Attention by investors to environmental, social and governance (ESG) factors continues to grow and, with it, a desire for reliable data to effectively measure company performance on these factors. In August, the U.S. Securities and Exchange Commission (SEC) took a step toward ensuring public reporting on one piece of relevant data: board diversity.
The SEC approved a disclosure rule for the Nasdaq Stock Market requiring a listed company, with some exceptions, to “have, or explain why it does not have, at least two members of its board of directors who are Diverse,” and to disclose board level statistics on gender identity and demographic background.
As the SEC noted in its Order approving the proposal, the rule will “make consistent and complete statistics widely available to investors,” whereas currently such data is “not widely available on a consistent and comparable basis.” Depending on listing tier, companies will have between two and five years to meet the diversity objectives or explain why they have not.
At the same time, listed companies will be required to start disclosing board-level diversity data earlier, in 2022. Shareholders will no doubt be watching for what companies say on these efforts. Indeed, shareholders have already filed derivative suits seeking to hold companies accountable for alleged failures to successfully diversify boards. The combination of the increasing regulator expectations and accompanying shareholder interest will likely compel high profile companies to become more intentional in diversifying their boards. As McKinsey found in a recent study of corporate diversity and success, “Companies in the top quartile for both gender and ethnic diversity [were] 12 percent more likely to outperform” their peers in the sample set.
As SEC Commissioners Lee and Crenshaw stated in August, the rule is “a positive first step” but “there is more work to be done.” They added, “disability may be a relevant characteristic, as well as diversity among senior management and the workforce more broadly.” The Nasdaq rule provides an opportunity for companies to engage with meaningful change at the board level but, as Commissioners Lee and Crenshaw noted, the rule is hopefully “not the finish line.”
How can boards and companies increase diversity and ensure that the change is meaningful? Below are three practical tips for organizations seeking to move forward in their diversity and inclusion initiatives in and beyond the boardroom.
1. Lead by example.
A significant number of companies will make changes at the board level in the next few years. (For those that do, you may find our prior tips helpful.)
As Nasdaq explained in its response to comments on the proposed rule, increased board diversity will “enhance corporate governance and strengthen the integrity of the market by building investor confidence, and enhancing capital formation, efficiency and competition.”
But to build investor confidence, boards must be as strategic and intentional about recruiting diversity as they are about recruiting for any other core competency. Compliance with this rule cannot be about simply checking a box on a disclosure form. Boards must be self-reflective and reach beyond their own networks, leveraging, as needed, the experience and networks of executive search firms to help identify and recruit the highest number of the most qualified diverse candidates.
Boards wishing to lead in this space and demonstrate an overall commitment to diversity can do more than the minimum board diversity for which the Nasdaq rules aim. Meaningful diversity in the boardroom, including with respect to characteristics beyond those highlighted by Nasdaq, can be transformational and can compel a sea change throughout an organization. A board committed to prioritizing diversity within its own ranks will most effectively lead by example and push management to execute the same, rather than simply making performative statements regarding the importance of diversity.
2. Hold management accountable.
Once a board has established its own commitment and developed a strategic action plan to enhance diversity, it must trickle these objectives down and develop metrics by which to measure management commitment to embedding a culture that not only celebrates but protects diversity throughout the organization.
In order to hold management accountable for diversity goals, boards should ensure that they receive comprehensive information that reveals the true picture on diversity—including as to employee recruitment, advancement and retention efforts—on a periodic basis. Many companies package diversity statistics and tell a powerful story. But these overall numbers can mislead as to whether there is diversity throughout an organization (often times, diverse populations are concentrated among the lower ranked employees). For instance, companies often focus on reporting statistics of diversity at middle- and senior-management levels, but fail to demonstrate accountability by disclosing more detailed information on their employee populations, recruitment, advancement and retention at those levels.
Boards should also engage with management to ensure that management is carrying out diversity objectives in qualitative, and not just quantitative, ways. For example, boards committed not only to building but also to protecting diversity will want to obtain data on employee experiences, which will include obtaining access to reports of discrimination and harassment, and seek to understand—and push management to understand—the root causes of the issues reported. Similarly, to ensure meaningful change, companies should not only focus on diversity and inclusion in hiring but must also support employees who join the organization. To that end, companies must provide employees with avenues to safely report discrimination and harassment issues and ensure that their in-house investigations function is well resourced and appropriately trained to address these issues.
Finally, from a compliance perspective, diverse boards that hold management to account can bolster a company’s compliance goals as well. Such boards can help employees feel comfortable reporting issues as they arise as well as help companies to think about compliance issues from varied perspectives. In that regard, as the U.K. Financial Conduct Authority noted this summer, “greater gender diversity improves risk management culture…” While the statement specifically focuses on gender, the principle applies to all categories of diversity. Employees who see themselves represented in their organization are more likely to trust that their concerns and interests will not only be heard, but understood.
3. Tone at the top needs to trickle through the organization.
A board that is itself diverse will be more credible in, and subsequently more capable of, instituting change in an organization. Fundamental to that effort is a strategy to ensure that all employees understand that their voices and experiences matter. That means active and proactive communication to employees regarding the company’s commitment to diversity, plans to implement that commitment, and, more importantly, its expectation that employees will speak-up if the company falls short—regardless of where gap may arise.
Boards and companies should recall that an employee’s most frequent interaction is with middle management. It is important, therefore, for a company to dedicate time and resources to trainings middle-managers and supervisors on how to demonstrate the company’s commitment to diversity in all aspects of their management responsibilities. These messages should begin in the recruitment and interview process and should be carried out with intentionality at on-boarding, periodic trainings, performance reviews and in salary and promotion considerations.
For messages of commitment to flow through a company, middle-managers should be leveraged as the faces of the organization to disseminate messages to employees on the company’s and their own commitments to diversity. In this way, not only will the board and company accomplish the important task of messaging commitment to diversity, it will ensure that the company actively demonstrates and lives out that commitment.
The new Nasdaq rule shifts baseline expectations on board diversity for publicly listed companies. However, simply meeting Nasdaq’s requirements will not be enough to demonstrate a true commitment to diversity objectives. Boards that lead by example, hold management to account on objectives, and set a tone for their organizations will have the opportunity to set themselves apart from the pack.
 The rule defines “Diverse” to mean “an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or Two or More Races or Ethnicities; and “LGBTQ+” would be defined to mean an individual who self identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.” https://www.sec.gov/rules/sro/nasdaq/2021/34-92590.pdf