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Valuing board diversity

Commitment to diversity in corporate governance could improve financial performance

Enhancing boardroom diversity is becoming an important objective for many public companies and their investors, and fund managers have begun using their shareholder voting rights to demonstrate their commitment to this issue within investee companies. What is driving this growing interest in board diversity, and what actions can institutions take to achieve it?

Key insights

  • Regulators and investors around the world are incentivizing public companies to consider diversity policies and hire board directors with various backgrounds and perspectives
  • Enhancing boardroom diversity has the potential to increase the performance of public companies and provide better returns for shareholders
  • A critical mass of women or visible minorities is needed in order for boards to see a real change

Regulation is coming to the boardroom

Regulators around the world are increasing efforts to monitor and encourage diversity in the boardroom. In the United Kingdom (UK), the Financial Reporting Council's 2018 Corporate Governance Code called for board appointments and succession plans to promote “diversity of gender, social and ethnic backgrounds." The UK's Financial Conduct Authority requires public companies to disclose their diversity policies and those that do not have such policies must explain why.

The European Union's European Securities and Markets Authority (ESMA) requires similar disclosures for large companies, while countries such as Belgium, France, Germany, and Iceland have instituted mandatory quotas for women on boards, according to a report by MSCI.1

Canada is no exception to this regulatory trend. The government's proposed Bill-C25, which became law in May 2018, amends the Canada Business Corporations Act to require federally incorporated public companies to adopt a similar “comply or explain" approach to board diversity policies. Whilst regulations relating to the specific disclosure requirements are yet to be finalized, they will track the number of Indigenous People, those with disabilities, and other designated groups under Canada's Employment Equity Act on boards.

Enhancing diversity can improve corporate governance

Regulatory requirements are not the only reason companies are becoming interested in boardroom diversity. According to research by management consulting firm Russell Reynolds Associates, having a range of perspectives in the boardroom is crucial to providing effective corporate governance. By enabling boards to draw on a variety of competencies and knowledge, it can help them better address complex problems.2

Diversity can enhance innovation by discouraging “group think" and reduce the risk of directors holding unspoken assumptions, according to Russell Reynolds. Additionally, more diverse boards are also better able to communicate with, and consider the perspectives of, various stakeholders and constituencies, such as customers and employees. That will enable them to better serve shareholders, the report found.

Financial institutions
around the world are
learning that increasing
boardroom diversity
makes good business sense

Better corporate governance can also have direct impacts on human capital. In a 2018 study of 617 companies, MSCI found that boards with higher levels of female representation employed better talent management practices, and that companies with a “persistent critical mass of female directors" demonstrated higher levels of employee productivity growth.3

“Financial institutions around the world are learning that increasing boardroom diversity makes good business sense, both in terms of improving corporate governance and financial performance. It is important to spend the time and resources necessary to achieve diversity, and view this as a long-term investment," commented Wendy Phillis, Managing Director, Regulatory Solutions at RBC Investor & Treasury Services.

The financial incentives for boardroom diversity

A growing body of research shows a positive correlation between board diversity and financial performance, both in terms of returns and share price.

A study of Fortune 500 companies by the nonprofit Catalyst found that those with the highest percentage of women directors demonstrated 53 percent higher returns on equity than those with the lowest percentage. Returns on invested capital were 66 percent higher and returns on sales 42 percent higher.4

Similarly, in a study of two million European companies, the International Monetary Fund found an 8- to 13-basis point increase in returns on assets when companies replaced one man with a woman in senior management or on the board.5 For knowledge intensive and high-technology sectors, it found a 30-basis point increase.

Increasing gender and age diversity on boards can also improve companies' stock market performance.6 According to a study in the South African Journal of Economic and Management Sciences, this correlation is due to more diverse boards being able to better accommodate the needs of various stakeholders, as well as incorporating broader skills and experience.7

If companies do not pursue board diversity themselves, investors will

Institutional investors are increasingly engaging with public companies to encourage diversity in corporate governance

Institutional investors are increasingly engaging with public companies to encourage diversity in corporate governance. In Canada, the Canadian Pension Plan Investment Board (CPPIB) in 2017 began engaging with investee companies that did not have any women directors. It voted at the shareholder meetings of 45 such companies. A year later, almost half of those companies had hired a female director.8

More recently, in December 2018, CPPIB announced it was initiating an international policy to vote against any chair of a board committee responsible for nominating directors if the board does not include women.

“We believe that companies with gender-diverse boards are more likely to achieve superior financial performance over the long-term," said Mark Machin, President and Chief Executive Officer of CPPIB. “For that reason, engaging with companies to drive better corporate behaviors is a key part of CPPIB's mandate."

Other fund managers are encouraging Canadian companies to hire more diverse directors. In 2016 and 2017, OceanRock Investments Inc. sent Restaurant Brands International a shareholder proposal calling for it to adopt a board diversity policy with plans to increase gender diversity.9,10 It received a majority of the independent shareholder votes in both years.

The Canadian Labour Congress Staff Pension Plan sent a similar shareholder proposal to Canfor Corporation in 2017, receiving support from 32 percent of voters, while Fonds de solidarité des travailleurs du Québec sent one to Constellation Software the same year, receiving 42 percent of shareholder votes.11,12

These actions by institutional shareholders are beginning to show results. Morguard Corp. in 2017 announced the appointment of a woman to its board as well as plans for a board diversity policy after the British Columbia Teachers' Federation sent it a similar proposal.13

Asset managers pushing diversity

Among the growing number of asset managers using their influence with investee companies to increase board diversity are some of the largest fund managers in the world.

US asset manager BlackRock has highlighted gender diversity as a key priority for engaging with companies. “If there is no progress on enhancing diversity at the board level within a reasonable time frame, we may hold nominating and/or governance committees accountable for an apparent lack of commitment to board effectiveness," it said in a January 2019 update on its engagement priorities.14

According to RBC Global Asset Management's 2018 Responsible Investing Survey, 42 percent of respondents believe that the best method for achieving board diversity is through shareholder action. Moreover, 75 percent of respondents see gender diversity on corporate boards as important to their organization.15

How to achieve boardroom diversity

If nominating committees hope to build truly diverse boards, they must make conscious efforts to bring in a range of perspectives. According to Russell Reynolds, simply turning to one's own network for candidates will lead to “self-reinforcing homogeneity." Rather, boards should decide on specific priorities or competencies they are seeking, perform a gap analysis and actively screen for those qualities.16

One way to achieve true diversity would be to explicitly require recruiters to identify female and minority candidates for board positions, according to research by Canadian law firm Osler, Hoskin & Harcourt.17 Nominating committees should also incorporate high-potential women and minorities into formal networking programs and consider making flexible work arrangements for board members, such as allowing them to work from home, the report noted.

Boards should hire an adequate number of people with a variety of perspectives and backgrounds to achieve real change

Importantly, boards should hire more than one token diverse director but rather an adequate number of people with a variety of perspectives and backgrounds in order to achieve real change. A 2016 MSCI studied found that US companies with at least three female directors had both higher return on equity and higher earnings per share than those without. They attributed the stronger performance both to better decision-making by more diverse board members as well as its positive influence on gender diversity throughout the workforce, including in senior leadership, which is correlated to reduced employee turnover.18

Similarly, a Journal of Corporate Finance study on boardroom diversity in China found that boards with three or more women had a stronger positive effect on financial performance, supporting the idea that a “critical mass" of women is necessary to elicit results.19

Having a more diverse board of directors can help public companies to address a broader range of challenges, better communicate with shareholders and employees, and improve financial performance. The regulatory landscape will increasingly require companies to consider boardroom diversity. At the same time, public companies are beginning to feel pressure from investors to diversify their directors. They should actively pursue measures to do so in a meaningful, lasting way.

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  1. MSCI (December 2016) The Tipping Point
  2. Russell Reynolds Associates (2009) Different Is Better
  3. MSCI (March 6, 2018) Women on Boards
  4. Catalyst (2007) The Bottom Line
  5. International Monetary Fund (March 7, 2016) Gender Diversity in Senior Positions and Firm Performance
  6. Academy of Management Journal (November 7, 2014) Women on Boards and Firm Financial Performance
  7. South African Journal of Economic and Management Sciences (August 25, 2015) Board diversity and financial performance
  8. Canada Pension Plan Investment Board (December 21, 2018) CPPIB to Increase Board Diversity Advocacy
  9. Shareholder Association for Research and Education (June 20, 2016) Majority of non-controlling shareholders at RBI want better board diversity
  10. Shareholder Association for Research and Education (June 5, 2017) Adopt and publish a formal board diversity policy
  11. Shareholder Association for Research and Education (April 26, 2017) Adopt and publish a formal board diversity policy
  12. Shareholder Association for Research and Education (April 28, 2017) Adopt and publish a formal board diversity policy
  13. The Globe and Mail (March 8, 2017) Morguard commits to increasing board's gender diversity
  14. BlackRock (January 2019) BlackRock Investment Stewardship's approach to engagement on board diversity
  15. RBC Global Asset Management (October 2018) Charting a Sustainable Advantage
  16. Russell Reynolds Associates (2009) Different Is Better
  17. Osler, Hoskin & Harcourt (September 2017) Diversity Disclosure Practices 
  18. Ibid. MSCI (December 2016)
  19.  Journal of Corporate Finance (October 2014) Do women directors improve firm performance in China?