More age diverse boards save $1.6 million in loan provisions
We hear a lot about the role diversity plays in organisations and on company boards, but this often tends to revolve around ethnicity.
We are not aware of any regulation or governance code emphasising the importance age, even though nearly 90 per cent of directors of firms in the Standard and Poor’s 500 consider age diversity important. And yet only six per cent of S&P 500 firms have directors younger than 50, according to research conducted by PwC in 2018.
This paucity of information also holds true for academic papers, where we found there was very little around the topic of age diversity, so along with Mohamed Janahi, of the University of Bahrain, and Georgios Voulgaris, of the University of Manchester, we decided to investigate it.
We looked at the banking sector in particular, partly due to its significance to the wider UK economy, and partly because it’s so opaque in how it performs from a management perspective that it can be hard for external stakeholders to assess how effectively banks manage risk.
Will a diverse board be less prone to groupthink?
Our theory was that the more diverse a group is – especially regarding age – the more prone it is to arguments and disagreements, so the social cohesion is lower. The logic is that a mix of backgrounds, perspectives, experiences and reference points will make it less likely that they will agree in an Orwellian groupthink mentality.
Having a board that regularly argues might sound problematic, but boards essentially are designed to do two roles: give advice and monitor activity. Our contention was that a less homogenous board that is made up of a diverse range of individuals and ages may be slower at providing advice, as it’s more prone to disagreement, but tends to be better at monitoring how well the executives are doing their jobs.
Our study looked at 232 US banks, from 1996 to 2006, and assessed the impact of age diversity in non-executive directors on loan loss provision (LLP). This is the amount of money banks put aside to cover cases of loans going bad, and is generally considered a reflection of a bank’s approach to risk.
One initial early finding was that bank boards in general are older and less age-diverse than boards in non-financial industries. The average age of bank directors is 62, which – at least from 1996 to 2014 – is some three years older than non-financial firms listed on the S&P 500.
Age-diverse boards better at spotting risky behaviour
Our research backed up the initial hypothesis: that boards with greater age diversity were better at identifying risky or less-than-prudent behaviour in banks. They are more prudent with customers’ money, and more likely to make greater discretionary loan loss provisions (DLLP).
In turn, this impacts on the need to engage in earnings management – the application of accounting techniques to smooth out losses over a number of years – which can be indicative of poor-quality reporting and low levels of competence among both executive and non-executive directors.
Other studies have also made a link between banks that do not manage earnings, and which report timelier loan loss provision, and decreased loan risk.
Specifically, we found that age diversity is associated with a decrease of 0.0187 percentage points in DLLP. For a median-sized bank, this is equivalent to a reduction of $1.6 million; a significant figure given that the median LLP in our sample was $6.52 million, and median earnings were $32 million.
Our results hold even after we control for CEO characteristics, as well as for tenure diversity and board education. Furthermore, there was also a positive association between reduced earnings management and bank growth.
In the current landscape, when there are again concerns emerging over how resilient banks are, this has practical implications. Under risky conditions, banks that adopt a more prudent approach are more likely to save themselves from potential losses and gain a reputation for responsible management.
The 2007-09 financial crisis shows that excessive risk-taking by banks can be costly to the economy as a whole. With the recent downfalls of Silicon Valley Bank and Credit Suisse, now would be a good time for boards to consider improving their diversity, and to include age within that.
Policymakers should also be interested in the findings. In 2015 The Basel Committee on Banking Supervision explicitly specifies that the complex nature of banking operations calls for banks’ boards to include a diverse set of directors. Our results support this, and regulatory bodies’ inducement of companies to increase diversity in their boards more generally.
There are some wider findings, too, for other publicly traded organisations or those that have non-executive directors. It stands to reason, as a more general rule, that those boards that are more deliberate and essentially give executives a harder time can be more effective, delivering higher-quality reporting and reducing risk overall.
Boards need younger and older executives
But just putting in place one person of a different age – whether older or younger – does not make for an age-diverse board. Any conscious attempt to improve the age diversity of a board will typically require a concerted effort to extend the age profile of the board at both ends of the spectrum, taking on younger and older people.
For some organisations, this will mean actively extending the potential pool of candidates for non-executive roles and not rejecting people on the basis that they may be too young.
It also means boards should avoid thinking that someone already in place may be too old. They may even look to welcome individuals who are instinctively prone to challenge, rather than overlooking them.
All this fits with other studies that have regularly demonstrated the benefits of having more diverse workforces in general. Age diversity should be seen as a central part of this, and should be welcomed rather than feared.
Janahi, M., Millo, Y. and Voulgaris, G. 2022. Age diversity and the monitoring role of corporate boards: evidence from banks. Human Relations.
Janahi, M., Millo, Y. and Voulgaris, G. 2021. CFO gender and financial reporting transparency in banks.
The European Journal of Finance, 27, 3, 199-221.
Yuval Millo is Professor of Accounting and teaches Financial Statement Analysis & Security Valuation on the Undergraduate programme plus Financial Analysis on the Executive MBA and Distance Learning MBA. He also lectures on Financial Reporting & Financial Statement Analysis on the MSc Accounting & Finance.
Follow Yuval Millon on Twitter @yuvalmillo.
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