Diversifying your board could lead to better performance

Research shows the multiple benefits of a diverse board including higher returns on equity and making a company more responsive to competitive pressures.

A study of the largest US companies by AXA IM Rosenberg Equities, conducted between January 2005 and July 2017, shows the correlation between board diversity and higher returns goes further than previously thought. The level of board diversity is not only associated with higher contemporaneous returns, but is also a predictor of better financial outcomes and a company’s ability to protect future profits. Specifically, the study found that:

• More diverse companies exhibit higher contemporaneous returns on equity.
• Companies that are more diverse are more likely to show greater profitability one year on.
• Board diversity provides a “profitability moat” to companies that are already profitable and keeps competition at bay.

Predicting returns

The study divided the companies into two groups: those with greater than 20 per cent gender diversity on the board, and those with less. Studying the companies over almost 12 years, the authors (Kathryn McDonald, head of sustainable investing at AXA IM Rosenberg Equities and Srilatha Singh PhD, earnings forecast director) showed the higher-diversity group go on to have higher profitability in the future than the lower-diversity stocks, or than the market as a whole.

“We can confidently say that, historically, higher diversity ‘today’ has translated into higher return on equity ‘tomorrow’,” says McDonald.

No pain, no gain

For the most profitable companies, the only way to go is down. But the study shows that gender diversity helps even in this situation. The authors isolated the 25 per cent most profitable stocks then divided them into the higher and lower diversity groups. The study showed that higher diversity can act as a “moat”, making the most profitable companies more resistant to competitive pressures.

The study looked at competitive pressures known as Porter’s Five Forces (attributed to Harvard professor Harold Porter in 1979): the bargaining power of suppliers and buyers, the threat of new entrants and substitutions, and industry rivalry. “We believe that more diverse firms most likely have advantages when it comes to discouraging new entrants, discouraging brand/product substitution, and innovation,” the authors wrote.

No distinction between bulls and bears

In bull markets, it’s harder to sell the diversity message to boards that may be tempted not to challenge the status quo when times are good (also why high-profit companies resist diversity, the report suggests). For this reason, the authors included a period of “profitability stress”, says McDonald. “There’s a risk of doing your analysis only in an extreme bull market where everybody’s making a lot of money. We need to get some tough times in there as well.”

Boards must act

McDonald says both big institutional investors and “smaller coalitions of investors” are demanding greater diversity of companies, while in some European companies, regulators are setting and meeting gender diversity quotas. McDonald says boards must ask themselves tough questions: “How often do all of us agree? How often are we in lockstep on issues? Do we have anybody on our board with ideas on how to get our products or services in the hands of markets we haven’t considered yet?”

Tap into the talent

Catalyst.org has a comprehensive list of 46 pieces of research on the benefits of gender, ethnic and cultural diversity to the business case. This ranges from higher retention of talent, to better understanding of customer needs, greater cognitive diversity reducing groupthink, lower incidence of fraud, benefits for reputation and financial performance.

However, in a 2018 research update, Catalyst says it is time for companies to go beyond the traditional business case and the bottom line. “Even though the business case for diversity has been documented by Catalyst, McKinsey, Credit Suisse, and others for over 15 years, it never seems to be enough. Some people still ask for more proof that gender diversity is ‘good for business’, yet it never occurs to them to ask for the business case demonstrating that the status quo or all-male leadership teams and boards are good for business,” the update says.

“Instead of trying to seek that elusive ‘proof’ that diversity causes improved business performance, companies should focus on diversity as a talent issue, and recognise that to be an industry leader, it is critical to tap into the full talent pool.”

Asia capability drives business opportunities

By 2030, Asia is expected to account for more than half of global middle-class consumption, with India, Indonesia and Vietnam expected to grow their middle-class markets by $20.7 trillion collectively, more than 11 times Australia’s current GDP.

Businesses that engage with Asia are more likely to experience revenue growth, according to Asialink Business, and recent bilateral trade deals — most recently with Indonesia — promise improved market access and opportunities.

Yet only 13 per cent of Australian small and medium-size businesses export internationally, according to its recent discussion paper, Growing with Asia: Developing Asia Capability in Australian Businesses.

“Australian businesses need to develop Asia capabilities to take full advantage of the opportunities,” says the report, the latest in a series of research papers aimed at deepening Australia’s capacity for doing business in the region. These include Match Fit: Shaping Asia Capable Leaders, which showed a strong correlation between Asia capabilities and business performance; and Australia’s Diaspora Advantage, on the value of leveraging Australia’s culturally diverse workforce as a source of innovation, enterprise and entrepreneurship.

The report identifies six specific capabilities that SMEs need to succeed in the region. These range from deep insights into individual Asian markets, practical experience “on the ground” in the region, the ability to adapt behaviour to different cultural contexts, and the ability to form long-term, trusted relationships. Leadership commitment to a focused strategy and an ability to customise product or service offerings are especially important.

The second phase of the research includes case studies of the strategies of a number of SMEs, which have recently built businesses in the region. These range from online digital platform Digivizer, Tiller, a productivity platform, and Icon SOC, a Singapore-based company that provides cancer treatment services across the region.

Asialink Business CEO Mukund Narayanamurti says Australian SMEs “overlook opportunities... in emerging Asia, where the scale of growth significantly exceeds domestic prospects”.