Michelle Leder

Forcing Companies to Diversify Their Boards Works

California has become the focus of a battle over how companies should address the lack of diversity on their boards: Should they actively seek out directors who aren’t White males, or should they simply seek to treat all candidates equally? A Superior Court judge has ruled in favor of the latter approach, declaring unconstitutional a law requiring publicly traded companies based in the state to add as many as three board members from under-represented groups.

This is unfortunate, because the law was actually working.
Nobody in the California case challenged the idea that diversity is desirable. As the judge rightly put it: “A homogenous board is vulnerable to stagnant thinking and common assumptions; it is also less flexible in responding to challenges. This results in poorer business practices, less innovation, and ultimately less profit.” The key question in the legal challenge — filed by the conservative group Judicial Watch — was whether the state constitution allowed the legislature to advantage some groups over others in its efforts to address the problem.

During its brief time in force, beginning on Sept 30, 2020, the legislation demonstrated just how effective a mandate can be in reversing long-entrenched discrimination. As of July 2021, the share of California companies with at least one Black or one Latino director stood at 30% and 17%, respectively — up from 16% and 13% a year earlier, according to a Latino Corporate Directors Association analysis of Equilar data. As of September 2021, nearly a third of boards had at least one woman, up from less than a quarter a year earlier, according to Equilar.

Companies wanting to be known as socially responsible sought to stand out. Apple Corp. used the word diverse or diversity 70 times in its most recent proxy statement, compared with 20 times a year earlier. It also added a section near the beginning touting its board diversity.

Perhaps Apple would have done this without the 2020 law. But it’s hard to imagine the other 700-odd publicly traded California companies doing the same in the absence of an official mandate.

The state can appeal the Superior Court’s decision — though California Secretary of State Shirley Weber, who recently released a detailed report on board diversity as the law requires, hasn’t said whether she plans to do so. Meanwhile, Judicial Watch is also challenging a 2018 law that focuses on female board representation. If the group prevails, much of the progress in seating women as directors could evaporate.

One potential backstop is a Nasdaq rule approved by the Securities and Exchange Commission last year. It requires the boards of most companies that list on the exchange to have at least one female member and one from an under-represented group defined by race or sexual preference. But that rule faces its own legal challenges, including from a conservative activist in California and from attorneys general in 17 Republican-led states.

For the most part, the board-diversity measures have been modeled after similar rules in Europe — most notably Norway, where a 2005 law has successfully nudged the country’s publicly traded companies to meet a requirement for 40% female representation on boards. Most likely, officials and legislators can find a way to make them work in the US too. In California, for example, the state legislature could adjust the law to address the issues the judge raised — if the Secretary of State chooses not to appeal.

Even better, companies can diversify boards on their own. Why, after all, should they need to be told to do what’s in their best interests?