More women on boards makes companies more ethical

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Article by Professor Haithem Nagati, Emlyon Business School

Over the last two decades there has been a huge shift in the importance of ethics in most businesses, this is because it not only helps ensures a good reputation for your company which means good business, but it also means you treat employees well and therefore attract the best talent.

Business ethics refers to what is considered morally right and wrong conduct. So, these guidelines go beyond what the law says, business ethics enhances the law by outlining acceptable behaviours outside of government control.

Almost every busines has a set of ethics guidelines in place, but with that being said, the quality can vary and as we have seen due to several scandals over the years, standards can slip, and mistakes are made.

An example of what can be seen as unethical business is related-party transactions (RPTs), which are more commonly known as backdoor deals. These are a deal or arrangement that is made between two parties who already have some form of a relationship, whether it is a pre-existing business one, or just common interest.

Whilst they are seen as unethical by many, RPTs do happen often, but policymakers globally are trying to reduce this occurrence. This is because RPTs have potential to have a conflict-of-interest which are usually deemed to be value-destroying. These transactions might be associated with insiders’ opportunistic behaviour, expropriation of minority shareholders and managerial rent extraction.

In short, many RPTs may not be done with the business’ best interest in mind, and so for this reason, many companies have strict methods to regulate if/how RPTs take place.

In most companies, the power to approve any RPT is exclusively down to the board of directors, specifically the audit and control committee. Every time someone wishes to do an RPT that entails or might entail any conflict of interest, or corporate assets, the board of directors will conduct a report on the proposed transaction.

Until this report has been done, the transaction is not allowed to be approved. Companies have this process in place to regulate RPTs as much as possible, and prevent any transactions with a conflict of interest taking place, but unfortunately this doesn’t always work.

So, what can companies do to prevent RPTs from taking place? According to our research, by having more women on their boards.

In our study, my co-authors, Mehdi Nekhili from Le Mans University and Moez Bennouri from Montpellier Business School, and I investigated the relationship between gender diversity and RPTs.

We used the introduction of the gender quota law in 2011 to help compare the effects of having more women on boards. We used a sample of 97 French firms, both before and after 2011, and counted the number of RPTs listed in the companies’ special reports.

After this, we compared the number of RPTs to the number of women on the board of directors, focusing on three key positions of female directors: inside directors, independent directors, and audit committee members.

This comparison highlighted a significant negative correlation between the proportion of female directors and the number of RPTs that took place, which brought us to the conclusion that having more women on boards can make a business more ethical.

We found that the more women that are on the board of directors, especially if they are independent directors and audit committee members, there are less RPTs that are approved. This is because women have more independence and involvement in boards, and are therefore more likely to challenge managers use of RPTs.

Furthermore, a woman’s demographic, social, and psychological differences from their male peers actually provides them with additional means an incentive to carry out strict monitoring. In other words, they are more motivated because of the risks associated with validation of questionable and disputed transactions.

The reason for this is because the majority of these women who have earned their place on the board of directors, have had to break through the glass ceiling and work incredibly hard to get to where they are. As a result, they are more inclined to assert their role as a substitute for weak protection of minority shareholders and weak regulation of RPTs.

Our research suggests that board members need to have the ability and motivation to monitor managers effectively, and this is why we suggest that female independent directors and female audit committee members are good candidates to effectively perform this task because of their attributes.

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