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Muffling the Echo Chamber
Board Diversity Linked to Fewer Reporting Problems
In theory, the board of directors of a corporation is supposed to provide oversight and ensure executive accountability. In practice, says Susan Parker, associate professor of accounting at the Leavey School of Business, CEOs often use their considerable power and influence to help select a board that thinks the way they do and exercises less independent control.
This can create an “echo chamber” situation, in which the board doesn’t sufficiently challenge company executives or practice, sometimes with serious negative results. Parker and two colleagues from the University of Memphis have looked into the question of whether greater board diversity, as measured by the presence of at least one female board member, can reduce that problem.
“Gender documentation is fairly rare in accounting research,” Parker says. “Some people think it’s too touchy-feely. But there is evidence that when you introduce a woman to an all-male group (or vice versa), it changes group dynamics in a way that could affect certain corporate behavior.”
To test that hypothesis, Parker and her colleagues, Lawrence J. Abbott and Theresa Presley, did an extensive database search into financial restatements by publicly held companies, then checked to see if such restatements were more or less common in firms that had at least one woman on the board.
“A restatement typically occurs when a company’s financial reporting is wrong enough that a reasonable person relying on it would be misled. There has to be some sort of serious error or fraud internally for that to happen,” she says, and a vigilant board or audit committee should catch it.
Parker and her colleagues tested their hypothesis by searching financial records online to come up with 278 companies that had restated their annual financial statements between 1997-2002. They then created a control sample of firms matched by date, size, auditor and industry that didn’t restate their earnings.
After compiling that information (which Parker says “took ages”), they combed the lists of board members for both sets of firms to see how many companies had at least one woman on the board.
“The frequency of women on boards was not that high,” Parker says. “Only a third of the boards had at least one female member, and women held only six percent of board seats overall.”
When the numbers were run, it turned out that the likelihood of financial restatement was substantially less with at least one woman on the board. Preliminary results show that the effect of gender diversity is similar to that of director independence. “Our paper contributes to the restatement literature by showing that an observable measure of board diversity is associated with a lower likelihood of restatement,” they write in the paper’s conclusion.
The paper, “Female Board Presence and the Likelihood of Financial Restatement,” is currently undergoing final revisions. It was presented at a Diversity Section meeting of the American Accounting Assn. and will be a forum paper at the 2009 Mid-Year Auditing Conference.
“When people heard the paper presented,” Parker says, “a common response was, ‘Yeah, that’s how that works. I’ve seen that.’” But she cautions that the findings of the paper are not definitive and admit of other explanations.
One of those explanations is that CEOs who push for a more diverse board already tend to value internal controls and board oversight. In that case, the paper posits, the presence of women on the board might simply reflect an existing corporate culture.
“A lot of it is about the CEOs, who, by the way, were all male in this study,” Parker says. “What kind of CEO adds a diverse voice to the board? Some CEOs think about their own decision-making processes and use the board of directors to check their impulses. It’s one way of slowing and expanding the decision-making process.”
A DIFFERENT PERSPECTIVE: Susan Parker’s research shows that companies with at least one female director are less likely to have to restate their earnings, perhaps because of more thorough board review.