2. Better Utilisation of Talent Pool
Stakeholders are demanding more from directors, in particular from non-executive directors (NEDs). Having NEDs on the board has already been a common requirement across countries. NEDs are, however, often criticised for having insufficient devotion of time and effort in understanding the business and representing stakeholders to scrutinise executive directors in making appropriate decisions.
One of the problems of searching for suitable directors lies on the limited number of candidates – there is especially a tendency to search for board members with typical characteristics, such as male directors. If directors expand the pool of potential candidates by considering more diversified attributes, like women and ethnic minorities to be included in the boardroom, it will alleviate the problem of ‘director shortage’ and therefore better utilise the talent pool. It is therefore vital for companies to initiate tapping into the under-utilised pool of talent through board diversity.
3. Enhancement of reputation and investor relations by establishing the company as a responsible corporate citizen:
Having a heterogeneous board can enhance corporate reputation through signalling positively to the internal and external stakeholders that the organisation emphasises diverse constituencies and does not discriminate against minorities in climbing the corporate ladder. This may somehow indicate an equal opportunity of employment and the management’s eagerness in positioning the organisation as a socially responsible citizen.
It is also argued that board diversity reflects the diversity of the society and community served by the organisation. This reflection strengthens the social contract between a business and its stakeholders, which, in turn, improves its strategic fit that the business has with its environment. As a result, it is suggested that a diverse board can help a company build its reputation as a responsible corporate citizen that understands its community and deserves its trust.
Further, more institutional investors have taken into account board diversity as a factor for investment evaluation due to the reasons that: (i) a number of academic research papers indicated the positive correlation between firm value and board diversity; and (ii) institutional investors are placing greater emphasis on corporate social responsibility. Board diversity can, improve its investor relations.
Costs of diversifying the board
Diversifying the board is not without costs. Though a board is inherently subject to conflict as it is formed by individuals collectively, having a diverse board may potentially increase friction between members, especially when new directors with different backgrounds are stereotyped by existing members as atypical. This may split the board into subgroups, which reduces group cohesiveness and impairs trust among members, leading to reluctance to share information within the board.
Another danger of board diversity is sometimes referred to as tokenism. Theoretically, the minorities in the boardroom are said to contribute to value creation of the organisation by their unique skills and experiences; however, in practice, they may feel that their presence is only to make up the numbers required by the external stakeholders. They may then tend to undervalue their own skills, achievements and experiences, which demean their potential contribution to the organisation.
Further, the board may potentially ignore the underlying important attributes of successful directors as a sacrifice to meet the requirement of board diversity. The board needs to pay special attention to these costs when implementing measures to diversify the board.
Regulatory Board Diversity
Board diversity can be promoted by a number of methods. Measures currently adopted by different regulatory bodies are generally classified into the following approaches: (i) through imposing quotas on the board; and (ii) enhancing disclosures using the ‘comply or explain’ approach.
Imposing quotas refers to mandatory requirement in appointing a minimum number of directors with different attributes on the board. This legislation enactment mainly deals with gender diversity to tackle the relative underrepresentation of women in the boardroom. Spain and France are women fill at least 40% of directorship positions this mandatory requirements for gender diversity. The approach increases the number of women on the board at a faster rate also good if developing countries can apply same.
Another measure to enhance board diversity is through transparency and disclosure. Companies, under corporate governance codes are required to disclose their diversity policy in appointing directors so that investors and stakeholders can make proper evaluation. Those who fail to implement such measures have to explain their non-compliance in the corporate governance report or equivalent. The Corporate Governance Code (2010) of the United Kingdom, for example, stipulates that companies are required to: (i) incorporate diversity as a consideration in making board appointments; (ii) disclose in their annual reports describing the board’s policy on diversity, as well as its progress in achieving the objectives of that policy. Australia and Hong Kong are promoting diversity using a similar ‘comply or explain’ approach. The board appointments should be made on the basis of business needs, skills and ability instead of legislative requirements, which may sometimes be considered excessive in the market.
Finally
Board diversity is justified as a key to better corporate governance. The following extract from academic literature by Conger and Lawler (2001) serves as a good summary of board diversity:
‘The best boards are composed of individuals with different skills, knowledge, information, power, and time to contribute. Given the diversity of expertise, information, and availability that is needed to understand and govern today’s complex businesses, it is unrealistic to expect an individual director to be knowledgeable and informed about all phases of business. It is also unrealistic to expect individual directors to be available at all times and to influence all decisions. Thus, in staffing most boards, it is best to think of individuals contributing different pieces to the total picture that it takes to create an effective board.’
In implementing policies on board diversity, both the company’s chairman and the nomination committee play a significant role. The chairman, being the leader of the board, has to facilitate new members joining the team and to encourage open discussions and exchanges of information during formal and informal meetings. To create such a well-functioning team, the chairman further needs to commit and support mentoring, networking and adequate training to board members.
The nomination committee should give consideration to diversity and establish a formal recruitment policy concerning the diversity of board members with reference to the competencies required for the board, its business nature as well as its strategies. The committee members have to carefully analyse what the board lacks in skills and expertise and advertise board positions periodically. They are strongly encouraged not to seek candidates merely through personal contacts and networks in order to carry out a formal and transparent nomination process.
The most important ingredient to the success of board diversity, however, would most probably be the board members’ changing their mind set to welcome a more heterogeneous board, as well as to place greater trust in one another and work together more effectively.
In finance, diversification means reducing non-systematic risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituents
Dr. Dada.MBA, PhD, CPF Acct., is a Finance / Management Consultant and Certified Forensic Accountant ([email protected], 08052043855).
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