Board diversity and firm performance: The role of business group affiliation
Introduction
The board of directors of a firm, often referred to as the board, is its highest decision-making and supervisory body. The literature enumerates two major authoritative views on the functioning of corporate boards: the agency view and the resource dependence view. The agency view documents that a board performs a monitoring role and helps to discipline self-interested managers (Fama & Jensen, 1983; Hart, 1995; Jensen & Meckling, 1976). Following the agency view, structurally more diverse boards that have an adequate number of independent directors should be able to monitor managers optimally. The resource dependence view, on the other hand, proposes that a board performs an advisory and a counseling role (Pfeffer & Salancik, 1978). Demographically more diverse boards, in line with the resource dependence view, are expected to have higher quality resources at their disposal to better advise management (Anderson, Reeb, Upadhyay, & Zhao, 2011; Ben-Amar, Francoeur, Hafsi, & Labelle, 2013). Following the agency and resource dependence views, it may be argued that structurally and demographically more diverse boards are likely to have superior monitoring and advisory capabilities, and should, therefore, improve firm performance.
Even though theoretical considerations based on the agency and resource dependence views indicate that diversity in the board of directors enhances firm performance, empirical evidence has failed to arrive at a consensus to support this theory. While some studies report a positive effect, several others report a negative or no significant effect of board diversity on firm performance (Adams, de Haan, Terjesen, & van Ees, 2015; Miller & Triana, 2009; Post & Byron, 2015; Tasheva & Hillman, 2018). The deviation of the empirical results from the theoretical predictions calls for examining the contextual idiosyncrasies or confounding factors that are likely to shape the diversity-performance relationship (Post & Byron, 2015). Our study addresses this significant research gap by hypothesizing that business group affiliation is an important contextual factor, which if ignored can potentially contaminate the board diversity–firm performance relationship.
Prior studies largely ignore the role of business groups in influencing the diversity-performance relationship in markets with the presence of such group structures (see, for examples, Ahern and Dittmar (2012), Bennouri, Chtioui, Nagati, and Nekhili (2018), and Campbell and Mínguez-Vera (2008)). The board structure of group-affiliated firms is likely to be different compared to standalone firms because group-affiliated firms often have director interlocking arrangements with other firms from the same group often with a large numbers of family or group members serving as directors (Khanna & Rivkin, 2000, 2001, 2006; Silva, Majluf, & Paredes, 2006). Further, unlike in standalone firms, the business group family members serving on boards of group-affiliated firms are more likely to represent group goals rather than individual firm goals (Strange, Filatotchev, Buck, & Wright, 2009). Therefore, the failure to recognize the heterogeneity in the board structure between standalone and group-affiliated firms can potentially result in drawing erroneous conclusions about the effect of board diversity on firm performance in markets with business groups.
Our study considers two broad forms of diversity in the board of directors: demographic diversity that is based on the demographic characteristics of the board members such as gender, educational qualifications, age, and tenure, and structural diversity that is based on the independence status of board members. We argue that interlocking of directors with goal conflicts within business groups is especially likely to reduce the demographic diversity in the board of directors at affiliated firms in spirit (de facto) but not necessarily in letter (de jure), and it is, therefore, unlikely to produce similar benefits that standalone firms can reap from similarly diverse boards. Further, if director interlocking within business groups is inappropriately used to tunnel or transfer profits across groups firms, demographic diversity may negatively influence the performance of affiliated firms. Structural diversity, on the other hand, is unlikely to be affected by the director interlocking of family members as regulations generally prohibit the appointment of family members in the independent director positions.
We propose that the effect of board diversity on measures of firm performance is not uniform for all firms. Taking into account the nature of heterogeneity in board composition between group-affiliated and standalone firms and using agency and resource dependent views on the functioning of boards, we contend that business group affiliation likely impairs the positive effects of board demographic diversity, while the effect of structural diversity is little affected. Thus, unlike prior literature, our paper attempts to address the important research gap on the role of business groups in the board diversity–firm performance relationship.
In addition to addressing the aforementioned research gap, our study makes several refinements to the current state of the literature on board diversity. First, unlike most of the empirical studies in prior literature, we do not confine ourselves to merely examining the influence of board gender diversity on firm performance, rather we extend the diversity discussion to take into account other observable demographic aspects of board members such as their educational qualifications, age, and tenure as well. Second, the usual measures of firm performance are somewhat subjective and may not be directly linked to board composition (Green & Homroy, 2018). To highlight and add further to the value of our research findings, we additionally identify and use a novel performance measure rarely used in other board diversity studies – the market-based M&A outcome that is directly influenced by board decisions and reflects non-subjective market assessments.2 Finally, unlike most of the prior studies, we do not use simple proportions or percentages as diversity measures, rather we use measures such as Blau index (for discrete attributes) and the coefficient of variation (for continuous attributes) that are real measures of diversity (Harrison & Klein, 2007).
We base our analysis of board diversity-performance relationship on a sample of firms constituting the NIFTY 500 index in India using financial statement and board composition data over the ten-year period starting from April 1, 2006 (starting FY06) to March 31, 2015 (ending FY15).3 Our tests are based on two different measures of performance, general performance measured by Tobin’s Q and special performance measured by the stock market reactions around M&A deal announcements by acquiring firms. The results from these tests indicate that business group affiliation impairs the positive firm value effects of demographic board diversity in their affiliated firms, but the performance effects of structural diversity remain relatively unaffected. These results, are also evidence of a previously undocumented cost of business group affiliation, and also show in a fresh context that cross-country studies should account for international differences in ownership and institutional structures such as the prevalence of business groups.
The rest of the paper is organized as follows: In Section 2, we review the existing literature and develop our framework as well as hypotheses. In Section 3, we describe the empirical context of our study as well as our data, variables, and methodology. In Section 4, we report our results. In Section 5, we discuss the theoretical contributions of our paper, its limitations, and some avenues for future research. We conclude in Section 6.
Section snippets
Literature review and hypotheses development
Research and scholarship on board diversity has been one of the most prolific topics in the last decade or so. Prior research on the diversity of the board of directors differentiates between its demographic and structural diversity. While the demographic diversity of a board is linked with gender, culture, nationality, and experience of its directors, structural diversity is usually linked to the board independence (Ararat, Aksu, & Cetin, 2015; Tasheva & Hillman, 2018). Since board
Empirical context
We make use of the Indian setting to test our hypotheses. First, the Indian landscape is dominated by business groups (Khanna & Yafeh, 2005, 2007). About 60% of the top 500 firms in India are affiliated with business groups and make up about two-thirds of the total market-capitalization (Jackling & Johl, 2009). Second, unlike state-owned and bank-owned business groups in China and Japan, respectively, the ownership of business groups in India is more independent (Cuervo-Cazurra, 2007). Third,
Descriptive statistics and correlations
The descriptive statistics of our sample for examining the general measure of firm performance are shown in Panel A of Table 6. Two-thirds of our sample firm-years are affiliated with business groups. The mean insider ownership in the sample firms is 54%, which is considerably higher when compared to the proportions in most developed nations. On average, a board is composed of about 9 members with the board meeting about 9–10 times in a fiscal year, and a director in our sample holds close to 6
Theoretical contributions
Our study makes three contributions to the literature. First, we contribute to the literature on board diversity by providing compelling evidence that it is not sufficient to just examine whether diverse boards influence firm performance, rather it is even more important to consider the conditions/contexts that might shape this relationship differently. Our findings, which are consistent with the meta-analysis of past studies by Post and Byron (2015), call for differentiating between the de jure
Conclusions
The board diversity–performance relationship has attracted much attention globally in the last decade or so, but despite theoretical considerations advocating a positive relationship, there is little empirical consensus on whether diversity in the board of directors has a positive, negative, or no significant influence on firm performance. The inconsistent results documented in the prior literature point to incomplete research designs with missing contextual factors important for understanding
Acknowledgments
We are grateful to the editor and two anonymous reviewers for suggestions that significantly improved the paper. This paper has benefitted from useful comments by colleagues on earlier drafts and participants’ feedback received at the International Conference on Financial Markets and Corporate Finance (ICFMCF) 2017 in Kharagpur, India, the Academy of Management (AOM) Annual Meeting 2018 in Chicago, Illinois, USA, and the Academy of International Business (AIB) Annual Meeting 2019 in Copenhagen,
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Rama Seth in on leave from the Indian Institute of Management Calcutta.