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.
It is well documented that culture significantly influences individuals’ values, beliefs, and preferences. The variety of values and perspectives of a culturally diverse board can facilitate information sharing, catalyze critical thinking, and foster innovative strategies and solutions. On the downside, culturally diverse boards may have a harder time reaching a consensus because board diversity can also exacerbate communication difficulties and conflicts.
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.
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. To alleviate reverse causality concerns between board cultural diversity and firm performance, we use an instrumental variable approach with the local ancestral cultural diversity in the firm’s headquarters location as an instrument for our cultural diversity measure. Also, we use U.S. import tariff cuts as an exogenous shock that significantly intensifies product market competition to examine the causal impact of board cultural diversity on firm performance in a more competitive situation. We find that firms with culturally diverse boards outperform in their product markets following those tariff cuts.
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. Second, we explore the role of the firm’s position within an industry and its interactions with other firms in the industry. The interdependency of firms can increase their exposure to competition and enhance the value of creativity. We 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 evaluate whether culturally diverse boards are effective in monitoring managers. 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.
Our empirical findings contribute to the debate on the costs and benefits of diverse boards and, specifically, culturally diverse boards based on directors’ ancestry. Literature highlights that board diversity brings both financial benefits and costs to firms. We contribute to the literature by showing how the impact of board cultural diversity on firm performance varies with economic conditions, such as product market competition.
Our study also contributes to the literature on the effectiveness of diverse boards of directors in performing their key functions as advisers and monitors. Studies show that female directors and independent directors can improve boards’ monitoring effectiveness and, in turn, affect corporate outcomes. However, the literature on the role of diverse boards as advisers is still scant. We contribute to this literature by showing the value of culturally diverse boards as effective advisers to firms in competitive industries.
Finally, our study adds to an influential body of finance and economics research linking product market competition to corporate governance issues. Previous studies posit that competition is vital in aligning interests between managers and shareholders and serves as an external corporate governance mechanism. Our study extends this literature by showing the effect of culturally diverse corporate boards on firm performance in different competitive environments.
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.
This post comes to us from Senior Lecturer Olga Dodd at Auckland University of Technology, New Zealand, Professor Bart Frijns at Open Universiteit, Heerlen, the Netherlands, Robin Kaiji Gong at The Hong Kong University of Science and Technology, Hong Kong, and Assistant Professor Shushu Liao at Kühne Logistics University, Hamburg, Germany. It is based on their paper, “The Impact of Cultural Diversity in Corporate Boards on Firm Performance,” available here.