Board Diversity: A Reflection on Improvement and a Look Ahead for the Coming Decade
In the second half of this decade, diversity and inclusion rose to the forefront of top priorities for many companies. Due to evolving social norms, companies began to acknowledge that diverse environments are key factors for promoting growth and competitive advantage. The unique perspectives brought by diverse individuals help companies and boards of directors build a better mousetrap, identifying and evaluating a variety of risks, alternatives and advantages. The results are better decision-making and demonstrated stronger financial performance.
Some Strides for Women, Fewer for Minorities
In 2010, women held only 16 percent of board of directors seats at Standard & Poor’s (S&P) 500 companies and 9 percent of board seats at Russell 3000 companies, while minorities held just over 8 percent of board seats at Russell 3000 companies. In 2019, records were set for board diversity: Women held over 20 percent of board seats at Russell 3000 companies, every company on the S&P 500 had at least one female director (and women held 26 percent of all directorships), and minorities held more than 10 percent of board seats at Russell 3000 companies for the first time.
While significant progress has been made, there’s still work to be done. One woman holding a seat on a large board may not impact decision making and, often, there is overlap with the same women holding board seats for multiple companies.
Much of the energy in promoting diversity has been geared towards adding women to boards, so the progress of minority representation on boards has been slower than gender diversity. For example, in the S&P 500, women were voted into 46 percent of new board seats in 2019, while minorities were voted into 21 percent of new board seats. Despite this growth, representation of both women and minorities serving on boards does not nearly reflect the makeup of the general population.
Change Starts in the Boardroom
To effect change, board members should take an active role in guiding a company culture that values inclusion and human capital. Although 72 percent of male directors believe that their investors are too focused on board diversity (according to PwC’s 2019 Annual Corporate Directors Survey), it continues to be a focal point for investors, employees, customers and other stakeholders. It’s unlikely that efforts to improve diversity will wane any time soon. Institutional investors only seem to be pushing harder for diversity through investment stewardships and affirmatively taking action when they do not see progress. Investment management companies actively seek board diversity based on a number of factors—gender, ethnicity, age and professional experience.
Recent years have held promise:
- In the 2019 proxy season, a global investment management company held true to its 2018 commitment to promote gender diversity by voting against board members at 52 Russell 1000 companies with boards that had fewer than two women on their boards or no other diverse directors.
- In the same time period, another investment management company published standards requiring companies to disclose their perspectives on board diversity, the makeup of their boards and measures to improve diversity, and to conduct broader searches for director candidates in order to add diversity.
- In 2017, State Street Global Advisors (“State Street”) launched the “Fearless Girl” campaign, calling out companies that did not have at least one female director. State Street furthered this campaign in 2019 by announcing that, as a direct result of 57 percent of the companies failing to take action, during 2020 it will vote against all members of the nominating and governance committees in target markets where they have not seen improvement in gender diversity for four consecutive years and have not been able to engage in productive dialogue. (Note that 43 percent of the companies identified in the Fearless Girl campaign responded to the call for action.)
Along similar lines, in October 2019, New York City Comptroller Scott Stringer issued a letter to 56 companies urging them to adopt the “Rooney Rule,” which originated in the National Football League (NFL) and requires companies to consider at least one female or minority candidate for each position (see Shareholder Activism starting on page 21). The comptroller also published a matrix that can be used by companies to assess the composition of their boards and director nominees.
Diversity in the Age of #MeToo
A diverse board can also greatly improve a company’s ability to proactively address issues that impact corporate culture and reputation, such as the #MeToo movement. A board unimpeded by gendered group think is more likely to investigate and/or take actions in the event of allegations of sexual harassment or assault, and even remove officers or directors subject to these accusations.
Confronting these issues up front can help to preserve and increase shareholder value by mitigating the reputational, legal and financial harm caused by such accusations. A company that prioritizes a corporate culture intolerant of sexual harassment will be a more attractive candidate in a mergers and acquisitions (M&A) transaction. It will be in a better position to provide representations and warranties about these matters—which are being requested by buyers more often—and deliver greater value to shareholders by avoiding separate remedies and holdbacks to protect buyers from liability related to sexual harassment lawsuits. The company will also have a competitive advantage in attracting executive talent and employees.
No Sure Path
While there is general agreement that board diversity is important, there is no proven strategy to increase diversity. Governments typically use quotas or disclosure requirements. Many European countries (including France, Germany and Norway) have imposed quotas for several years, and the European Commission (EC) is considering a quota for women to hold 40 percent of nonexecutive director positions of large, publicly-listed companies. As of November 2019, the directive had not been passed and is scheduled to be addressed in the next mandate of the EC.
New Laws in California
California was the first state in the United States to implement quotas in 2018, with bills in Massachusetts, Washington and Pennsylvania under consideration.
California’s law (SB 826) was passed in September 2018. It requires public companies headquartered in California to have at least one female director by the end of 2019 and two to three female directors by the end of 2021, determined by the overall size of the board.
On July 1, 2019, the California Secretary of State Alex Padilla published a report, required under the law, listing the companies whose principal executive offices are located in California and who had at least one female director. The report listed 537 corporations that would be subject to the law, of which 184 had at least one female director on the board. The report did not specify the total number of female directors on a board.
To eliminate data gaps between Securities and Exchange Commission (SEC) filings and the California Corporate Disclosure Statement (which is required to be filed annually by all public companies in California within 150 days after the end of their fiscal year), in May 2019, the secretary of state updated the form of the California Corporate Disclosure Statement to require companies to report whether or not the board has at least one female director.
The next mandated report from the secretary of state, which is due on March 1, 2020, is required to contain information about the number of companies that:
- Are compliant
- Moved to or from California in the prior year
- Ceased to be publicly-traded.
Another potential data point helpful in evaluating the impact of California SB 826 is more detailed information about the number of women on boards and what percentage of overall board size they make up.
Action on Other Fronts
Other states’ federal agencies and the United Kingdom have taken action requiring disclosure. An Illinois law passed in August 2019 requires public companies headquartered in Illinois to submit annual reports about the demographics of their boards and their plans for promoting diversity. The first disclosure deadline is January 1, 2021.
In addition, in February 2019, the SEC clarified the disclosure requirements under Item 401(e) and Item 407(c)(2)(vi) of Regulation S-K. Under these new compliance and disclosure interpretations, a company must discuss if and how any self-identified diversity characteristics were considered in assessing the fitness of an individual to serve as a director and selecting nominees for the board. The goal of these disclosure laws is that transparency will encourage companies to evaluate and improve their diversity efforts.
Will Quotas Work?
Both approaches have potential downfalls. Statutes imposing quotas are still being implemented and it is too soon to gauge whether they have a meaningful impact on improving diversity. Mandated quotas could potentially be interpreted as violating the Equal Protection Clause of the U.S. Constitution and similar provisions of state constitutions, by facially discriminating based on sex.
Also, quotas are not necessarily supported by members of the business community, even women. They have been criticized as micromanaging business and adding “token” women to boards over other qualified candidates. In addition, companies can often comply by expanding the size of the board by one member to add a woman without any meaningful impact. On the other hand, while disclosure laws help shed light on board composition, they do not require any specific actions for improvement.
Progress, but More Work Lies Ahead
Although leaps and bounds have been made in improving diversity, companies must be proactive to keep making progress. While gender diversity has been the main focus during recent years, tackling ethnic diversity ought to and will be the goal for the next decade.
Companies should consider implementing the Rooney Rule and considering a woman or minority candidate for each open board position. They can further diversify board makeup by searching for candidates with expertise that goes beyond the traditional financial skill set deemed attractive for board members—think chief executive officers and chief financial officers. Technology, sales, marketing, regulatory, and environmental, social and governance (ESG) matters will be areas where board skills are in demand.
To keep up with the various trends impacting boards, companies should continue to review and update their diversity policies and board nomination procedures. This includes term limits, refreshment and greater flexibility in requirements for directors.