In this episode of Lehigh University‚Äôs College of Business ilLUminate podcast, Parveen Gupta and Heibatollah Sami, who have coauthored a study examining the relationship between boardroom gender diversity and long-term firm performance. The study was published in the International Journal of Disclosure and Governance.

Gupta holds the William L. Clayton Distinguished Professorship in Accounting at Lehigh's College of Business. He is nationally recognized in Sarbanes-Oxley, corporate governance, financial disclosure and internal control, audit committee effectiveness, and enterprise risk management. 

Sami holds the John B. O'Hara Professorship in Accounting. His research interests include accounting and auditing regulations, quality of accounting numbers, and implications of accounting numbers for capital markets from the U.S. and international investors' perspective.

They spoke with Jack Croft, host of the ilLUminate podcast. Listen to the podcast here and subscribe and download Lehigh Business on Apple Podcasts or wherever you get your podcasts.

Below is an edited excerpt from that conversation. Read the complete podcast transcript

Jack Croft: Your study specifically looks at zeroing in on the long-term impact of boardroom gender diversity on firm performance. Why did you decide to zero in on the long-term impact?

Gupta: When designing the study, the reason we focus on the long-term impact is because there is a lack of studies with regard to assessing or understanding the long-term impact of these changes in the composition of the board. And the very basic reason there is that it takes time for performance to show up once you install female board members or diverse board members. A lot of the studies that we examined are looking at impact at a fairly short interval.

In our study, we are looking at T+3 [years] and T+5 [years] kind of a scenario in order to understand. And finally, there are lots of mixed and inconclusive results with regard to the prior studies that we wanted to address also in our study. Last, but not least - it's a bit technical, so I will not go into too much detail - we also try to address the endogeneity issues which prior studies have ignored, and that has to do with the causality in both directions of the variables being studied.

Sami: Parveen mentioned the directional effects, and that's right. That is, the corporations that are performing well, they are profitable, they are doing very well. In order to show the good profitable corporation, to signal their equality, a lot of time, they try to [diversify] their boards and hire women as directors to signal their equality. But at the same time then, the women directors also contribute to the profitability of the companies and impact the performance of the company in both financial and nonfinancial areas. That's why there is a two-way relationship between them. That's called endogeneity. And to control for it, you have to do what's called two-stage least squares analysis to take care of that problem.

Examining Nonfinancial Performance

Croft: [Your study looks] at both the financial and nonfinancial performance. So let's take those one at a time here. First, what is included in nonfinancial corporate performance, and briefly, how did you go about measuring that?

Sami: The database that we use is a firm's corporate social responsibility scores that is aggregated by KLD database, which is produced by a risk matrix group. And in this database, they evaluate the corporate social responsibility and assign a score to different elements of the corporate social responsibility [CSR] in five areas. And then also, they provide an overall CSR score. So our main measures are these five areas and the overall CSR scores.

When a company has got any strength in elements of any one of these, they assign a positive score to it. And when they have a weakness, then they assign a negative score to it. So starting with the environment is one element that they measure. And to measure the environmental effect, they evaluate 15 items, such as, for example, pollution prevention, emissions, recycling, clean energy, etc. The second area is employee relations. They evaluate 12 items to measure the employee relations, and that includes items such as relations with the union, health and safety issues, whether the company really provide a safe and healthy environment for the employees to work, profit sharing, and things like that.

The third one is corporate governance. And in this area, they evaluate 11 items, which is proper directors' and officers' compensation, whether there is a procedure for determining their compensation, independent directors, and things like that. Whether they have independent directors on the board and how many and what percent are independent rather than being selected from the internal executives of the company. The fourth one is community, the corporation's relationship with the community. And they evaluate 13 items in this area, which includes charity, both giving volunteer programs in the community and the engagement with the community, how engaged are they in their community, and others.

And then the last one is diversity. They evaluate 11 items. One is the company's policy with regard to diversity as they disclose their policy, what is their policy, board diversity, what is the actual diversity on the board. Another element that they evaluate is contracts, how many contracts that are awarded to women and minority [businesses] and things like that. So these are the five areas that they evaluate the company, and then the overall CSR score. We use all of these six as measures of the nonfinancial corporate performance.

Measuring Financial Performance

Croft: And the same question for financial performance. What did you look at and how did you measure it?

Gupta: Certainly, one of the strengths of this study is that we have nonfinancial and financial measures both. So we try to provide a very holistic perspective with the same data with regard to the impact of females on the board. To specifically answer your question, we try to divide the financial performance into buckets. And one of the buckets is the accounting variables we talk about. And the key variable that we talk about there is the return on equity, which is a very common measure.

It is the net income divided by the outstanding shareholders' equity. And that tells you how much one dollar invested in the equity is yielding and whether the needle is moving on that or not as a result of T+3, T+5 time frame after the induction of the females on the company's board of directors. Then the other bucket within the financial category we have, we kind of group them under the market measures. And a very common measure we start with is called Tobin's Q. It's an established matrix in the governance literature as an outcome variable. And it is essentially the ratio of the market value of a company's shares to the book value of the company's shares.

In other words, it is the market capitalization of the company divided by the shareholders' equity or the common stock in order to find that particular ratio. Because the real formula with regard to Tobin's Q is a bit more complicated and it's difficult to implement. So this is a proxy of the Tobin's Q that is a generally accepted variable in the accounting and finance and even behavior literature.

The two other variables that we throw in the market measures are cumulative annual stock returns. It is basically the raw return of an individual company that is accumulated over a year. And when we talk about the cumulative annual market-adjusted stock return, we are basically talking about the same variable, but we are adjusting it for the market in order to understand the abnormal performance by a firm. So those are the financial measures that we are focusing in our study.

The Bottom Line

Croft: That brings us to the bottom line here for your study, which is-- and let's start again with the nonfinancial performance, but what were the key findings? Does increased gender diversity on corporate boards have a long-term impact on nonfinancial performance?

Sami: As Parveen mentioned, we use T+3 and T+5. In the paper, we call it a three-year and a five-year lags performance when we analyze the nonfinancial measures. So notice that we have six measures: those five elements, and then the overall CSR score. And then when you consider the fact that we have two periods, three-year lag and five-year lag, so that means 12. And then when we do the regular ordinary lease squares analysis versus the two-stage lease squares analysis, then we have about 24 different tests.

And our result shows that all of the components of the CSR have significant and positive relations with the percent of female directors on the board for both the three-year lag as well as the five-year lag. And out of all of those 24 different variations of analysis, there is one exception, which is very minimal. The impact of employee relations is not significant, just for the five-year lag. That's the only part that is not significant. So overall, we conclude that inclusion of women on corporate boards improve company's CSR performance in the long run.

Croft: And does increased boardroom gender diversity have a similar long-term impact on financial performance?

Gupta: Yes and no. So I will give you some of the specific findings with regard to the accounting measure, which is the return on equity. The impact of the female directors on the board is positive and significant for both the three and the five-year lags, or the T+3 and T+5.

For the market measures, the cumulative annual stock return and the market-adjusted stock return, we do not find any impact at all. And generally, one of the arguments that is presented at times in defense of the nonsignificant results is that perhaps it has something to do with the critical mass of the women on the board of directors because still the number or the proportion of females on the board of directors is relatively smaller as opposed to the larger board size.

With regard to the presence of the female directors on the board, when we try to assess their impact through the Tobin's Q, we find that there is a positive impact on both three-year and a five-year lag. And we also use the two-stage least squares model in order to ferret out some of the confounds to revalidate that result. So we have sort of a mixed finding there when it comes to the financial performance.

Parveen P. Gupta

Parveen P. Gupta

Parveen P. Gupta, Ph.D., is a professor in the Department of Accounting at Lehigh University College of Business.