Quotas v. Competitiveness?
hw s13 2The following is reproduced by kind permission of Professor Vermaelen, Finance Professor at INSEAD. It was originally published in November 2012 as a personal viewpoint and reply to the INSEAD Knowledge News Alert "Women on Boards: No Quotas... Yet".

In the middle of the economic crisis one would expect that Eurocrats would find something more constructive to do with their time than imposing absurd laws such as requiring women to make up at least 40 % of listed European companies’ boards. This law is the brainchild of Ms. Viviane Reding, the Commissioner for justice, fundamental rights and citizenship.

The fact that there are fewer women than men on boards is not necessarily proof of injustice or male chauvinism as Ms. Reding seems to imply. Typically, board members are CEOs of other companies and it is a fact that most CEOs are men. Unless if Ms. Reding wants also to put a gender quota on CEOs,  the board gender quota will put more people on boards without leadership experience in business.

Given today’s Europe’s massive unemployment and fight for survival, any regulation should pass a cost-benefit test: what are the consequences of the regulation for European competitiveness and growth? After all, a board is not a social club. Board members are chosen by shareholders who expect them to maximize shareholder value.

The proponents of the law could argue that there are no negative consequences, quite the contrary: male chauvinist boards systematically discriminate against highly qualified women, so replacing men by women will increase shareholder value. If this was the case, one would expect activist hedge funds to take stakes in companies with all-male boards, change the gender composition and make money in the process.  In other words, if male chauvinism was inefficient, it would create arbitrage opportunities and there would be no need for regulation.  However, I am not aware of any activist hedge fund that is involved in such a strategy.

The idea for gender quotas comes from Norway that imposed them in 2004. Evidence published in a top journal that mandatory gender quotas in Norway destroyed shareholder value in the short and long run can be found in the study of two University of Michigan Finance professors, Kenneth Ahren and Amy Dittmar, one of the leading female finance scholars in the world.1 The Norwegian case provided an ideal experimental setting as the announcement of the law was unexpected. On the day of the announcement stocks of companies without women on the board fell by 3.5 % while stocks companies with women on the board did not fall.  Examining subsequent performance they conclude that a forced 10 percent increase in women representation led to a 12.4 % decline in Tobins’Q.  On average, the size of the boards did not increase which means that men were fired to make room for women. They find that the law brought in less experienced and younger board members, as expected.  Another explanation could be that women typically care more about stakeholder value than shareholder value2 . Regardless the authors conclude (page 5) that "the results suggest that the constraints imposed by the law had a large negative effect on firm value."

The findings can be explained by the fact that in Norway, a very socialist country, shareholders don’t matter so these costs are irrelevant.  But then this should be made clear to European investors up front: we are going to put people on the board who don’t care about your interests or don’t know how to create shareholder value.  These investors can then decide whether they want to hold stocks in companies with such a new governance model.  I expect that Europe will then follow the Norwegian example: before the law was enacted, there were 600 publicly traded companies in Norway. Three years later the number was reduced to 300, reflecting the fact that companies responded to the law by going private, a fact also documented by Ahren and Dittmar (2012). So an honest argument of the proponents should be: we know that this is economically inefficient, it will destroy our capital markets, but we don’t care as this is all about fairness and equality.

The EU evidence:
The European commission document of 14 November 2012 "Impact assessment on costs and benefits of improving the gender balance in the boards of companies listed on stock exchanges" ignores the evidence on Norway, but cites a number of studies (using data of companies that don’t have gender quotas) that show that there is a positive relation between financial performance and the percentage of women on the board. For example a McKinsey study finds that companies with women on the board have a 41 % higher return on equity. If this was true, then there is no reason for gender quotas: all board members in the world should be sent a copy of the McKinsey report and any Chairman concerned about shareholder value should immediately replace men by women. The reason why this may not be happening is that correlation does not mean causality. It could simply be that women are more represented in high growth companies. Moreover as the samples are based on companies who voluntary choose women on the board the research is irrelevant for the question at hand: what happens if women are forced on the board (at the expense of men) because of EU imposed quotas. The Ahren and Dittmar (2012) paper is the only one who answers this question.

The European Union was originally motivated as a union to promote free enterprise and trade. Today it’s obvious that we moved far away from this objective. Regulating all aspects of people’s lives and using corporations to promote political pet projects, regardless of costs, seems to be the new mantra.

Theo Vermaelen, Professor of Finance, INSEAD

1 "The changing of the boards : the impact on firm valuation of mandated female board representation" Kenneth Ahren and Amy Dittmar, Quarterly Journal of Economics, 2012

2 "Shareholders and stakeholders: how do directors decide?" David Matsa and Amalia Miller, Strategic Management Journal (forthcoming)