Board Diversity and Stock Price Crash Risk

Subject: Management
Pages: 2
Words: 589
Reading time:
3 min
Study level: PhD

The main cause of the stock crash is the hoarding of bad news by management. However, a diverse board has the potential to positively influence the same by minimizing future crash risk. Board diversity entails the incorporation of different attributes, characteristics and skills pitched independently by members regarding planned processes and decision-making practices. There are two dimensions of board diversity: task-oriented ones that refer to work based differences such as education and relation-anchored diversities, for example, gender and age. Both diversities independently influence crash risk at any given organization (Jebran, Chen and Zhang, 2020, p. 2). For instance, a female-dominated board is averse to taking risks while the one that comprises millennials is more likely to embark on perilous ventures and have high chances of financial restatements. Collectively, gender and age can help diminish a board’s risk-taking capacity, income management, and information opaqueness resulting in quality financial reports thus lessening cash risk. Alternatively, education and tenure help minimize crash risk. Boards made of members with different levels of education have lower motivation to take part in earnings management while tenure-diverse ones are less likely to face financial restatements as they are more discrete. Therefore, task-oriented diversities reduce crash risk by limiting the suppression of negative news by management and increasing the monitoring performance by a board.

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Different theories elaborate on the impact that board diversities have on corporate governance. Diverse boards are more likely to have multiple resources such as knowledge and expertise from the members thus easily making decisions and achieving objectives, as stated in the resource dependency theory. On the other hand, the agency theory states that a diverse board is likely to share information and improve the monitoring of management. This, in turn, minimizes agency costs, increases information symmetry, and creates a good reputation. Stock price crash risk is highly dependent on the agency theory concerning the dissemination of information (Jebran, Chen and Zhang, 2020, p. 9). Withholding negative news from the public results in a stock crash, a massive decline in the cost of capital. Managers suppress bad news from the market allowing them to accomplish personal interests such as promotions and compensation. However, upon reaching a certain threshold, the negative news piles up and can no longer be withheld. This forces the management to release all information at once into the market thus causing a tremendous drop in the stock price.

Jebran, Chen, and Zhang (2020, p. 17) affirm that future stock price is reduced by a large overall board diversity, that is, both task and relation-oriented diversities. As the diversities broaden, the stock crash lessens since board decisions are a result of collaborative agreements among corporate members. For establishments with low organizational possession and high information opacity, the effect of board diversity on subsequent cash risk is enormous and the opposite is also true. Relation diverse boards reduce the asymmetry of information in the market, which promotes transparency through improved dissemination of stock price data to the public. They also improve on timely action to prevent the negative reputation that may arise because of delays. On the other hand, task-oriented boards incorporate resources, perspectives, expertise, and backgrounds to increase efficiency in monitoring, minimize interior conflicts, and improve corporate governance. Board diversity positively influences stock price cash risk by putting into consideration the individual contributions of corporate members such as knowledge and skills irrespective of age or gender before making any decision. Diversity allows a board to prevent a stock crash in the market by limiting the amassing of bad news by the organization.

Reference List

Jebran, K., Chen, S. and Zhang, R. (2020) ‘Board diversity and stock price crash risk’, Research in International Business and Finance, 51, pp. 1-19.