Board Diversity and Firm Performance:

Board Diversity and Firm Performance: How Legislative Requirements Might Help Boost Earnings Just under a decade ago, Norway made headlines by passing a law that required all public limited companies (PLCs) had boards made up of at least forty percent female members, in an effort to establish greater gender equality in business.

The law was and is seen as controversial by many despite the fact that other countries have since passed highly similar laws, and the question of whether or not diversity in organizations -- and especially in their leadership teams -- is something that should be legislated remains a hot topic amongst individuals in the business world and amongst policy makers in countries around the globe. The following pages examine certain practical implications of this type of legislation.

The Impact of Diversity There are, of course, ethical considerations that must be taken into account in any full and fair investigation of the issue of board diversity. Norway's law requiring greater levels of female representation and inclusion in the upper echelons of the business world would not have been seen as required and would certainly not have been implemented if the proportion of female board members more closely matched the proportion of females in the wider population -- i.e.

about half -- and equal opportunity is generally seen as an inherent ethical right in democratic societies. Others contend that boards are selected to promote value, and that restrictions on the freedom of any company and its shareholders to select the most advantageous board is itself an ethical violation.

These issues are certainly worthy of consideration and are not wholly separate from the practicalities of achieving board diversity and the impact of board diversity on firm performance, but they are far more involved considerations than can be covered in the scope of this paper.

Instead, a focus on the practical effects of board diversity on firm performance, such as they have been ascertained through observation and analysis and then reported in current literature on the subject, will be provided below, with reference to current literature on the topic demonstrating the practical benefits and concerns that might be caused by such legislation regardless of its ethicality or lack thereof.

Though there is still some controversy surrounding the issue, on the whole it appears as though diversity has been linked to better financial performance and better of firm performance and recognition in other areas, as well. The evidence of a positive practical impact from Norway's law is mixed at best, though some firms definitely seem to have benefited from the mandated inclusion of a higher proportion of females on their boards (Nygaard, 2011).

According to Nygaard (2011), the immediate benefits to companies was mediated by another factor, namely the degree to which internal and external information regarding the company were in agreement. This was due to investor anticipation and confidence in the firms' ability to effectively incorporate and utilize the new board demographics, which was raised in companies with low information asymmetry and negligibly reduced in firms with high information asymmetry (Nygaard, 2011). Diversity requires more in order to lead to benefits, according to this research.

Other researchers assert that a more definite negative impact can be seen as a result of the Norwegian law, noting that the law tended to lead to younger and necessarily more inexperienced boards as a result of including a large part of the population demographic that was previously unrepresented on these boards (which was, of course, the reason for the legislation in the first place) (Ahern & Dittmar, 2012).

This inexperience and youthfulness, according to these researchers and theorists, led to an overall drop in stock prices for the firms affected by this law as investors became wary about the direction of the firm (Ahern & Dittmar, 2012).

This research was specifically concerned with the perception of firm performance on the part of investors, however, and not with actual measures of firm performance from within the companies themselves, which means it does not actually provide useful information regarding the direct impact of board diversity on performance, though it does suggest a potential problem in maintaining confidence (Ahern & Dittmar, 2012).

More performance-oriented research conducted in the United States during the 1990s, however, found that firm diversity does appear to have a direct correlation with actual firm performance, at least when measured on a strictly financial basis (Erhardt et al., 2003). This research performed a strictly quantitative analysis on over one hundred firms in the United States with varying levels of diversity on their boards, and the results suggest a significant improvement in overall financial performance when boards are more diverse across different demographic measures (Erhardt et al., 2003).

This research does not explain why this is the case, however. For that, Miller and Triana (2009) provide some possible explanations, having conducted similar research yet from a very different (though not at all contradictory or conflicting) theoretical perspectives and coming to the conclusions that racial and gender diversity in firms definitely causes better performance through increasing innovation and firm reputation.

Racial diversity in a firm's board was seen to directly correlate with higher levels of firm reputation and of recognized innovation within the firm, suggesting that the diversity extends far deeper in such organizations' structures than the surface.