Strine, Jr. (discussed on the Forum here).

Despite the growing emphasis on gender diversity, women still represent less than 20% of board members in publicly listed firms worldwide. To boost the presence of women in top business positions, many jurisdictions have mandated a minimum number of female directors on corporate boards. In 2004, Norway became the first country to legislate that all Norwegian publicly listed firms should have at least 40 percent female directors. Since then, a wave of board gender legislation and campaigns have swept across the world, including campaigns by institutional investors such as the Big Three (BlackRock, State Street, and Vanguard) who also sought to promote board gender diversity among their portfolio companies.

Is there a business case for board gender diversity? The literature provides mixed evidence on the impact of female board representation on firm value. The skillset view holds that female directors have unique skills and risk appetites that complement the skillsets of male directors, resulting in a diversity premium and higher firm value. The supply view on the other hand states that mandatory board gender quotas can lead to a shortage of qualified female board candidates. Firms that must meet quotas may have to appoint less capable directors, or they may have to overburden existing directors, both of which lead to value destruction and investor exits.

In this paper, we offer a new perspective on the relation between board gender diversity and firm value. We argue that board gender diversity can increase firm value by attracting institutional capital to the firm, increasing its access to finance and lowering the firm’s cost of capital. Gender equality on corporate boards, together with many other environmental, social, and governance (ESG) issues, is increasingly at the top of institutional investors’ agendas, driven by the growing amount of capital concentrated in socially responsible investment (SRI) funds and institutional investors’ desire to appeal to shareholders’ sustainability preferences. In their search for ESG performance, SRI funds target firms that have balanced boards or that are expected to do well in terms of board diversity, to showcase that they are forward looking. We therefore hypothesize that an expected increase in female board representation is more likely to attract investment by SRI investors and ESG-focused funds.

To test this investor demand view, we investigate the announcement by Norway’s sovereign wealth fund (SWF), Norges Bank Investment Management (NBIM), on February 15, 2021. In the announcement, NBIM stated that it would require its portfolio firms to set targets for female board representation at 30% or more, and it would start voting against nomination committees that failed to meet the 30% threshold. In extreme cases, noncompliance would result in the divestment of the holding. The announcement was a shock to investor expectations about female board representation in global equity markets, and provides a number of advantages relative to campaigns by commercial investors.  NBIM’s unique position as a SWF implies that it carries a dual objective of delivering sustainable financial returns for its shareholders, while also promoting nonfinancial social welfare. Given Norway’s tradition of advancing board gender equality via mandated quota and NBIM’s reputation of actively screening and voting against firms with ESG risks, NBIM’s campaign can achieve higher credibility from shareholders relative to campaigns by commercial investors, whose fiduciary duty is primarily to maximize financial returns. NBIM is also one of the largest asset managers in the world, holding on average 1.5 percent of listed equity in 73 countries. Given these broad holdings, it can exert significant influence on global equity markets and on other investors’ actions. Moreover, NBIM’s portfolio composition is relatively more exogenous than that of other asset managers such as index investors, whose ownership is often endogenously correlated with firm characteristics that predict a firm’s inclusion in major equity indices. The international scope of NBIM’s portfolio also enables us to investigate cross-country variation in the effect of female board representation, which is relatively scarce in the literature.

Using an international sample of 8,806 NBIM-held firms, we find significantly positive returns in a [0,+1]-window around NBIM’s announcement, driven entirely by firms with a female board representation shortfall. We find that shortfall firms earn 0.15% to 0.31% higher returns relative to firms without a shortfall. The return difference increases with the size of the shortfall and is strongest for firms that were targeted first by the campaign (i.e., large firms and those in Europe and North America). We also confirm these findings in a regression discontinuity setting, where we focus on firms with female board representation within a 5% bandwidth around the 30% threshold.

We find that the higher returns for shortfall firms are concentrated in firms that have the most potential to attract additional institutional capital, namely those with low institutional ownership (low-IO firms). In contrast, firms with high institutional ownership (high-IO firms) earn significantly negative returns. Moreover, we find that low-IO firms with a female director shortfall experience an increase in institutional holdings that is up to 0.55% higher relative to low-IO firms without a shortfall. These increases in institutional holdings are driven by SRI fund investment, whereas IO decreases are driven by non-SRI funds, and are concentrated in firms with high NBIM ownership. We also find a larger decrease in the implied cost of capital for shortfall firms, concentrated among firms with low IO.

We confirm the credibility of NBIM’s campaign by showing that NBIM is 3.4% more likely to vote in favor of female directors in firms with a shortfall and that shortfall firms add 5% more female directors in the following year relative to non-shortfall firms. We also contrast our results with those for the 2017 board gender diversity campaigns by the Big Three institutional investors, and find that the positive stock market reactions to the Big Three’s announcements were driven by high-IO shortfall firms that did not close their gender gap. This suggests that, unlike SWF-initiated campaigns, commercial investor-initiated campaigns may lead to capital reallocation between compliant and noncompliant firms by different types of investors.

Our study has significant policy implications. Existing studies usually find government-mandated gender quotas to be associated with a significant drop in firm value. Governments act as agents of their citizens and have a “delegated philanthropy” mission to promote social outcomes through laws and regulations, even if these come at the cost of economic efficiency and shareholder value. Gender diversity campaigns initiated by commercial investors, on the other hand, are usually believed to be motivated by financial incentives. Different from direct government-mandated regulations and commercial investors’ campaigns, SWFs have a dual objective to not only promote social outcomes but also to deliver sustainable financial returns. Therefore, it may be a more efficient way to promote social outcomes that lead to both economic and social welfare improvements. In this regard, our study sheds light on how governmental and market forces can be combined to promote gender equality and other social issues to achieve Pareto improvement in society.

The complete paper is available for download here.

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