Board Gender Diversity and IPO Performance
Article of Professor Theo Vermaelen based on INSEAD Working Paper No. 2021/05/FIN
Over the past two decades, academic research has found little evidence that gender diversity on the boards of directors has a positive impact on firm value. In recent years, however, practitioners have increasingly argued that diversity among the board of directors has a positive economic impact on firms. In January 2020, the Nasdaq Stock Market filed a proposal with the Securities and Exchange Commission to adopt Rule 5605(f) (Diverse Board Representation) which argued for mandatory diversity on boards of firms listed on NASDAQ, based on economic arguments that diverse boards were positively associated with improved corporate governance and financial performance. In the same month, Goldman Sachs announced it would stop financing the Initial Public Offerings (IPOs) of companies in the U.S. and Europe with only white male board members again on the basis of superior performance by firms with gender-diverse boards.
In a paper “Are Women Underpriced? Board Diversity and IPO Performance”, co-authored with Jason Sandvik from Tulane University and Raghu Rau from the University of Cambridge, we examine the economic impact of gender diversity on the performance of IPOs from 2000–2018. IPOs are an appropriate venue to study the effect of shareholder preferences on gender diversity because it is the only type of corporate transaction where investors can express their opinions about company valuation. Specifically, the book-building process provides a unique opportunity for investors to give feedback on the valuation range proposed by the investment bank. Investors can show that they value stocks differently from traditional valuation methods, such as discounted cash flows and earnings multiples, by incorporating a premium for diversity, for example. Because the underpricing of IPO shares reflects the difference between market valuations and the valuations by the investment bank, such a premium can be measured directly. There is no other event where this is empirically feasible. In addition, investment banks have an outsized impact on the terms of the offering and the structure of the firm. For example, the insistence by Goldman Sachs that it would not consider taking public a firm that did not have a gender-diverse board is unique. Investors can invest in any type of publicly listed firm, such as “sin stock” firms, depending on their preferences. However, if a non-gender-diverse firm is unable to go public, investors are necessarily constrained in expressing their preferences. Finally, IPO underpricing is likely to be less subject to the endogeneity problems that plague many studies that find a positive relation between gender diversity and stock market or operating performance. Indeed, it is not obvious whether diversity causes performance or vice versa. On the other hand, it is implausible that underpricing encourages firms to put women on the board.
In our analysis of IPOs, we split the sample period into roughly two decades (2000–2009 and 2010–2018). The first decade coincides with the introduction of the Norwegian female board representation quota that originally brought attention to gender diversity in 2003 and achieved full compliance by 2009. The second decade begins in 2010 when the SEC began requiring public companies to disclose the role diversity considerations play when they select directors. Several large pension funds, including CalPERS and CalSTRS, wrote letters in support of this regulation. After this mandate when into effect, there were several prominent IPOs that did not initially include women on their board—specifically, Facebook (2012) and Twitter (2013)—creating a good deal of controversy for the firms. Consistent with the split in time periods, the gender diversity of IPO boards changes drastically between the two decades. Less than 35% of all 2000–2009 IPOs had gender-diverse boards, whereas nearly 50% of 2010–2018 IPOs did.
We posit two non-mutually exclusive hypotheses as to why gender diversity might be linked to underpricing. The superior firm hypothesis argues that firms with greater board diversity are better firms because of the presence of women on the board. For example, if women are more risk-averse than men, then having more women on the board may reduce the negative consequences of male overconfidence, such as over-investment and excessive risk-taking. It may also be the case that gender-diverse boards are less susceptible to groupthink, improving their ability and disposition to advise and monitor management. Furthermore, diverse leadership may send a positive signal about a firm’s ability to attract and retain a diverse talent pool of employees. In contrast, the investor demand hypothesis argues that diversity is a demand placed on firms by investors, potentially for reasons beyond expected future firm performance. Over the past decade, corporate social responsibility (CSR) ratings, such as the KLD rankings issued by MSCI, have become important considerations for institutional investor portfolio holdings. If institutional investors feel pressure to include CSR criteria when forming their portfolio holdings, it is plausible that institutional demand for firms with gender-diverse boards will increase.
In our sample of over 1,100 US IPOs over the 2000–2018 period, we find that gender diversity is positively related to underpricing on the issue date, but only in the 2010–2018 period. In addition, this underpricing effect only holds for IPOs underwritten by bulge bracket investment banks. This underpricing effect suggests that by not considering the demand for diversity at the offering, gender-diverse IPOs leave approximately $34 million in IPO profits on the table relative to non-diverse IPOs. However, gender diversity has no impact on either the stock or operating performance of the firm. Gender-diverse IPOs do not earn significant excess returns in the short-term over the six weeks following the issue date relative to non-gender diverse IPOs. Similarly, in both the sample periods, there is no significant difference between the long-horizon excess returns earned by gender-diverse and non-diverse IPOs. For IPOs underwritten by non-bulge bracket investment banks, gender diversity is unrelated to the performance of IPOs at the issue date, in the short horizon following the issue date, and over the long horizon. Gender diversity also has no significant effect on economic performance, measured by industry-adjusted return on assets in the years after the IPO.
We find that the institutional ownership of IPOs led by bulge-bracket investment banks is significantly greater than that of non-bulge bracket IPOs. In addition, IPOs underwritten by bulge bracket underwriters are approximately four times larger than those underwritten by non-bulge bracket investment banks, making them more attractive to institutional investors. Because institutional investors are both highly motivated to invest in gender-diverse companies and own a larger fraction of bulge bracket IPO shares than non-bulge bracket shares, it is plausible that the gender effect would show up more in bulge bracket IPOs.
We also find that the number and the experience of female non-executive directors has increased in recent years, which should reduce the concern that there are not enough qualified females to promote the diversity agenda. The relative lack of experience among female directors in the 2000–2009 period may well explain why it took some time before firms and investors embraced the diversity agenda. Our results suggest that institutional investors have private information about their valuation of and demands for gender- diverse firms, but this information is not fully incorporated into IPO firms’ offer price, leading to increased underpricing among gender diverse firms.
Theo Vermaelen, UBS Professor of Investment Banking, INSEAD. Theo Vermaelen is also portfolio manager of PV Buyback USA, a fund that invests in firms that announce buybacks because they are undervalued.
Original paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3783771
PV Buyback USA Fund Manager