Public company boards have been focused on diversity in their own ranks for several years. But progress has been slow, and the pressure to move faster is mounting. Lawmakers, regulators, shareholders and other stakeholders expect boards to better reflect their companies’ customers and the communities in which they operate. Directors face a choice. They can act now and diversify their boards on their own terms. Or they can wait for powerful stakeholders to force their hand. Those that take the initiative now are likely to come out ahead.
The final months of 2020 illustrated the growing momentum for change. A variety of stakeholders have ramped up calls for more decisive action on boardroom diversity.
In September 2020, California passed a law that requires companies based there to have at least one director from an “underrepresented community” by the end of 2021. By the end of 2022, boards will need to have either two or three such directors, depending on board size. The law covers directors who identify as Black, Latinx, Asian, Pacific Islander, Native American, Native Hawaiian or Alaska Native, or as lesbian, gay, bisexual or transgender (LGBT). It’s patterned after another California law, adopted in 2018, that mandates greater inclusion of female directors.
Other states are also taking action on this front. Washington requires that companies headquartered there have “gender-diverse” boards by 2022. Several states have also considered legislation that would mandate greater disclosure of board diversity data. Illinois, for example, adopted a law in 2019 requiring companies based in the state to provide information on the gender, race and ethnicity of board members by the end of 2021.
In December 2020, Nasdaq filed a proposed rule with the SEC that would significantly change requirements for many companies. If approved, Nasdaq could require that listed companies disclose board diversity data, and have at least one director who is a woman and one who is a racial or ethnic minority or self-identifies as LGBT. Companies would have two years after the rule’s approval to add one such director if their board does not already have one, and four or five years, depending on company size, to add another. Those that don’t comply would have to explain why not—or risk being delisted.
Some of the largest asset managers announced in 2020 that they will seek additional disclosure about board diversity from companies they invest in, including how they plan to increase it in the future. Some have gone further, announcing that they may begin voting against directors on boards that haven’t made sufficient progress in the coming years. Investors have also begun to organize their efforts around this issue. The Russell 3000 Board Diversity Disclosure Initiative, launched in October and representing institutional investors with $3 trillion in assets, is pushing for increased communication with shareholders about the racial and ethnic backgrounds of companies in that index.
Institutional Shareholder Services has announced that it will begin highlighting Russell 3000 and S&P 1500 companies that lack racial and ethnic diversity on their boards this year. After a one-year transition period, ISS said it may recommend voting against such boards that lack racial and ethnic diversity starting in 2022. And starting this year, Glass Lewis will assess S&P 500 companies on their board diversity practices, including the percentage of directors who come from racially or ethnically diverse backgrounds. Though the assessment may play into voting recommendations when other board-related concerns exist, it won’t be the sole factor.
According to PwC’s 2020 Annual Corporate Directors Survey, directors understand the benefits that board diversity brings. Ninety-four percent say it brings unique perspectives to the boardroom, and more than 80% say it strengthens relationships with investors (85%) and enhances board performance (83%).
Progress toward achieving boardroom diversity has been slow. Just 28% of board seats in the S&P 500 were filled by female directors in 2020. And while every company in the index now has at least one woman on its board, many still lack a Black director. In fact, as of 2019, 187 index constituents didn’t have a single Black person on their board.
Boards that are determined to address this problem can take a variety of actions:
What’s on the resume of a highly qualified board candidate? Experience running a company and previous experience as a director probably come to mind. And while those experiences are excellent preparation, when they become prerequisites, they can exclude a lot of people who would excel in the role. Female and non-white directors are less likely to be current or former CEOs than their white, male peers. They’re more likely to have finance or technology expertise. And they’re more likely to be first-time board members. To capture the benefit of that perspective, boards have to cast a wider net when recruiting new members.
Boards can help ensure that they become more diverse over time by requiring that a certain number of people it considers nominating to fill open board seats are women, from racial or ethnic minorities or from the LGBT community. Several prominent executive search firms have recently announced that, from now on, at least 50% of the candidates it presents to clients for board positions will be from these groups. That’s a significant step that all companies should consider emulating.
Low board turnover can make it difficult to add directors who bring diversity. Only 55% of S&P 500 companies added a new director in 2020. Term limits remain uncommon and even on boards with mandatory retirement ages, turnover lags. This means that adding seats—at least temporarily—can be a more effective way to accelerate board refreshment. Indeed, 28% of the S&P 500 companies that added a female director in 2020 also increased their boards’ size. It may prove to be an equally powerful tool when it comes to adding directors who bring other types of diversity, as well.