In this fourth installment on D&O liability from Fox Rothschild’s Stephanie Resnick and John Fuller, the authors explore the importance of having a diverse board to address the challenges posed by various social issues.
with co-author John Fuller
Why Is Diversity Important?
As with the social issues discussed in prior articles, diversity is quickly evolving from an aspiration for equality to a corporate necessity with an increasingly discernable impact on the bottom line.
At the organizational level, a lack of diversity along gender, racial, ethnic, sexual orientation and/or age lines can open the company to complex and unsavory litigation. For instance, tech giants have been rocked by the publication of internal memoranda regarding diversity practices and numerous lawsuits resulting from the termination of certain individuals who attacked or defended the existing corporate processes. Increased diversity and improved practices for promoting diversity can help avoid such litigation.
At the board level, recent studies have shown that diversity – in particular gender diversity – can have a direct impact on the corporate liability. For example, researcher Chelsea Liu studied 1,893 environmental lawsuits brought against 1,500 companies listed by Standard & Poor’s between 2000 and 2015. Liu found that for every additional woman on company’s board, there was approximately a 1.5 percent reduction in the risk of litigation. Liu also determined that the average environmental lawsuit cost 2.26 percent of an organization’s market value, meaning that the addition of a female board member equated to an average savings of $3.1 million of organizational value each year.
These findings support the widely accepted understandings that adding diverse perspectives to a board improves decision-making by among other things, refreshing core skill sets and challenging potentially complacent board culture.
How Can a Board Improve Diversity in Its Recruitment?
Having identified the benefits of a diverse board, the focus becomes the steps boards can take to improve diversity. Of course, there is no easy solution. However, common to many boards that find themselves lacking in diverse viewpoints is a need to critically examine – and likely change – how the board identifies and recruits board members. Below are four best practices which blend proactive efforts to change board culture with accountability metrics to help board recruitment practices genuinely evolve.
1. Boards should move toward more transparent and objective criteria for board positions that center on the identified skills the board needs.
Focusing on the skills the board needs, not the merely skills it currently provides, may force the board to re-examine how it identifies, recruits and selects potential board members.
To drive skill-based board recruitment, many boards create a skill matrix. The first step in developing a skill matrix is to critically examine the abilities of the board as whole and those of each individual member. Candid evaluations of board members’ expertise paired with surveys of what skill sets the board members feel are important (or may be lacking) can help form an objective foundation for the board’s recruitment targets. Boards may also consider soliciting shareholder input on the criteria for board membership and necessary skills to ensure that there is alignment of priorities with the stakeholders. The focus on objective skills can help the board avoid the tendency to recruit network contacts who may only be generally qualified for board service and can help board members re-examine their networks to find diverse individuals with the identified skills.
2. To further promote transparency and encourage refreshment of necessary skills, boards should undertake formal performance evaluations of the directors and officers.
Such evaluations, which can be administered in person or through a digital platform, examine the goals the board has set for itself or its committees and evaluate the performance of individual directors and officers in obtaining results. A significant benefit of evaluations is that evaluations create comparable data on which directors and officers can rely to identify, discipline and/or remove underperforming directors and officers. Having performance data in hand can be particularly valuable where prevailing board culture may have permitted underperforming directors and officers to remain. Evaluations, possibly in concert with board term limits, help create a board culture that is constantly looking to the future, not merely looking to the directors and officers currently across the table.
3. When the time comes to replace directors and officers, boards should avoid the tendency to replace “like for like.”
One of the significant benefits of a diverse board is that a variety of perspectives prepares the board to meet new and evolving challenges, like those posed by social issues. Far too often, however, even if using a skills matrix, the board will instinctively replace an existing director with an individual with similar experience. The board should use a vacancy in the board to evaluate whether the skills possessed by the departing board member are adequately represented by other directors and officers and, if so, determine what other identified skills should be priorities when filling the position.
4. The board must actively develop a pipeline of diverse board candidates who possess the skills and new perspectives that will serve the board into the future.
Trainings about unconscious bias and other forms of discrimination that pervade the corporate world are undoubtedly beneficial to any organization. Boards, however, should take special care not only to foster an inclusive culture in the boardroom, but must create opportunities to connect with and mentor potential board members. This means looking beyond C-Suite executives and existing business contacts to find individuals who offer genuinely diverse perspectives, but may not have been afforded the opportunity to amass experience through board service.
A diverse set of qualifications and perspectives will enhance any board. With ongoing refreshment and a commitment to developing the next generation of board members, the board will continue to reflect changing demographics and shareholders’ increasing demand for socially responsible corporate governance.
Read the authors’ previous articles on how social issues such as sexual harassment in the #MeToo era, digital privacy and demands for environmental sustainability are manifesting in shareholder lawsuits and shaping the fiduciary duties that officers and directors owe to their organizations.