California’s recently signed Assembly Bill 979 is requiring organizations to diversify their boards of directors. As Michael Volkov writes, the change is not only long overdue, but also in organizations’ best interests.
The United States continues to lag in corporate board diversity; many corporate boards are dominated by white males. Progress on this issue has been slow.
The number of women on Russell 3000 boards rose from 15 to 19 percent, with most of the increase occurred on boards of mid- and large-cap companies. In 2019, 45 percent of new board members were female, and only 15 percent were non-Caucasians.
Board diversity is imperative – social and professional diversity are both important. Gender, race and ethnicity and age diversity improves board performance and overall governance.
California has entered this public policy area by enacting AB 979, which requires California-based public companies to increase diversity through a phased-in requirement by 2023. Approximately 35 percent of California company boards consist of all white members.
The California law applies to all domestic or foreign companies with its principal office in California. Under the law, companies are required to increase the diversity of their boards to include “underrepresented” communities, including Blacks, African Americans, Hispanics, Latinos, Asians, Native Americans and members of the LGBTQ community.
Two years ago, California mandated that at least one board member has to be a female.
California companies have to meet specific requirements: By the end of 2021, all boards must have one underrepresented member; by the end of 2022, boards with nine or more members must have three underrepresented members, while boards with five to eight members must have two underrepresented members. Companies that do not meet these requirements will be subject to penalties of $100,000 to $300,000.
The California business community will need to plan to meet the phased-in deadlines. Not only is board diversity imperative for a company’s culture and public engagement, research has shown that it improves board performance. A diverse board also improves financial performance. The same can be said for senior executive management.
California corporations have to plan ahead. Nomination committees will have to determine what changes, if any, will be needed. The new requirements will require careful consideration of the need to replace certain board members or change the board size.
The law could be used as a way to implement other governance reforms to assess the overall board composition and operation. Boards should consider mandatory retirement at certain ages and including designated seats for certain expertise, such as potential board members with compliance expertise.
Boards need to redefine expertise requirements and seek increased diversity in this area as well. If needed, the company may consider increasing board size, keeping in mind that if membership increases to nine or more, three members must be from an underrepresented group.
Companies have to begin active searches to recruit and entice underrepresented individuals to join the company’s board. Hopefully, boards will be able to identify underrepresented candidates – particularly those in the same industry.
While noncomplying companies may be subject to penalties, the larger risk to companies is the public perception and reputational damage from failing to embrace a commitment to diversity. The harm to a company’s reputation could be significant.