New research on RPTs has found an increased female presence on the board results in more ethical outcomes, says Haithem Nagati of Emlyon Business School
Over the last decade, fuelled by a number of corporate scandals, there has been a huge shift in the importance placed on ethics in business.
Business ethics refers to the standards for morally right and wrong conduct in business. The law does partially define good business conduct, but it is important to remember that “legal” and “ethical” are two different things. Business ethics enhances the law by outlining acceptable behaviours beyond a government’s control. Most businesses have ethical guidelines in place in order to promote integrity within the company and their employees, and help gain trust from key stakeholders such as investors and consumers – it makes a company not only a better environment to work in, but also to invest in as well.
That being said, while every company has some form of business ethics, the quality can vary, and as we have seen in the news on many occasions, standards can slip, and mistakes are made.
One example of what can be considered as an unethical business practice is “related-party transactions” (RPTs), also known as back-door deals. The term refers to a deal or arrangement made between two parties who are joined by a pre-existing business relationship or common interest.
Now, RPTs do happen often, but they are usually perceived negatively by outsiders because of the existence of conflict of interests in these transactions – usually deemed to be value-destroying. These transactions might be associated with insiders’ opportunistic behaviour, expropriation of minority shareholders and managerial rent extraction.
In other words, RPTs may not be done with the company’s best interest in mind. For this reason, those companies with high ethical standards have strict methods to regulate if/how RPTs should take place.
Within most companies, the power to approve any RPTs is exclusively reserved to the board of directors, specifically the audit and control committee. They do a report on the transactions which entail or might entail any conflict of interest, or any RPT which uses corporate assets. Until the report by the audit and control committee has been done, the board of directors are not allowed to approve the transaction. This process is in place to regulate RPTs as much as possible, and prevent any unethical transactions taking place. But unfortunately, this doesn’t always work.
So, how can companies further regulate the number of RPTs that take place? According to our research, by having more females 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 found that when there are more women on a company’s board, especially if they are independent directors and audit committee members, there are less RPTs that were approved.
This is generally because a woman’s ability stems from their independence and involvement in boards, and as a result are more likely to challenge managers use of RPTs.
Add to this that a woman’s demographic, social, and psychological differences from their male peers actually provides them with additional means and incentives to carry out strict monitoring. In other words, they are more motivated because of the risks associated with validation of questionable and disputed transactions.
Why is this? Because the majority of these women have had to break through the glass ceiling and work hard to get to where they are, and as a result are more inclined to stand against weak protection of minority shareholders and weak regulation of RPTs.
Monitoring managers effectively
In order to come to this conclusion, we used the introduction of the gender quota law in 2011 to help compare the effect of having more women on boards. We analysed a sample of 97 French firms, both before and after 2011, and counted the number of RPTs listed in the companies’ special reports. We then compared these numbers to the number of women on the boards – we considered three positions of female directors: inside directors, independent directors, and audit committee members.
This comparison revealed a significant negative correlation between the proportion of female directors and the number of RPTs, which allowed us to come to the conclusion that having more women on boards can make companies more ethical. As previously pointed out, RPTs are viewed worldwide as a major policy issue due to the conflict of interest they cause. Many jurisdictions rely on the board of directors (audit committee) to curb the propensity of managers to engage in abusive RPTs.
Our results suggest that board members need to be endowed with the ability and motivation to monitor the managers effectively. For this reason, we suggest that female independent directors and female audit committee members are good candidates to effectively perform this task because of their key attributes. Our research also contributes to the debate on the effectiveness of the gender quota law in terms of its impact on boards’ decision-making processes.
Even though the law does not apply to audit committees and does not distinguish between female inside directors and female independent directors, our results shed light on the effectiveness of the quota law in reinforcing boards’ monitoring role.
In fact, our study reveals that gender quota law has benefited companies by appointing more women to boards, not just because it makes them meet their quota but because it benefits them in the way they run their businesses.
Our results contradict the idea that the quota law is merely symbolic and may exacerbate female tokenism on corporate boards, which has led to some academics and observers to question the legitimacy of female directors newly appointed during the transition period. This shouldn’t be the case as the women deserve their job roles. That said, the gender quota law does need to be improved slightly, to include implementation rules on the positions and attributes of (female) directors required to join boards.
In sum, more women needed to be added to boards because they can make positive changes, such as making a company more ethical. Their different personality traits and experiences compared to their male peers help them to act in a much more ethical way when it comes to RPTs.
About the author
Haithem Nagati is Associate Professor at the Emlyon Business School (France). His research interests focus on corporate governance, CSR and management of supply chain relationships.