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Board Diversity Empirically Linked to Financial Performance

By Melissa J. Anderson

What measures of board diversity can help a firm perform better? According to a new empirical study by Pei Sai Fan of the Monetary Authority of Singapore, board diversity in the areas of gender, ethnicity, and discipline of study impact firm performance. Diversity in the areas of discipline of study and tenure can improve board independence.

Pei writes, “firms should consider appointing more females and people with different ethnic backgrounds to their boards which can help provide knowledge and experience of different customer segments and wider contacts which ultimately improve firm performance.”

As for board independence, he continues, diversity can help break “groupthink,” which can lead to poor decisions. He writes:

“The implication is that firms should consider people from different educational, training and ethnic backgrounds as future directors to enrich their board discussions in order to make better board decisions affecting firm performance. Perhaps firms should consider paying more attention to the ‘inner’ independence of the entire board by encouraging more diversified board members in terms of their background, fields of study and profession.”

The study shows how the benefits of diversity are prevalent in different geographies and economic structures.

Diversity and Success

Pai says diversity has been shown to provide firms with a number of advantages. For example, he writes that diversity is considered to create “a more thorough consideration of problems and solutions, and thereby enhancing board independence.” He continued, “people with a different gender, ethnicity or cultural background might ask questions that would not come from directors with similar backgrounds or experience.”

Finally, he adds, “According to resource dependence theorists, the skills, experience, expertise and contacts of board members form the important resources of a firm which can guide and help firm performance. A diverse leadership within a firm can also increase a firm’s competitiveness.”

But, Pei continued, most of the research done in this area has been focused in the US, and much of it anecdotal. Another market context would provide distinct differences, he said. “For example, in Asia, there is generally a prevalence of family ownership, government interference, weak legal systems and enforcement, and low level of minority rights protection.”

He wanted to focus specifically in Singapore, based on the city-state’s unique business environment. He continued:

“It is considered a good candidate for this study on diversity on a board of directors because it is a multi-lingual and multi-cultural society, a cosmopolitan and open-economy city state, has a policy of attracting foreign investments and foreign talent which results in changes in population demographics and its companies generally have an international or regional outlook as they are expanding business regionally if not globally in order to overcome the constraints of a small domestic market.”

The study, “Is Board Diversity Important for Firm Performance and Board Independence?” [PDF], tracks whether empirical evidence supports the business case for board diversity. The study tracks the performance of Singapore companies on the Singapore Stock Exchange.

It tests the benefits to firms in diversity of gender, age, tenure of directorship, discipline of study, educational qualifications, and ethnic background. The data was based on the performance of 390 firms between 2002 and 2004 for most of the variables being tested (for age, the number of firms was 114, and, for tenure, the number was 162).

Pei concludes that in the interest of various stakeholders, firms should focus on establishing greater diversity in the boardroom, with diversity of ethnicity and gender showing the strongest positive correlation to firm performance over the course of the study.

Given the backdrop of increasing globalization, the study shows that the benefits of boardroom diversity aren’t confined to Western companies. Even considering the different business contexts of ownership and legal structures across the world, diversity seems to help companies produce stronger results. By engaging in a geographically and culturally broad range of research on the subject, the business case for diversity becomes even more compelling.

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