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ANALYSIS: Board Diversity—From Policy Objective to Business Imperative

Oct. 10, 2016, 1:45 PM

Diversity in the boardroom is a subject of great interest to the SEC. At its fall meeting Oct., the SEC’s Advisory Committee on Small and Emerging Companies discussed the importance of diversified boards to smaller companies.

The SEC has no authority to mandate the makeup of corporate boards, but the Commission does require disclosure of various diversity-related factors. In 2009, the SEC amended Item 407(c) of Regulation S-K to require companies to disclose if their nominating committees consider diversity when selecting director candidates, and if so, how that is done. In addition, if there is a diversity policy, the company must disclose how it is implemented and assessed. According to Betsy Murphy, associate director of the SEC’s Division of Corporation Finance, few companies have disclosed the existence of a formal policy.

The SEC did not define diversity in the rulemaking. According to the Commission, “some companies may conceptualize diversity expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin.” The SEC concluded that “companies should be allowed to define diversity in ways that they consider appropriate.”

The committee heard from guest speaker Cari M. Dominguez, a former chair of the U.S. Equal Employment Opportunity Commission and a board leadership fellow with the National Association of Corporate Directors. She observed that while both directors and shareholders agree on the importance of board diversity, progress toward the goal has been slow. She quoted an NACD Blue Ribbon Commission Report stating that “the sluggish transition to more diverse boards has been antithetical to the pace of business, technology, and human progress in general.” According to Dominguez, it is essential for boards to establish, implement, evaluate and publicly disclose robust diversity policies.

According to NACD data, the U.S. lags behind other industrialized nations with regard to gender diversity. Forty percent of Norwegian directors are women, as are 33 percent of Swedish and 26 percent of French directors. Women make up a significantly smaller percentage of U.S. board members—approximately 20 percent. It should be noted, however, that the three cited European countries cited have statutory or regulatory diversity quotas.

Dominguez cited several barriers to increasing board diversity, and suggested some solutions to the problems. Initially, there are structural factors, including:

—the absence of tenure-limiting mechanisms to encourage board turnover;

—small board sizes;

—inadequate use of evaluations as a tool for board turnover; and

—inadequate use of executive talent management to develop directors from within.

Some solutions are simple, such as expanding the size of the board or adding or enhancing mechanisms to increase director turnover, such as age or term limits. Companies will face much greater challenges in expanding the pool of diverse directors and evaluating board performance.

Social barriers to board diversification include:

—little knowledge of where to find candidates;

—overboarding of certain “star” board members;

—reluctance of sitting directors to leave a board; and

—consolidating diversity into one category and related stereotyping.

Dominguez said that companies must expand their horizons when seeking candidates. If companies are willing to pay for assistance, many search firms specialize in finding diverse board candidates. Overboarding or recycling of “star” directors does not increase the size of the candidate pool, and companies must move beyond reviewing a short list of women or minority candidates.

She noted that there may be a stigma attached to directors who leave board service early. This can be avoided by adhering to term-limiting mechanisms to build turnover acceptance. The tendency to consolidate diversity into one category, where there is no distinction between gender, race, ethnicity or other categories, may be mitigated by avoiding a “check the box” approach and “keeping score.”

There are also habitual obstacles to diversification, including:

—failure to put diversity on the board’s agenda as a discussion topic;

—tendency to seek only CEOs and experienced public company directors for board seats; and

—a lack of diversity on the nominating/governance committee.

Boards must be willing to talk about diversity, and must actively expand the pool of candidates they review. In addition, boards must critically examine the makeup of the nominating committee to see if its makeup serves to perpetuate the status quo.

Advisory Committee member Xavier Gutierrez, president and chief investment officer of Meruelo Investment Partners, said that he was disturbed by the lack of diversity on small company boards. These boards often serve as the “bench” from which larger companies choose their directors.

Committee co-chair Sara Hanks, co-founder and CEO of CrowdCheck, said that companies should act to diversify when they are small. If the company fails to act on diversity at this stage, she said that it is unlikely that they will do so as they grow.