The case for diversity

As economic pressures continue, corporate directors today must make trade-offs and tough decisions regarding deployment of corporate resources. Diversity efforts, like all others, require time, manpower and money. At a time when it may no longer seem remarkable to find women and non-white professionals serving in corporate leadership positions, including as corporate directors, boards may be tempted to put aside the issue of diversity. They do so at their peril, however: shareholders, regulators and consumers are watching.

Some of the nation’s largest and most influential shareholders – among them California’s two large public pension funds, CalPERS and CalSTRS – are increasing their focus on diversity. At the same time, large institutional investors are formalizing their diversity positions and pushing for change at companies with boards that do not meet their standards. For example, CalPERS has adopted a set of Global Principles of Accountability for Corporate Governance as a framework for executing its proxy voting responsibilities. In the document, CalPERS urges its portfolio companies to select directors who address a range of issues, including ‘historically under-represented groups on the board, including women and minorities.’ The corporate governance policy statement of TIAA-Cref, the leading retirement system for those in the academic, medical and cultural fields, expresses a similar sentiment.

Should shareholders be concerned with board diversity? Research indicates that, after rising rapidly in the 1980s and 1990s, recruitment of diverse directors has leveled off. In 2007, the 34th annual Korn/Ferry Board of Directors Study found that 85 percent of Fortune 1000 firms had at least one female director, virtually unchanged from the 2005 figure of 84 percent, and 78 percent had at least one director from an ethnic minority, compared with 76 percent two years before. Considering that women and minorities represent a majority of consumers, investors and employees, this lack of representation seems to be a marketplace disadvantage.

Responding to the call
In today’s post-Sarbanes Oxley, post-financial crisis world, director recruitment is tough, and is only going to get more difficult. The task is more demanding and must be performed under greater scrutiny than ever before. Add identifying and recruiting diverse candidates to a nominating committee’s plate, and the search for the right director candidates becomes that much more complex. This challenging environment, therefore, is an excellent reason to start working on the issue now in order to ensure long-term success.

If your board has a diversity strategy that already includes women and minorities, you have a foundation for refining and improving recruitment of diverse candidates. If not, the board will need to make some initial plans. All boards may consider taking some or all of the following steps to enhance diversity.

Create a historical profile of your board. How diverse has your board been over the past 10 years? Has representation from women and minorities changed? Improved? Declined? How does your board compare with that of other companies within your sector? Take a hard look at the numbers.

Schedule a serious discussion about the importance of diversity. What are the demographics of your market? What are your shareholders saying about diversity? The board should review the business strategy and reach consensus on the role diversity plays in achieving results and creating shareholder value.

Being attuned to the ethnic and gender composition of your company’s marketplace is important. For example, in 2009 the Hispanic Association on Corporate Responsibility (HACR) adopted a corporate accountability strategy to identify Fortune 500 corporations ‘that profit from, yet ignore, the more than 50 million Hispanics who spend an estimated $1 trillion a year, constitute one in every eight employees in the labor force, and remain the largest and fastest-growing ethnic population in the US.’

Broaden candidate specifications. Often, boards specify that they seek, for example, a sitting or former CEO. This narrows the candidate pool considerably, especially in terms of women and minorities. If the focus is more on the experience and skills required, however, it’s possible to identify a woman or minority candidate who has headed a multi-billion-dollar subsidiary, a major academic institution or other sizable organization.

Develop a methodology for identifying candidates. It is a misconception that the pool of qualified minority and women candidates is small. Work by Korn/Ferry’s Hispanic Business Initiative found that qualified and appropriate Hispanic directors, for example, commonly operate outside of traditional corporate sectors, such as on boards of large, privately held companies, large foundations and non-profit organizations, in the legal profession and in executive government positions. It is reasonable to assume that this holds true for women and men from other ethnic groups.

Boards that are serious about improving their diversity, therefore, should expand their recruitment beyond the traditional corporate mining grounds. This includes developing strong relationships with organizations that are identifying and developing the next generation of women and minority directors (such as Catalyst, HACR and similar groups that advocate board diversity).

Include more finalists. Rather than presenting only one finalist for a directorship, nominating committees might consider adding candidates from the non-traditional pool. These efforts will help boards identify a broader field of qualified nominees and will create a pipeline of prospective women and minority directors for future searches.

Not going away
The bottom line is that shareholders want strong financial performance from the companies they own. As business grows more global and consumer markets become more diverse, investors want portfolio companies to be able to set strategies to meet these new realities. Shareholders want to see that the companies they invest in are making business decisions based on the realities of the global marketplace. They also want companies to behave in socially conscious ways.

There have been various reports indicating a link between board diversity and business performance. For example, the 2009 CalPERS-commissioned study entitled ‘Board diversification strategy: realizing competitive advantage and shareowner value’ suggests that ‘companies with more diverse boards, especially gender-based diversification, have higher performance and key financial metrics such as return on equity, return on sales and return on invested capital.’ There has been much debate about these studies, but it becomes moot in light of growing shareholder activism on board diversity.

To enhance the information provided to shareholders, the SEC recently approved new rules requiring disclosure of whether – and how – a nominating committee considers diversity in identifying nominees for directorships. If the nominating committee or the board has a policy on the consideration of diversity in identifying director nominees, the final rules require disclosure of how this policy is implemented and how the nominating committee or the board assesses its effectiveness. This new rule will be in force in the upcoming annual reporting and proxy season.

As director diversity remains in the shareholder spotlight, it is clear that now, more than ever, boards that develop and execute a diversity strategy will reap the benefits of stronger ties to consumers and shareholders in the future.