Board Diversity: Business Case or Public Policy?

Given that half of the world’s population is female, the political quest for equal representation of both sexes in leading positions seems almost self-evident in both the public and the private sector. For the private sector, Germany adopted two separate laws introducing a 30% female quota in supervisory boards (2015) and a minimum representation in management boards (2021) of stock-listed, co-determined companies (Rentsch, 2022). Both laws wear marks of preceding political processes, affecting their effectiveness. Prior to the adoption of the first law, the legitimacy of ‘policy-oriented’ regulation of this type in corporate law was highly disputed, if not outright rejected by well-renowned voices in the corporate law literature. The discussion mirrored the ensuing criticisms in the context of the introduction of an ‘equal gender balance’ recommendation in the German Corporate Governance Code in 2009. That is, board diversity was not considered a suitable subject of the Code. The same criticism was, however, also raised against the legitimacy of legislation for equal gender balance, which was considered an undue interference with corporate autonomy.

The 2015 German act overcame these reservations through a shift in the political rationale and narrow confines of a now public policy-oriented regulation. Stressing the political desire for implementing equal gender balance in German Corporate Boards, the first act introduced a mandatory gender quota for seats in the supervisory board of stock-listed co-determined public corporations, while introducing a ‘target’ for the board of directors seats and for public corporations below the co-determination threshold. By virtue of the target, corporations had to commit themselves to a gender balance of their choice, but with a minimum of 30% male/female representation. This was meant to stimulate a race to the top, nudging corporations into ambitious self-commitment. The idea has not proven successful, with many corporations either setting a target of zero or being non-compliant with the duty to set a target at all. The 2021 gender quota law, unsuccessfully, aimed to tackle these issues by introducing stricter reporting duties for zero-person targets, but taking no measures to raise compliance with the duty to set a target.

The European Union has recently adopted a directive on gender quotas for boards. It exceeds the German equality regulation in scope, introduces a more ambitious quota (40%) and supports its effective implementation with procedural and reporting duties. Against this backdrop, it may come as a surprise that Germany has declared to refrain from measures implementing the directive beyond the gender equality regulation in force.

In sum, there seems to be an apparent political desire for gender equality in the boardroom, but just as much resistance against effective implementation. This may explain why a highly skewed gender imbalance persists in practice. Unfortunately, the causes for the underrepresentation of women in management positions remain unclear. Both explicit (old boys’ networks) and implicit (biases) discrimination is possible, but so is a simple underrepresentation of women in the executive labor market. The discussion about the imperative of gender quotas tends to presume the former and makes a business case for diversity: Gender-diverse leadership teams make ‘better’ decisions in complex economic environments. This is what numerous studies on the association between diversity and business success claim to prove. Indeed, if balanced gender ratios actually increased performance, companies were currently making inefficient selection decisions, for example, by discriminating in recruitment decisions. According to this interpretation, gender quotas would be legitimate in two ways: Politically, they would realize the equality mandate, while economically remedying market failure and thus increasing the efficiency of companies. In contrast, if the skewed gender ratios were caused by a shortage of suitable female executives, the quota system would negatively impact the efficiency of companies, and thus indirectly harm them.

Empirically, the business case for gender diversity is not clear. The majority of studies are based on simple correlations and do not necessarily prove any causal relationship (ie, that more diversity causally leads to more success). Correlations can occur in the absence of a causal effect of diversity: Successful companies may ‘afford’ more diversity. Or there may be other unobserved factors that correlate with both corporate success and diversity and are difficult to control in empirical studies. Second, corporate success can be measured in several ways. Indeed, many studies do not consider effects on profitability or returns, but instead on aspects such as employee satisfaction or broader ESG goals. It remains unclear, however, to what extent these aspects influence a company's financial success or should be an explicit part of a company’s objective function (Hart & Zingales, 2022). Third, gender diversity does not trivially map to diverse perspective-taking, which is the proposed channel for successful decision-making (Ely & Thomas, 2020). Female executives often follow similar educational and career paths as their male colleagues, which may strongly influence their perspectives. This channel is potentially more effective for a diversity of geographic and social origins, as well as diversity in terms of educational and career paths.

There are thus several conceptual problems with the business case as commonly stated. Foremost though, our reading of the empirical literature on the business case, based on several large meta-studies that synthesize the empirical work in this field (Jeong & Harrison, 2017; Pletzer et al., 2015; Post & Byron, 2015), suggests that gender quotas are in fact success-neutral: It could be summarized as ‘probably no effect, most likely no negative effect.’ This suggests that neither direct discrimination against better female candidates, nor scarce human resources are behind skewed gender ratios. In the first case, we would otherwise expect quotas to have a clearly positive effect, and in the second case, a clearly negative effect on business.

A neutral business case for diversity would prima facie suggest other approaches to regulation such as improving conditions for female employment or dismantling of stereotypes in professional careers. These are, however, long-term projects with uncertain success. In contrast, binding gender quotas at management level have a direct and timely effect on achieving the societal goal of gender equality. Moreover, they can generate powerful social multiplier effects by activating relevant role models (Meier et al., 2020). Herein lies their real justification, and, in our view, a convincing rationale for the approach via corporate law in the absence of evidence that quotas harm corporate success. In contrast, constructing a weak business case for diversity is not conducive to the project of gender parity (Eagly, 2016): If the business case got empirically refuted, it would ultimately discredit the societal goal of gender-diverse leadership levels in business.

Bettina Rentsch is an Assistant Professor of European Private Law at the Free University of Berlin.

Stefan Trautmann is a Professor of Economics at Heidelberg University.