California Bill May Force Boards To Debate Diversity

The new legislation is certain to face strong opposition in the courts—but too much vocal opposition by individual directors could do reputational harm.

A bill passed by the California State Assembly in August is seeking to require companies headquartered in the state appoint at least one person from an “underrepresented group” to corporate boards by the end of 2021. The bill, modeled after the 2018 law mandating public companies headquartered in California appoint more women to corporate boards takes efforts to diversify corporate boards into a new phase—incorporating diversity of race and sexual orientation with the relatively successful effort at gender diversity. If the bill becomes law, it will increase pressure on companies in California and elsewhere to re-examine their board composition and choose whether they believe in having a truly diverse board or not.

The bill calls for at least one director of California-based company boards to be a member of the following groups by the end of 2021: Black, African-American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native or LGBT. By the end of 2022, boards are required to include three directors from the underrepresented groups. Boards with between five and nine members should have two directors from the underrepresented groups and boards with four board members or less are required to have one director from the underrepresented groups. As with the California gender diversity law, fines from $100,000 to $300,000 can be imposed for non-compliance. The governor must sign the bill by September 31, 2020 for it to become law. If signed into law, it would be the first of its kind in the country.

Since there are currently lawsuits trying to repeal the California gender diversity law, this new legislation is certain to face strong opposition in the courts. However, it’s the level of opposition individual directors communicate about board diversity that boards should be most concerned with.

Whether this new bill is passed or not, every corporate board—whether based in California or not – could potentially be asked by shareholders whether they would support such legislation. The idea that corporate boards should be diversified based on race and sexual orientation is now a topic for corporate board agendas. Directors will need to thoughtfully and respectfully address the question and come up with an answer that they believe will satisfy shareholders and stakeholders. Depending on the board response, companies could risk reputational damage that could hurt the bottom line. Workforce morale and the ability of the company to recruit and retain diverse workers may suffer as well. And individual companies may find that the public has ways to hold them accountable for their response, which could hold other risks.

This summer, in the wake of George Floyd’s death and the nationwide protests calling for an end to racial injustice, hundreds of companies issued public statements that said they believed in racial justice and support an end to racial inequalities. So to forcefully reject or simply ignore legislation that seeks to remedy what many have said are inequities in the makeup of corporate boardrooms might be viewed by some as hypocritical. If boards reject legislation, how else will they suggest ending inequitable representation on boards?

Clearly this will be a sensitive issue for boards to deal with. However as corporate leaders and company fiduciaries, directors will need to find a way to discuss the merits of having a diverse boardroom; what a diverse boardroom should actually look like; what steps, if any, will the company commit to taking in order to meet their definition of a diverse boardroom; and when they plan on making that vision come to fruition. Then boards must effectively communicate their diverse boardroom vision to shareholders or explain why choosing not to pursue a diverse boardroom is in the best interest of the company. Either way, boardroom diversity will be an issue for boards to grapple with for the foreseeable future. Chances are, the subject will either bring boards together or break boards apart.