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Lawrence A. Cunningham’s Quality Investing: Women and minority directors on company boards add value, but not for the reasons you think

At universities across the country this week, students are taking final exams. Two questions that could appear in many contemporary courses, such as investing or corporate governance, are given below. What’s your answer?

Question 1: Which of the following is a reason for the underrepresentation of women and minorities on public company boards?

A. Lack of prioritization by existing boards and shareholders

B. Gender and racial stereotypes or group bias

C. Underrepresentation of women or minorities in traditional pools or pipelines

D. All of the above

Question 2: Which of the following are valid arguments favoring increasing women and minority representation on corporate boards?

A. Women and minorities are better directors than white men

B. Diverse boards cause increases in company and shareholder value

C. Society is better off when its corporate leaders represent a cross-section of society

D. All of the above

Few readers will be surprised that the answer to question #1 is D. But many may be surprised that the answer to question #2 is C: Society is better off when its corporate leaders represent a cross-section of society. 

Many would choose A or B in question #2 because those are common arguments made by powerful sources such as Institutional Shareholder Services, one of the two dominant proxy advisers to asset management giants.

In fact, while the social case for board gender diversity is compelling, there’s no reason to believe that any gender or race supplies the best directors. Academic empirical evidence does not support the claim that board diversity causes increases in corporate value. Moreover, there’s no evidence indicating a cause between any sort of board demographic and corporate performance, whether by gender, race, independence, expertise or other factors.

Rather, and subtly, the evidence indicates correlations between board diversity and corporate performance, and there are many theories about why this might be so.  But the infinitely varied context of board service and corporate performance is simply too complex for researchers to identify such causal connections.

Despite such subtleties and complexities, proxy advisers, policy entrepreneurs (whose job is to influence public policy) and politicians repeatedly portray correlation as causation and confidently assert that board diversity boosts the corporate bottom line. The rhetoric is succeeding, as board diversity has accelerated in recent years. So what’s the harm?

There are two potential types of harm from such exaggerated claims. First, it may stoke increased opposition to what should be an easy case. Stick with the argument for equitable treatment on the merits, and expect board diversity to flourish. Overstate the case with deceptive assertions, and invite more impassioned pushback.

As an example, earlier this year, the  NASDAQ stock exchange adopted a rule requiring disclosure of board diversity. It may sound innocuous, even to foes of regulatory intervention, but it drew intense controversy, including from a distinguished pro-regulatory Democrat, Arthur Levitt Jr., a former chair of the U.S. Securities and Exchange Commission. His main point? There’s no evidence that board diversity on its own causes increases in shareholder value — despite repeated assertions by proponents that it does.

The second harm is more personal, a burden on the individual directors being appointed under these false pretenses. When proxy advisers and politicians say that minority and women directors will boost corporate economic performance, despite no evidence of such power, they set up such people for failure. After a few years, if such promised performance does not come to pass, recriminations will result.

Read: More women than men were named to California boards in 2021, as mandate prepared to grow more strict

Read also: Can California legally require corporate boards to include women?

Returning to the multiple-choice questions #1 and #2, my academic research suggests that the reason the historical rate of progress of diversifying boards was slower than many desired were the mixed rationales for the quest. There are two broad potential rationales for board diversity: (1) the quantifiable economic interests of corporations and their shareholders and/or (2) the qualitative social aspects of equitable and meritorious board opportunities.    

A continued emphasis on the answer to question #1, rather than the answer to question #2, is likely to slow the pace of progress rather than to promote it. Honest and fair-minded participants should stress the point of #2 and stop overstating #1.  As I concluded in a recent academic article reviewing the empirical literature and prevailing policy debate:

“[The article] advises advocates to avoid exaggerated claims about the economic payoffs from diversity, urging instead to focus on the fairness merits of the equation. That way, as progress on board gender diversity continues to be made, appointees can feel pride and be assessed on the merits, rather than serve under a cloud of stigma.”

Finally, one reason proponents might exaggerate claims to corporate benefits from board diversity is to make the cause appealing to directors whose duties include promoting corporate value. Indeed, if board gender diversity increases shareholder value, then perhaps boards ought to diversify in the name of their duty to increase shareholder value.

But, for one, such a rationale does not excuse rhetorical overstatement.  For another, boards have wide latitude in their business judgments to promote board diversity without resorting to such exaggerated claims. And ultimately, it is the shareholders, not boards, who by law elect the directors, and they will not long be fooled by such exaggerations. It would be better for proxy advisers and policy entrepreneurs to be straight with them. 

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.”  For updates on Cunningham’s research about quality shareholders, sign up here

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