Firms With Greater Board Diversity Associated With Lower Risk Taking

An examination of the association between board diversity and corporate risk taking showed firms with greater board diversity were associated with lower corporate risk taking, specifically with spending less on capital expenditure, research and development and acquisitions, according to study results.

“The U.S. Securities and Exchange Commission (SEC) recently required companies to disclose if and how they consider diversity in their board selection,” Ya-wen Yang, PhD, CPA, assistant professor at Wake Forest University School of Business, told O&P Business News. “However, the SEC did not say what diversity is, so there is no clear definition. We can talk about race or nationality or gender, but my colleagues and I believe that diversity actually is a very general and big area. We can have different experiences and expertise and we contribute to the board by adding that extra diversity.”

Why diversity matters

Researchers created diversity indexes to measure board diversity among a sample size of 2,041 firms in six dimensions, including gender, race, age, experience, tenure and expertise. The researchers used capital expenditures, research and development (R&D) expenses, acquisition spending, the volatility of stock returns and the volatility of accounting returns to proxy for corporate risk taking. They also controlled for a set of board characteristics variables, such as the percentage of independent directors, the percentage of directors appointed after the current CEO took office, average director age, experience and tenure.

Results from the working paper showed firms with more diverse boards spent less on capital expenditure, research and development and acquisitions. These firms also exhibited lower volatilities of stock returns and accounting returns vs. firms with less diverse boards, according to study results. Compared with homogeneous boards, boards that were more diverse were more likely to pay dividends and pay a greater amount of dividend per share, according to results. Researchers found that diversity significantly curbs excessive risk taking for firms with above industry median risk taking activities.

“Just like other papers out there, we also found that gender is a driving factor [for less risk taking],” Yang said. “We were hoping that diversity outside of gender mattered, and we did find one or two [other factors] that mattered. If I sat on a board, I am female, Asian, in the age group of 35-40 [years] and my expertise is financial. If I go to an all-male, Caucasian board, I add different dimensions of diversity. It is not that I am female. I have other attributes. I think the study shows not to look at one diversity; [there are] also other dimensions.”

Understanding the effects of board diversity

Yang and colleagues, Rini Laksmana, PhD, associate professor at Kent State University, and Agus Harjoto, PhD, associate professor at Pepperdine University, believe these results could be of interest to both academics and practitioners due to the examination of multiple dimensions of board diversity that shows if a board is similar in gender and race, it can be diverse in other dimensions, such as age, tenure, experience and expertise.

The study also provide support for the recent movement toward greater board diversity in the United States and several European countries, such as Sweden, Norway and Spain, and help individuals understand the effect of board diversity on corporate risk taking. The researchers believe the implications of the study should be considered by nominating and governance committees when forming the best practices for board composition.

“Most boards are all male and Caucasian, so perhaps for those companies they can start to think about adding different people, like females or people with different experience and expertise on the board and perhaps that will help in the decision making and avoid excessive risk taking,” Yang said. — by Casey Tingle

Disclosures: Yang received funding from Wake Forest University. Laksmana and Harjoto have no relevant financial disclosures.

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