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Want Better Governance? Put Women on the Board

September 12, 2014
Diversity & Inclusion

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Gender-balanced boards perform better. Shareholders like them. Consumers reward them. They are better governed and less susceptible to fraud.
 
I am not arguing that one gender makes better decisions than the other, but rather that boards are more likely to make bad choices when members grow too comfortable with each other and when they lack the benefit of different perspectives. Homogenous boards become “clubbish,” and then the tendency feeds on itself as such boards over-emphasize the importance of “personality fit” when looking for new members. This would happen as readily with all-female boards as with all-male boards.
 
Even if you are indifferent to gender parity more generally, you should balance your board because you care about high performance. Such change will be resisted. Boards won’t want to feel as if they’re having their options narrowed or dictated. And, naturally enough, boards will gravitate toward candidates who will fit in and who won’t generate friction. But some friction and discomfort are exactly what boards need to ensure that sensitive issues are raised and explored and that the status quo is questioned.
 
Familiarity Can Lead to Fraud
Familiar and comfortable relationships can smooth the decision-making process, but when problems arise, chumminess breeds a greater willingness to compromise—which can lead to tolerance of irregularities that may indicate fraud and other schemes. Over time, it becomes increasingly difficult for one or two long-serving members to stand up to others
 
People are more likely to behave poorly and emulate misconduct when they’re comfortably ensconced among peers. In one of his many studies on honesty and ethics, MIT behavioral economist Dan Ariely found that when people witnessed a peer cheating, overall cheating within the group increased. Ariely planted an actor wearing a college sweatshirt to cheat during an exam. Cheating increased when the actor wore a sweatshirt from the same school as the rest of the participants in the experiment. There was much less cheating when the actor wore a sweatshirt from another school. The hesitation that arises within a more diverse group setting disrupts the confidence and complacency that lead to misconduct.
 
Another study points to a correlation between male-dominated boards and the increased likelihood of fraud. There is no evidence that men as a group are less ethical, so what is the explanation for this correlation? Of course, it’s possible that fraud-prone boards do not seek out unfamiliar and diverse voices. But the answer may be that more gender diversity leads to greater discussion, dynamism, oversight and scrutiny, which can create an environment less hospitable to fraud. Whichever direction the causality flows, the news is good for companies with boards that are not dominated by one gender—and that’s good news for their shareholders.
 
The Value of Friction
Women are generally more risk averse, a trait that may hold both criminal misbehavior and reckless expansionism at bay. A Journal of Corporate Finance article concludes “that the presence of female directors on a corporate board is negatively associated with their firms’ acquisitiveness.” According to Professor Kai Li, co-author of the study cited in the article, “[f]emale board members play a significant role in mitigating the empire-building tendency of CEOs through the acquisition of other companies.” More importantly, the article also concludes that the amount paid for acquisitions is lower when there are women on the board, and the cost reduction is significant: over 15 percent.
 
The study also argues that the presence of female directors reduces the number of attempted takeover bids by 7.6 percent. “On average, merger and acquisition transactions don’t create shareholder value, so women are having a real impact in protecting shareholder investment and overall firm performance.”
 
Balanced Boards Make More Profitable Companies
Companies with women on their boards are more profitable. According to Catalyst, a nonprofit think tank committed to expanding opportunities for women, organizations without women on their boards under-perform and produce less shareholder value compared to those with gender-diverse boards. In contrast to their male-dominated counterparts, Catalyst found that businesses with the largest percentages of women on their boards had a 53 percent higher return on equity, a 66 percent greater return on invested capital and a 42 percent better return on sales.
 
Making the Case
Arguably, the optimal composition of female board members is 50 percent. The only country that comes close to that is Norway, where women hold 40.5 percent of board seats—because of government quotas. In November 2012, the European Union proposed mandatory quotas to achieve 40 percent female representation on boards of large companies by 2020.
 
Current numbers in the U.S. are not encouraging. Women occupied just 16.9 percent of the boardroom chairs among the Fortune 500 in 2013—a very slight increase from 16.6 percent the year before, according to Catalyst. And 10 percent of Fortune 500 companies had no women on their boards at all. The U.S. public rarely embraces quotas, but U.S. companies are often quick to respond to compelling arguments, pragmatic advice and shareholder demands.
 
As companies invest more money in compliance and face the specter of extraordinary penalties for bribery, fraud and other malfeasance, the governance-bump that women on boards appears to deliver should be compelling. Greater profitability and public confidence should make the transition more palatable to the naysayers.
 
A 10 percent increase in the number of female board members in the U.S. over the next three years seems a modest target. Higher targets over a longer period have been suggested too, but we need to get started now. While a 10 percent increase won’t reflect the proportion of women employees, consumers and shareholders, as with most matters of good governance, once the shift begins, it will get easier with time.
 
By Alexandra Wrage
 
 

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