Earn more by investing in firms with boards that have diverse members

If you want to invest in companies that achieve superior performance, look beyond just company financials and also consider diversity of gender, ethnicity and age on the board. Studies show that companies with more diverse boards generate better results.

WHAT RESEARCH HAS FOUND

Consulting firm McKinsey found, for example, that companies in the top quartile for racial and ethnic diversity are 35 per cent more likely to have financial returns above national industry medians, and companies in the top quartile for gender diversity are 15 per cent more likely to have higher financial returns.

While correlation does not demonstrate causation, as McKinsey puts it, the relationship between greater diversity in the leadership at large companies and better financial performance is significant.

Closer to home, research done by the International Finance Corporation on six countries in the Association of Southeast Asian Nations (Asean) showed that companies with more than 30 per cent female board members had better financial performance, with an average return on assets of 3.8 per cent compared to 2.4 per cent for companies where less than 30 per cent of the board is women.  

Here in Singapore, research into the top 100 Singapore Exchange-listed companies by advisory firm Willis Towers Watson similarly found that companies with at least one woman on the board outperformed companies without one — in terms of total shareholder returns, return on equity and revenue growth.

And although 89 per cent of the companies here do not have ethnic diversity on their board, firms with ethnically diverse boards had about a 10 per cent higher price-earnings ratio.

Moreover, a study by the Centre for Governance, Institutions and Organisations of the National University of Singapore Business School found that a Singapore company’s financial performance rose by 11.8 per cent if the average number of female independent directors increases by just one woman.

WHY DIVERSITY MATTERS

While there is more of a focus on gender when studying diversity, board diversity also includes age, tenure, ethnicity and expertise.

Concentrating on only one form of diversity is not enough, Assistant Professor Stephanie Creary of the University of Pennsylvania explains.

Social diversity that includes gender, ethnicity and age, as well as diversity in professional experience, are all important for increasing the range of perspectives on the board.

In the case of gender diversity, for instance, Willis Towers Watson said that women often bring different competencies and approaches to stewardship and risk-reward orientations that may provide more balanced perspectives in decision-making.

Female board members may also be able to represent the views of the wider employee base and provide an enhanced understanding of customer preferences.

Similarly, greater ethnic diversity on boards should bring stronger inclusiveness, creativity, and acceptance to innovative ideas, which may improve strategic decision-making.

Ethnic diversity may allow the board to understand and consider the company's employees and customers better.

WHICH COMPANIES TO CHOOSE

Since the performance of companies with more diverse boards and management often turns out better, the question for investors is how to consider diversity when choosing companies for investment.

UBS bank suggests that a way of aligning private investments with gender equality goals is to invest in listed companies with progressive gender policies, since a greater proportion of female executives and directors generally correlates with higher returns.

While women in leadership may not necessarily be the direct cause of outperformance, UBS says, gender balance may be a reliable indicator for better-performing companies.

One more specific option is simply not to invest in companies that do not have gender or other diversity on their boards. In Australia, for example, investment adviser Future Super removed all Australian companies without gender diversity on their boards from its portfolio.

Another is to look for companies that appoint a female chief executive officer or increase the percentage of women in management.

Research in the United States by financial analytics firm S&P Global found that in the two years following a new CEO appointment, the stock price for companies that appointed female chief executives outperformed those that appointed men by an average of 20 per cent.

And a study by investment manager Calvert Impact Capital found that once women represent 33 per cent of leadership teams in companies, the increase in financial performance was significant. 

Leveraging research on diversity can also be helpful. Companies on the Impax Global Women’s Leadership Index, for instance, which includes firms such as Singtel, Singapore Press Holdings and CapitaLand Commercial Trust, outperformed the MSCI World Index by 8.5 per cent cumulatively over the past five years.

Even though it might seem that finding information about diversity would be straightforward, it may require looking at board members’ names and profiles in companies’ annual reports or press announcements as well as reading their policies to figure out how diverse the firms are.

While the Singapore Code of Corporate Governance was revised to require companies to report a board diversity policy starting this year, some companies simply state their policy and may not provide details about the diversity of their board.

While it is still essential to look at a company’s financial performance when deciding whether to invest in a firm, checking on the company’s board and management diversity may also give investors an extra means of achieving even better investment results.