Board Diversity

Inclusive boards and shareholder value

Advocates of board diversity believe that an insular composition can impact a company's bottom line. A 1999 study by the American Management Association found that organizations with diversity among senior executives and the board have better sales performance than those companies with only white male executives.[5] Conversely, violations of workplace antidiscrimination laws lead both to expensive litigation and damage corporate reputations-neither of which is in the best long-term interests of shareholders. Companies such as Shoney's Inc., Advantica Restaurant Group, Inc., (owner of Denny's Restaurants), Texaco Inc., and Hughes Aircraft Co. posted multi-million dollar losses as a result of settling various discrimination lawsuits. In several instances, the financial impact on shareholders exceeded $100 million.

In a 2000 study, The Conference Board concluded that changes in corporate performance and shareholder value could not be statistically attributed solely to the presence or absence of directors of any given background.[6] However, it did identify a number of economic arguments for broadening board inclusiveness. Board-level representation of different races and genders can bring additional perspectives into the boardroom, help companies better understand and serve their customers and clients, and promote the recruitment of a more expansive workforce. All of these can contribute to enhanced profitability.[7]

A link to executive diversity?

Proponents of board diversity maintain that inclusiveness at the board level may help break down barriers to minority and female advancement at all levels within a company. Some studies offer support for this argument, though the evidence is not uniform.

Using 1995 data, Walden Asset Management examined the relationship between gender diversity on boards and the "glass ceiling" issue of gender diversity in senior management.[8] Interestingly, there was no statistically significant relationship at the aggregate level. Boards with an above-average number of female directors might or might not have above-average female representation in senior management.

In a follow-up study in 1996 of 165 firms, however, Walden showed that the composition of senior management was the most significant factor in determining gender inclusivity on boards. Firms with above-average numbers of women managers were 50 percent more likely to have diverse boards than companies with few women managers This study also examined other factors that could influence the degree of board and executive diversity-company size, industry, and insider and institutional ownership. At companies lacking any female executives, industry was the most important determinant of board diversity. Healthcare, consumer product, communication, industrial materials, and utility companies were over four times more likely to have female board members than firms in the producer product, energy, financial services, and technology industries.

A 1998 study by the Catalyst advocacy group confirmed these results, noting that there was a correlation between the number of women corporate officers and women on boards. Hence, the progress of women through corporate ranks can be linked to the hiring and promotion of women on all levels from junior executive to board member.[9]

Criticisms of board diversity proposals

When faced with resolutions to report on or take steps to improve board diversity, companies often respond that these proposals are unnecessary. Most companies recognize the merits of a diverse and inclusive workforce and typically have processes in place to recruit qualified individuals to serve as directors from a broad range of candidates. These may include the use of outside search firms, formal board nominating procedures, and an independent nominating committee.

The concern of target companies is in a strictly outcome-based approach. Above all, board members should be nominated on the basis of their qualifications for the position without regard to gender, race, or religion. Board diversification proposals that result in tokenism, constituency representation, or the institution of quotas or deadlines harm the company's director-selection process while failing to serve the interests of shareholders. Directors have a fiduciary responsibility to all shareholders, not just specific groups.

Report only

Requests for reports on board diversification initiatives are generally supportable. Transparency is a matter of good corporate governance, and shareholders should have access to material information about their company's practices and procedures. Moreover, because social issues may have an impact on long-term value, it is generally in the interests of shareholders to make sure that management gives serious consideration to them.

The merits of publishing a report must be weighed against the company's current reporting and any resulting costs or negative implications in providing the requested disclosure. If the company already reports on its nominating procedures and diversity initiatives, then the proponent's request may be largely duplicative. Even so, additional disclosure may be warranted if it is apparent that the board has historically been monolithic or lags in diversity in relation to companies of similar size and business. Given changing demographics, it would be in shareholders' interests if the company reviewed its standing in this area vis-a-vis its competitors.

In most cases, there is minimal expense involved in producing a board diversity report. If the company already studied the issue internally and has a comprehensive recruiting process in place, it would not incur significant costs in reporting its findings to shareholders.

Actions

This type of proposal goes a step further by asking the company to issue a public statement on its commitment to board diversity and to make a greater effort to locate qualified women and persons of color to serve on the board. Often these resolutions also seek a program of steps to be taken and a timeline for completion, which, from the standpoint of issuers, is both unduly restrictive and puts the emphasis on outcome rather than process.

While the presence of women and minority directors can add unique and valuable perspectives to a board, shareholders should avoid the implementation of quotas or arbitrary numeric goals. From a value-creation standpoint, what is of paramount importance is selecting the most qualified directors, regardless of race or gender. To ensure that a wide net is cast, shareholders should first scrutinize the process for director selection. At the least this should include an independent nominating panel, though many firms engage an outside search firm as well. Contrary to an argument that companies sometimes advance, expanding the universe of board candidates can be done at a reasonable cost, particularly if the company already uses a recruiting firm for filling executive positions.

If the company is truly open to a diverse board culture and the selection process is thorough, it should be evident in the composition of the board itself. There should be some degree of inclusiveness. But how much? A starting point is to examine the historic makeup of the board, both in terms of composition and independence. Inbreeding of any sort can lead to myopic thinking, if not more serious governance problems. Shareholders should also compare the board composition to that of companies of similar size and business. Large-cap firms in mainstream industries should have less difficulty in seeking out a diverse pool of qualified board candidates than small firms operating in specialized or niche businesses. Finally, shareholders should consider whether the targeted firm has a history of EEO-related problems, which could signal a need for the corporate leadership to be more representative of broader segments of the population.