At the beginning of October, Melinda Gates announced she would commit $1 billion in the fight for gender equality in the United States, and that one of her key priorities is to “mobilize shareholders” to put pressure on companies to improve diversity practices.
But do shareholders really value gender diversity? Research on the relationship between firm value and the appointment of women CEOs or directors has yielded mixed findings. At best, efforts to increase female representation have no impact on the firm’s market performance.
In some cases, however, shareholders will actually penalize firms for appointing women to senior leadership positions.
This seems counter-intuitive, given how much attention there has been in the press on stakeholders insisting that companies diversify their boards. Surely shareholders should be rewarding the companies that meet the challenge, not punishing them?
In a recent paper, we analyzed data on publicly-traded firms in the United States between 1998 and 2011. We found that firms with gender-diverse boards suffered a decrease in market value, even though profitability remained constant. We also found that the penalty was most severe for firms that worked hard to promote diversity practices across the organization.
To understand why, we conducted an experimental study with business school alumni. We found that observers expect companies that appoint female directors to care more about improving the firm’s social performance, and less about maximizing profits, compared to those that appoint male directors.
It seems, then, that investors take board diversity as a signal of a firm’s preferences, and punish those firms that they believe are less focused on shareholder value.
The function of a corporate board is to exert a form of control over the CEO and senior managers, and ensure that they run the company in a way that furthers the interests of its owners (in some jurisdictions, the law has empowered managers to consider the interests of other stakeholders when designing firm strategy, but this remains very much the exception to the rule). And furthering the interests of the firm’s owners typically means maximizing financial returns in as short a time as possible. If managers do not deliver, shareholders expect the board to intervene and find new management.
Managers will therefore go to great lengths to communicate to capital markets that they can be counted on to promote investor interests first and foremost. Appointing new directors, especially new independent directors who can be counted on to represent the interests of shareholders, is one way managers can signal their good intentions. Unfortunately, our results suggest that when those directors are women, firms will not get the positive impact they might have been hoping for.
Let’s think about the way firms go about appointing female directors. Often, the firm is responding to public pressure about the absence of diversity on its board.
But even when that is not the case, the firm will proudly announce that it has appointed its first, or in some cases second female board member (the numbers rarely go above that). The press release may even mention that, in doing so, the company has met its commitment to diversity.
In any event, gender will be a major feature in announcing female board members. By contrast, gender never comes up in male appointments.
If gender is presented as the salient feature of an appointment, it is likely that investors will assume gender motivated the appointment. They would not be so far off. Research in finance and management shows that firms select female directors primarily to satisfy a preference for diversity (whether that preference is internally or externally driven).
And so, we suspected, higher levels of gender diversity on a firm’s board will be interpreted negatively by shareholders who are scouring the landscape for signs that firm managers are concerned only about maximizing returns to their investors.
In line with this prediction, we found that firms that had not invested in diversity policies within the organization suffered no penalty for having more women on their boards. Low social performance ratings for diversity tells investors that these firms do not, in fact, have a diversity preference and that the presence of women on the board must be attributed to some other motivation.
By contrast, firms that were rated highly for their efforts to address diversity challenges suffered significant market losses for choosing to put women on their boards.
The results of our experimental study confirmed that observers associate gender diversity with a tendency to care more about the firm’s social impact (and less about whether the firm is creating value for its shareholders).
The effect was even stronger for participants who saw an appointment announcement where the word diversity was mentioned. This suggests to us that we need to be very careful about the language we use when discussing issues of gender equality, especially in a business context.
Ironically, the prevalence of the diversity discourse around female leaders, and the emphasis on gender when women attain senior roles, may ultimately hurt women. First, women are less likely to be taken seriously if they are assumed to be a “diversity hire.” Second, negative market reactions to female appointments will lead those companies that are relatively indifferent to the diversity issue to prefer male candidates. This might explain why, after decades of (slow) progress, we seem to have reached a plateau in female representation at the top.
The fight for gender equality is an important fight, and Melinda Gates should be applauded for her commitment to it. But let us ensure that by focusing on “diversity” we are not unintentionally doing more harm than good.
Isabelle Solal, Kaisa Snellman. “Women Don’t Mean Business? Gender Penalty in Board Composition.” Organization Science 2019.
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