The effect of mandating women on public boards
In 2018, California mandated women on the boards — a controversial move that raises new questions about governance.
On September 30, 2018, California enacted Senate Bill 826 mandating that all publicly traded companies headquartered in the state have at least one female director by the end of 2019. It also required that by the end of 2021, all firms have at least one female director (in boards with four members or fewer) and two female directors (if the board has five members), and three female directors for boards with six or more members. The law imposed penalties for non-compliance. In addition to mandated, the law imposed penalties. For example, firms are subject to a compliance assessment and subject to a monetary fine of $100,000 for the first violation. With this law, California became the first U.S. state to mandate women directors on the board of public firms.
At the time, the law was presented as both beneficial for California's public firms and a model to be emulated elsewhere. New research from the Kenan Institute of Private Enterprise tries to assess the impact of the California mandate two years later. The results of their study are interesting. They point out the various factors that must be considered to correctly design quota-based mandates and that must be addressed to achieve the impact these laws are intended to create.
To cut to the chase, the most notable conclusion from this team (and others) is that, overall, the addition of mandate women directors had a slightly negative effect on firm value at the time of the law's enactment. As the authors note:
We present results consistent with the view that mandating board gender diversity through legislating quotas is costly for shareholders. At the announcement of the signing of SB 826, companies headquartered in California experienced a statistically significant abnormal return of -1.4%. This result is robust to alternative approaches for assessing statistical significance. Using the pre-legislation variation in board composition and the differing thresholds on female representation mandated by the law as a source of variation (henceforth shortfall), we show that the decline in shareholder wealth effects for California firms is related to the requirements imposed by the quotas.
In other words, investors lowered the value of public firms once California mandated that they add women to their boards. The team wanted to understand (a) why the market would react this way and (b) if that reaction was justified. After all, they note that there existed two possibilities before the law went into effect. First, boards were composed optimally pre-mandate, so any mandate would make them worse. Or, second, the boards were composed sub-optimally (because they lacked sufficient women) so the law would improve their overall performance.
The authors found that when firms were forced to hire women directors, they encountered several issues. First, highly qualified female directors were in high demand, so recruiting them proved more costly than recruiting the equivalent male directors. Indeed, at the elite level, women directors serve on more boards than their male counterparts. This scarcity made getting the best female candidates a challenge. The researchers also discovered that a public firm with a reputation as being generally unfriendly to female employees had a more challenging time attracting women to its board, which is understandable. The opposite was also true: women-friendly firms found it easier to attract female directors.
Digging deeper, the team found that, though on average, the newly recruited female directors had similar competency levels as the men they replaced (about 40% of the time notes other research), their skill sets were different in many cases, as their paper notes:
Indeed, within the menu of skills, new female director appointees have different skill sets than men. For example, they are less likely to have CFO experience or financial skills but they are more likely to have international experience, leadership, risk management skills, and skills related to strategic planning.
Maybe because of this skills differential, the researchers found that new women directors often did not get the same committee assignments as their male predecessors, possibly limiting their influence in the most crucial board deliberations.
In summing up their findings, the team concluded that "the negative portfolio returns at the passage of the law suggest that its expected costs outweigh its benefits to shareholders." They attribute the cost, primarily, to the "limited supply of potential female director candidates at the time of the law's passage." This scarcity means that "board quotas decrease firm value because they disturb the equilibrium matching of director characteristics to boards or due to search costs needed to identify new qualified directors." Put another way, a law that mandates female directors but does not at the same time increase the supply of qualified candidates, in their view, is bad for shareholders. Going further, the team concludes that, given the pool of available candidates pre-mandate, the boards were optimally composed.
As the authors note, their findings have several policy implications:
They suggest that mandates are more likely to achieve desirable outcomes if combined with other measures to increase the supply of female directors. In addition, mandating increased female board representation when supply side constraints are present may not necessarily result in female directors having a greater voice in board decision-making.
In its simplest form, what the paper is saying is that they found a "chicken and egg" problem when female director quotas were imposed in California. A real or perceived lack of qualified female candidates made them more costly to recruit. Firms that could not get directors with equivalent skill sets to the men they were replacing tended, therefore, to place women in less important board roles. Anticipating this exact outcome, investors lowered public firms' value when the law was announced.
Of course, the paper does not address if the scarcity of female candidates was a reality or just the perception of the search committees, which were probably composed mostly of men. Even assuming the scarcity is real, a strong argument could be made that forcing firms to hire women will incentivize more female executives to present themselves as director candidates, which will, in turn, alleviate the "scarcity" problem. It will be interesting to follow this mandate's evolution over time and to analyze, several years down the road, if the market's initial reaction proved justified. It may transpire that the initial negative assessment of both the quantity and quality of the female director pool proved wrong and yet another myth that California's mandate helped to dispel once and for all.
Hwang, Sunwoo and Shivdasani, Anil and Simintzi, Elena, Mandating Women on Boards: Evidence from the United States (October 13, 2018). Kenan Institute of Private Enterprise Research Paper No. 18-34, Available at SSRN: https://ssrn.com/abstract=3265783 or http://dx.doi.org/10.2139/ssrn.3265783