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Do gender quotas make sense?


In the UK, the regulator announced a mandatory gender quota for companies listed on the main market of the London Stock Exchange. From next year, companies must have at least 40% women on their board of directors, at least one woman in a senior board position (chairman, CEO, CFO or senior independent director) and at least one woman from an ethnic minority on the board of directors. Companies that do not comply with these quotas must explain why they are not complying and how they intend to remedy the situation. But does it make sense?

My initial reaction to this new rule was, “I hope companies don’t hire a female CEO just to tick a box. It would make governance worse, not better.” Speaking to a number of foundation and corporate executives after the ruling was announced, I noted that I was not alone. Everyone cares the same. By specifying a fixed price, the temptation is to simply meet the requirements by hiring less qualified people.

Don’t get me wrong. I’m all for increasing diversity on the board. I have written many times about the evidence that companies led by a more diverse management team take fewer extreme risks and are more profitable in the long run. But diversity doesn’t come from hiring people with different genomes, it comes from hiring people with different perspectives, different experiences and abilities, and from breaking up the old clubs of (mostly) middle-aged white men sitting in no-longer-smoked-but-still-closed rooms .

Interestingly, however, the empirical evidence is generally in favor of mandatory diversity quotas. In theory, companies may be tempted to hire less qualified directors, but in practice they do not because directors must be approved by shareholders.

Martina Hertzberg and her colleagues looked at the implications of the 2018 mandate on the representation of women on boards of directors in California. California Senate Bill 826 required all public companies headquartered in California to have approximately 25% to 40% female board representation by the end of 2019. When the bill was announced, the stock market reacted negatively, as investors feared that companies would appoint less qualified individuals.

But the opposite happened. The chart below shows the approval of new and existing directors at shareholder meetings. Incumbent female directors received more votes than male directors, and new female directors received significantly more votes than new male directors. After the introduction of the gender quota, the approval of new female directors declined somewhat, but always remained higher than that of male directors. California companies have had no problem finding qualified women directors, and those companies’ stock prices have gotten a boost from hiring women directors when these new directors replace incumbents with low shareholder approval ratings.

Approval of new and existing directors by shareholders

Source: Gertsberg et al. (2021)

And here lies the catch. When companies replaced male directors, who were highly praised by shareholders, with a new female director, stock prices fell because the market didn’t like the departure of a qualified director. But when companies replaced the director with the least shareholder approval with a woman, share prices rose as investors recognized improved governance by bringing in a more diverse board.

So me and my fellow investors probably don’t need to worry too much about the new regulations in the UK. Having spoken to a number of UK companies, they all intend to hire female directors, but only if they are qualified. None of the corporate executives I’ve talked to will hire a woman just to tick some boxes. And that’s good.

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