Gender Diversity On Boards -- A Driver Of Value

Gender Diversity On Boards -- A Driver Of Value

September 2016


Howard Sherman is Executive Director and Head of Corporate Governance Business Development for MSCI ESG Research. He is a co-founder and former CEO of GovernanceMetrics International, which merged with The Corporate Library and Audit Integrity in 2010 to form GMI Ratings. GMI was in turn acquired by MSCI in 2014. Howard also serves as Treasurer of the IRRC Institute, a not-for-profit organization headquartered in New York City that serves as a sponsor of environmental, social and corporate governance research. He is also a member of the Council of Institutional Investors’ Markets Advisory Council and the Global Advisory Council at Cornerstone Capital Group.

Christopher P. Skroupa: Why do you think diversity at the board level and board refreshment have become such important corporate governance issues?

Howard Sherman: When I began working in the field in 1986, most investors were focused on the question of director independence: is the board truly independent of management? Some believed that there were ties that might cloud the board’s objectivity, therefore lessening their resolve when it came to overseeing management on behalf of the shareholders.

While director independence remains a core governance concern, in recent years the discussion has shifted. A focus on whether the board has the right mix of talent is now a major consideration. This is a very healthy development, and companies are responding by publishing a skills matrix. In my opinion, these matrices are among the most helpful new disclosures in recent years. For good examples, see the matrices from Coca-Cola and Prudential.

Boardroom diversity is defined by a diversity of skills, backgrounds and age in addition to gender or ethnic diversity. There is a growing perception that “groupthink” is an investment risk, and that more diversity on boards can lead to more nuanced discussions and more informed decisions. McKinsey Quarterly wrote an article in 2012 about this entitled, “Is There a Payoff from Top Team Diversity?

A growing body of research has found an interesting link between board diversity and various measures of corporate performance. For example, Credit Suisse found 5% outperformance on a sector-neutral basis for companies that had at least one woman on the board from the start of 2012 to June 2014. This amounted to a compound excess return since 2005 of 3.3% (Credit Suisse, The CS Gender 3000: Women in Senior Management, September 2014).

In our own Women on Boards 2014 report, we found that companies in the MSCI All Country World Index (ACWI) with a higher percentage of women on the board had fewer instances of bribery, fraud and corruption, and that companies with at least one female director had a higher Return on Equity. We also found a positive correlation between the proportion of women on a board and our Environmental Social and Governance (ESG) rating of a company. In our Women on Boards 2015 report, we found that companies in the MSCI World Index with strong female leadership generated a Return on Equity of 10.1% per year versus 7.4% for those without. In addition to this, a superior average valuation (price-to-book ratio of 1.76 versus 1.56) has been found, compared to those companies without strong female leadership. Companies lacking board diversity also suffered more governance-related controversies than average.

The real question is whether this is correlation or causation: does having a significant number of women in leadership positions lead to better outcomes? Or, do companies with relatively good governance see board diversity as a natural extension of how they already operate? Either way, board and senior management diversity is becoming an interesting investment signal for investors attuned to the issue.

Skroupa: How can regulatory efforts promote director diversity?

Sherman: As you probably know, some markets have imposed quotas for female directors, and it clearly works; but only up to a point. The Norwegian quota law, initiated in 2002, was one of the first of its kind, and it heavily influenced other European markets. Now, Norway has the highest proportion of female directorships in the world—approximately 40%. France also has a quota, and although the percent of women on board has clearly increased, the number of women serving as board chair hasn’t even budged. This speaks for itself, and it may relate to why we’ve seen many markets—and many women—shy away from quotas, preferring to earn a board seat on merit alone.

The United Kingdom, as is often the case with respect to corporate governance matters, set an interesting example of how to promote change without regulation or quotas. The first Davies Report, released in 2011, recommended that companies mount a voluntary effort to improve gender diversity among its leadership, this included both executives and directors. The report called for the FTSE 100 to target 25% of board positions to be filled by women by 2015, a goal that was attained six months ahead of schedule. In an updated review, released in late October, 2015, Davies called for all FTSE 350 boards to have 33% female representation by 2020, which would require around 350 more women in top positions.

I think the U.S. presents a tougher challenge. In a well-researched report, the U.S. Government Accountability Office found that although representation of women on the boards of U.S. publicly-traded companies has been increasing, it estimated that “it could take more than four decades for women’s representation on boards to be on par with that of men’s,” even if equal proportions of women and men joined boards each year beginning in 2015. (United States Government Accountability Office, “Corporate Boards – Strategies to Address Representation of Women,” December 2015.)

Skroupa: What are shareholders doing to promote board diversity and board refreshment in general?

Sherman: There are a number of noteworthy efforts in this area, too many to mention here, but the 30% Club in the U.K. was launched in 2010 with a goal of achieving 30% women on FTSE 100 boards by the end of 2015. This action is based on the principle that, “gender balance on boards not only encourages better leadership and governance, but diversity further contributes to better all-round board performance, and ultimately increased corporate performance for both companies and their shareholders.” The group was founded by Newton Investment Management CEO, Helena Morrissey, and supports voluntary efforts over quotas. It has sparked similar efforts in other markets, including the Thirty Percent Coalition in the United States.

With regard to board refreshment, an effort has surfaced in the United States called “proxy access” which would allow qualified shareholders to nominate directors. This endeavor is led by the Office of the New York City Comptroller, which manages the city’s five pension funds. It’s had notable success with its proxy access efforts. The need for reform in the U.S. may come as a surprise to shareholders in markets like Italy and Sweden, where shareholders are heavily involved in the nomination process. I recently met with a client in Stockholm, who told me that he was a member of eight separate nominating committees—simply unheard of in the United States.

In recent years, a focus on board tenure has risen. CalPERS, State Street Global Advisors and the United Kingdom’s Legal and General Investments have advocated new ways of thinking about board tenure and independence as part of the board refreshment process. Earlier this year, CalPERS approved revisions to its Global Governance Principles, which require that companies take a comply-or-explain approach to the issue of long-tenured directors. Companies with a director that has served on the board for more than 12 years have two options: They could either classify the director as non-independent, or they could disclose a basis to continually deem him or her as independent each year. State Street compares its portfolio holdings to the average market tenure, to see if the average board tenure for each company that they own is above one standard deviation from the average market tenure, or if one-third of the non-executive directors have tenures longer than two standard deviations. According to State Street Global Advisors (SSGA), it expects “long-tenured directors to refrain from serving on the audit, compensation and nominating governance committees on boards of companies with high average director tenure.” (“Addressing the Need for Board Refreshment and Director Succession in Investee Companies,” SSGA, February 2015.) Legal & General Investment Management announced that in 2017 it will begin to vote against the chair of the nomination committee for an array of reasons, such as: If the average tenure of the board is 15 years or more, there has not been any new board appointments for 5 years or more, or if the key board committee members and/or the lead independent director have been serving for 15 years or more.

Issuers need to be aware of this significant development. Why does it matter? Besides the connection to board diversity, a study orchestrated by Harvard Business Review found a correlation between board turnover and overall company performance.  It looked at board turnover at 500 large-cap U.S. companies from 2002 to 2013, they examined company performance over a subsequent three-year period, and found that the worst performers were companies with either no director changes, or more than five changes. (George M. Anderson and David Chun,”How Much Board Turnover is Best?”, Harvard Business Review, April 2014.)

Finally, a new push for ethnic and LGBT diversity has emerged. On June 1st, officials representing twelve U.S. public pension funds issued a joint statement calling on U.S. companies to “cast wide nets in their search for the best talent and include nominees who are diverse in terms of race, gender, and LGBT status.” The signatories included treasurers and comptrollers for California, Chicago, Connecticut, Illinois, Maryland, Massachusetts, New York City, New York State, Oregon, Philadelphia, Rhode Island and San Diego County. Another push comes from the United Kingdom. The Labour MP and former shadow business secretary, Chuka Umunna, have urged other ministers to set a target for ethnic minority representation on FTSE 100 boards. Mr. Umunna called for “no all-white boards by 2020″ and for companies to be required to divulge the ethnic breakdown of their board rooms.

Skroupa: What can you tell us about the MSCI ESG Research Diverse Director DataSource (3D)?

Sherman: This is another important initiative, and it serves as a resource for board nominating committees or search firms who are looking for “non-traditional” board candidates. It was developed with the help of CalPERS and CalSTRS, who were interested in creating a candidate pool that extended beyond the traditional profile of mostly sitting CEOs. It costs nothing for a candidate to enter their credentials and there are now over 800 approved candidates in the database. Approximately two-thirds are women and the same percent have not-for-profit, private or public board experience; 37% have undertaken some type of board training; and 13% indicate they have the necessary financial expertise to serve on an audit committee. It’s a truly impressive group!


This article was written by Christopher P. Skroupa from Forbes and was legally licensed through the NewsCred publisher network.

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