Does board diversity mitigate risk? The effect of homophily and social ties on risk-taking in financial institutions

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