Does board diversity reduce the likelihood of financial distress in the presence of a powerful Chinese CEO?

Purpose This paper empirically investigates the impact of board diversity in terms of demographic and cognitive dimensions on financial distress likelihood in an emerging Chinese market to explore whether the Chief Executive Officers' (CEOs) power moderates the relationship between board diversity and the probability of financial distress. Design/methodology/approach To test the hypothesized relationships, demographic diversity through gender, age and nationality, and cognitive diversity through education, expertise and tenure, are taken as independent variables to investigate their impact on the probability of financial distress measured by the Altman China Z score. Data is collected for 13,740 firm-year observations from 2009 to 2018. This study employs panel data regression under fixed effect assumptions. Further, to control the possible endogeneity issue, this study uses a two-step System Generalized Methods of Moments (GMM) model as a robust check. Findings The results reveal that board diversity is positively associated with financial distress Z score, suggesting that diverse boards are helpful in reducing the likelihood of financial distress. Moreover, CEO power positively moderates this relationship. It means that board diversity, in the presence of powerful CEOs, is more effective in reducing financial distress likelihood by controlling the wrong financial decisions taken by top executives to reap personal benefits. Further, the robustness model confirms the relationship between board diversity and the probability of financial distress. Originality/value To the best of researchers' knowledge, this is one of the earliest studies to investigate board diversity by constructing demographic and cognitive board diversity indexes as a determinant of financial distress likelihood in China. Further, researchers found no study in the literature using CEO power as a contextual variable on the relationship between board diversity and financial distress.