Efforts to secure diversity on corporate boards have reached a new level of intensity. Governor Gavin Newsom of California signed a statute into law on Wednesday, September 30, which will require publicly held corporations whose principal executive offices are located in California to satisfy mandated levels of racially, ethnically and other diverse directors beginning in 2021.
By emphasizing the interests of “underrepresented communities,” the new legislation promises to significantly increase the level of boardroom engagement on matters of leadership diversity. In so doing, it serves to broaden existing concepts of diversity to include specific ethnic groups and matters of sexual orientation. It is also a dramatic supplement to 2018 California legislation that required public companies headquartered in the state to assure the appointment of specified numbers of women to the board of directors—a groundbreaking development at the time.
While California politics are unique in many ways, this new law may well spark similar legislative initiatives in other states— as occurred with California’s 2018 legislation. For that and other reasons, the new law is noteworthy to the board nominating committees of public, private, and nonprofit corporations across the country and across industry sectors. Many boards may already believe, with some justification, that they have made great strides on matters of diversity. They just may no longer be enough, given the goals and objectives of the California statute, and the likelihood that they will be broadly promoted by corporate stakeholders and other interested parties.
The law provides for an escalating level of racial and ethnic diversity on the board, to be implemented over the next several years. Specifically, the new law requires affected companies to ensure that their boards have a minimum of one director from an underrepresented community on its board by the close of the 2021 calendar year. By the close of the 2022 calendar year, the obligation shall increase in accordance with the size of the board.
If its number of directors is nine or more, the corporation shall have a minimum of three directors from underrepresented communities. If its number of directors is more than four but fewer than nine, the diversity requirement drops to a minimum of two such representative directors. If the number of directors is four or fewer, the diversity requirement drops further, to a minimum of one such representative director. The new law expressly permits companies to increase the size of their board of directors to accommodate adding directors.
For purposes of the new law, “Director from an underrepresented community” means an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender. (Note that these are defined in the context of California demographics and might not reflect underrepresented communities as exist in other states or regions.) Specific reporting obligations, as well as penalties for noncompliance, are associated with the new law.
There’s no question that the legislation is controversial. Indeed, there is a general expectation of a conservative challenge to its implementation, similar to the one filed in connection with the 2018 statute that requires companies to increase the number of women on their boards.
Yet California Governor Newsom has stated that the new law is necessary to promote diversity in corporate boardrooms and as part of broader efforts to address matters of racial equality. To that end, the legislative history of the new law states that it is consistent with both the Civil Rights Act of 1964, and the Sarbanes Oxley Act of 2002 (e.g., those provisions that emphasized greater independence on boards in order to decrease the potential for corporate fraud).
So yes, there’s a political aspect to this legislation—but one that demands board attention. The new law underscores the continuing willingness of legislatures and other corporate stakeholders to directly intervene in corporate governance. The Wall Street Journal notes that the broader business community has not sought to challenge the new law, in part because of the pressure from institutional investors such as BlackRock Inc. and State Street Corp. and public officials such as New York City Comptroller Scott Stringer to increase gender diversity on their boards.
Anticipate efforts of corporate stakeholders, institutional investors and legislatures to extend the themes of the California law more broadly, either though expected governance standards or actual legislation. So the big picture governance message is ‘don’t dismiss’ this new law as some quirky “California thing,” but rather consider it as consistent with a new stakeholder emphasis on diversity that is emerging from state legislatures as well as more traditional stakeholders. And with that comes a focus on several related governance implications including the following:
– Efforts by the board to improve gender, racial and other diversity over the last several years may have been made in good faith, but they’re not likely to be considered sufficient to meet evolving expectations.
– The work of the board governance and nominating committee is likely to become more intense, with increasing pressure to add gender, racial and other diversity to the board.
– The emphasis on board gender diversity should continue notwithstanding this new development.
– The use of search firms to identify candidates from underrepresented communities will dramatically increase; there will be a seller’s market for such candidates.
– Board size may be increased in individual circumstances to accommodate the addition of new members from underrepresented communities.
– Onboarding programs may need to be expanded in situations where new directors from underrepresented communities lack familiarity with the company’s industry sector.
– Additional training efforts may be necessary to assure that these new, diverse directors exercise their fiduciaries strictly in favor of the company, its stakeholders and its mission, and not of any particular interests of their personal constituency.
– Boards should anticipate greater public and political discourse on aspects of corporate governance that have traditionally been limited to private boardroom discussion. Efforts to include workforce representation may be the next proposal.
Boards reviewing the new California statute should keep in mind the underlying message. The inclusion within governance of diversity that encompasses all intersections of society—gender, race, age, experience—remains an important best practice for both the full board and its nominating committee. Regardless of whether the California law is sustained long-term, this emphasis won’t be changing any time soon. It will only become a more important element of board composition.