2017 Finance Prize: Board Diversity and Firm Performance Volatility
The European Corporate Governance Institute (ECGI) held its Annual Working Paper Prize-giving ceremony in Lausanne on 28 April 2017. Two awards were presented to the best papers in the Finance Series and the Law series from the previous year.
This year, the Law Series prize of €5,000, which is sponsored by Allen & Overy, the global fund manager, was awarded to Professor Mariassunta Giannetti (Stockholm School of Economics) and Professor Mengxin Zhao (University of Alberta), for their paper on “Board Diversity and Firm Performance Volatility”.
Speaking about the announcement, Professor Ernst Maug, Editor of the ECGI Finance Series commented;
Dealing with the topical issue of board diversity, this paper contributes to what seems to be an emerging alternative viewpoint, namely that diversity has also the downside of leading to less coherent decision-making if board members do not share a common perspective. The paper’s notable insight is in theory and in relating diversity to firm risk.
The paper explores the determinants and effects of diversity in the boards of US listed companies. Directors may differ along a number of dimensions including gender, education, experience, tenure, age as well as diversity of ancestral origins. Using a principal component approach, the authors show that ancestral origin is the main driver of differences in diversity across the boards of US listed companies. The ancestral diversity of a firm directors in turn reflects the diversity of the population in the MSA where the firm is incorporated. Interestingly, board diversity appears to have costs and benefits, which are reflected in high volatility of the performance of firms with more diverse boards.
The authors argue that the decision-making process in firms with diverse boards is more erratic because diverse individual preferences fail to univocally aggregate in collective preferences. Consistently with this conjecture, firms with diverse boards have less persistent strategies and analysts make larger forecast errors in predicting their performance, supporting the conjecture that board members’ diverse preferences lead to hard to predict decisions. Consistent with the presence of conflicts in the boardroom, executive and director turnover is higher in firms with diverse boards. These firms also have more board meetings. There is no evidence that results may be driven by firm risk-taking or complexity.
The authors also find that board diversity may benefit innovative firms for which diverse boards are associated with more cited, and arguably more innovative, patents. Thus, the paper suggests that diverse groups may have costs and benefits and that the development of decision rules aiming to make the decision process more efficient may improve the performance of diverse boards and diverse groups in general.