Management Accounting

Do Board Quotas Cause Bad Accounting?

While the European Union is now requiring that women comprise 40 percent of a company’s outside directors by 2020, new research suggests it may not...
David McCannAugust 16, 2013

A truckload of academic research performed in recent years suggests that having women CFOs and board members helps companies achieve some important financial goals. Studies have concluded that the presence of women in one or both of those roles causes statistically significant positive results in profit growth, market reaction to acquisitions and equity offerings, bank-loan terms and financial-reporting accuracy.

One corporate response to those findings might be to proactively bring more women into top finance positions and boardrooms. And that’s happening — for whatever reason. The number of female finance chiefs among S&P 500 companies leaped from 40 to 54 in 2012, according to a Bloomberg report. The shift is also evident, albeit at a slower pace, for boards of directors. Recruiting firm Spencer Stuart reported late last year that women held 17% of outside board seats in the S&P 500, up just one percentage point from 2011 but five points since 2002.

4 Powerful Communication Strategies for Your Next Board Meeting

4 Powerful Communication Strategies for Your Next Board Meeting

This whitepaper outlines four powerful strategies to amplify board meeting conversations during a time of economic volatility. 

Still, board diversity is a popular topic, and a number of groups have launched or expanded whose mission is to promote that goal, particularly with respect to women. And under a landmark ruling by the European Commission last November, women must comprise 40 percent of outside board members by 2020 at all companies listed in European Union markets.

But diversity-minded boards at U.S. companies might want to be careful about ratcheting up their female membership too quickly, considering a new study by three professors at Carlos III University in Madrid. The study was presented at the American Accounting Association’s annual conference earlier this month.

The study sought to determine the effect of women board members on accounting quality at 81 companies in Norway, which 10 years ago established a target of 40 percent female membership on the boards of publicly held companies. After only 13% of companies had achieved the target by 2005, the quota was mandated. Companies were required to comply by 2008 or face liquidation.

Through regression analyses that controlled for other factors that could impact accounting quality, the professors found that such quality declined as the Norwegian companies replaced male directors with women, especially in the few years following 2005. The negative effect dissipated in 2009 and 2010, the last years examined in the study.

The authors used as a proxy for accounting quality the prevalence of discretionary accruals, or items recognized on balance sheets or income statements at the time they’re earned or incurred, regardless of when cash actually changes hands. As accruals provide considerable accounting flexibility through the use of estimations and forecasting, they are more subject to manipulation than cash flow is. Abnormally high levels of accruals tend to be regarded as a sign of questionable accounting and earnings management.

The study found that the changes boards had to make to achieve the 40 percent quota resulted in higher levels of unexpected accruals — that is, levels exceeding what would be expected based on growth in sales and other publicly available information. After meeting the quota, companies that had no female board members in 2002 averaged four percent more discretionary accruals over the next few years than did a control group of companies with at least one woman director in 2002, says one of the study’s authors, Mariano Scapin. The same result applied to companies that had to hire two or more women to reach the quota, compared to a control group that had to hire zero or one woman.

(For statistics wonks, the level of abnormal accruals was calculated by dividing the value of such accruals registered in a particular year by the company’s total assets at the beginning of that year.)

For purposes of the study, it was assumed that high discretionary accrual levels equated to lax accounting oversight by the board. But there was no implication in the findings that women inherently influence such laxity. Rather, the study blamed the relative paucity of women with the level of experience that the average male board member had. During the period examined, 2002 through 2010, new women directors were an average of nine years younger than retained male directors and seven years younger than men replaced by women. Only 38 percent of the women had CEO experience, compared to 75 percent of the men.

“These new, qualitatively different boards may have [had] lower monitoring skills than boards before the quota,” wrote the authors — Scapin, Juan Manuel Garcia Lara and Jose Penalva Zuasti. “The monitoring capabilities of boards of directors may be hindered by exogenous shocks, giving managers opportunities to use their discretion to choose a level of accruals that benefits certain stakeholders.”

They also cited other studies that have documented negative consequences resulting from quotas for other kinds of skilled workers.

Photo credit: Creative Commons, Flickr member Nationale Bank van Belgie