Does Board Demographic Diversity Enhance Cognitive Diversity and Monitoring?

Abstract

We examine whether board demographic diversity enhances cognitive diversity (measured as director dissent in the boardroom) and monitoring. At the director level, we find that individual directors who are dissimilar relative to other board members in terms of tenure and experience are more likely to dissent. At the board level, boards composed of directors with heterogenous tenure, experience, and gender are more likely to dissent. We also find that stock market reactions to director resignation announcements are more negative for directors who have ever dissented than for other directors. Moreover, following dissent-driven proposal rejections, firms experience an improvement in value and internal governance and a decrease in risk. The results suggest that directors with diverse qualifications and skillsets and female directors enhance cognitive diversity and that this enhanced cognitive diversity helps increase firm value and monitoring effectiveness.

A better start: board diversity matters in assessing stock price crash risk

“…Our research period coincided with a time when KOSPI200 firms were required to enhance their governance mechanisms by increasing board diversity in accordance with the government's policy of promoting equality and diversity in the boardroom. The Korean Corporate Governance Code mandated the establishment of a nomination committee to consider diversity-related factors, such as age and experience, in the selection of board directors (Kang et al , 2022). Therefore, our context provides a valuable opportunity to examine the effects of board diversity on stock crash risk.…”

“…To obtain the necessary data, we collected financial and nonfinancial information from the KISVALUE and TS2000 databases (Cho and Lee, 2018a, 2018b, 2018c; Jeong et al , 2022; Kang et al , 2022). Board diversity data was sourced from the Financial Supervisory Service's DART system (Jeong et al , 2022; Kang et al , 2022), which is an electronic disclosure platform used by firms to submit disclosures online in Korea.…”

“…Our analysis employs a sample of Korea Composite Stock Price Index 200 (KOSPI200) firms from 2010 to 2019, during a period when firms were required to enhance governance mechanisms through board diversity according to the Korean Corporate Governance Code, which promotes equality and diversity in the boardroom (Kang et al , 2022). The findings reveal that relation-oriented diversity can reduce future stock crash risk, particularly in situations of high-performance hazard and concentrated ownership structure.…”

Network Centrality and Dissent Voting by Directors on Boards

“…For example, the rejection of a proposal on related-party transaction was followed by reduced related-party activity in the subsequent year. Using data on Korean listed firms, Kang, Kim, and Oh (2022) treated director dissent against proposals as a proxy for cognitive diversity and found that this cognitive diversity helps enhance monitoring effectiveness and increase firm value. Specifically, they found that firms with boards that reject proposals engage in earnings management to a smaller extent, are less likely to restate their financial statements, and are more likely to replace poorly performing CEOs in the years following the proposal rejection.…”

“…Specifically, they found that firms with boards that reject proposals engage in earnings management to a smaller extent, are less likely to restate their financial statements, and are more likely to replace poorly performing CEOs in the years following the proposal rejection. In general, Kang et al (2022) showed that dissent acts as active monitoring that prevents bad behaviors (Tirole, 2001).…”