Abstract

This study aims to determine the combined effects of board diversity in terms of board member age, gender and educational level on firm risk. Composite diversity indices, constructed from a combination of Blau (1977) and Shannon (1948) heterogeneity measures respectively, reflecting each board’s composition with respect to the three aspects, are employed for a sample of 3,513 US non-financial and non-utility firms for the years between 2000 and 2017.

The results indicate that both gender and educational diversity amongst board members reduce firm systematic and total risk, measured as a firm’s beta and annualized stock return volatility respectively. However, age heterogeneity does not significantly affect firm risk. Additionally, the combined effect of all three diversity aspects as a whole, estimated by the composite diversity indices, is found to be negatively related to firm risk suggesting that a firm’s risk tends to decrease as a function of the overall diversity of its board members. Moreover, in high financial volatility periods, larger dissimilarity levels amongst board members reduce firm risk at a lower rate than that noticed under normal market conditions. Therefore, the net effect of board diversity is found to be significantly lower during more volatile market conditions. This suggests that boards fail to accommodate their risk decisions to fluctuating market conditions. This could also be an indication of an increase in inter-member conflicts and disagreements, making it more difficult for boards to agree on business decisions thus reducing the level of risk taken on by firms under normal market conditions.