January 21, 2021

Board Diversity – a Passing Fad or the Wave of the Future?

7 min

In late 2020 California Governor Gavin Newsom signed Assembly Bill 979, which requires publicly held corporations headquartered in the state to diversify their boards of directors. This bill was modeled after Senate Bill 826, signed into law in 2018, which similarly required publicly held corporations headquartered in California to include women on their boards. Driven at least in part by these legislative measures, businesses across the country are beginning to diversify their boards. In this Q & A, Venable partner Belinda Vega discusses the pros and cons of government mandates, how diversity impacts companies' bottom lines, and why this trend is likely to continue.

How did the California laws related to board diversity come to be?

The idea of actually having the government get involved in mandating board diversity is really something that came from Europe. A lot of European countries have implemented mandates, which have been very successful. So, I think, Europe is leading the way to begin with, and then California is leading it here in the U.S. by passing gender diversity legislation in 2018. The follow-up legislation mandating the inclusion of minority groups on boards was part of a package of racial justice measures signed by Governor Newsom against the backdrop of the social justice movement that was invigorated by reactions to recent police shootings this past summer. The national social justice movement brought heightened attention to the importance of diversity and inclusion, and we saw many high-profile companies making statements on the issue in its immediate aftermath. In support of the bill, the California legislature cited numerous studies showing the lack of minority members serving on public company boards. At the time, 35% of publicly traded companies headquartered in California had all-white board members.

So, have these combined legislative measures done anything to change that?

We are already seeing the impacts of the gender diversity bill, which, according to a report released in early 2020 by KPMG, showed that it had already led to the addition of many female directors on the boards of companies headquartered in California. By the law's first deadline in December 2019, just over a year after it was enacted, the number of such companies with all-male boards had decreased from 29% to just 4%. Early reports also indicate that nearly all firms in California are choosing to comply. So, the mandate for an increase in gender diversity is already changing boardrooms. I expect we will see similar impacts with the diversity legislation.

The California bills are already facing legal challenges. What is driving these objections?

I think there is a big debate across the country as to whether the right way to pursue diversity is to do it through mandate versus having a more harmonious relationship between a company's board and its shareholders, where everybody buys into the idea of diversity. But the two lawsuits (one state and one federal) that were filed against the gender diversity bill are challenging it on constitutional grounds. One of the challenges is asserting that because state institutions in California are not allowed to use quotas, it would be unconstitutional for the state to mandate quotas at public companies. The other case is challenging the mandate on taxpayer grounds, claiming it's unconstitutional to use taxpayer money to mandate these requirements. They've gotten mixed results so far, but I do think that a lot of the opposition comes down to people saying, "Let us do this on our own."

But one could argue that doing "this on our own" has meant that many boards have remained largely male and white.

Yes, in terms of the numbers, that bears out. Some of the studies that were done before the gender bill came out showed that if we continued on the path that we were on, that is with no mandates, it was going to take 40 years for SNP 500 companies and Fortune 500 companies to have true diversity and gender diversity on their boards. It was simply going too slowly. One of the reasons for that is that for many companies, board terms tend to be very long. Many terms are around 10 years in duration, so you naturally do not have that attrition. Also, without mandates, there seems to be a tendency to find more/new members among the people that companies traditionally look to, which is often still primarily a white male population. So, it is fair to say – we've already seen it – that the bills are creating change just by the fact that they are requiring diversity. So, yes, I think sometimes you need the push and pull of government and capitalism working together to create change.

Although California is the only state to require mandates so far, companies across the country are already beginning to diversify their boards. Is this trend likely to continue?

Yes, nationally, public companies are facing increased pressure to move beyond verbal commitments and incremental progress. Investors, proxy advisors, and activists are demanding data-driven, measurable changes. They are leveraging litigation, legislation, shareholder proposals, and direct engagement to push companies to increase their commitment to diversity, to disclose their diversity data, and to make significant financial investments in diversity initiatives. In the private sector, some prominent U.S. firms have begun to implement quota-based policies. The chairman of Goldman Sachs announced in January 2020 that the investment bank would, as of July 1, decline to take a U.S. or European company public if the board lacked "at least one diverse candidate, with a focus on women." And the two largest U.S. pension plans in California, CalPERS and CalSTRS, which between them manage hundreds of billions of dollars in assets, have both publicly stated their commitment to a more diverse and inclusive investment industry culture. So institutional investors and policy leaders are likely to continue to pressure companies to increase the diversity of their board and leadership, and specific target numbers are likely to become more widespread. That, together with increasing social awareness of diversity and the incoming Biden administration, means this is a trend that is definitely going to continue.

Beyond shareholder pressure, are companies beginning to realize any benefits from having more diverse boards?

Aside from the fact this it is important to be a good corporate citizen and do what is socially imperative, what matters is the bottom line, and diversity affects the bottom line. Corporate performance studies have shown time and again that diversity at both the board and management levels correlates with higher financial performance. The reason for this is that diverse representation at the executive and board levels leads to diversity of thought, and improves decision making. That is what corporations need to be telling their shareholders. So, the board culture, and the onboarding process, must be such that new directors with diverse perspectives are valued for their contributions and what they can bring to the table to make a company successful. In other words, this is not going to work unless the top-level executives at corporations and firms, and their respective boards, are invested and committed. Embracing diversity as an organizational value is not simply a matter of hiring a handful of directors or achieving certain demographic metrics, but of cultivating an environment in which a variety of perspectives can collaborate on equal terms and drive innovation.

It sounds like companies are moving on from the need to just tick boxes on diversity.

I think if you would have asked me maybe two years ago, in 2018 when the first bill in California came out requiring gender diversity, the discussion was still very much about what you should do as a good corporate citizen, with some nod to the idea that diversity brings innovation, and innovation brings revenue. But now I think there's been plenty of studies, that are constantly coming out, proving that diversity adds to the bottom line. Period. It really does change the way people think, the way people approach problem solving and innovation. As I continue to research this area, I've really been seeing a shift in the conversation, from having to prove that this is something that is necessary for financial success of a company, to "we know that's the case, now how do we do it?" But what's becoming clear is that it's not going to work if we just set a mandate; or even if we litigate these issues and require companies and boards to do it, it's going to work only if these boards are fully invested, and prepared to do what it takes to find candidates who have the right experience and happen to be a woman or a minority. I think they're out there. We're lucky to live in a country where a lot of people from different backgrounds can be very successful. And if companies are willing to do the work and look outside the traditional channels, they will not have much difficulty finding highly qualified and diverse candidates.