Ethnic and Gender Diversity in Boards of Directors and Their Relevance to Financial Performance of Malaysian Companies

The purpose of this paper is to empirically examine the effect of demographic diversity on boards of directors with regard to firm financial performance. This paper uses secondary data of non-financial listed companies over the period 2000 to 2006. Relevant concepts, propositions, hypotheses and control variables are specially developed to meet our requirements. Demographic diversity is represented by ethnic and gender diversity and performance is measured by return on asset (ROA) and return on equity (ROE). A series of OLS regressions using on the cross-sectional data are also presented. The results seem to be quite inconsistent to prove the relevance of diversity among the board members with regard to financial performance.


Introduction
Despite the major roles carried out by managers at strategic level, the boards of directors also have the primary duty and responsibility for the corporation's performance (Fischel & Bradley, 1986).The literature concerning the roles of the board of directors encompasses stewardship theory and the agency theory.The stewardship theory offers the positive effects of managers' participation in organizations (Donaldson, 1990;Donaldson & Davis 1991).Agency theory emphasizes on the agent -principal relationship which may cause agency cost as managers tend to place their personal goals ahead of the corporate goals (Jensen & Meckling, 1976, Eisenhardt, 1989).Admittedly, the board members have the obligations in maximizing shareholders' wealth through an effective monitoring or controls over top management (Kose & Senbet, 1998).The board members are also perceived to be an important device for upholding an effective corporate governance to ensure as there is a need to create adequate returns for shareholders (Vafeas, 1999;Weir & McKnight, 2001;Coles et al., 2001).Fundamentally, the resource dependence theory proposed that corporate boards are a mechanism for managing external dependencies (Pfeffer & Salancik, 1987), reducing environmental uncertainty (Pfeffer, 1972) and reducing the transaction costs associated with environmental interdependency (Williamson, 1984).In the case of Malaysia, after the 1997 Asian financial crises, the Malaysian Code of Corporate Governance has hinted on the importance of board structure, board size and independent board of directors since year 2000.And, the Bursa Malaysia has also started limiting on the number of directorship of a person starting since 2002.
Investigation on the characteristics of the top level management that mainly involves top managers and board of directors (BODs) is always the main discussion be it in the academic or corporate world.It will be of great value when we link this discussion to firm performance (Kakabadse & Kakabadse, 2006;Kakabadse et.al., 2006;Cadbury, 1992;Dahya & Travlos, 2000;Kroll, Walters & Le, 2007;Auden, 2006).Undoubtedly, women's and multi-ethnic groups' involvement in the top level management has become a very important component in understanding characteristics of the top level management including the board of directors.However, relating the characteristics of the BODs to firm performance will be a valuable contribution.It has been noted that quite a number of studies have been carried out in this area (e.g Burke, 1997;Burke & Nelson, 2002;Carter, Klenke, 2003).

Focus of the Study
The demographic characteristics on top management team (TMT) includes age, functional background, education, tenure, (Hambrick & Mason, 1984), who dealed with diversity within top management and its impact on firm performance that is strongly linked to the Upper Echelon Theory.They insisted that top management's characteristics (e.g.demographic) influence the decisions that they make and therefore the actions adopted by the organizations that they lead.It occurs because demographic characteristics are associated with many cognitive bases, values and perceptions that influence the decision making of top management.Top management members could with greater demographic diversity, influence decision making process in the top management and positively contribute to firm performance.The basic foundation of this theory could be linked to the earlier concepts on the characteristics at the top management and competitive behaviours (Cyert & March, 1963).Thus, firm performance could be positively impacted by the competitive behaviours at top level of an organization.In the case of BODs, diversity enhances greater creativity, innovativeness and quality decision making, thus this study expects the similar outcome at strategic level particularly involving the boards of directors (Zahra & Pearce, 1989) since boards are the most influential actors, boards are also to carry out the monitoring role representing shareholders (Hambrick 1996).
Research shows that increasing diversity on boards of directors would be beneficial to organization in terms of gaining critical resources (Pfeffer & Salancik, 1978) and where corporate governance is concerned, benefits at strategic level are positively related to diverse top management (Eisendardt & Bougeois, 1988).Occupational diversity among board members is also positively related to performance in the context of social obligation (Siciliano, 1996).Zander (1993), stresses that efforts must also be taken to make fullest use of the talents of board members.The presence of the demographic heterogeneity at top management level is expected to increase firm performance, hence, heterogeneity is suitable for complex, ambiguous business operations and the decision making processes are structured in nature whereas, homogeneity in top management is more effective especially when faced with unstructured decision making processes (Hambrick & Mason, 1984).This paper expands the boundary of the upper echelon theory and its application and implications on firm performance.However, instead of focusing on age, functional background, educational background and tenure of the individual manager as most researchers have done earlier, this study focuses the proportion (in percentage) of demographic diversity based on gender and ethnicity among board members and its implications on firm performance.As clarified in the literature, demographic diversity includes gender, age, race and ethnicity whereas, cognitive diversity includes knowledge, education, values, perception, affection and personality characteristics (Maznevski, 1994;Pelled, 1996;Boeker, 1997;Watson et al., 1998;Peterson, 2000;Timmerman, 2000).There have been interesting contemporary studies on demographic diversity in relation to boards of directors and firm performance (Lee & Far, 2004;Evans & Carson, 2005;Bergen & Massey, 2005;Roberson & Park, 2007;Erchardt, et al., 2003;Certo et al., 2006;Carson, et al., 2004;).
This study is therefore to investigate the impact of diversity (demography) among the boards of directors on firm performance.Some related discussion has recently been presented by Maran (2008) and Maran & Indraah (2008).Hence, the purpose of this study is to empirically examine the relationship between demographic diversity (gender and ethnic diversity) on boards of directors with firm performance (Certo et.al., 2006, Kroll, Walters & Le, 2007;Auden, 2006).

Definition
Ethnic groups are defined as 'people of other countries' (Yin, 1973) but however, ethnic groups do not necessarily share a country of origin but instead share a sense of common political or cultural origin (Capehart, 2003).Hassan, Samian and Silong (2005) …managing diversity is very much based on tolerance and respect …to preserve inter-ethnic harmony.

Theoretical Argument on Diversity
Studies reveal that the relationship between diversity and organizational or financial performance can be either positively correlated or negatively correlated and some studies show give inconclusive results.Diversity within the senior management ranks was evidenced in higher perceived levels of overall performance, profitability and return on equity (Allen, Dawson, Wheatly & White, 2008).Some empirical findings indicate that diversity results in greater knowledge, creativity and innovation and thus, organizations tend to become more competitive (Watson et al., 1993) and diversity also able to attract and retain the best talent available; reduced costs due to lower turnover and fewer lawsuits, enhanced market understanding and marketing ability, better problem solving, greater organizational flexibility and better overall performance (Coz & Blake, 1991;Griscombe & Mattis, 2002) via improvement in decision making at strategic level (Bantel, 1993).Siciliano (1996) argues that board diversity offers positive results in performance.This is also supported by Eisenhardt et al., (1998), Smith et al., (1994), Carpenter (2002) and Greening and Johnson (1996).Heterogeneity is positively linked to better problem solving and offering creating solutions (Michael & Hambrick, 1992).
Meantime, some argue having homogeneous management team would be more beneficial with regard to firm performance (Wiliams & O'Reilly, 1998), homogeneous groups can also result in better performance (Murray,1989).In fact, heterogeneity tends to lead to conflicts and negatively affect the effectiveness of communication in top management (Pelled at al., 1999;Amason, 1996;Carpenter, 2002).Besides this, racial and gender diversity can have negative effects on individual and group outcomes in certain instances (Miliken & Martins, 1996).For example, group members who differ from the majority tend to have lower levels of psychological commitment and higher levels of turnover intent and absenteeism.It should be noted that the upper echelon diversity is associated with the demographic diversity of the workforce, with evidence of homo-social reproduction taking place in organizations, particularly with regard to gender and race (Nishii, Gotte & Raver, 2007)

Hypotheses
The Upper Echelon Theory by Hambrick and Mason (1984) becomes an important input in relating heterogeneity in top management team (TMT) to firm performance.The boards of directors (BODs) that can be viewed in the same context as TMT (Hofman, Lheureux & Lamond, 1997) and it should be noted that it is not organizational performance rather financial performance that is being investigated here and demographic diversity is represented by gender and ethnic diversity (Roberson & Park, 2007;Conyon & Mallin, 1997;Daily et al., 1999;Zander, 1979;Costa & Kahn, 2003;Kang & Cnaan, 1995;Rutledge, 1994;Widmer, 1987;Carson, Mosley & Boyar, 2004).Therefore, these arguments allow us to develop a set of directional hypotheses that support a strong correlation between demographic diversity among the board members with firm financial performance, thus the following hypotheses are proposed:

Hypothesis1: Gender diversity among board members is positively correlated with firm financial performance
Hypothesis 2: Ethnic diversity among board members is positively correlated with firm financial performance.

Methods and Measures
Top 100 Malaysian listed companies from the non-financial sector were selected for this study over the period 2000 to 2006 (Appendix 1).The selection was based on their market capitalization.This sample represented the overall performance of the main board as they accounted for almost two-thirds the total market capitalization on the main board.A financial database (OSIRIS) and companies' annual report were used for data collection.The main focus was to detect the effect of gender and ethnic diversity on board of directors (BODs) with regard to firm financial performance from year 2000 to 2006.This period reflects the beginning of the corporate governance enhancement in Malaysia (The Malaysian Code on Corporate governance, 2000).The dependent variable was financial performance, independent variables were gender and ethnic diversity and the control variables were board size, firm size and firm age.Besides this, previous years' performance was also used as part of the control variables.
The dependent variable, ROA, (net Income divided by total asset), ROE, return on equity (net Income divided by total equity) and was a measure used to measure firm financial performance (Thomas & Ramaswamy, 1994, Certo et al., 2006 ).The use of two different dependent variables was to check on the consistency of the regression results as both were widely adopted by researchers.The independent variables, gender and ethnic diversity on BODs were measured using a ratio scale.Gender and ethnic diversity on BODs were determined by taking female directors and non-Malay directors divided by total board directors.The control variables; board size was determined by the number of directors sitting on the board, firm total asset was a measure for firm size, firm age refers to number of years of business operations and performance of year 2000and 2003. (Roberson & Park, 2007;Jehn & Bezrukova, 2004;Cohen & Cohen, 1975, Erchardt et al., 2003, Rosenthal & Rosnow, 1984).

Results
This study is to examine the effect of demographic diversity in boards of directors (BODs) on firm financial performance.The correlation results using the data of year 2006 are shown in Table 1.Table 2 shows the regression results using two different dependent variables (ROA and ROE) based on the cross-sectional data from year 2000 to 2006.
Table 1 reveals that ethnic diversity is significantly (positively) correlated with performance (ROA) at 0.05 (0.263), significant correlation can also be found with ROA in year 2000 and 2003.Thus, the effect is consistent with performance at different periods.In addition, gender diversity was not correlated with performance and this is a kind of early signal that gender diversity might not create any impact on firm financial performance.As for the multi-collinearity effect, it was verified that the VIFs (Variance-inflating factor) for all the independent variables were between 1.0 and 1.3 Based on the findings in Table 2, as expected, gender effect did not have any impact on firm financial performance throughout the years except in year 2005, where it registered a positive relationship with ROE.Hence, hypothesis 1 is not supported.However, ethnic diversity did create some significant impact on financial performance in the second half of the period from 2004 to 2006.It is quite disappointing as we fail to obtain consistent results over the seven year period, however it could be viewed that ethnic diversity with regard to firm financial performance is becoming increasingly important in boards of directors.Thus, hypothesis 2 is partially supported.The graphical expressions relating to the correlation between ethnic diversity (EDIVBOD) and performance (ROA and ROE) is shown in Figure 1 and 2 below.Linear relationship between ethnic diversity and ROA is slightly steeper as compared to relationship between ethnic diversity and ROE, which is slightly flatter.

Discussions
In the case of board of directors (BODs), demographic diversity partially influenced firm financial performance.It is quite surprising when gender effect among the board members did not turn out to be significant with regard to financial performance.However, to a certain extent, ethnicity in boards of directors created a significant impact on firm financial performance.These findings are quite consistent with our earlier study (Maran & Indraah, 2009).Hence, ethnic diversity could be used an effective way to improve on corporate governance among the listed companies in the event of economic instability (Mitton, 2002).It should be added here that heterogeneity in boards of directors would further enhance the quality of corporate decisions as the members on the boards are directly involved in issuing, restructuring, takeover exercises, introducing measures to enhance regulatory, transparency, accountability and independence.Though women's role was not felt in boards of directors, again it could be argued that the effect was only for a short run.

Limitations
Some limitations or potential weaknesses in this study must be addressed.First, homogeneous characteristics of the companies selected might have been violated as there various industries involved.The sample size could be relatively smaller and the data collected involved only large companies.There could be different effects on different sizes of company.There could also be a curvilinear relationship between demographic diversity and financial performance.This means diversity may result in adverse results for a certain period, followed by indifferent results, then positive relationship with regard to performance.

Conclusions
Despite the inconsistent findings, we believe this study has offered some meaningful information especially in terms our readiness and the need to emphasize on the gender and ethnic diversity in boards of directors.Admittedly, this study fails to draw a conclusive set of findings on the relevance of heterogeneity among board members.However, it is believed that many companies on the other hand do prefer homogeneity at top level management especially for decision making process.Probably, more research should be carried on different samples involving different industries to further verify the results.(2000 -2006)

Table 1 .
Mean and Correlation results

Table 2 .
Parameter Estimates from Cross-sectional Regressions of Financial Performance on Demographic Diversity