Corporate boardroom diversity has increased significantly over the last few years, and the interest in and demand for gender and racial/ethnic diversity on boards of directors remain high. Lack of corporate board diversity has attracted the attention of shareholders, regulators, employees, customers and other stakeholders, resulting in regulations and various initiatives intended to increase the number of women and members of underrepresented communities serving on boards. Companies that fail to address this important issue do so at their own peril, as shareholders and other stakeholders have demonstrated an increased willingness to take action against companies lacking board diversity, including by voting against or withholding votes from existing directors or otherwise exerting public or commercial pressure. This guide discusses board diversity trends and relevant regulations and initiatives and provides some recommendations for companies looking to achieve or increase board diversity.
We have seen notable strides in achieving board diversity. According to the Missing Pieces Report by Deloitte and the Alliance for Board Diversity, in 2020 there were 347 companies with more than 30% board diversity in the Fortune 500, representing an approximately 21% increase from the number of companies exceeding 30% board diversity in 2018 and more than twice the number of companies in 2010. Similarly, the 2021 Spencer Stuart Board Index revealed directors from historically underrepresented groups — including women and Black/African American, Asian, Hispanic/Latino/a, American Indian/Alaska Native or multiracial men — accounted for 72% of all new directors at S&P 500 companies recently, with 47% of those new independent directors belonging to historically underrepresented racial and ethnic groups and 43% being women. There has also been a significant increase in gender diversity among the companies in the Fenwick – Bloomberg Law SV 150 List, with women directors of such companies representing 30.2% of directors, closing a historical gap with the larger companies in the S&P 100, as discussed in our 2021 Corporate Governance Practices and Trends report. Despite these recent gains, women and ethnic/racial minorities remain underrepresented in the boardroom. According to the Spencer Stuart Index, women and ethnic/racial minorities (including those identified as Black/African American, Hispanic/Latino/a, Asian, American Indian/Alaska Native and multiracial) still constitute only 30% and 21% of S&P 500 board members, respectively.
In an effort to accelerate the pace at which public companies achieve diversity, regulators and legislators have enacted various measures to compel companies to take action.
Although several states have passed laws requiring companies to disclose the demographic composition of their boards, the state of California has arguably enacted the most prescriptive board diversity requirements. In 2018 and 2020, California passed legislation requiring public companies with headquarters in California to have a certain number of women and people from underrepresented communities on their company boards or be subject to fines ranging from $100,000 to $300,000 for each violation.
On April 1, 2022, the Superior Court of California, County of Los Angeles, ruled that AB 979 violated the California Constitution’s equal protection clause and expenditures of taxpayer funds or taxpayer-financed resources could not be used to implement or enforce the provisions of AB 979, effectively striking down the law. For more information on the case, Robin Crest, et al. v. Alex Padilla (No.20ST-CV-37513) (Crest v. Padilla II), that challenged AB 979 and the court’s ruling, see our prior alert.
On May 13, 2022, a second California Superior Court decision, Robin Crest, et al. v. Alex Padilla (19STCV27561) (Crest v. Padilla I), ruled SB 826 to be unconstitutional (see our prior alert). Although it is not clear whether the state of California will appeal these rulings, we expect the benchmarks established in AB 979 and SB 826 will continue to influence the expectations of stakeholders, even if both statutes remain invalid after any final appeals.
In August 2021, the U.S. Securities and Exchange Commission (SEC) approved exchange listing rules requiring Nasdaq-listed companies to have at least two diverse directors (including at least one woman and one member of an underrepresented minority or who self-identifies as LGBTQ+) or explain their failure to meet the requirement. Affected companies must provide the disclosure in their proxy statements (or Forms 10-K if a proxy statement is not filed) or on their websites. The rules provide for a transition period — companies must have one diverse director by August 2023 and two diverse directors by August 2025 (companies listed on the Nasdaq Capital Market have until August 2026 to fully comply). Companies that fail to comply with the rules’ requirements face delisting. The rules also require annual board diversity disclosure in a tabular format, beginning on the later of August 8, 2022, and the filing of a company’s proxy statement for its 2022 annual meeting. For more information on Nasdaq’s board diversity rules, see our prior alert.
Currently, public companies must disclose if diversity is considered in selecting board nominees and, if there is such a policy, how the company implements it and how the board or nominating committee assesses the effectiveness of the policy. In addition, if the board considers a nominee’s self-identified diversity characteristics, the company must identify such characteristics. Although there is no requirement to disclose the gender or racial/ethnic composition of the board, the SEC has recently indicated that board diversity is a likely focus for SEC rulemaking in 2022.
Because attempts to mandate board diversity or its disclosure have faced legal challenges, private ordering may ultimately prove to be more effective in achieving diversity. In recent years, a number of large, institutional investors and the major proxy advisory firms have expressed strong support for board diversity and have adopted voting policies and other guidelines that penalize companies lacking board diversity.
Institutional Shareholder Services (ISS) will generally recommend a vote against or withhold from the election of the chair of the nominating committee, and potentially other directors, on a case-by-case basis at any Russell 3000 or S&P 1500 company that lacks at least one woman director and racially or ethnically diverse members. ISS’s policy regarding board gender diversity will extend to all companies in 2023. Glass Lewis generally recommends against the nominating committee chair if a Russell 3000 company has fewer than two gender diverse directors and against the entire nominating committee of a board with no gender diverse directors (companies outside of the Russell 3000 index and boards with fewer than seven directors are only required to have one gender diverse director). Beginning in 2023, it will generally recommend against the nominating committee chairs of such companies if their boards are not at least 30% gender diverse.
While Glass Lewis does not have any requirements for racial/ethnic diversity, it will assess a company’s racial/ethnic and gender diversity disclosure, including whether a company has adopted a policy requiring that women and minorities be included in the initial pool of candidates when selecting board nominees, and may use such information in its overall recommendation when there are additional board-related concerns. In addition, for S&P 500 companies lacking adequate board diversity disclosure, Glass Lewis may recommend voting against the chair of the nominating and/or governance committee and, beginning in 2023, will generally recommend against such committee chair if the company does not provide any disclosure of individual or aggregate racial/ethnic minority board demographic information.
Many institutional investors, including three of the largest global asset managers, BlackRock, State Street Global Advisors (SSGA) and Vanguard, advocate for board diversity through their proxy voting policies and stewardship activities.
In its proxy voting guidelines, BlackRock states that boards should aspire to be 30% diverse and encourages companies to have at least two directors who identify as female and at least one director who identifies as a member of an underrepresented group. BlackRock considers individuals who identify as belonging to the racial/ethnic categories described above as well as those “who identify as underrepresented based on national, Indigenous, religious, or cultural identity; individuals with disabilities; and veterans.” To the extent companies do not achieve board diversity within a reasonable time frame, BlackRock may vote against members of those companies’ nominating/governance committee.
SSGA expects boards of all companies to have at least one woman director and companies in the Russell 3000 to achieve 30% board gender diversity by 2023. SSGA may vote against the chair of a company’s nominating committee (or the board leader in the absence of a nominating committee chair) if a company does not meet this gender diversity requirement. Failure to meet this expectation for three consecutive years may result in votes against all incumbent members of the nominating committee. If an S&P 500 company does not have at least one director from an underrepresented community or does not disclose the gender and racial/ethnic composition of its board, SSGA will vote against the chair of the nominating committee. Further, if an S&P 500 company does not disclose its EEO-1 report (an annual form filed with the Equal Employment Opportunity Commission and the U.S. Department of Labor that provides a demographic breakdown of a company’s employees by race and gender), SSGA will vote against the chair of the compensation committee.
Similarly, Vanguard has indicated a commitment to board diversity through its stewardship activities. Though Vanguard does not take a prescriptive approach, it has indicated it may vote against nominating committee chairs or other relevant directors in cases where board diversity lags market norms and expectations. Vanguard expects companies to publish their perspectives on diversity, disclose the diversity composition of their boards, look beyond traditional candidate pools to consider candidates who bring diverse perspectives and make progress on boardroom diversity across multiple dimensions.
In light of institutional investor and proxy advisory firm demands, we recommend that companies voluntarily disclose information regarding board diversity. Although only Nasdaq companies are currently required to provide board diversity composition information, we expect the disclosure of gender, ethnic/racial and LGBTQ+ board demographics will soon become the norm, as many prominent institutional investors will expect companies to provide board composition data that enable investors to better determine whether such companies comply with investors’ board diversity policies. In fact, the demand for diversity statistics has expanded beyond the boardroom, as shareholders and other stakeholders are also requesting that companies publicly disclose diversity information more broadly, including at the employee and management levels below the C-suite. Providing diversity information on an aggregated basis using gender and the same racial categories as used in the EEO-1 reports should suffice in most cases (with some potential modification, as discussed below).
However, if the form of diversity disclosure is not mandated, companies should engage with their key stakeholders (and consult investors’ proxy voting policies) to understand the preferred form of disclosure. In discussing board and management/employee diversity, companies should consider whether they wish to disclose diversity beyond the prescribed categories used in the EEO-1 reports or in regulations. For example, individuals of North African and Middle Eastern backgrounds are not regarded as minorities under the EEO-1 report’s racial categories (which also form the basis of the Nasdaq board diversity rules), although many companies and stakeholders would regard directors from such backgrounds to be “diverse” or “underrepresented.” Accordingly, companies may choose to also disclose other forms of diversity which they or their stakeholders consider to be important.
As disclosure of racial, ethnic, gender or LGBTQ+ identity may be a sensitive topic for certain directors, companies should be thoughtful in soliciting such demographic information and respect the wishes of any directors who would prefer not to publicly disclose their demographic information. Companies can solicit demographic information from their directors through the directors’ and officers’ questionnaires that are typically used to gather biographical and other information used for the annual report and proxy statement. The purpose of gathering this information and how it will be disclosed (e.g., aggregated v. individual disclosure) should be explained, and directors should have the ability to decline to provide demographic information, in which case company disclosures should indicate that demographic information is undisclosed for certain directors. While in most cases regulations and investor policies do not require the disclosure of demographic information on an individual basis, some investors may seek such information to understand whether diverse directors hold leadership positions on a board or, in the case of contested elections, to use such information to ensure that they are voting for a diverse slate of directors.
Apart from regulatory requirements and investor and other stakeholder pressure to diversify boards, companies and their boards are also recognizing the benefits of board diversity. In PWC’s 2021 Annual Corporate Directors Survey, a significant number of directors noted the benefits of board diversity, including:
In addition to these perceived benefits, a company may choose to diversify its board to better reflect its employees, customers and the communities in which it does business or sells its products or services. A diverse board may also signal to a company’s stakeholders that it values diversity and inclusion, including at the highest levels of its organization.
While the call for diversity is clear, some companies struggle to meet the minimum diversity expectations and requirements discussed above. Below are some common obstacles to achieving board diversity and recommendations for addressing them.
Although achieving board diversity may take time for some companies, it is important for companies lacking board diversity to show progress. Institutional investors have commented that companies with lower levels of diversity but that are showing progress may be perceived more favorably than companies with higher levels of diversity but whose progress has stalled for some period. For example, engaging with key stakeholders to affirm that board diversity is a priority may thwart shareholder activism. Given the importance of board diversity to many institutional investors, it is likely that it will be a topic during engagement meetings. Accordingly, the board should have a strategy for achieving or increasing board diversity, and the board’s leadership and relevant spokespeople should be prepared to discuss its plans in detail. Despite some setbacks, demands for board diversity are likely to continue to increase, so companies should be prepared to meet stakeholder expectations.