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​The View from NTU Professors: Board diversity: Policy should weigh benefits and costs

Published on: 07-Oct-2014

By Eugene Kang

The topic of diversity in the corporate boards of publicly-listed firms has captured the attention of various interest groups. Since 2012, at least 80 news articles in Singapore have highlighted the importance of diversity in a firm’s upper echelons.

While corporate boards may be diverse in various ways, much of the attention has focused on gender diversity. For instance, it has been widely reported that women occupy around 8 per cent of board seats in SGX-listed firms, a number that pales in comparison with other advanced economies such as Australia and Britain.

Apart from gender, other forms of diversity have also been discussed, albeit less so. For instance, committee members from the Singapore Institute of Directors have delivered excellent discourse on boardroom diversity in terms of age, ethnicity, competency, industry experience and nationality in the weekly “Boardroom Matters” column of the Business Times.​​

While much has been written about the benefits of boardroom diversity, it is important to note that some firms may not fully harness these benefits, thus leading to lower-than-expected performance. Costs and contingencies have to be considered when boards seek to increase the diversity of their membership.

The conventional wisdom of diversity is succinctly summarized by Ms Barbara Voskamp in a Boardroom Matters article (Back to Basics: Financial Literacy for Board Members – BT 12 May 2014): “…diversity adds a greater depth of thought, experience, knowledge and perspective to a company and how it does business,” said Ms Voskamp.

The underlying premise is that a diverse team has access to more information or cognitive resources, thus enabling the team to consider different perspectives, deliberate on a greater variety of potential solutions to problems, and enhance decision outcomes.

In Singapore, the importance of having diverse boards is institutionalized in guideline 2.6 of the 2012 Code of Corporate Governance, which states: “The Board and its board committees should comprise directors who as a group provide an appropriate balance and diversity of skills, experience, gender and knowledge of the company.”

The business case for board diversity is a strong one and has been extensively discussed. For instance, the Diversity Task Force has published an excellent report that made a strong case for improving gender diversity in the upper echelons of SGX-listed firms. A Diversity Action Committee has been formed to facilitate the implementation of the 10 initiatives listed in the report.

While the benefits of diversity are clearly understood, the costs of diversity have not been given adequate attention in current discussions. Overemphasizing the former while overlooking the latter can lead to excessive diversity that may be counterproductive.

The costs of diversity come in various forms. For instance, increasing diversity may decrease cooperation and erode cohesion among team members, or increase communication and coordination costs that hamper the speed of decision-making.

Research shows mixed results

Diverse teams are at risk of developing fault lines, or strong divides between subgroups within a team, that may hinder team-level processes and impair performance. The genesis of fault lines comes from the tendency of individuals to associate with similar others, based on common characteristics such as age, gender, tenure, educational background, and functional expertise.

Given that diverse teams have both benefits and costs, it is not surprising that research on the relationship between team diversity and performance has found mixed results. In other words, diversity does not always lead to better outcomes.

Increasingly, there is growing awareness of the contingencies that influence the extent of benefits reaped from diverse teams. For instance, a study of Swiss-listed firms (Top management team nationality diversity and firm performance) found that the national diversity of top management teams has a stronger impact on firm performance for firms with more extensive international operations or when these top executives have longer shared tenure.

Another study on S&P 1,500 firms in the US (Does female representation in top management improve firm performance?) found that the presence of female top executives improves firm performance when the firm emphasizes innovation in its strategy. A recent study on Fortune 500 US firms (The double-edged nature of board gender diversity) concluded that gender “diversity is double-edged because it can propel or impede strategic change depending on firm performance and the power of women directors”.

The “comply or explain” governance approach in Singapore eschews a one-size-fit-all perspective, enabling a firm’s corporate board and its nominating committee to decide on the level and nature of diversity that best creates value for the stakeholders of the firm.

As a start, it is useful to consider the contingencies under which certain types of diversity are more likely to create value for a firm.

If geographic diversification is an important strategy for a firm, then greater diversity of experience in target overseas markets may provide valuable insights that shape strategic decisions. Likewise, if women comprise a significant portion of a firm’s target consumer group, then appointing more female directors may be the way forward.

Other than linking board diversity to value creation through strategic initiatives, diverse boards should also institute processes to mitigate the costs of diversity. The board chair plays a pivotal role in providing leadership that creates an inclusive climate where diverse views are actively solicited and deliberated in an open and honest manner. Directors in diverse boards should also be equipped with soft skills, such as cultural intelligence, to improve cooperation and communication when relating with peers from different backgrounds.

Board diversity is an important aspect of corporate governance. However, for diverse boards to be effective, corporate boards should consider developing and substantively implementing a diversity policy that takes into account the benefits, costs and contingencies of diversity.

The writer is an associate professor in strategic management at NTU's Nanyang Business School

Source: The Business Times, 7 October 2014

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