The Promise of Diversity, Inclusion, and Punishment in Corporate Governance

Motivated in part by a desire to change corporate behavior in a more pro-social direction, a number of governance inclusion mandates have been proposed that would require a corporate board to include diverse individuals or representatives of a constituency. This article applies the economic insights of the Coase theorem to determine if and how such mandates will affect corporate activities. The boardroom is a "Coasian bubble" in which the abilities to bargain and contract are greatly enhanced; inclusion of interests in the boardroom allows those interests to be taken into account. Inclusion also results in some transfer of corporate surplus from shareholders to the newly included. This implies that corporate behavior may not change since all those represented in the boardroom have incentives to maximize corporate surplus. Exceptions are where inclusion enables efficient contracting that was otherwise infeasible or if the included group has significant interests that are subject to corporate externalities. The latter channel is most likely to result in more pro-social corporate behavior since such interests represent significant "skin in the game" for avoiding corporate malfeasance. Skin in the game can also be manufactured through ex post liability, such as by making a represented constituency liable for corporate failures or misbehavior; further, such liability may be necessary so that incentives are not degraded where the constituency receives benefits that are not in the nature of residual claims. Viewed through this lens, constituency mandates, in which directors are accountable to groups with significant interests, show some promise for promoting socially beneficial corporate behavior; diversity mandates, in which diverse but atomistic directors generally lack such accountability (at least as proposed), do not.