Banking on Diversity: Does Gender Diversity Improve Financial Firms’ Risk Oversight

SMU Law Review Volume 70 | Issue 2 Article 5 2017 Banking on Diversity: Does Gender Diversity Improve Financial Firms’ Risk Oversight Kristin N. Johnson Seton Hall University, Follow this and additional works at: https://scholar.smu.edu/smulr Part of the Law Commons Recommended Citation Kristin N. Johnson, Banking on Diversity: Does Gender Diversity Improve Financial Firms’ Risk Oversight, 70 SMU L. Rev. 327 (2017) https://scholar.smu.edu/smulr/vol70/iss2/5 This Article is brought to you for free and open access by the Law Journals at SMU Scholar. It has been accepted for inclusion in SMU Law Review by an authorized administrator of SMU Scholar. For more information, please visit http://digitalrepository.smu.edu. BANKING ON DIVERSITY: DOES GENDER DIVERSITY IMPROVE FINANCIAL FIRMS’ RISK OVERSIGHT? Kristin N. Johnson* TABLE OF CONTENTS I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II. SENIOR MANAGEMENT AND BOARDS OF DIRECTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III. WHY BUILD DIVERSE BOARDS? . . . . . . . . . . . . . . . . . . . . . A. ENHANCED FINANCIAL PERFORMANCE . . . . . . . . . . . . . . . . 1. Studies Finding a Positive Relationship Between Gender Diversity and Firm Performance . . . . . . . . . . . 2. Studies Finding a Negative or Inconclusive Relationship Between Gender Diversity and Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. BETTER GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Misconduct Risk Related Governance Failures . . . . . 2. Excessive Risk-Taking Related Governance Failures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. ALTERNATIVE RATIONALES . . . . . . . . . . . . . . . . . . . . . . . . . . . IV. WOMEN ON CORPORATE BOARDS: A STRATEGY FOR IMPROVING RISK OVERSIGHT . . . . . . . . . . . . . . . . . A. EMPIRICAL EVIDENCE ON WOMEN AND RISK MANAGEMENT IN FINANCIAL INSTITUTIONS . . . . . . . . . . . B. EVIDENCE DEMONSTRATING EFFECTIVE USE OF RISK MANAGEMENT TOOLS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. Conventional Risk Management Tools . . . . . . . . . . . . . 2. Governance as a Risk Management Tool . . . . . . . . . . 3. Culture as a Risk Management Tool . . . . . . . . . . . . . . . V. DIVERSIFYING STRATEGIES TO MITIGATE RISK EXPOSURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. INSTITUTIONAL INVESTORS, SHAREHOLDER PROPOSALS, AND BOARD DIVERSITY INITIATIVES . . . . . B. CIVIL RIGHTS LEGISLATION . . . . . . . . . . . . . . . . . . . . . . . . . . . 328 332 337 338 339 342 344 345 349 352 356 356 359 359 360 362 363 364 366 * Professor of Law, Seton Hall University Law School; B.S., Edmund A. Walsh School of Foreign Service, Georgetown University with honors; J.D., University of Michigan Law School. For his careful review of earlier drafts, I thank Carlos Lopez. For significant research assistance, I thank my research assistants Yolanda Bromfield, Beata Safari, Sarah Wilbur, and Carla Zavala. 327 328 SMU LAW REVIEW [Vol. 70 C. DERIVATIVE LITIGATION: A RISK MANAGEMENT CASE STUDY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373 VI. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376 I. INTRODUCTION I N 2007, a financial crisis ensconced global markets. As details of the crisis began to unfold, scholars raised questions regarding the influence of certain structural and organizational dynamics within the financial firms at the center of the crisis. For almost a century, a complex web of federal legislation has aimed to protect taxpayers from the negative consequences of financial institutions’ business decisions.1 Banking laws, for example, include specific capital and reserve requirements, governance mandates, and detailed licensing standards to reduce systemic risk.2 Federal securities laws include an intricate mandatory disclosure framework created to protect investors and to promote efficient and transparent markets.3 In the run up to the financial crisis, financial market participants intentionally engaged in regulatory arbitrage, designing financial products that had features removing them from the ambit of regulatory oversight.4 After the crisis, risk management scholars posited that the market participants who created and traded these financial products in the shadows of financial markets may have been influenced by an insular culture within financial firms, a culture that encouraged excessive risk-taking.5 Adding 1. See infra Part II. A. The term “financial institution” refers to investment banking firms, bank holding companies, and traditional depository banks or thrifts that engage in investment businesses in the financial services industry—including custodial, brokerage, lending, and underwriting services for securities and other assets, insurance companies, hedge funds, private equity funds, and mutual funds. ANTHONY SAUNDERS & MARCIA MILLON CORNETT, FINANCIAL INSTITUTIONS MANAGEMENT: A RISK MANAGEMENT APPROACH 97–103 (6th ed. 2008). The literature also refers to financial institutions as financial intermediaries. RICHARD S. CARNELL ET AL., THE LAW OF BANKING AND FINANCIAL INSTITUTIONS 36–38 (5th ed. 2013). 2. For a discussion of systemic risk see Kristin N. Johnson & Steven A. Ramirez, New Guiding Principles: Macroprudential Solutions to Risk Management Oversight and Systemic Risk Concerns, 11 U. ST. THOMAS L.J. 386, 426 (2014); See Kristin N. Johnson, Macroprudential Regulation: A Sustainable Approach to Regulating Financial Markets, 2013 U. ILL. L. REV. 881, 897 n. 103 [hereinafter Macroprudential Regulation]; Iman Anabtawi & Steven Schwarcz, Regulating Systemic Risk: Towards an Analytical Framework, 86 NOTRE DAME L. REV. 1349, 1351 (2011); Steven L. Schwarcz, Systemic Risk, 97 GEO. L. J. 193, 204 (2008). 3. Id. 4. The primary government inquiry into the causes of the financial crisis found that “stunning instances of governance breakdowns and irresponsibility” within financial firms drove all aspects of the crisis as a key cause. FINANCIAL CRISIS INQUIRY COMMISSION, FINANCIAL CRISIS INQUIRY COMMISSION REPORT xix (2011). 5. See, e.g., Arthur E. Wilmarth, Jr., The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-to-Fail Problem, 89 OR. L. REV. 951, 954 (2011); The Causes and Current State of the Financial Crisis Before the Financial Crisis: Hearing Before the Financial Crisis Inquiry Commission (2010) (Statement of Sheila C. Bair, Chairman, Fed. Deposit Ins. Corp.), http://fcic.law.stanford.edu/documents/view/2144 [https://perma.cc/ 8SWG-GJEC]; Viral V. Acharya & Matthew Richardson, Causes of the Financial Crisis, 21 2017] Banking on Diversity 329 to the precipitating conditions that contributed to the (...truncated)