One of the most popular posts on this blog discussed the advantages of privately held companies having a corporate board with outside directors. I argued that outside directors can provide broader and deeper knowledge relevant to the business than company management can. If shareholders select directors with expertise the business needs, and if those directors develop ongoing knowledge of the business, the company will benefit.
My post dealt with private companies, but boards of directors can serve the same function in public companies of all sizes also. When board members bring expertise and when they develop ongoing company knowledge, they can contribute greatly to the company’s success.
Obviously, then, it is important for shareholders to choose wisely when electing board members. In the usual course of affairs, management (generally the CEO) proposes board candidates. But boards of larger and more sophisticated companies often have board selection committees that propose the candidates. However the candidates are selected, and shareholders then approve or disapprove the choices.
My premise is that who is on the board makes a difference.
So what happens when jurisdictions adopt diversity requirements for directors? California has just become the first state in the U.S. to require large companies to have female directors, Will that requirement help or hurt California-based companies?
California Senate Bill 826, which Governor Brown signed into law last month, mandates female directors on company boards. The stated purpose of the law is to advance gender diversity. SB 826 requires all publicly traded companies with headquarters in California to have at least one woman on their boards by the end of 2019. And by 2021, firms with at least five board members will be required to have two or three women on the board, depending on the total size of the board. If companies do not comply, they face fines of between $100,000 and $300,000.
About 94 publicly traded companies headquartered in California currently have no female directors and would be affected by SB 826, assuming they do not change their board membership by the end of 2019.
But will this law lead to improved corporate governance and financial performance?
It is tempting to say that companies should be able to locate sufficient women with the credentials to provide the expertise required. And most of the time that will probably be true.
It is also tempting to say that women provide a different perspective than men on management. And in the wake of the #MeToo movement, that is true in certain circumstances and about certain issues.
But I am cynical enough to believe that corporate management is usually not sufficiently broad-minded to look far enough for women capable of serving in board roles. I believe competent women exist, but some competent women will have backgrounds different than their male counterparts, and they might be passed over for consideration. And so, it is possible that the same women will be tapped repeatedly for board roles.
Moreover, female candidates selected after passage of SB 826 face the stigma of being “affirmative action candidates.” Their opinions may not be given the same credence that male board members’ opinions receive. The problem with any legal mandate is that it stigmatizes the very people it purports to help.
On a more practical note, Wharton research shows that adding female directors to a board does nothing for company success. The gender composition of the board does not matter, for better or for worse, when it comes to improving financial performance.
The California statute will face legal challenges. Legal scholars, even those who believe the law is “well-intentioned,” have called the mandate unconstitutional, because the Supreme Court has previously ruled that the makeup of a corporate board is governed by the state where the corporation is is chartered, not where it is headquartered, which is what the California statute purports to cover.
The Wall Street Journal reports that 35% of new directors in Russell 3000 companies (one broad cross-section of public companies in the U.S.) have no female directors at present. So if laws like California’s SB 826 are passed in other states, the composition of many corporate boards will change. Perhaps it would be wise to wait to see what happens in California before more states jump on the board diversity bandwagon.
And will California’s mandates stop with gender diversity? What is to keep the liberal California legislature from mandating racial diversity? What about sexual orientation? Religion? Age?
In the meantime, public corporations in California will have to choose whether to comply or whether to fight the law. Privately held corporations in California remain free to decide for themselves the composition of their board, and even whether to have outside board members at all.
What do you think about requiring a diverse board composition?