How Boards’ Cultural Diversity Affects Firm Performance
Awareness of the cultural dimension of diversity in corporate boards has been on the rise. Directors’ cultural values can affect how effective corporate boards are in advising and monitoring managers and, ultimately, how well a firm performs. At the same time, increased globalization and rapid technological developments put substantial competitive pressure on businesses. In a new paper, we examine whether cultural diversity on corporate boards can help firms compete.
By Olga Dodd, Bart Frijns, Robin Kaiji Gong & Shushu Liao
This piece first appeared on the Blue Sky Blog.
We consider product market competition a mediator of the relationship between board cultural diversity and firm performance. Product market competition fosters the survival of more efficient firms, stimulates efficiency, and encourages hard work. One way to outperform competitors is with frequent and consistent innovation, and we argue that a culturally diverse board makes innovation more likely by offering creative and complementary insights, broadening managers’ vision, seeking innovation to outperform rivals, and experimenting with new ideas and innovation more effectively. However, in a less competitive environment that requires fewer creative strategies, the net benefits of board diversity diminish and can be outweighed by erratic decision-making.
Cultural Diversity has a positive impact firm’s sales growth
Our empirical findings for U.S. firms in the S&P 1500 index confirm that, in highly competitive industries, board cultural diversity has a positive impact on a firm’s sales growth. The results hold when we use alternative measures of firm performance, including return on assets, Tobin’s q, abnormal stock market return, and market share growth. The results also survive various robustness checks, such as controls for the impact of differences in gender and age, director tenure differences, board independence, and the use of alternative measures of product market competition and board cultural diversity.
We investigate several potential channels through which board cultural diversity may affect firm performance in competitive industries. First, we consider innovation and show that the positive effect of such diversity on firm performance is greater for innovative firms and firms that request more creative inputs. These findings imply that culturally diverse boards benefit firms that deal with more complex tasks, require innovative solutions, and have greater advising needs.
We also show that culturally diverse boards can add more value to firms that are highly interdependent with other firms in the industry and, therefore, require innovative strategies to compete. These findings support the argument that culturally diverse boards have superior advisory capabilities.
Lastly, we consider CEO power, which can limit the board’s ability to monitor the CEO’s behavior, including pursuing private benefits. We find that culturally diverse boards are effective under competition pressure only when their CEOs are less powerful. Therefore, we find no evidence that culturally diverse boards can effectively monitor powerful CEOs.
CUltural diversity should be advocated
Collectively, our findings support the view that cultural diversity based on ancestry should be advocated, at least in the context of corporate boards. Despite potential shortcomings associated with diverse boards, we show that the benefits of board cultural diversity in competitive industries likely outweigh its costs.
Original Publication: Dodd, Olga and Frijns, Bart and Gong, Kaiji and Liao, Shushu, Board Cultural Diversity and Firm Performance Under Competitive Pressures (September 7, 2022). Available at SSRN: https://ssrn.com/abstract=4212481 or http://dx.doi.org/10.2139/ssrn.4212481