A Quantitative Investigation into the Business Case for Diversity in the Boardroom: a Multi-Theory Framework

The past two decades have witnessed unprecedented governance failures coupled with the 2007/8 financial crisis. This highlighted inherent problems that were created by ‘groupthink’, where directors made decisions as a group with no one to challenge them or to offer different perspectives. The board of directors of a company has a fiduciary duty to provide oversight and protect shareholders’ interests, however governance failures suggest that not every board is well equipped to perform this critically important duty. Drawing on the business case, this study examines whether board diversity enhances the decision-making process and positively impacts financial performance. The study integrates agency, resource dependence and upper echelons theories in order to overcome the current myopic single based theory perspective, providing a more complete understanding of the relationship between board diversity and financial performance. On a global level, most of the studies regarding this topic are also focused on gender composition of the board. However, what makes this study different is the theoretical framework developed which allows both structural and demographic issues of diversity to be explored simultaneously. These are measured in terms of gender, age, education, experience, networks and board practices. Drawing on a positivist ontology, data on board diversity is gathered from a sample of the FTSE 350 companies in the UK from 2004 to 2014. In order to address the endogenous nature of corporate governance, a two-stage least squares estimation with instrumental variables is applied, using Tobin’s Q, return on equity and return on assets as measures of financial performance. Results from the multivariate analyses reveal that gender diversity, experience diversity and multiple directorships are significantly and positively associated with financial performance. However, in contrast to existing theory, the results reveal that directors’ age, education, experience levels and board practices have no association with financial performance. This indicates that the effects of board diversity on firm performance are mixed. In addition, an industry analysis of the findings reveals that ‘one size does not fit all’ and, in particular, this analysis displays a much stronger business case for board diversity in the mining and quarrying industry than in other industries. Therefore, the study provides empirical support for the importance of contextual factors between board diversity and performance. The findings from this study confirm the need to utilise theoretical paradigms that combine multiple theories when assessing the link between board diversity and financial performance, thus justifying integration of agency, resource dependence and upper echelons theories. The study furthermore provides empirical support of a business case for gender diversity, experience diversity and multiple directorships on boards, as well as offering insights to policy makers in formulating recommendations related to desirable characteristics of boards. Board members, nomination committees and shareholders can also benefit from these findings in creating boards that are well suited to perform their duties and in advancing the diversity agenda.