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5 December 2019 CFA Institute Journal Review

Women on Boards and Bank Earnings Management: From Zero to Hero (Digest summary)

  1. Peter Eickelberg, CFA

This is a summary of "Women on Boards and Bank Earnings Management: From Zero to Hero," by Yaoyao Fan, Yuxiang Jiang, Xuezhi Zhang, and Yue Zhou, published in the Journal of Banking and Finance.

Banks with at least three female board members display reduced earnings manipulation. A lower number may reflect tokenism and does not correlate with improved monitoring. Organizational effectiveness increases when women sit on audit and nomination committees. More experienced and more educated female board members display reduced monitoring influence, possibly because of enculturation.

What Is the Investment Issue?

The existing literature regarding women’s impact on corporate boards has generally ignored their influence as bank directors. The authors seek to address this research gap—specifically, banks’ critical role in the economy. Banks traditionally have less transparency in their lending activities, and board managers face pressure to manipulate earnings by using discretionary loan loss provisions to ensure stock price consistency or to maximize incentive pay. Bank boards may often operate in an “old boys’ club” that does not provide effective checks on this behavior. The authors investigate whether adding women to the board, particularly as independent directors, moderates bank earnings management.

How Did the Authors Conduct This Research?

The authors analyze 4,823 quarterly observations across 91 US bank holding companies between 2000 and 2014. Each quarterly observation includes a measure of the percentage and number of women on the bank board as well as that quarter’s use of discretionary loan loss provisions, an item associated with earnings management. More than 60% of banks have one or two female directors, whereas less than 20% have three or more.

Regression analysis controls for bank, CEO, and board characteristics (age, tenure, size, independence, and so forth) so that a proxy for bank earnings management—discretionary loan loss provisions—can be analyzed in isolation.

The authors also use two alternative measures of earnings management and investigate two additional hypotheses for the relationship.

What Are the Findings and Implications for Investors and Investment Professionals?

When banks employ one or two women as directors, these board members may be viewed as tokens or may lack the critical mass to have a substantial influence on the board. Once there are three female directors, or 20% of the board, critical mass has been reached and women have a greater influence. Banks whose boards have strong female representation tend to have lower levels of earnings management and loan loss provisions. This more conservative management can lead to higher stock price volatility and lower earnings growth. Lower levels of loan loss provisions and accounting accruals tend to lead to higher-quality earnings, fewer earnings restatements, and lower degrees of tax avoidance.

The authors’ principal finding is that a bank board needs to add at least three women to experience a real change in earnings management. They even encourage banks without the financial means to expand their boards sufficiently to hold off hiring any women until the board can add at least this number, because lower numbers were associated with even greater earnings management in their study. They point to prior research on tokenism and critical mass to explain why this result might be the case.

Women’s influence also seems greater when they occupy positions on important committees—such as audit or nomination committees rather than the compensation committee, for example. Women who have more board experience (e.g., multiple appointments) or longer tenure, however, risk becoming enculturated in a “man’s world” or becoming too busy to monitor earnings as effectively as newer, independent female directors who are less burdened.

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