The Downside of Cultural Diversity on Corporate Boards

Diversity in corporate boards is a hot topic. We contribute to the debate on the role of diversity by empirically documenting that greater national cultural diversity in corporate boards leads to lower performance at UK firms accounting for more than 95 percent of the market value of London Stock Exchange-listed companies. The negative impact is economically significant, with a reduction in return on equity of 1.43 percent for firms with higher levels of cultural diversity (those at or above the 75th percentile) versus firms with lower levels of cultural diversity (those at or below the 25th percentile). Why do we observe such a strong negative relationship? In the academic literature, diversity is often referred to as a double-edged sword, meaning it can have positive and negative effects. In terms of positive attributes, diversity is seen as a means to bring different perspectives to the board, which will ultimately lead to better decision making. In the case of cultural diversity, these different perspectives may refer to different world views, different approaches to problem solving, and also variations in market-specific and cultural knowledge. In terms of negative attributes, diversity creates communication difficulties and may lead to personality clashes. Differences in points of view may be interpreted as personal attacks or the promotion of hidden agendas, which may lead to reduced effort and commitment to the group. In addition, diversity may reduce trust. These negative aspects are observed in the context of cultural diversity, where trust among members of the same culture is higher than among members from different cultures. Our empirical finding of the negative relationship between cultural diversity in corporate boards and firm performance indicates that cultural diversity makes boards less efficient.