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Board diversity and corporate innovation

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“Given boards’ responsibility to oversee management’s strategies and decisions related to disruption, innovation, risk, talent, technology and other fast-moving developments, the need for diversity will likely continue to intensify,” notes Mike Fucci, chairman of the board, Deloitte.

 ~ by Fucci, M. (The Wall Street Journal, Dec. 20, 2017).

Abstract

This paper aims to investigate the effect of board diversity on corporate innovation. We classify board diversity into two aspects based on the demographical features of directors (inherent diversity) and traits that directors gain from training and experience (acquired diversity). We hypothesize that the effect of inherent board diversity on corporate innovation is less clear, while the effect of acquired board diversity on innovation is positive. We develop three composite board diversity measures, i.e., inherent diversity, acquired diversity, and aggregated diversity, to capture the diversity among board members. Our results indicate that board diversity is positively and significantly associated with a firms’ innovation. Specifically, inherent board diversity is positively associated with innovation output (measured by patents and citations). Acquired board diversity and aggregated board diversity are significantly and positively associated with innovation factors, including R&D expenses, patents, citations, and the innovation output per dollar of R&D capital. Our results hold after addressing endogeneity issues and reverse causality concerns. We also find that board diversity has a stronger effect on innovation when a firm is in a competitive industry and when the CEO has high equity ownership.

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Notes

  1. The conventional view of the role of the board of directors is to mitigate the agency problem and effectively discipline the management team (Fama and Jesen 1983; Jensen 1993).

  2. Literature suggests that a firm with a diverse board of directors has both positive and negative effects on corporate innovation. On the one hand, a board of directors with high diversity provides firms with multi-dimensional knowledge, skills, and expertise that increase the effectiveness of a company’s strategies as it receives a broader view and opinions from the board of directors (Pfeffer and Salancik 1978; Hillman and Dalziel 2003; Erhardt et al. 2003; Campbell and Mínguez-Vera 2008; Payne et al. 2009; Faleye et al. 2011, 2012). On the other hand, combining directors of different backgrounds in the boardroom may exacerbate conflicts, increase difficulty to reach a consensus, reduce group cohesion, and result in more erratic decisions (Kesner 1988; Hambrick et al. 1996; Forbes and Milliken 1999; Twenge et al. 2010; Li and Wu 2014; Faccio et al. 2016). Different from the previous studies that do not differentiate sources of board diversity, we postulate acquired board diversity is more important than inherent board diversity in corporate innovation.

  3. For example, Boone and Hendriks (2009) indicate a firm with high top management team diversity as related to their expertise or experience could enhance a firm’s decision quality and is beneficial to firm financial performance. Talke et al. (2011) find that firms with heterogeneity in the educational, functional, industry, and organizational backgrounds in their top management teams are better able to proactively focus on emerging customer needs and on novel technologies, resulting in a better innovation outcome and firm performance.

  4. The patents and citation data is available from https://kelley.iu.edu/nstoffma/.

  5. As the research and development data comes from Compustat, we extend the research period to 2012 when we analyze the effect of board diversity to innovation input.

  6. This is calculated dividing the standard deviation by the mean.

  7. Around 69% of the sample firms’ boards are composed of directors with the same nationality. This may result in the value of the 25th percentile and the median of the sample distribution being the same.

  8. The coefficient of correlation between the inherent diversity and the acquired diversity is − 0.061.

  9. We take the natural log of sales and the natural log of firm age in the regression analyses.

  10. If we simplify Eq. (2) as Ln (1 + Y) = b*X + controls, then \(\Delta \mathrm{Y}\) can be derived approximately by \(\left(1+\mathrm{mean}\left(\mathrm{Y}\right)\right)[\mathrm{exp}\left(\mathrm{b}*\Delta \mathrm{X}\right)-1]\).

  11. We also consider the possibility that our regression setting suffers from a “bad controls” bias as we include a vector of time-varying controls that are thought to affect innovation performance; this inclusion introduces an additional bias when any of these controls are affected by board diversity (Gormley and Matsa 2016). Therefore, we include only the board diversity measure and conduct the fixed effect regression. The results are quantitatively similar to the baseline results. To save space, we do not report the results in the text, but they are provided in Table 16.

  12. We sincerely appreciate the reviewers’ insightful comments, which have allowed us to enhance the soundness of our empirical analyses.

  13. To save space, we do not report the results for the coefficients of the control variables. However, they are available upon request.

  14. We sincerely appreciate the reviewers’ insightful comments, which have allowed us to enhance the soundness of our empirical analyses.

  15. To save space, we do not report the results for the coefficients of the control variables. However, they are available upon request.

  16. Studies use the numbers of segments (lines of business) for which separate accounting disclosures are made by management in accordance with FASB No. 14 and SEC Regulation S-K (Berger and Ofek 1995). Focused firms are those reporting exactly one segment on the CIS database, whereas diversified firms are those reporting two or more segments.

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Acknowledgements

We wish to thank Chia-Ying Chan, Chih-Yung Lin, Chin-Wen Hsin, Hong-Yi Chen, Hsin-Han Shen, Po-Hsin Ho, Sheng-Syan Chen, Shin-Rong Shiah-Hou, and Yan-Zhi Wang, **yu (Thomas) Zhou, and conference participants at FMA Annual Meeting (San Diego), Pacific Basin Finance, Economics, Accounting, and Management Conference for very insightful comments and helpful suggestions. I-Ju Chen acknowledges the funding from the Ministry of Science and Technology, Taiwan, R.O.C. (MOST 110-2410-H-155-006-MY2). Huai-Chun Lo acknowledges the funding from the Ministry of Science and Technology, Taiwan, R.O.C. (MOST 110-2410-H-155-004-MY2).

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  1. Discipline of Finance, College of Management, Yuan Ze University, 135, Far-East Rd., Chung-Li, Taoyuan, Taiwan

    I-Ju Chen, Wei Chih Lin & Huai-Chun Lo

  2. Department of Finance, College of Management, National Taiwan University, No.1, Sec. 4, Roosevelt Road, Taipei, Taiwan

    Sheng-Syan Chen

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Table 16 The association between board diversity and firm innovation
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16.

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Chen, IJ., Lin, W.C., Lo, HC. et al. Board diversity and corporate innovation. Rev Quant Finan Acc 61, 63–123 (2023). https://doi.org/10.1007/s11156-023-01145-4

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