California Law To Mandate Racially Diverse Boards Could Speed Change

Companies may soon find themselves being asked to explain why they have a lack of ethnic diversity in their boardroom. Consider these proactive steps.

As pressure to add more racial diversity to corporate boards has increased, California appears to be taking the lead on the issue by proposing legislation that mandates boards appoint more people of color or face fines of $100,000 to $300,000. Since many corporations recently stated public support for the elimination of racial inequities in the United States, companies should expect stakeholders to ask if they are committed to eliminating inequities in the board room. The introduction of this legislation may spark debate about the best ways to increase the representation of people of color on corporate boards.

This new legislation is similar to a 2018 bill that mandated that public corporations headquartered in California appoint at least one woman to their board of directors or face monetary fines. More than 250 companies in California complied with that rule which helped lead to a record percentage of women being appointed to new directorships in the U.S. last year.

The new California legislation, Assembly Bill 979, seeks to require corporations to appoint a minimum number of board members “from under-represented groups” based on the total number of directors on its board. Boards with four members or less would need to have one director of color; boards with between five and eight members would need two directors of color; boards with more than nine members would need to have three directors of color. The bill asks companies to comply between the year 2021 and 2022. Legal challenges to the legislation are expected, so don’t expect these timelines for compliance to stand.

Although ethnic and racial diversity on boards has been increasing over the years, it has done so at a very slow pace. According to ISS, in 2019, the boards of Russell 3000 companies were made up of 10 percent ethnic and racial minorities, a record high. However, some governance experts have argued that those numbers should be higher based on the percentage of the population ethnic communities represent. They also point to a 2018 study by McKinsey & Company that showed that companies with higher levels of racial and ethnic diversity were 33 percent more likely to have higher financial returns.

Whether boards agree with the stakeholder arguments based on percentage of population or the shareholder arguments based on financial returns, companies may soon find themselves being asked to explain why they have a lack of ethnic diversity in their boardroom. They may also be challenged by shareholders, stakeholders or regulators to explain what they intend to do to resolve the issue. Here’s what corporate directors might consider:

• Accept ethnic and racial diversity on boards as a governance best practice. Gender diversity on boards did not start out as a governance best practice, but now institutional investors are insisting gender diversity be observed. Many companies that had no women on their boards reached out to their networks and created campaigns to find suitable candidates. As a result, a significant number of women were elevated to board positions last year. A similar process can be implemented to recruit racial and ethnic minorities onto boards. If a genuine effort is made, what worked for women should also work for racial and ethnic minorities.

• Adjust the criteria used to qualify for a directorship. Any adjustments should be made to expand the pool of people who are considered for board appointments without reducing the level of expertise needed to be a director. Many boards covet experience as a CEO as one of the primary factors they look for in candidates for a directorship. With so few CEO positions at publicly traded companies held by non-white individuals, focusing on that as the top criteria for board membership practically eliminates people of color. Candidates who are respected by their peers and have an in-demand skill and a track record for getting results may deserve higher consideration for board appointments. Many people of color who fit into this category never get promoted to higher positions that might afford them more recognition as a potential board candidate. The current criteria haven’t worked to increase the numbers of racial and ethnic minorities on boards, so there is little reason to think that keeping the criteria the same will change anything.

Forge new relationships with diverse board members on other companies. Building relationships with directors of color on other boards can expand your network and introduce companies to candidates of color they were unaware of. Directors of color are likely aware of other potential board candidates that have not gotten an opportunity yet. Retired board members from racial and ethnic minorities may be mentoring potential candidates for board seats. Reaching out to them may yield promising results.

Address any bias in hiring, promotion and retention at your company. Each company must assure that its own executive pipeline operates fairly and affords all employees opportunities for advancement that can lead to board appointments. Is your company free of unconscious bias toward racial and ethnic minorities? Are the top ranking executives at your company racially diverse? Are top executives interacting with and making presentations to board members? If a company has not embraced hiring racial and ethnic minorities in general, it might need additional help adding candidates of color to its board.