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Nina Röhrbein finds out whether diversity on company boards help stave off crises by bringing fresh thinking and different skills?

One of the issues on the minds of responsible investors this year has been the composition of company boards. The Swiss foundation for sustainable development, Ethos, for example, and global proxy adviser Institutional Shareholder Services (ISS), review board composition - including board diversity - as part of their guidelines. Aviva Investors has incorporated board diversity and, more specifically, women on boards, into its policies and approach and made it a high-profile topic for 2011.

The EU Corporate Governance Framework green paper published in April - and the recommendations of Lord Davies’ report in the UK two months earlier - have highlighted the matter even more by paying attention to professional, international and gender diversity.

But why should this be a concern to institutional investors?

The second largest public pension fund in the US, the California State Teachers’ Retirement System (CalSTRS), is a long-term investor with average holding periods of more than 10 years. The market crashes of 2000 and 2008 wreaked even more havoc on its portfolios than they would otherwise have done, thanks partly to short-term actions on the part of management and failure of director oversight.

“The financial crisis brought more attention to the failure of those company boards, some of which have since ceased to exist as before,” says Anne Sheehan, the $150bn (€105bn) plan’s director of corporate governance. “As long-term shareholders, we believe that the most important counters to such short-termism are diverse directors, with fresh ideas, differing backgrounds and focused skill sets that promote long-term growth and increased share value. Greater diversity of thought and background helps to break up that group-think that was a significant factor in the last two major crashes.”

An ever-increasing amount of research has been published showing that a more diverse board leads to better financial performance, including studies such as: the ‘2010 Catalyst Census: Fortune 500 Women Board Directors’ survey; Stanford University’s Rock Center for Corporate Governance’s study ‘Diversity on Corporate Boards: How much difference does difference make?’; the 2007 McKinsey report ‘Women Matter: Gender diversity, a corporate performance driver’ and its follow-ups; and Governance-Metrics International’s ‘Beyond the Boilerplate: The performance impacts of board diversity’.

However, other studies have found no such correlation - and not everyone is entirely convinced by academic studies that have.

Jean-Nicolas Caprasse, head of European governance business at ISS warns that academic literature needs to be interpreted with caution. “Academic studies are sometimes able to point out a correlation but you need to interpret whether or not there is causality too,” he says. “However, the majority of academic evidence has a positive bias and shows that more diverse boards are essential to ensure good functioning of the board, which is an aspect well accepted by institutional investors.”

Georgina Marshall, regional head of corporate governance at Aviva Investors, adds: “Although some studies show a positive correlation between the number of women on boards and financial outperformance it is not something that we necessarily accept per se. It is just common sense that companies that fail to tap into their full potential will be doing themselves a real disservice.”

A better financial performance cannot be attributed solely to a more diverse company board but different skill sets and asking difficult questions ultimately helps drive better performance and keep management on their toes, according to Sheehan.

However, it is difficult for institutional investors to measure whether or not that diversity will automatically or directly improve one of the financial metrics.

CalSTRS, in collaboration with the California Public Employees Retirement System (CalPERS), is currently working on its Diverse Director Datasource project (‘3D’), a database of known prospective directors. This is a tool for entities seeking board candidates, allowing them to access a broader universe of untapped talent often overlooked as a result of board profiles that are too narrowly focused. It is expected to be operational by mid-2011.

“We believe that having greater diversity - not just ethnic and gender diversity but diversity of thought, experience, expertise, backgrounds and skill sets - broadens the pool of individuals eligible to serve on these boards, which is the better long-term shareholder value proposition for us,” says Sheehan.

Shareholders are expected to benefit from being able to move beyond simply withholding votes from director candidates to accepting responsibility for proposing suitable director candidates for nomination.

Institutional investors generally have two options of dealing with board diversity - dialogue or proxy voting. However, it is difficult to reject a candidate on the basis of gender, which is why proxy voting is not a good method. Instead, industry participants believe it is more important to engage with the board on this matter.

“Usually, institutional investors will favour the independence of directors, adequate checks and balances and the right mix of business background over other diversity criteria if they are in a position to choose between different board members, which, in practice, is not often the case,” says Caprasse. “In the UK, for instance, the shareholders theoretically select all board members. However, in practice they mainly approve board members that are presented to them. Therefore, it is important that nomination committees pro-actively try to increase diversity when they present board members for election or plan the board’s long-term succession.”

The main reason companies give for their lack of board diversity is the difficulty in finding suitable candidates and the time the whole process, including implementation, takes.
“But sometimes the specification for a particular director points towards fewer women on the shortlist, so I suspect a lot of cultural expectations and subconscious barriers on both sides,” says Marshall. “Boards often look to replace a director with someone who is pretty much like them and as they are generally male, this would militate against a female replacement.”

Nevertheless, in order to avoid disruption to their board composition investors should accept explanations as to why a particular company might have decided to present, for example, a male board candidate, particularly in sectors known for their skills shortages. “Instead, they should push boards to state their short-term and long-term ambitions and explain their recruitment process much more openly,” says Caprasse.

Aviva Investors is interested to know why, for example, a company with no women on the board is in that position. In that context, Marshall believes, Lord Davies’ recommendation that chairmen publish their thoughts on board gender diversity is a helpful catalyst, because it gives investors more focus and understanding in their engagement with companies.

“We tell companies to set up a diversity policy so that they are able to create a pool of capable candidates and integrate it in their renewal process,” says Vinzenz Mathys, corporate communications manager at Ethos. “But it certainly takes time.” Ethos has seen only a minimal increase in the number of women on Swiss company boards, from 6% in 2005 to 8% in 2011.

According to Sheehan, most companies agree that greater diversity is good, which is why they tend to renegotiate shareholder resolutions instead of letting them go to a vote. CalSTRS has previously withdrawn shareholder proposals for six companies after they agreed to actively consider diversity as a criterion in their board member recruitment process. Five of the companies changed their nomination committee charters to facilitate the diversity of their boards, while one even nominated its first woman director.

In general, investors favour a business-led approach rather than a legal - national or investor-imposed - approach of quotas in their diversity strategies. It is, after all, one of their key responsibilities to elect board members and ensure adequate board composition.

But it is not all about the boards. “In the longer term it is about companies managing their workforce in a way to retain and nurture talent all the way through their employment,” says Marshall. “At the moment it is only the boards that we see and are able to take a view on, while the rest is fairly invisible to us as investors.”

Addressing their own board compositions often seems to be an entirely different and less relevant matter for investors, particularly when they are not listed. “But when you come up with a number of standard best practices for investee companies, eventually pension funds and insurance companies start asking themselves the same questions in terms of their own governance and board composition,” says Caprasse.


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