Impact of board diversity on firms’ economic sustainability in Sri Lanka

Abstract

Introduction

Sustainability is one of the most recent trends, which has become an integral part of the developing business world. Every type of business regardless of its size should apply sustainability for its success. Economic sustainability is measured in terms of financial performance of a firm. Therefore, sustainable development affects financial performance of the business firm. To increase the financial performance of a firm, it is important to have a diversified board which generates effective decisions for the company. As such, this will set the background for supportive working conditions, thereby enabling economic growth of the company. Variety inherent in boards’ composition referred to as board diversity, can be measured via a number of dimensions, such as gender, ethnicity, nationality, educational background, industrial experience and organizational membership (Kevin Campbell, 2008).

Evidence on board diversity in the recent literature is that it is comparatively low in Sri Lanka (Nirosha Hewa Wellalage, 2013). Increased emphasis on sustainability by firms could have a positive influence on the board diversity in Sri Lanka. Therefore, this study aims to measure the impact of board diversity on firms’ financial performance in Sri Lankan listed companies in 2018. This study draws on agency theory and human capital theory which have been identified from the literature on board diversity. Agency theory discuss the conflicts between the interests of owners and managers. Human capital theory focuses on the experience of board members. It is concerned about how directors’ experience affects firm performance. Furthermore, agency theory and resource dependency theory posit a positive effect of board diversity on firm performance. Agency conflict occurs due to the separation of decision making and risk bearing of a company, and agency problem occurs at any point where the managers have an intention to pursue their own interests (Eugene F. Fama, 1983). Resource dependency theory provides an explanation for a board’s function of providing critical resources to the firm. Moreover, there is a positive linear relationship between board demographic diversity and firms’ financial performance. This means that board of directors were in a position to provide better resources to the knowledge intensive firms (Muneza Kagzi, 2017).