A diverse board is one wherein members have heterogeneous characteristics in terms of gender,
age, ethnicity, experience and professional background (Anderson et al., 2011). Diverse boards
are commonly recognised as being more likely to provide a wide range of experience,
knowledge and competence as compared to homogeneous boards (Buse et al., 2016). Board
diversity is an effective tool in corporate governance, as it creates value for a corporate board
by enhancing the decision-making process (Adams and Ferreira, 2009; Anderson et al., 2011),
improving managerial monitoring (Kim et al., 2013), satisfying the needs of stakeholders
(Harjoto et al., 2015) and drawing additional attention to the ethical aspects of firm activities
(Hafsi and Turgut, 2013). The increasing importance of corporate governance codes and
government agencies, in conjunction with insistence from social activists, imposes greater
pressure on firms to promote the improved diversity of their boards (Anderson et al., 2011;
Farag and Mallin, 2016a).
Board diversity is traditionally underpinned by two main theories: resource dependence theory
(Pfeffer and Salancik, 1978) and agency theory (Jensen and Meckling, 1976). These two
theories are related to the service and control task of the board, respectively (Forbes and
Milliken, 1999). Drawing on the agency theory, Hillman and Dalziel (2003) and Adams and
Ferreira (2009) stated that corporate boards with an appropriate mix of experience and
background have a better ability to monitor managerial behaviour and assess business
strategies. This is consistent with Carter et al. (2003), who argue that directors with different
genders, ethnicities, or cultural backgrounds might ask questions that might not come from
156
be more active and have better monitoring roles compared to non-diverse boards. Consistent
with Farag and Mallin (2017), the resource dependence theory provides the theoretical
foundation for board diversity and suggests that boards with diverse directors have a broader
range of skills and more talented and well-connected directors.
Using the Russell index31, Anderson et al. (2011) analysed the impact of board diversity on
firm performance between 2003 and 2005. Their results revealed that diverse boards enhanced
firm performance, and firms that operated in complex environments exhibited greater demand
for heterogeneous directors. Furthermore, using a sample of US-listed firms in operation from
1999 to 2011, Harjoto et al. (2015) found that boards whose members had varied characteristics
were positively associated with corporate social responsibility, thus indicating that
heterogeneous board members enhance a firm’s ability to satisfy stakeholders. More recently,
Mallin and Farag (2017) examined the relationship between board diversity and firm
performance using FTSE all-shares from 2004 to 2013; their results revealed that diverse
boards drove improved firm performance in UK-listed firms.
Given the level of fiduciary responsibility held by institutional investors, I posit that such
parties will view board diversity as an issue to be improved when considering the composition
of their investee firms’ corporate boards. Hence, the next hypothesis is formulated as follows: H6.The higher the presence of institutional investors, the higher the diversity of the board.
‘Diversity of the board’ is measured by the Board Diversity Index (BDI16) as explained in Table
6.5.
5.3.1. Board Gender Diversity
The gender diversity of corporate boards has received special attention and is one of the most
studied topics in the field of demography diversity (Terjesen et al., 2009). Recognition of the
31Represents the 1,000 largest US-listed firms with higher market capitalisation levels (Servaes and Tamayo,
157
importance of gender diversity has driven a number of countries to introduce compulsory
legislation mandating the adoption of gender quotas for the boards of public firms (Terjesen et
al., 2015a)32. In accordance with the agency theory, the presence of female directors on a
corporate board may improve the board’s monitoring ability, which in turn will trim down
agency costs (Carter et al., 2003; Farag and Mallin, 2016b). From the perspective of the
resource dependence theory, women directors may bring different resources and benefits to the
company (Carter et al., 2010). This is consistent with Mateos de Cabo et al. (2012), who argue
that women directors are likely to bring new opinions and perspectives which may improve
and enhance firm performance. The enactment of gender-quota legislation in several countries
has created pressure on corporate boards to employ more women on their boards (Grosvold
and Brammer, 2011; Terjesen et al., 2015b), thus exemplifying the institutional theory (Scott,
2004). For instance, ten countries33 have enacted quotas for female representatives on the
corporate boards of public firms and state-owned businesses ranging from thirty-three to fifty
percent with various sanctions, while fifteen countries34 have introduced gender quotas under
a system of ‘comply or explain’ (Terjesen et al., 2015b). The growing significance of government agencies and corporate governance codes and the demands of social activists puts
additional pressure on firms to promote board diversity (Anderson et al., 2011; Farag and
Mallin, 2016a).
It has been argued that women are more committed to their board responsibilities; this claim
is supported by their higher rates of attendance (Adams and Ferreira, 2009), their greater risk
aversion (Byrnes et al., 1999) and their increased conservatism when making investment
decisions (Bernasek and Shwiff, 2001) as compared to their male counterparts. Carter et al.
33Norway, Spain, Finland, Quebec (Canada), Israel, Iceland, Kenya, France, Italy and Belgium. 34 Australia, Austria, Denmark, Germany, Ireland, Luxembourg, Malawi, Malaysia, Netherlands, Nigeria, Poland, South Africa, Sweden, United Kingdom and United States.
158
(2003) examined Fortune 1000 firms in 1997 and reported a positive association between the
gender diversity of a board and that firm’s financial performance. Srinidhi et al. (2011) examined a sample of US-listed firms between 2001 and 2007 and reported that gender-diverse
boards were associated with higher-quality earnings. This indicates that female participation in
corporate boards leads to the improved oversight of manager reporting.
Torchia et al. (2011) examined a sample of Norwegian-listed firms and reported that a greater
presence of female directors on a board led to a higher level of innovation within the firm.
After investigating a sample of Chinese-listed firms in operation between 2001 and 2010,
Cumming et al. (2015) found that a greater presence of female directors on a corporate board
correlated with a reduced likelihood that a company would commit fraud or violate securities
regulations. Their results also indicated that the presence of women on a board reduced the
severity of fraud; this effect was even stronger in male-dominated industries. Francoeur et al.
(2008) analysed a sample of the 500 largest Canadian firms between 2001 and 2003 and
reported that a female board presence had a positive association with abnormal returns,
especially for firms operating within a complex environment. Lucas-Pérez et al. (2015)
examined a sample of Spanish-listed firms in operation between 2004 and 2009 and reported
that a greater presence of female directors on a board correlated with a higher likelihood that
manager compensation schemes would be properly designed and linked to firm performance.
Given the need for female directors to join the ranks of corporate boards, I posit that
institutional investors play a role in the improvement of board gender diversity.
H7.The higher the presence of institutional investors, the higher the gender diversity of the
board.
‘Gender diversity of the board’ is measured by the proportion of female directors serving on the board.
159
5.3.2. Board Age Diversity
Heterogeneity of board directors’ ages may prevent groupthink and improve monitoring by balancing the energy and enthusiasm of younger directors with the experience and risk aversion
of older directors (Ararat et al., 2015). According to the resource dependence theory, a firm
with a homogenous board may display poor performance because it lacks the required mixture
of skills and expertise. Age diversity is seen as one of the important characteristics that provides
a greater range of opinions and expertise to the corporate board (Ali et al., 2014). Supporting
this view, Hafsi and Turgut (2013) argued that age diversity in the corporate board is likely to
bring more balanced decision-making that considers the interests of the firm’s various
stakeholders. Companies who target customers of various ages should hire directors of multiple
age groups; such an age diverse board will provide a firm with a variety of perspectives that
will positively impact the company’s reputation and financial outcomes (Fombrun, 1996; Kang et al., 2007). This is consistent with Jhunjhunwala and Mishra (2012), who argue that a board
that is dominated by older directors may lack knowledge of current technologies.
Several studies have reported that age diversity in corporate boards improves governance
outcomes. For instance, Goergen et al. (2015) examined a sample of the largest German-listed
firms in operation between 2005 and 2010 and found that the greater the age difference between
the CEO and company chair, the better the monitoring and performance of the firm. Consistent
with this view, Ararat et al. (2010) examined Turkey’s largest firms and reported that greater age diversity was positively associated with firm valuation, thus indicating that board age
diversity increases the monitoring of managers’ actions and therefore alleviates agency problems. Furthermore, upon examining Mauritanian-listed firms in 2007, Mahadeo et al.
(2012) found that firms with directors of diverse ages were positively associated with enhanced
160
(2010) reported that firms whose independent directors were of diverse ages were associated
with higher levels of firm performance. Hence, the next hypothesis is formulated as follows:
H8. The higher the presence of institutional investors, the higher the diversity of directors’
ages.
‘The diversity of directors’ ages’ is measured by the standard deviation of directors’ ages divided by the mean age of all members of the board.
5.3.3. Board Nationality Diversity
The internationalisation of firms, whereby organisations operate across multiple countries, has
led to a need to hire foreign directors who have the necessary knowledge and competence to
link a firm to the environment in which it operates (Carpenter et al., 2001). The resource
dependence theory considers the presence of international human resources as the most
valuable and unique resources of a firm (Kaczmarek, 2009). With the increase of business
diversification, firms demand dynamic resources that help to achieve a competitive advantage
in the global capital markets (Katmon et al., 2017). Supporting this view, foreign directors can
contribute valuable advice and bring foreign contacts to a company, thus allowing it to better
understand the foreign market. This is especially beneficial to companies that engage in foreign
operations or have plans for future international expansion (Adams et al., 2010). When
companies expand their operations to other countries, they are likely to encounter a different
legal, regulatory and cultural environment. For these firms, foreign directors who are native to
the target country can be beneficial assets, as they are able to utilise their advantageous working
knowledge of the local environment and of local customers’ preferences (Masulis et al., 2012). Estelyi and Nisar (2016) examined sample of FTSE all-shares from 2001 to 2011 and found
that UK-based firms whose boards had directors of diverse nationalities demonstrated
improved operating performance. Their results also revealed that foreign directors were more
161
which indicates that firms benefit from the experience of foreign directors when crafting
compensation packages. Investigating a large sample of non-US firms, Miletkov et al. (2013)
found that foreign directors were positively associated with firm performance, provided that
they originated from a country with strong legal protections for investor rights. Thus, the next
hypothesis is presented as follows:
H9. The higher the presence of institutional investors, the higher the nationality diversity of
the board.
‘Nationality diversity of the board’ is measured by the proportion of foreign directors serving on the board.
5.3.4. Board Education Diversity
Board members with diverse educational backgrounds can bring multiple perspectives to a
boardroom (Anderson et al., 2011). According to the resource dependence theory, an
education-diverse board (level of education, e.g. postgraduate studies) may supply the
corporate board with different viewpoints, cognitive paradigms and professional development
(Anderson et al., 2011; Farag and Mallin, 2016b).The presence of heterogeneous education
levels provides directors with different perspectives and insights that can be utilised to advance
their career development and improve their social contacts (Anderson et al., 2011). Independent
directors with advanced academic degrees and considerable work experience can convey
insights to a board and thus contribute to the overall success of a firm (Terjesen et al., 2015b).
Most corporate governance codes recommend that a company’s board establish committees to
handle specific issues (i.e., audit, compensation, nomination and strategy committees).
Therefore, a board should consider appointing directors with various educational backgrounds
to its key subcommittees in order to facilitate the completion of specific tasks (Mahadeo et al.,
162
Bell et al. (2010) conducted a meta-analysis and found that the inclusion of members with a
variety of educational backgrounds tended to enhance the creativity, innovation and
performance of a firm’s top management team. Using a sample of non-financial Chinese-listed firms that initiated their IPOs between 1999 and 2012, Farag and Mallin (2016a) examined the
relationship between board education diversity (as measured by the percentage of directors
with postgraduate degrees) and firm performance. Their results revealed that boards with
higher levels of education diversity were associated with better financial performance. Their
results also indicated that directors with high levels of education brought different backgrounds
and perspectives to their corporate boards. In addition, using a sample of twenty-five high-tech
firms in the Fortune 500, Midavaine et al. (2016) investigated the effect to which board
diversity (education, gender and tenure) influences firms to invest in research and development.
The findings revealed that education and gender diversity are positively related to the
investments in research and development, while tenure diversity is not. The study indicates that
education-diverse boards tend to be more innovative and competitive. Therefore, the next
hypothesis is formulated as follows:
H10.The higher the presence of institutional investors, the higher the education diversity of
the board.
‘Education diversity of the board’ is measured by the proportion of directors with postgraduate degrees.
163
5.4. Chapter Summary
This chapter explained and developed the hypotheses used in this study. These hypotheses were
divided into two groups: the first set focused on the role of institutional investors in the
improvement of board attributes, while the second cluster concerned their role in improving
board diversity. It is worth noting that these hypotheses will also be examined in light of
different institutional environments, to include various economic conditions (pre-crisis, crisis
and post-crisis periods), legal systems and ownership structures. Table 5.1 provides a summary
of the various hypotheses developed for this study.
Table 5.1 Hypotheses Summary
Institutional Investors and Board Attributes
H1.The higher the presence of institutional investors, the better the corporate governance in their investee firms.
H2a.The higher the presence of institutional investors, the higher the independence of the board.
H2b. The higher the presence of institutional investors, the higher the independence of the board’s key subcommittees. H3a.The higher the presence of institutional investors, the higher the activity of the board.
H3b.The higher the presence of institutional investors, the higher the activity of the board’s key subcommittees. H4.The higher the presence of institutional investors, the lower the board entrenchment.
H5.The higher the presence of institutional investors, the lower the board busyness.
Institutional Investors and Board Diversity H6.The higher the presence of institutional investors, the higher the diversity of the board.
H7.The higher the presence of institutional investors, the higher the gender diversity of the board.
H8.The higher the presence of institutional investors, the higher the diversity of directors’ ages.
H9.The higher the presence of institutional investors, the higher the nationality diversity of the board.
164
Chapter 6