Diversity in the boardroom: A long-term commitment

A research report, Board Diversity and Effectiveness in FT350 Companies, recently published by the Financial Reporting Council (FRC) in conjunction with London Business School, Leadership Institute and SQW, found that diversifying Boards pays dividends in terms of boardroom culture and performance. To maximise these benefits, the report states Boards should recognise that change takes time, and that diversity without an environment where members are actively included so they can freely and openly share their views is unlikely to encourage new talent to the Board. In this article, we take a look at and summarise the findings and recommendations of the research.

Diversity in many forms

What does the typical FTSE Board look like now and how has it changed over time?

The report finds that although progress has been made to date, particularly with regard to gender diversity, there is still a long way to go to reach equal representation. Board directors are typically white males with degrees from a small number of elite universities.

Gender diversity: FTSE-listed Boards have undergone significant changes over the past 20+ years. Representation of women stands at 34% of FTSE 350 Boards, with over 50% of the FTSE 350 exceeding the 33% target set by the Hampton-Alexander Review. But women are underrepresented in Executive Director and Chair roles leading to concerns that they are just being appointed into roles where there are low prospects for future advancement to these more powerful Board roles.

Ethnic diversity: In 2020, directors from ethnic minorities represented around 7% of the total compared to 13% of the UK population (Parker Report, 2020). 59% of FTSE 350 companies did not meet the target set by the Parker Review of having at least one Board member from an ethnic minority background.

Socio-economic diversity: When considering socioeconomic diversity, research found that Board directors are predominantly degree holders, with 25% coming from a small number of top tier universities.

Functional diversity: There has also been decreasing functional diversity. Nearly half of FTSE 350 Boards are qualified in accountancy or finance - this number was less than 38% 20 years ago.

What is the impact for businesses of diversity on Boards?

Gender diversity: The research demonstrates the positive impact that greater representation of women on Boards has had for companies, namely:

• better future financial performance (as measured by EBITDA margin), with the effect being the strongest after three to five years
• higher stock returns and less likely to experience shareholder dissent
• greater emphasis on boardroom relationships and collaboration

Interestingly, negative effects were seen where Boards appointed more than one female member but did not reach equal levels of gender representation. In this instance, the report concludes that the boardroom culture is key in accommodating diverse perspectives in order to reap the benefits offered by gender diversity.

Ethnic and Socio-economic diversity: Despite the positive shift towards gender diversity, the lack of other diversity data meant the report found less definitive positive correlations between ethnic/ socioeconomic diversity and Board effectiveness. However, the FRC concludes that a link can be made between ethnically diverse FTSE 350 Boards and a lower likelihood of shareholder dissent.

A key finding from the research was that higher socioeconomic status (SES) directors are more likely to report greater cohesion and confidence in the Board, and sees the Board as pursuing high-risk initiatives. This finding caused the researchers to question to what extent Boards like to recruit in their own SES image.

The researchers said more research needs to be done to investigate whether the increasing number of women is being achieved by appointing high SES women in place of low SES men. Despite too few data points to confidently conclude what the impact of socioeconomic diversity is on Board dynamics, many of those interviewed by the researchers expressed strong concerns about social mobility.

Recommendations on how to diversify Boards

The research confirms that both setting clear diversity targets and using data to make decisions about diversity rather than personal impressions are two important ways to improve Board diversity.

In addition, the report identifies three less understood ways to do this:

1. Take the time to discuss and facilitate boardroom culture. Most directors know that creating an inclusive culture is important, and are aware of the need to consider how specific individuals talk and behave. However, they need to talk more about the collective culture that, for example, allows a difficult individual to engage in inappropriate ways without being challenged.
2. Prioritise learning. Successful Boards say that by becoming more diverse you will learn things about yourself and your business that you never knew that you needed to know. It turns out this is good for making your business more profitable, as well as diverse.
3. Appreciate there is no single diversity code to crack. Building on the first two points, each type of diversity you target will require learning something new. Discuss what type(s) of diversity matter to you. Then, yes, build the inclusive culture in which all types of diversity will thrive, but also understand that success in one category is no guarantee of success in another because the barriers for one are not the same as the barriers for the next.

The Chair is seen to be a key player in affecting change and driving diversity. The report found that Chairs who are committed to long-term diversity plans and who are willing to analyse the internal Board culture are more successful in building a diverse Board.

Further, the research found that current ethnically diverse Boards have been successful in their appointment and retention of talent by:

1. Actively monitoring the internal and external pipeline of potential candidates
2. Promoting an inclusive culture that is diversity-friendly to attract diverse talent
3. Having a Chair that is a good listener
4. Having strong targets and a clear policy to drive cultural change.

The role of the Nominations Committee

The Nominations Committee is an important player in promoting diversity and Board effectiveness. The findings suggest that companies can create a more diversity-friendly approach in the appointment of non-executive directors in the following ways:

1. Undertake a skills assessment to redefine the selection criteria each time a Board vacancy comes up to avoid automatically looking for a ‘like for like’ replacement
2. Manage the pipeline to ensure diversity is a priority from the bottom up
3. Assess the company’s image to ensure it is attractive to diverse individuals
4. Set clear targets and regularly and publicly report on progress towards target
5. Provide a clear mandate to a search firm with a diverse talent pool and start early
6. Ensure the committee itself is diverse
7. Invest time and energy in making diverse appointments.

How diversity impacts on Board effectiveness and dynamics

The report concludes that more effective Boards have a healthy dynamic which encourages conversations and information sharing from a wide range of diverse perspectives. This subsequently leads to more effective problem-solving and decision making. However, in certain instances, a greater variety of perspectives from diverse backgrounds can create hurdles if those views are not managed effectively. The research found that lower performing and highly diverse Boards may struggle to communicate internally due to the diverse viewpoints, which then has a negative impact on their effectiveness. Therefore, it is essential that, in order to avoid a breakdown in communication, Boards actively promote an inclusive environment where members can freely and openly share their views.

Key takeaways

The research shows that many Board members have largely committed to diversity and Boards have made efforts to change, with some success especially in relation to gender diversity. In particular, the research finds positive correlation between having more women on FTSE 350 Boards and future financial performance, with better-performing companies experiencing the greatest benefits. The greater representation of women in the boardroom is reshaping culture and dynamics and benefiting businesses from a social justice as well as a performance perspective. The findings on ethnic diversity are less definitive – which is a consequence of the lack of available ethnicity data and the lack of ethnic individuals on Boards to measure noticeable differences.

Regulators and companies must focus on collecting more data on the types of diversity, Board dynamics and social inclusion. The report supports the need for companies to set clear targets and report against them as a means to improving diversity. It is the responsibility of the Chair of a Board to drive inclusion. The Nominations committee should be diverse and work with executive search firms that will find talent from diverse backgrounds.

A key finding is that how diversity is managed influences performance. The research concludes that Board diversity and effective Board dynamics can have a positive impact on financial performance. However, this is contingent on diversity being nurtured and the subsequent change in Board dynamics being actively managed. Further, diversity is a long-term journey which requires full-time commitment for companies to reap the benefits.

Board Diversity and Effectiveness in FT350 Companies: published by the Financial Reporting Council (FRC) in conjunction with London Business School, Leadership Institute and SQW.