International diversity of boards in Ukraine

International diversity of boards in Ukraine

ECONOMICS RESEARCH COMPETITION, FALL 2013
RESEARCH PROPOSAL
Project leader – Kateryna Kondrunina (Sumy State University, Ukraine)
International diversity of boards in Ukraine: implications for corporate governance and
performance
With the current trends of globalisation aiming at growth, development and effective cooperation, no
country can stand beyond the implementation of the best global practices and standards. At this moment
many companies are active in a broad set of different environments. Thus, the essential issue is how those
differences are best handled in setting up the strategy for the firm. Since the board of directors (as the
internal corporate governance tool) is called to monitor and support the top management in strategic
development, a natural question is whether the board will do a better job if it includes members with the
diverse set of backgrounds, and whether this diversity can make any impact for the corporate governance
system and performance.
While such aspects of board diversity as gender, for example, are largely studied for now, the place of
non-residents and their correlation with the performance lacks research with regard to different contexts.
In addition, in an ever-more-global business environment, the international dimension of diversity plays a
particularly important role (Marcus, 2012). Having an international member on the board is now almost a
standard for Europe’s top companies as reported by Egon Zehnder International (2012)1.
Ukrainian companies can strive to follow this trend of boardroom globalization due to several reasons: the
practice and experience of foreign corporations (as mentioned above); expectations about the benefits the
foreign directors can bring; complying with the good practices of corporate governance (which can work
as additional advantage for investors’ perception or stock exchange listing rules) and so on. However, the
matter is whether this concept can really make an impact on performance and add value in Ukrainian
corporations or it’s just a “fashion” to have international board member. Hence, the purpose of the
research is to examine the relationships between the internationality of the board and corporate
performance in the context of Ukraine.
The research question of this study is as follows: Is there a relationship between the internationality of
the board members and performance of the Ukrainian companies? The research question can be thus
targeted by the examination of the following sub-questions:
-
1
How does the international diversity affect the corporate performance of the Ukrainian corporations?
“European Board Diversity Analysis 2012” - the study is organised by the Global Diversity and Inclusion Council at Egon
Zehnder International. More details about the methodology of the survey, data mining and other results could be found at
http://www.egonzehnder.com/files/european_diversity_analysis_2012_1.pdf
-
Whether the benefits of importing foreign Board member outweigh the costs associated with that?
-
Does the “globalised” board act as a more value-adding boardroom?
-
Whether the composition of the Ukrainian boards reflects the level of the international expansion of
the firms?
-
Does the presence of foreign Board members influence the quality of the corporate governance of the
firm?
Even though the research question is focused more on the performance, it could also be elaborated to
understanding whether this directors’ import could improve the overall picture of the corporate
governance quality in Ukraine. Hence, practical contribution of the research is the assessment of the
necessity of the international board diversity in the Ukrainian corporate context, which can be then
implemented in a national codes or principles of corporate governance. For example, one of the
supportive principles of the UK Corporate Governance Code is to search for board candidates with due
regard for the benefits of diversity on the board (The UK CG Code, 2012). Thus, the new draft of the
Principles of corporate governance of Ukraine (NSSMC, 2008) can potentially develop the results of this
research. Moreover, with the introduction of quotas and targets for gender diversity in many countries
during the past two years (Deloitte Global Center for Corporate Governance, 2012), this project can
contribute to the national discussion of another form of diversity. At the same time, the employment
procedures for the foreigners are quite difficult and the obtaining the permits can be a problematic issue,
hence the justification of the value which international board member potentially add, may act as a good
policy action. The policy-level approach to the topic (at least in the framework of voluntary rules and
recommendations) may mitigate the obstacles of Ukraine’s move towards the best global practices,
improvement of investment climate, integration into the world market and, especially, the effectiveness
evaluation of such practices in the national dimension.
With regard to the research focus the following hypotheses are suggested to be tested.
Firstly, it’s worth testing whether the composition of the board in the aspect of the foreign board members
presence, is correlated with the level of transnationality of the firm. Therefore, the initial hypothesis is:
(H1) The composition of the board reflects the level of international expansion of the company.
It is expected that the null hypothesis will be rejected, and the idea of international diversity in
composition of the board (as one of the reflectors of the levels of globalisation) will be supported.
The 2nd hypothesis is suggested to be as follows: (H2) The international diversity within the boardroom
of a company in Ukraine influences firm performance. It is expected to find the evidence supporting the
possible positive effect of having foreign directors on corporate performance, especially for the
companies with the substantial international operations.
And finally it’s worth testing whether the presence of foreign board director is associated with the better
corporate governance quality. Hence, the 3rd hypothesis is: (H3) International board diversity leads to the
better corporate governance quality.
Literature review
The board of directors is among the main corporate governance mechanisms. Huse (2007) defines
corporate governance as the interaction between external, internal actors and board members who aim at
directing the company to the value creation. Thus, as he explains it, the board effectiveness is closely
connected with the corporate value creation (Huse, 2007).
As Demb and Neubauer (1990) emphasise the board of directors could add value to the corporation via
exercising at least three of their main roles. More specifically, they name monitoring management,
helping and assisting in formulation of the corporate strategy and responsibility for identifying and
prioritising standards for company among them.
The board of directors, being one of the most important internal corporate governance mechanisms and
potential value-adding tool, has attracted the attention of researches for many years, including the
assessment of boards’ composition influence on firm performance. The correlation between the board
diversity in the designing the boardroom and the company’s performance is among the commonly
discussable topics nowadays in the area of corporate governance.
Despite the increasing acceptance of the importance of diversity and benefits it can bring, the empirical
evidence on the issue is mixed (Rhode & Packel, 2010) and the relationship between the heterogeneity
and firm value depends highly on the choice of the performance variables (Smith et al., 2005). For
example, Erhardt, Werbel, and Shrader (2003) find a positive relationship between the board diversity and
various measures of firm performance for the U.S. companies. They report the positive correlation
between gender and minority representation and such performance measures as return on assets and
return on investment. Carter et al. (2002) also explore the positive effects of board diversity on Tobin’s Q.
They emphasize that the diversity contributes to the shareholder value creation (Schwizer et al., 2011)
through the better understanding of the diverse market needs, evaluation of more alternatives and more
effective global relationships.
At the same time, the negative correlation is also reported by the existing studies. For instance, Zahra and
Stanton (1988) investigate that the ratio of board member minorities, including women, was inversely
related to the company’s performance in terms of profitability. They reported no significant relationship
between diversity and such indicators as ROE, sales to equity, earnings per share, or dividends per share
for Fortune 500 firms. Another study concerning non-American companies finds that for the Norwegian
firms there is a negative relationship between diversity and market-to-book ratio (Bøhren and Strøm,
2006).
Even though the diversity includes a number of attributes, as this is:
“..the combination of the different qualities, characteristics and expertise of the individual
members in relation to decision-making and other processes within the board” (Van der Walt
and Ingley, 2003),
meaning background, experience, education, age, nationality etc., the huge mass of research and public
interest concentrate often on the gender diversity. Nevertheless, even though there is little academic
research existing beyond gender diversity (Anderson et al., 2011) certain interesting conclusions
concerning the specific component of diversity, which is the representation of the foreigners, started to
appear recently. Moreover, there is an observed trend of increasing board diversity on the dimensions
other than gender. For example, Egon Zehnder International (2012) in its report “European Board
Diversity Analysis 2012” emphasizes that:
“Boards are simultaneously becoming more diverse in other ways too [besides gender diversity],
as is evident in the sharp increase in non-national directors since 2010.In 2012, 32% of the board
members of Europe’s top companies were non-nationals, against 27.8% in 2010 – reflecting an
increasingly international outlook”.
The Egon Zehnder International report (2012) also shows that one in three board members across Europe
is non-national to the date. According to the report, this evidence is the sign of the European boards’
awareness of the value of diversity, especially taking into account that boards are becoming smaller,
while companies go far beyond the borders and thus need a wider range of individual board member
skills.
To conclude, the issue of the board composition and effects on performance has the mixed evidence.
However, as Ferreira (2010) highlights the main conclusions from the academic literature in the field of
board diversity can be stated as follows:

Different types of companies (in terms of industry, region etc.) tend to choose different levels
of director heterogeneity

Firms select directors as a tool to deal with the external environment

CEOs and top executives appear to prefer directors with the similar characteristics as they have

Social networks and backgrounds affect director appointments in dynamic and complex
environments

Directors from minority groups very often perceive their status as a barrier.
One of the most up-to-date and grounded multinational studies in the field of international board
diversity is presented by Miletkov et al. (2012). Miletkov et al. (2012) examine the within- and crosscountry determinants of having the foreign independent directors and their influence on performance,
using a data from 98 countries. They conclude that the decision of importing the foreign director is
determined by the trade-off between the costs and benefits associated with the appointment. They found
no significant relation between the international diversity and firm performance in countries that seem to
benefit from the internalisation the most (i.e. less wealthy countries with smaller population and lower
levels of human capital development) and reported negative relation for countries with developed equity
markets and higher legislative and educational levels.
Masulis et al. (2011) examine the impact of foreign directorship from the position of the costs and
benefits associated with it among the U.S. firms. They find a negative relation between foreign
independent directors and firm performance for the U.S. companies, especially in those cases, when the
foreign director’s home region is not represented significantly in the firm’s operations. Nevertheless, they
emphasise that with the companies having sufficient ratio of sales in the foreigner’s region or aiming at
cross-border acquisitions with the targets from director’s region, the impact of having foreign directors is
determined by the positive effects on performance due to their international background and expertise.
Both studies by Masulis et al. (2011) and by Miletkov et al. (2012) evaluate the effects of international
diversity on performance taking into account the country-specific characteristics. They claim that
basically for countries with weak investor protection and poorly-developed equity markets the benefits of
having a non-resident director (especially when he/she is imported from the country with the higher
corporate governance levels) outweigh costs associated with it, while for wealthy countries with highquality legal and educational systems, such as the USA, for instance, the net impact on performance is
significantly negative.
According to Giannetti, Liao, and Yu (2012), who studied the Chinese perspective of foreign board
members, hiring such directors usually leads to higher firm valuation, productivity and profitability.
Moreover, companies with international board diversity are more likely to make cross-country
acquisitions and raise of capital through the direct private placements abroad (Giannetti et al., 2012).
Staples (2007) defines the globalisation (or internationalisation) of the boards as the process of an
appointing the board members who are not the citizens of the parent enterprise country. Thus, a “nonnational director” is an individual whose citizenship (or alternatively the nationality) is different from the
home country of the company. Another measurement of board globalisation, which is used in the studies,
is the number of different countries represented on the board.
The reasons for picking up the non-national board members could cover a number of aspects. The
globalisation of the boardroom could lead to the increased awareness of the cultural and social norms,
business environment, political connections etc. in the countries other than the home one. Moreover, it
can also provide the knowledge of the foreign markets, ensure networking and better monitoring (Ryan,
2013). At the same time, board globalisation can be associated with the increased costs and coordination
problems.
The recent literature offers an insight towards the particular benefits and costs which the appointment of
the international board member can bring to the company. The observed benefits are highly important for
the companies, which operate globally and are dependent on international environment and decisions. At
the same time, there are a number of costs because of this heterogeneity. A brief summary of the
associated costs and benefits is presented in the table 1.
Table 1
Costs and benefits of foreign directorship for the firm
Benefits
Costs
Expertise
Reduced communication due to cultural and
language difference
Networking and connections
Lack of physical proximity to the companies
Improved monitoring of owners, managers and Demand of higher compensation
other directors
Variety
of
backgrounds,
views
and Coordination problems
experiences
Thus, the effects of the international diversity still remain questionable and the evidence is mixed. The
decisions towards the heterogeneity of the board are determined by the trade-off between the costs and
benefits of the certain components of diversity, which emphasizes the importance of the optimal choice of
composition, with the profile of the country (the development of its equity market, legal and educational
institutions etc.) having an impact on its linkage to performance. As indeed according to Palmer & Varner
(2007) national composition of the board could be determined by the country national views and patterns.
Hence, the project’s contribution might be to reveal the trends and inter-dependencies for Ukraine as the
country with the transition character of economy, where foreign trade, access to the global resources and
knowledge, and complying with the best practices play an especially important role. Moreover, it’s worth
understanding whether the Ukrainian perception of benefits and costs associated with the foreign
directorship follows the international trend and, as a result of the diversity-performance assessment,
prevent Ukrainian corporations from ineffective decisions.
Research strategy
Data set
The sample of the companies under consideration will cover 94 companies –stock issuers, summarized by
the investment company Concorde Capital in its fourth survey of corporate governance standards and
practices among Ukrainian publicly traded companies “Corporate Governance in Ukraine – May 2013”
(Concorde Capital, 2013). They evaluate corporate governance of the companies in the rating, based on
ten criteria in the areas of accounting and disclosure of information, protecting minority shareholder
rights, investor relations and public face. The data concerning variables and determinants of performance,
firm-specific characteristics and so on will be collected manually from multiple sources, such as Orbis
database (a product of Bureau van Dijk Electronic Publishing), web-sites of the companies, annual reports
of the companies, Stock market infrastructure development agency of Ukraine (SMIDA).
Methodology
As has been mentioned above, the research question of this study is whether there is a relationship
between the internationality of the board members and performance (with the potential impact on
corporate governance quality) with three hypotheses to be tested:
(H1) The composition of the board reflects the level of international expansion of the company.
(H2) The international diversity within the boardroom of a company in Ukraine influences firm
performance.
(H3) International board diversity leads to the better corporate governance quality.
The performance will be assessed using the Return on Assets (ROA) indicator. The work is related to a
certain extend to the Miletkov et al. (2012) study and thus uses the analogues definition of the foreign
directors. The director is treated as the foreign one, when he/she is based in other geographical location
than the country of firm’s incorporation or has different nationality. Moreover, I also follow the same
logics with determining the variables to report the presence of foreign directors in the boardroom. In
particular, I will use a measurement of the percentage of the international board members in the company
boards and indicator variable, which will reflect the general phenomena of board nationality
heterogeneity by awarding those companies who have at least one international director with 1 and 0
otherwise.
Within the first research phase I plan to present some key summary statistics for the corporations in the
sample, including summary on the variables used in the paper and their definitions as given in the table 2.
Table 2 Definitions of main variables
Variable
Definition
FD
Indicator variable of the presence of foreign
director in the board (1 – if there is at least one
international director, 0 – otherwise)
FD percent
The number of foreign directors to the total
number of board members
Foreign sales
Foreign sales as a percent of total sales
Foreign assets
Foreign assets as a percent of total assets
ROA
Return on assets measured as net income
divided by average total assets
Board size
Number of directors in the company board
Corporate governance quality
Value of the corporate governance quality
rating for a given company in a given year
Industry
Controlling variable. An industry where a
company operates.
The strength of the testing relationships and variables will be assessed using the regression analysis. For
the hypothesis, which assumes the alignment between the degree of firm international expansion and
board internalisation the analysis is carried out using the regression approach. Next, in order to explore
the effect of board internationalisation on firm performance the ordinary least squares (OLS) regressions
method is offered, where ROA is the dependent variable. It’s planned to estimate OLS regressions of
ROA against the presence of foreign directors while controlling for a wide array of other related
characteristics.
In order to investigate how international heterogeneity affects firm performance and make it reliable and
credible, we should take into account the control variables to avoid flaws. With regard to the previous
researches (Kaczmarek, 2009; Miletkov et al., 2012) I plan to include the following main control
variables in the model:
- Company size – to be defined as the natural logarithm of total sales; because larger companies tend to
expand globally more often due to the scale advantages
- Board size – to be defined as the natural logarithm of the total number of board members; because with
larger boards the likelihood of foreign directors’ presence is higher.
As far as ‘long’ models of companies’ performance usually suffer endogeneity and multicollinearity some
instruments are needed to resolve the problem. The alternative way to avoid endogeneity and
multicollinearity problem is to run a reduced-form equation. For example, to examine the influence of the
international board diversity on firm performance, the following regression equation can be suggested :
ROA = β0 + β1*FD % + β2*Ln(board size) + β3*Ln(total sales),
where ROA is return on assets and FD % is the percentage of the foreign directors in the boardroom;
logarithmic values of board size and total sales are the control variables in the model.
The model could lead us to the minimal description of the effect, because the real effect is higher due to
the internationality aspects such as international education, experience etc. which are difficult to measure
and are not included in the model. Thus the diversity variable is underestimated here, leading to the claim
about the observed minimal effect which can be expanded.
Limitations
The key limitation concerns the non-nationality of the directors. The phenomena of being “non-national”
can be described as quite complex and wide, including international experience, education etc., which, as
a result, is extremely difficult to observe and measure, hence the research will only consider the formal
nationality of the board members, which we can obtain from the corporate reports, CVs of the board
members and other above-mentioned sources. Moreover, some difficulties concern also the duality of the
reported nationality of the board members. In such cases I consider the nationality, which is foreign with
regard to the company home country, because this still shows board member’s international background.
The performance of the company can be measured with several variables, but I consider here only ROA,
even though I’m aware of the fact that ROA can be highly influenced by the leverage and is significantly
dependent on the industry.
In addition, I’m aware that there are more complicated ways of approaching the problem with the
regression; however they can be presented in the future researches.
Expected results
We expect to find that the more the company is involved into foreign trade and have substantial foreign
operation, the more the chances that there will be foreigners in the board. Due to the specific transition
profile of the country the companies are expected to benefit from the international board diversity due to
his/her international background, networking, expertise and skills. Moreover, I expect to find that
following this trend of boardroom globalisation the companies will show the better corporate governance
quality, which as a result can be turned as the performance improvement reason.
BIBLIOGRAPHY
Anderson, R., D. Reeb, A. Upadhyay and W. Zhao, 2011. The economics of director heterogeneity.
Financial Management, Vol. 40, pp.5 - 38
Bohren, Ø. and R. Strom, 2005. The value creating board: theory and evidence. Research report. BI
Norwegian School of Management. Department of Financial Economics, Oslo
Carter, D., B. Simkins and G. Simpson, 2002. Corporate Governance, Board Diversity, and Firm
Performance. SSRN, viewed 18 September 2013, <http://ssrn.com/abstract=304499>
Challenging board performance: European Corporate Governance Report 2011, Heidrick & Struggles
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<http://www.heidrick.com/PublicationsReports/PublicationsReports/HS_EuropeanCorpGovRpt20
11.pdf>
Corporate Governance in Ukraine – May 2013, Concorde Capital, viewed 3 October 2013,
<http://concorde.ua/en/research/corp-governance/>
Demb, A. and F. Neubauer, 1990. How Can the Board Add Value. European Management Journal, Vol.
8, pp. 156-160
Diversity and Inclusion. Egon International Zehnder, viewed 19 September 2013,
<http://www.egonzehnder.com/global/clientservice/diversityandinclusion>.
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Governance: A Synthesis of Theory, Research, and Practice. John Wiley & Sons, Inc., Ch. 12, pp.
225- 242
Giannetti, M., G. Liao and X. Yu, 2012. The Brain Gain of Corporate Boards: A Natural Experiment
from China. ECGI - Finance Working Paper, No. 343/2013, pp. 1-56
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Cambridge University Press, Cambridge, 392 p.
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Implications for Performance”, Dissertation, University of St. Gallen, Graduate School of
Business Administration, Economics, Law and Social Sciences, Bamberg, Germany
Masulis, R. W., C. Wang and F. Xie, 2011. Globalizing the boardroom – The effects of foreign directors
on corporate governance and firm performance. Journal of Accounting and Economics
forthcoming
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Schwizer, P., M. Soana and D. Cucinelli, 2012. The relationship between board diversity and firm
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Van der Walt, N. and C. Ingley, 2003. Board dynamics and the influence of professional background,
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Державна комісія з цінних паперів та фондового ринку, Рішення від 24 січня 2008 року N 52 „Про
схвалення проекту нової редакції Принципів корпоративного управління України,
затверджених рішенням Державної комісії з цінних паперів та фондового ринку від
11.12.2003 N 571”
PARTICIPANTS
Head of the project – Ms. Kateryna Kondrunina (Researcher at Sumy State University, Ukraine)
ALTERNATIVE SOURCES OF FUNDING
The expected Consortium’s support is 80%, the other part of the value added is due to the increment of
the author.
PROJECT TIMETABLE
2014
Activity
Refinement
of the
research
strategy
Literature
review
Data
collection for
the research
Preliminary
data analysis
Interpretation
of the
preliminary
results, first
research
draft
Discussions
of the
obtained
results;
getting the
feedback and
remarks
Final report
preparation
Submission
of journal
paper/s
Jan.
Feb. March April
May June
July Aug. Sept. Oct. Nov. Dec.