Does Board Diversity Mitigate Risk? The Effect of Homophily and Social Ties on Risk-Taking in Financial Institutions

Research Question/Issue
This study investigates whether greater board diversity and looser social network ties have an impact on board independence and risk-taking in US financial institutions from 2010 to 2022.The econometric strategy involved structural equation models, where risk as a dependent variable was measured by two latent variables and a total of five measures of risk. Several aspects of board diversity were utilized including gender, social, experience and educational backgrounds.

Research Findings/Insights
The findings suggested that diversity in nationality had a significant positive effect, while age and gender diversity had a minor effect on mitigating risk. Two measures of educational diversity had mixed results while suggesting that financial education is associated with greater risk. Also, social networks had a significant effect on risk-taking, especially on market risk.

Theoretical/Academic Implications
The study highlights the importance of maintaining a sensible level of board diversity across all aspects to avoid issues of cohesion and poor communication. This implication arises from the conclusion that too diverse a board might suffer from the lack of cohesion and communication, while a board with very low diversity will not be able to benefit from diverse backgrounds and expertise.

Practitioner/Policy Implications
Results from this study recommend incorporating social networking requirements in defining the independence of directors.