How Do Board Diversity Mandates Affect Firm Value?

A new study suggests California's ill-fated board diversity requirements did not enhance firm value.

In 2018 and 2020, California adopted laws requiring corporations headquartered in the state to diversify their Boards of Directors. Specifically, the laws required that Boards include female representation and a minimum number of people from under-represented racial, ethnic or sexual orientation background.

These laws did not survive long. They were successfully challenged in state and federal court. But the laws may have been on the books long enough to get some sense of their effects on firm value.

A new study by Jonathan Klick, "Market Response to Court Rejection of California's Board Diversity Laws," just published in the Journal of Empirical Studies, looks at the effect of the invalidation of the Board diversity laws on firm valuation. Here is the abstract:

California mandated that firms headquartered in the state include women (SB 826) and underrepresented minorities (AB 979) on their corporate boards. These laws, passed in 2018 and 2020 respectively, were held to violate the state's constitution by judges on the Los Angeles County Superior Court in 2022. This paper examines the market reaction to these surprising court decisions, finding that California firms appreciated significantly on the days of the rulings, and there is evidence that firms that were not in compliance with the laws exhibited larger abnormal returns than firms that were in compliance.

And here is a summary of some of the study's conclusions:

Those who advocate for more diversity on corporate boards generally claim that more diverse boards improve firm performance, and they claim that identifying, attracting, and retaining female and minority board members will not generate large costs. Supporters of diversity mandates, such as those adopted in California, at least implicitly suggest that firms are unwilling to exploit this diversity premium without legal intervention. The market reaction to the invalidation of California's board diversity mandates suggests otherwise.

When California judges found AB 979 and SB 826 to be in conflict with the equal protection clause of the state's constitution, firms headquartered in California appreciated in value, with non-compliant firms gaining more than compliant firms. Because the court decisions arguably had no repercussions for other changes in corporate law and regulation in the state, which cannot be said with as much confidence for the original adoption of these mandates, these results improve confidence in the conclusion that board diversity mandates do not improve firm value and, perhaps, they even lead investors to lower their valuations.

Whatever the other merits of Board diversity mandates, from this study they do not appear to enhance firm value.

Comments

[Frank Drackman]

I'm amazed having Senator Poke-a-Hontas on the board wouldn't increase a company's value by at least 1/1,024th

[ReaderY]

While this may be true, I don’t really see its relevance as an argument. Laws regulating firms don’t have to, and often don’t wnhance their value. Various health and safety requirements usually require firms to spend money and increase their costs, which obviously reduces their value. Value is transferred from investors’ profits to workers and the public. Law does this all the time.

In addition, I see no reason why corporations should be required to maximize short-term value to shareholders. I suspect firms whose management follows religious principles, like Hobby Lobby, don’t increase their value by remaining closed on Sunday. The same with various other values-based decisions.

I think requiring companies to make decisions based strictly on maximizing short-term value to shareholders violates people’s liberty to invest and manage their businesses based on their values, and I think it would be hypocritical for libertarians to deny people the right to do this.

In addition, I’m not so sure it’s bad for business in the long as distinct from the short run. Values-based businesses can attract like-minded people as customers, giving them an advantage in a particular market segment. While this may limit their ability to expand to a larger market, incurring some additional costs that result in having an advantage in a smaller market strikes me as a perfectly reasonable strategy for a business to take considered solely as a business decision, and one that governemnt has no business interfering with.

In any event firm owners are entitled to pursue courses of action that make them happier as distinct from more wealthy. The Declaration of Independence referred to the pursuit or happiness. While some people may equate this with the pursuit of money, not everyone does.

[David Nieporent]

You're almost as bad as Lathrop in wanting to hear yourself speak. What do your comments have to do with this post? (Hint: what firm owners are "entitled" to do is not what it is about. It's about what they were required to do.)

[ReaderY]

I acknowledge understanding my comment requires a certain amount of skill at drawing logical inferences. So here’s a hint for those who find this difficult:

(Hint: The reason why what firm owners are entitled to do has something to do with what they are required to do is that if firm owners are entitled to do something, that means they are not required to refrain from doing it. And it works the other way around, too.)

[sparkstable]

They were required to hire a certain set of people. This means they were no longer entitled to hire a set of people outside this political mandate.

This denies property rights and association rights to the firm owners (and by extension the board they approve to operate on their behalf).

The justification for this was unfounded. That by itself does not mean it is unconstitutional... that is (was) a separate question that favored the firms against the state's imposition of preferred values. But it does show that the people who advocated for this law were wrong on their own arguments for its purpose.

Even if in a pure legalese sense this does not necessitate the law being struck down on such grounds... in an ethical and philosophical sense it does.

"We will pass Law A to accomplish X."

Law A is passed, does not accomplish X, and appears to make X worse.

The reasonable ethical conclusion is to repeal Law A even without needing an argument of Constitutionality.

[ReaderY]

My first argument was that legislatures are under no obligation to ensure that their requirements imposed on businesses add value to their owners, and indeed laws often transfer value from owners to workers and the public (think health and safety laws, minimum wage laws, etc.) This argument is directly relevant, with no need to make any sophisticated logical inference.

[David Nieporent]

It is not relevant, because nobody claimed that the legislature was under an obligation to do any such thing. Rather, the legislature had claimed when it enacted the law that it was actually good for business, based on platitudes about diversity and the like. Since the law was unconstitutional on other grounds, it doesn't matter legally whether that claim was true or not, but it's still a useful piece of information to have.

[Lee Moore]

The actual claim as summarised in the penultimate paragraph is actually “improved firm performance.” Not “improved firm stock performance.” Maybe the latter claim was made elsewhere, but the former claim is consistent with Reader Y’s theory that we may take into account ;

Value to stockholders
Value to customers
Value to suppliers (inc employees)
Value to government (taxes etc)
And any other value we can think up

all aggregated together.

Reader Y is also correct to note that even restricted to stockholders value, we are not restricted to dollars and cents.

However this “short term” crap is crap, I’m afraid. The dollar and cent stockholder value that the Board is theoretically attempting to maximise is the firm’s net present value. Which is not a short term thing. It extends to eternity. Though after about thirty or forty years the cash flows tend rapidly to be discounted to zero.

[damikesc]

"In addition, I see no reason why corporations should be required to maximize short-term value to shareholders."

Corporations should not increase value for the, you know, OWNERS of the corporation?

WTAF?

[ReaderY]

I’m making two arguments. The first is that legislatures are entitled to impose requirements on corporations whose purpose is to increase value to the public at the expense of value to shareholders. Most health and safety laws are in this category. Laws requiring adding, say, sprinkler systems and fire escapes to buildings, paying a minimum wage, and many others, add value to workers and the public but costs to owners.

The second is that value to the OWNERS of the corporation means what the OWNERS think value is, not what some law professor thinks it is. If the owners of Hobby Lobby think closing on Sundays adds more value to their lives than making more money by staying open, they are absolutely entitled to make that decision. Money isn’t the only kind of value there is in life.

[ReaderY]

That is, just as incorporating doesn’t mean religious people have to forsake their religion, it also means that all people, religious and non-religious alike, don’t have to give up their pursuit of happiness and their personal values and pursue only what somebody else thinks value is. Many businesses, religious and non-religious alike, have made good money by sticking to certain values or what makes them personally feel happy and then attracting a loyal customer base that finds these values valuable (and makes them feel happy too), and hence worth paying for. Many have failed at it too. Everybody is entitled to take the risk if they want to.

[damikesc]

In the case of, for example, Chic-Fil-A, them being closed on Sundays actually does bolster their sales. Christians support it because they feel, rightly or wrongly, that the company agrees with their views. Being closed on the Christian Sabbath is a big piece of their proof.

DEI has been shown to be, AT BEST, a non-benefit and, in many cases, and outright detriment.

"Diversity is our strength" is sketchy. Multiple racial groups who view the world in the same way is NOT beneficial diversity at all. Black and white Ivy League grads do not tend to have dramatically different views. VIEWPOINT diversity could be beneficial, but that is never the goal.

[Krayt]

The theory behind diversity is that expanded viewpoints enhances value because you're more likely to catch misses for beneficial things. It's not really that different from neural network training with simulated annealing. Crack you out of a local minimum in search of a better one. More DNA crossover attempts for more attempts to evolve a better fitness.

In practice, it is used as what it is, crypto affirmative action. The outrage at thwarting it is the outrage at thwarting affirmative action. Nobody gets bent out of shape because a corporation has a slightly suboptimal process scouring the business success fitness descent space.

"Diversity" was only needed because it was a more constitutionally acceptable alternative for affirmative action, which was starting to take it on the chin. Whether any of that is good policy is left as an exercise for the reader.

[David Nieporent]

What was so bad about the mandate was how so obviously unconstitutional it was. Either California legislators have the worst legal advice in the history of ever, or they were told that, and just didn't care.

[Real American]

Hard to see how hiring people for reasons that are unrelated to the skills they bring to the table helps build value in a company. Of course, people who push this diversity nonsense aren't that smart.

[Reallynotbob]

You're just begging the question by assuming the status quo doesn't pass over more highly qualified candidates for board positions because of biases "unrelated to the skills they bring."

[Brett Bellmore]

You're defending replacing a status quo which is conveniently hypothesized to pass over more highly qualified candidates, with a regime which expressly mandates selection based on criteria that have nothing to do with qualifications.

It would be a wild and highly unlikely coincidence if adopting criteria that have nothing to do with competence increased competence.

[JoeFromtheBronx]

"Funding: This work was funded by the American Enterprise Institute. Klick served as an expert in the state litigation challenging SB 826 and AB 979, focusing on the evaluation of the empirical studies used to justify the statutes."

Anyway, the "market response" is not the only way a firm might increase in "value." Also, the conclusion from the one report has conclusions that "seem" to lean a certain way.

That's not surprising. It's only one report and you should look at a collection of results. Maybe those funded by different groups.

[Joe_dallas]

The value of any business is the present value of the anticipated future cash flow.

If have a diversified board improves performance or is perceived that it will improve performance, then a diversified board will reflect that.

[damikesc]

If it DID improve performance --- a law would not be required to force it to happen.

[Joe_dallas]

Like - Duh
Though leftists never were good at understanding economics

[Brett Bellmore]

There was at one time some research which seemed to show that companies engaged in "ESG" grew faster than companies that refrained. OTOH, companies that refrained from it typically had better profit margins.

Turned out that banks and investment funds that had adopted ESG were refusing to invest in companies that didn't practice it, to the point where the less profitable ESG firms had much better access to capital for growth.

You can kind of simulate something working in the business world, if it becomes a widely spread enough ideology, and the ideologues discriminate enough against people who don't join the cause.

[Swede425]

A recipe for success!

[Reallynotbob]

I'm not sure I buy that short-term enthusiasm by market players who tend to skew conservative for companies that did not adopt DEI policies tells us much about the fundamental merits of the companies or their board selection policies.

[Kenneth Almquist]

Good point. By looking at short term stock movements, the researchers are effectively doing opinion polling. They are not investigating whether board diversity improves financial performance. Other people have investigated that:

https://www.mckinsey.com/featured-insights/diversity-and-inclusion/diversity-matters-even-more-the-case-for-holistic-impact

[damikesc]

McKinsey? The ones who will believe anything for the right price? Not an actual argument.

Remember, they thought Enron was right on the money for most of its existence.

[Kazinski]

Sure, that can be debated, but what can't be plausibly debated is the legislature can't mandate such diversity on their boards.

Nor can pension funds or other funds with a fiduciary responsibility to the beneficiaries use substitute that as criteria for performance.

Pick your own investments accordingly, but leave it up to the market to decide.