US companies have seen an important change in recent years in the makeup of boards of directors especially in regards to how boards are approaching diversity. Boards face growing pressure to respond to societal changes and developments, particularly with respect to an increasing focus on diversity. The trend of more frequently “refreshed” boards of directors has continued to grow and resulted in an overall higher rate of new directors as compared to the onset of this decade.
Though traditional skill sets are still viewed as the core criteria for selecting board members, there is now an additional focus on nontraditional criteria such as cybersecurity and technology, culture, and sustainability. Broad recognition of the importance of diversity has resulted in record growth in the number of minorities and women recruited by boards. These patterns are likely to continue.
There are well-documented advantages to building a diverse board. For example, gender diversity on boards has been found to display above-average performance, experience a lower level of volatility, and invest more in research and development. Such advantages in turn pressure companies to pursue board diversity with a greater sense of urgency. A number of investment groups have taken the steps to withhold votes for existing directors on company boards without female representation. Beyond these institutional pressures, a growing number of jurisdictions are passing laws to mandate diversity.
Europe Takes the Lead On Board Diversity Laws
A number of European countries have already pursued legislation to require diversity on corporate boards. For example, Germany, Belgium, Norway (adopting a 40 percent gender diversity standard) and India have adopted mandates for gender diversity. These requirements appear to be gaining a firm place in Europe. Since 2003, when Norway implemented its 40 percent standard, other countries, including Spain and France, have also imposed minimum requirements for diversity.
Is the US far behind?
As mentioned, the impetus for diversity on US boards in the past has come primarily from investors as well as nonprofit groups. In September 2018, then‒California Governor Jerry Brown signed Senate Bill 826 into law. The bill requires companies that are headquartered in California and publicly traded to have women board members. Companies failing to meet this threshold will incur financial penalties if they fail to have at least one-woman director serving on their board by the end of this year. That requirement increases to two in 2020 for boards with 5 or more members.
California’s board diversity law is clearly the most binding. However, several other states have taken legislative steps as well:
- In 2015, Massachusetts passed Resolution S 1007, with the goal to promote “equitable and diverse gender representation” on boards. The resolution encourages companies that do business in Massachusetts to develop plans to increase diversity on their boards.
- Also in 2015, the Illinois General Assembly passed HR0439, encouraging publicly held companies with more than eight board seats to include a minimum of three women members; and for companies with at least five but fewer than nine seats to have a minimum of two women. All corporations with fewer than five seats should strive to have at least one woman on its board.
- In 2017, Pennsylvania passed HR273, encouraging all Pennsylvania businesses to achieve 30 percent women board membership of women by 2020.
- Pending in New Jersey is NJ A 4726. The bill is similar to California’s legislation, and if passed will require public companies to have a minimum of one female director and increase that number over time.
Potential constitutional challenge for board diversity laws
A new bill passed narrowly in April 2019 by the Illinois House is designed to compel the state’s “largely white, male corporate boards to diversify.” Though the bill, HB3394, was originally drafted to require companies based in Illinois “to have at least one woman, one African American and one Latino on their boards,” in May, HB3394 was significantly watered down to eliminate the numerical mandate and instead impose on Illinois publicly traded companies an obligation to report its board demographics to the Illinois Secretary of State’s office. Additionally, the revised bill requires the University of Illinois to analyze the data, make recommendations to increase diversity, and publish “a rating on each company’s efforts to increase diversity on their boards.”
One of the reasons that the pending Illinois bill may have been modified is that federal civil rights law prohibits discrimination on the basis of race or sex in employment. The prohibition could potentially apply to the selection of corporate directors. University of Chicago law professor Todd Henderson points out that the US Supreme Court has ruled “explicit racial and gender quotas to be unconstitutional.” Undoubtedly, this is an area all boards should monitor.
How Boards Should Comply With Diversity Laws
One irony that will likely sort itself out over time is an increasing push to legislate a solution for a problem that may not in fact exist, as more and more companies have established board diversity as an ongoing best practice.
Clearly, the first step that a company should take to comply with relevant diversity laws is to become aware of laws on the books in their states as well as bills pending. To date, it does not appear that most such laws are particularly onerous. Second, boards should be fully apprised of investor and shareholder desires and pressures. Often these factors are more compelling than state law.
Finally, boards should recognize the demonstrated advantages of creating a diverse board environment. Building diversity on boards isn’t an easy task. It takes commitment, but it’s vitally important. Diversity adds new and creative thinking and insights and perspective about consumers, markets and business practices. Failing to build diversity, with or without legal requirements, represents a missed opportunity. Boards that become too homogenous can develop blind spots and miss important signals about market trends or internal problems. In short, a highly accomplished and diverse board—and that means more women, more people of color and a wide variety of ethnic backgrounds—is critical, particularly today, when businesses compete more and more on a global scale.