Nasdaq’s board diversity rule is here - but new research shows underperforming firms more likely to oust board members from diverse backgrounds

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Diversity has always been a focus for diginomica - if you want to understand why, you can read about it here. But as a media publication, we have long tracked the good, the bad and the ugly of how companies and governments aim to improve representation of underrepresented groups in organizations. 

Two main points always emerge in these analyses and discussions. Firstly, it has been shown time and time again that organizations that are more diverse ultimately perform better. It’s just good business. And secondly, it should be a priority for companies building products and services for broader society to have a workforce that accurately reflects that society. 

With this in mind, two important pieces of news caught our attention this week. Firstly, US-based Nasdaq has a new board diversity rule coming into force this month, requiring companies listed on its exchange to disclose the ethnic and gender makeup of their boards. 

The aim is to drive up diversity and diversity reporting on the exchange, with the aim of having at least two members on each board from underrepresented groups. Companies will have one year to meet this new requirement or they will have to explain why it has not been fulfilled. 

According to the most recent data from Deloitte, which looked at board diversity changes between 2018 and 2020 across the Fortune 500, 38.3% of board seats were held by either women or other minority groups. Diving a little deeper into the data, women hold 26.5% of seats, minority women hold 11.8% of seats, minority men hold 5.7% of seats and ‘minorities’ more broadly hold 17.5% of seats. 

Whilst things have improved in recent years, there’s clearly still room for improvement. 

Commenting on its plans, Adena Friedman, President and CEO of Nasdaq, said: 

Nasdaq’s purpose is to champion inclusive growth and prosperity to power stronger economies. 

Our goal with this proposal is to provide a transparent framework for Nasdaq-listed companies to present their board composition and diversity philosophy effectively to all stakeholders; we believe this listing rule is one step in a broader journey to achieve inclusive representation across corporate America.

New research

Nasdaq’s new rules come into force at the same time as Imperial College Business School has published some new research on board diversity, which makes for some interesting reading. 

The researchers looked at data collated on the boards of 733 US listed firms over 15 years, which resulted in a total of 6,672 firm observations. They were able to identify both the expertise and ascriptive diversity of the board and the changes that were made when these firms were underperforming. 

What’s interesting is that, according to the findings, businesses are more likely to sacrifice gender and racial diversity on their boards when they are underperforming compared to their competitors or during times of greater productivity. 

The research shows, however, that when the Chairs of company boards are from underrepresented groups based on gender or minority ethnic groups themselves, they are less likely to reduce the diversity of a board to fix any performance problems. 

The thinking behind the research is that underperforming companies are motivated to “enlarge their perspectives” and remove directors with different expertise from the existing one. In doing this, the end result is often a reduction in gender or racial diversity in the boardroom. 

The researchers suggest that the ‘urgent’ need to build consensus prompts the board to value “easiness to communicate, trust and solidarity” and to avoid potential conflict among directors. In other words, board members are picking their group based on gender or ethnic backgrounds - which says a lot in itself. 

The research adds that people perceive others with similar ascriptive backgrounds as trustworthy, and as a result changes in the board of an underperforming firm are likely to yield lower levels of diversity. This is of course only possible because boards aren’t particularly diverse in the first place. 

Dr. HeeJung Jung, Assistant Professor of Entrepreneurship at Imperial College Business School, said: 

A performance downfall is obviously a threat to a firm and to its board. Then the firm will search for expertise for finding a prompt fix, bringing in people with new knowledge while searching for someone of trust. In doing so, existing directors look for someone who are demographically similar to them, overlooking female and racial minorities. At the end, you can see firms becoming less inclusive in the performance downturn.

The study helps to understand the difficulties in achieving gender and racial diversity inside the boardroom of U.S corporations, even with growing calls for improvement. This research shows that this could be a result of firms trying to rectify their underperformance. As a profit-oriented organization, firms would prioritize their performance aspiration when they underperform and may overlook improving or even keeping the representation of female and racial minorities.

I’d argue that the premise of removing members from more diverse backgrounds equates to a path to profitability is false in itself, but it’s not hard to imagine dominant board members thinkin that way. 

Interestingly, the research shows that businesses who have a committee Chair that is a woman or someone from a minority ethnic group are more likely to keep and improve gender and racial diversity of their board, even in a time of crisis. That shows the significance of boosting diversity not only across a company, but in positions of power. Dr HeeJung added:

This research shows the difficulties for female and racial minorities to be represented on the board, despite the persistent call to correct it. By firms choosing those with similar demographic backgrounds, which often means White male directors, female or racial minority directors tend to be dropped from boards and not replaced with those with a similar demographic.

This research shows the difficulties for female and racial minorities to be represented on the board, despite the persistent call to correct it. By firms choosing those with similar demographic backgrounds, which often means White male directors, female or racial minority directors tend to be dropped from boards and not replaced with those with a similar demographic.

My take

Kudos to Nasdaq for enforcing these changes, recognizing that it is in a position of power to do so. Two board members as a requirement shouldn’t be too taxing for companies to achieve, and one could argue that the requirements should go further. But the key thing to note from the research highlighted is that diversity improvements are meaningless if they only happen when times are good - get under-represented groups into positions of power to sustain the changes.