Corporate board research links diversity gap with financial performance

Professor Chris Mallin and Dr Hisham Farag explain the findings of their research into the links between boards, diversity and financial performance.

In recent years there has been an increasing focus on the effectiveness and diversity of corporate boards and, in particular, on gender. 

Norway led the way in this regard in 2005, when it introduced a gender quota for listed companies. Following in Norway’s footsteps, 10 other countries have established gender quotas. In November 2013 the European Parliament overwhelmingly approved proposals that by 2020 all EU listed companies should substantially increase the number of women on EU corporate boards.

We believe, however, that building effective corporate boards is about directors’ skills, qualifications and experience, and is not solely reliant on a particular aspect. Rather, it is about having a balanced board, drawn from the widest pool of available talent.

Gender diversity is one part of the story but it is insufficient for an effective, balanced board. We also believe that directors’ skills and merits should remain the key selection criteria, and be key requirements for best-practice corporate governance.

The UK Corporate Governance Code reflects both the importance of diversity and that diversity is wider than gender, although gender clearly remains a key policy aspect of diversity.

The key research questions

Directors’ characteristics are under-researched in the context of the UK. Our study was therefore undertaken to answer two questions:

  • What are the characteristics of current boards of directors in the UK?
  • What are the directors’ traits and what is their impact on financial performance?

Our study investigates directors’ age, gender, nationality, education, board experience and professional experience across UK listed companies and industries. The analysis covers the FTSE 100, FTSE 250 and FTSE SmallCap indices to capture the differences in company size.

As part of our study we also constructed a comprehensive board diversity index (BDI) to measure directors’ characteristics across FTSE All-Share companies and industry sectors over the period 2004-2013. Furthermore, we investigated the relationship between directors’ characteristics and firm performance over the same period.

Characteristics of directors 

Our findings highlight some key characteristics of 3,590 directors for companies listed in the FTSE All-Share index in 2013. For instance, a directors’ average age is around 57 years with 41 per cent of FTSE All-Share directors’ ages in the range of 51-60 years. The proportion of female directors in the FTSE All-Share companies is 14 per cent.

FTSE 100 directors are also more highly educated, and have more board and professional experience, compared with the other FTSE indices. Non-financial companies seem to have more diverse boards as the BDI scores for financial and non-financial companies are 66 per cent and 69 per cent respectively. The utilities and basic resources sectors have the highest BDI score of 76 per cent while the real estate sector has the lowest BDI score of 59 per cent in 2013.

Does board diversity influence financial performance?

Our findings reveal that company size, company age and leverage are the main determinants of board diversity for non-financial companies. There is a positive and significant relationship between company size and board diversity. The results also show, however, that there is a negative and significant relationship between both company age and leverage and board diversity. Older companies, and those with a higher proportion of debt, have less diverse boards.

Director age is found to have a negative impact on the performance of non-financial companies. The younger the director, the better the financial performance of non-financial companies. The results also show, however, that the older the directors on financial companies’ boards, the better the financial performance. This may reflect the experience, knowledge, wisdom and influence that older directors have.

Policy implications

Board diversity is a topic that is in the public interest, and good governance depends on an effective balanced board. Our empirical results provide support for the calls for broader board diversity for qualified directors. Furthermore, the results support the recent recommendations to encourage board diversity as a feature of corporate governance best practice. 

Studying directors’ demographic characteristics may provide useful insights for policy makers and shareholders. Policy makers will be keen to see shareholders appoint successful directors so that they may achieve wealth maximisation objectives and hence boost the economy. Shareholders and other stakeholders may also be interested in the broader representation of views that a more diverse board may contribute.

Read the full version of this article in the April 2017 edition of CA magazine

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