Recent research provides actionable conclusions for bank executives and board members who want to improve the functioning of their boards.
By Ann OwenIt is no secret that women are underrepresented at the highest levels of bank management, especially on bank boards. Although the share of women on bank boards has increased over time, the average bank board is about 20 percent female.
Recent research that I conducted with Judit Temesvary of the Federal Reserve Board suggests that lack of gender diversity represents lost opportunity for better bank performance.
Our work showed that, under the right conditions, increased gender diversity increases banks’ revenue/expense ratio, return on assets, Sharpe Ratio (a risk-adjusted measure of return on assets) and stock-price growth. We also found that more diversity was associated with higher regulatory compliance and that these positive effects of gender diversity were especially strong during the financial crisis, a period when high-quality problem-solving from a board would have been especially valuable. To reach these conclusions, we studied a large sample of U.S. bank holding companies from 1999-2016.
What are the right conditions to reap positive benefits from gender diversity? There are two, and both are related to the ability to extract benefits from diverse perspectives. One condition is meeting a threshold number of women on the board before gender balance has a positive effect. Our estimates suggest that, for gender diversity to have a positive effect on bank performance at a typical bank, at least two women need to be on the board. The reason for this threshold effect is that both the behavior of the women and how their contributions are received by others can be affected by the presence of other women in the room.
On boards with only one female board member, her gender can be her identifying characteristic in the group. In other words, her gender can become her most salient characteristic, rather than one of many other attributes that qualify her for board service. This can affect her willingness to offer her views. It can also affect how others perceive her contribution. However, when more women are on the board, the gender of individual board members becomes less salient, increasing both the extent and impact of the contributions of individual board members.
A second condition for gender diversity to have a positive impact on bank performance is that the bank should be effectively managed. (In our study, we proxy for quality of management with a bank’s risk-weighted capital ratio.) Quality of management matters because diversity can cause performance-lowering conflict. However, well-managed groups can move beyond the conflict so that diverse perspectives will enhance the creativity and overall productivity of the board rather than detract from it.
Why so slow?
Given these positive benefits of gender diversity, one might question why diversification of boards has progressed so slowly. Part of the answer to that question lies in the practice of relying on social and professional networks of existing board members to recruit new board members. In another study that I conducted with Temesvary and Andrew Wei of Cornell University, we show the importance of these connections in board appointments. Using a large sample of more than 10,000 bank directors, we show that having prior connections to a bank’s incumbent board members makes an individual more likely to be appointed to that board, even when we compared two equally qualified directors. Furthermore, on average, a woman who is qualified to be a bank director has fewer connections than the typical man. Together, these conclusions can help to explain one reason why women are underrepresented on bank boards.
What does this research mean for bank executives and board members who want to improve the functioning of their board? Our research provides three actionable conclusions:
1. Banks should have enough gender diversity on their boards so that gender is not a salient characteristic of any individual. Greater gender diversity improves performance, but it must go beyond the “token woman” on a board.
2. To get the most out of a diverse board, chairs should be attentive to managing conflict and ensuring all are contributing.
3. Banks should establish recruitment practices that systematically identify qualified candidates, without relying primarily on the social and professional networks of existing board members.
Overall, these actions should ensure that banks will experience improved profitability as a result of gender-diverse boards.
Ann L. Owen is the Henry Platt Bristol Professor of Economics at Hamilton College. The views expressed in this article are solely those of the author and shall not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System.