Board diversity: could it help companies improve environmental and social performance?

In June 2022, a decade-long deadlock was broken.

After many years of debate, the European Parliament announced that the Women in Boards law would finally become a reality. The law states that women must make up at least 40% of non-executive boards at large companies in the European Union by mid-2026.

European Commission president Ursula von der Leyen hailed its potential to “break the glass ceiling” for women.

The path of the Women in Boards law was not smooth. Austrian politician Evelyn Regner argued that removing “informal male networks” was a necessary step to help women get top jobs. However, some EU members – most notably Germany –argued that these measures should be decided at a national level.

We are still several years away from being able to measure its full impact. However, stock market analysis by Newcastle University Business School indicates there’s a general sense of optimism about how it will benefit businesses in the EU. Furthermore, the research reveals that positivity is highest at firms who need to improve their environmental, social and governance performance.

The wisdom of markets

When researchers want to gauge the prevailing opinion about a new development, they often look at stock market reaction.

Sometimes, what people say in public can be very different from what they say in private. But it is possible to learn a lot about what people really believe by looking at how money moves afterward.

“Market reaction is often more unbiased, as you’re observing people’s reactions based on their trading behaviour,” says Shams Pathan, a Senior Lecturer in Accounting and Finance at Newcastle University Business School.

Dr Pathan was part of a team that investigated whether traders honestly believed board quotas would be good news for the businesses affected. They examined 1,241 firms from 18 different European countries, tracking daily returns to get a sense of how the markets were reacting to the news.

The paper came to three interesting conclusions. First, it revealed “significant positive market reactions” to the announcement across firms listed in Europe. Returns of 0.89% were spotted on the day of the announcement, and 1.23%, 1.25% and 1.16% in the ensuing days.

However, it also showed that this positivity was “more intense” at firms with lower Environmental, Social and Governance (ESG) scores. At these companies, the return was 0.7% higher on average than at firms with strong performance.

“The message there is very clear,” says Dr Pathan. “The reaction to the introduction of the law was good on average. But if you dig down, some are expected to benefit more than others.

“At firms with poorer environmental and social records, the market has reacted more, as they are seen to have a greater opportunity to benefit from the changes.”

Finally, it also showed that companies in countries with fairer social and economic systems, such as better workplace equality and conditions, benefit more from having diverse gender representation. This means having more women involved can really boost sustainability efforts, particularly in places where women’s welfare is prioritised.

A sign of changing attitudes –or more information?

The positive market reaction to this announcement was by no means certain.

In fact, the previous two major directives of this type received a more negative response from the markets. In 2002, Norway proposed a law threatening public-limited companies with liquidation if they did not establish gender-balanced boards within two years. The law came into force a few years later, and all affected companies had complied by 2008. But studies into the initial market reaction showed a “significantly negative” response, partly sparked by the severity of the penalty as well as the unexpected nature of the announcement.

In 2018, California became the first US state to mandate board gender quotas. Senate Bill 826 required public companies headquartered in the state to have at least one female director by the end of 2019, and at least two women on boards with five members by the end of 2021. Studies at the time identified a “large” and “negative” reaction, particularly for companies who would need to appoint more female directors.

Dr Pathan believes that the more positive reaction to the EU announcement can be explained by two factors: the existence of more information on the impact of such laws globally, and the cultural differences between Europe and the USA.

“When Norway introduced its quotas, investors did not have much information about how the gender diversity of boards might contribute to how a company runs its business operations. Today, there is much more research and evidence.

“The other aspect is that Europe has a very different perspective on mandatory measures such as these, and has always been more proactive in terms of promoting stakeholder orientation than the US.”

Following the announcement of the California bill, female representation on boards rose from 15.5% in 2018 to 33.33% in September 2022. Notably, after the law was ruled unconstitutional in 2022, that figure fell to 32.75% by September 2023.

Dr Pathan adds that the positive reaction to the EU law could partly be down to the markets recognising that all countries would be operating under the same rules in future. This could stem from a general sense that voluntary, piecemeal measures are largely ineffective in driving this sort of change.

“The countries that were expected to benefit more were the ones that were expecting more changes.”

“In countries such as France, Germany, Portugal and Sweden, you have better regulations to ensure sustainability and gender equality. Firms in those countries with better workplace equality and conditions, also expected to benefit from gender diversity.”

An opportunity for better environmental and social performance

So what impact could more gender-diverse boards have on companies?

In a paper entitled “ES(G) Performance and the Impact of Board Gender Diversity Through the EU Gender Quota Directive”, Dr Pathan’s team including co-author Carlos Fernandez Mendez from The University of Oviedo, Spain, suggested that the biggest impact could be at firms which need to improve their social and environmental focus.

The paper noted that “societal expectations impose a pro-social set of personal traits on women”, in that they are perceived as being more empathetic, sensitive to social issues, and altruistic compared to men”.

This was reflected in the stock market reaction. The most pronounced reactions occurred in companies which needed to improve their Environmental, Social and Governance (ESG) scores, especially in EU states which do not have a reputation for strong sustainability and equity regulation.

Dr Pathan’s paper hypothesised that “it’s reasonable to anticipate that companies with sub par social and sustainability performance would gain significantly from implementing the EU gender quota rule. This measure would guarantee a sustained critical mass of women directors, likely enhancing the company’s overall performance in these areas”.

Furthermore, the favourable responses to the law at firms with poor ESG performance could be the foundation of a “compelling business case for advancing Sustainable Development Goals”, which were adopted by the United Nations in 2015 to tackle issues such as poverty, hunger, climate change and gender equality.

The paper concluded in saying that “actions promoting environmental sustainability, health and equality are not solely matters of social justice; they also align with broader societal interests and directly benefit investors”.

The team will continue to investigate the effects of the law over the next few years, to observe how companies perform as they diversify their boards. Dr Pathan expects the impact to vary strongly by country and company, but he thinks the law is a good example of the EU working in the interests of its community as a whole.

“In the European Union you’ve got countries with good established performance, and other countries that aren’t doing as well. With a law like this, you’re bringing them under one umbrella and doing things that are beneficial, even if some have more stakes and others less.

“After all, the EU is there to strike a balance, and do things for the benefit of all countries.”

“Companies in countries with fairer social and economic systems, such as better workplace equality and conditions, benefit more from having diverse gender representation. This means having more women involved can really boost sustainability efforts.”

 

Dr Shams Pathan, Senior Lecturer in Accounting and Finance at Newcastle University Business School