Aurora Borealis
1 April 2016 CFA Institute Journal Review

Who Selects the ‘Right’ Directors? An Examination of the Association between Board Selection, Gender Diversity and Outcomes (Digest Summary)

  1. Sonia Gandhi, CFA

Gender diversity on a board is significantly and positively associated with both the existence of a designated nomination committee (NC) and the presence of women on the NC. Gender diversity on boards also moderates the association between risk and performance for a firm.

What’s Inside?

The authors examine the role of a nomination committee (NC) in diversifying board membership with respect to gender and the interrelationships between a separate NC, a gender-diverse NC, and gender diversity on a board. A designated NC and female representation on the NC both lead to enhanced gender diversity on boards. Greater gender diversity moderates excessive firm risk, which, in turn, improves financial performance as measured by return on assets (ROA). In contrast, increased gender diversity is linked to a negative association between risk and the market’s subjective assessment of firm value as measured by Tobin’s q.

How Is This Research Useful to Practitioners?

The authors address the critical issue of board diversity and its impact on risk aversion, decision making, and firm performance. In light of recent financial crises and corporate scandals, the issue of diversity is gaining enhanced focus from regulators, practitioners, researchers, and market participants.

The lack of gender diversity on boards can be attributed to the director selection process. Directors who make individual nominations are limited by the information they have and tend to nominate candidates who have backgrounds and characteristics similar to themselves. Gender diversity on boards is associated with the existence of an NC as well as with the presence of women on the NC. Furthermore, the composition of the NC is likely to influence the selection of new board members.

Instead of trying to establish a direct association between gender diversity on the board and firm performance, the authors examine whether gender diversity affects the association between board risk taking and firm performance by using two measures of financial performance—ROA and Tobin’s q. Enhanced gender diversity has a moderating effect on excessive risk taking, leading to improved financial performance as measured by ROA. But with respect to Tobin’s q and risk, there is a negative relationship with board gender diversity.

The need for directors to lead risk management is becoming increasingly vital in present circumstances. In contrast to homogeneous boards that may adopt a suboptimal level of risk, a gender-diverse board will take a more moderated approach to risk taking and will provide superior monitoring of risk.

How Did the Authors Conduct This Research?

The authors examine the role of the NC in selecting a gender-diverse board before and after the Australian Securities Exchange Corporate Governance Council (ASXCGC) recommendations in 2010, using data for the top 500 firms listed on the Australian Securities Exchange in 2007 and 2011. Data are collected from annual reports using Connect 4 and Aspect FinAnalysis. Risk measures are obtained from the Centre for Research in Finance.

The authors use the two-stage Heckman procedure (Annals of Economic and Social Measurement 1976) to compute the inverse Mills ratio from a probit model that predicts the factors associated with a separate NC. The Mills variable is then used as an additional control variable to determine the association between the existence of an NC and gender diversity on the board (H1). The same procedure is used to ascertain whether gender diversity on a board moderates the association between risk and performance (H2). H1 and H2 are formally investigated by using random effects generalized least-squares regressions estimated with clustered-robust standard errors to control for any serial dependence in the data.

To account for selection bias, the authors include several proxies for risk that are included in gender diversity research: leverage, price-to-book value, firm size, and market risk. The year dummy variables for 2007 and 2011 are included to account for the introduction of the ASXCGC recommendations in 2010.

The authors perform diagnostic tests for multicollinearity and sensitivity analyses, which include running the ordinary least-squares regressions excluding the inverse Mills ratio and two-stage and three-stage least-squares regressions. Firm performance is measured by using two proxies: ROA and Tobin’s q. Firm risk is total risk, which is calculated as the standard deviation of daily stock returns for each fiscal year.

Abstractor’s Viewpoint

With renewed focus on effective corporate governance, the importance of getting the director selection process right is becoming increasingly critical. To create a responsible risk culture, the tone has to be set from the top and group think must be avoided at all costs. Gender diversity on boards may not be the panacea, but it does address several such issues effectively. More and more countries are now mandating the presence of women directors on corporate boards. It is in the long-term interests of companies to implement this requirement in the right spirit instead of making token gestures. Businesses must establish a culture in which diversity is embraced as the norm instead of something “nice to have.”

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