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August 05, 2010
Corporate Disclosures Ignore Financial Benefits of Board Diversity
    by Robert Kropp

A new report from The Corporate Library finds that corporate compliance with disclosure requirements on diversity has been vague, while studies indicate a financial benefit.

2010 marked the first year in which companies were required to comply with a new Securities and Exchange Commission (SEC) rule requiring corporate disclosure of how diversity is considered in the nomination of board directors.

While there is not yet a substantial body of academic literature addressing all types of diversity, research that focuses on women directors in the US are emphatic in concluding that "diversity increases the intensity with which a board monitors a company's affairs," according to a recent report from The Corporate Library.

As Kimberly Gladman, Director of Research and Risk Analytics at The Corporate Library, and author of the report entitled Beyond the Boilerplate: The Performance Impacts of Board Diversity, told, "A board that includes women is a better overseer of a company's business, and more accurate in assessing a company's value. Board diversity leads to more questioning and more vigorous debate."

Because the SEC did not provide a definition of diversity in its rule on disclosure, companies were free to address diversity in their reports on their own terms. Not surprisingly, as the report found, "The disclosures are not very specific, thorough, or revealing." The report analyzed statements from 388 S&P 500 companies.

In a
blog post, Gladman describes corporate disclosures on board diversity as "a bit soporific," and casts too little light, she writes, on "the most interesting question about board diversity: what difference does it make, performance-wise, to have women and members of racial and ethnic minority groups serve on corporate boards?"

Gladman told, "The corporate reports are notable for what's not there. Companies are not talking about what they are doing to recruit more diverse directors, and there are no references to coordinated programs to make sure they are drawing on a more diverse pool."

"There is no concrete rationale included in the reports for why diversity is important," Gladman continued. "Companies need a diverse body of knowledge and livelier and more informed discussion, but the question of diversity is murky in a lot of the disclosures. None of them describe how they would go about increasing diversity."

On the other hand, as noted above, academics have concluded that diverse boards are better overseers of corporate activities. Diverse groups are less likely to share common assumptions, and it may also be the case that "directors from underrepresented demographic groups (are) especially strong performers, having had to overcome discrimination to reach the boardroom," according to the report.

Of special importance to investors, of course, is the effect of board diversity on the operating and stock price performance of companies. In a lengthy analysis of academic studies on takeover defenses, the report concludes that board diversity often leads to lower premiums on the price of a company in a merger, and a lesser spike in the stock price immediately following a merger.

However, the report continued, "Lower takeover premiums may actually be fairer and more accurate," a position that is upheld by studies finding that "most mergers are overpriced and indeed, ultimately value-destroying." Managers seeking to build empires and increase their compensation "enter into combinations that are bad for the long-term prosperity of the surviving entity, and thus ultimately also bad for that entity's shareholders," according to the report.

Gladman told, "The question depends on how you define good performance. In the short term, diversity can be bad for a company's stock price, because a diverse board is less likely to participate in an overpriced merger. If you're someone who wants to sell your company at an inflated price for a quick hit on the stock price, then diversity is bad for you."

"But if you are a universal owner that is broadly invested in the economy," she continued, "Then you want companies that can create more value and better goods and services in the future. If you're looking for value creation, then board diversity is a good thing."

Observing that skeptics often suggest that "any focus on personal aspects of diversity is primarily motivated by social justice concerns," the report concludes that "diversity increases the conscientiousness of board oversight, and leads to more accurate value assessments." Because "diversity is likely to promote greater value creation in the economy," both governments and institutional investors have a financial interest in board diversity.

"Pension funds may have been investors in these companies for decades, while the management team has only been in place for a couple of years, and will leave in a couple of years," Gladman said. "Companies do not seem to realize that diversity affects the value of their business. I think realizing it is going to have to come from investor demands."

"The ideal would be for companies to become aware of how boards can be most efficient, and put into place a program to ensure that they do have racial, gender, and personal background diversity," she continued. "But for this to take place, companies would have to be genuinely interested in being an enterprise that creates long-term value."


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