Board diversity to play big role in upcoming proxy season

Pressure on corporate boards to be more diverse is likely to intensify this year, as institutional investors ramp up requests and shareholder proposals, more states consider mandates and even Nasdaq gets involved.

The largest group of shareholder proposals — 64 out of 239 — submitted so far this year by the Interfaith Center on Corporate Responsibility involved diversity and racial justice, for example. The center's 300 members represent faith communities, asset managers, unions, pension funds and other socially responsible investors with combined assets of more than $500 billion.

"There is definitely momentum around diversity and inclusion, around companies' willingness to tackle these issues and regulators willing to do something. There's a lot happening right now," said Aeisha Mastagni, portfolio manager for sustainable investment and stewardship strategies at the $283.4 billion California State Teachers' Retirement System, West Sacramento.

"We are the ultimate long-term shareholder, and what we are trying to do is mitigate risk and add value. I don't think anybody debates the academics anymore; now it's about trying to move the needle," Ms. Mastagni said. A key priority for this year, she said, is getting companies to disclose the gender, racial and ethnic composition of their boards, and to see where they can improve.

"We are asking them to think about it. It is really about widening that pool," she said.

Martin Whittaker, CEO of JUST Capital, a non-profit that tracks company performance on multiple stakeholder issues, expects to see record engagement on board diversity by institutional investors, as companies "are increasingly competing in a marketplace that values leadership on social issues."

He is encouraged by recent pledges from major investors like BlackRock Inc. and New York City Comptroller Scott Stringer, fiduciary for the $239.8 billion New York City Retirement Systems, to push companies to improve ethnic and gender diversity on their boards and in their workforces and to publicly share annual Equal Employment Opportunity Commission reports known as EEO-1 reports.

Mr. Stringer and other investors, such as State Street Global Advisors, made it clear to companies that failing to disclose racial and ethnic diversity will trigger votes against their board's governance officials this year, and in 2022 if they fail to make progress.

New York state Comptroller Thomas P. DiNapoli, the sole trustee of the $226.4 billion New York State Common Retirement Fund, Albany, has filed several shareholder proposals asking companies for EEO-1 reports, commitments to board diversity, racial equity audits and other measures to address racial and gender pay inequity. He also has asked fund asset managers to disclose their own policies for promoting diversity and inclusion.

In the coming weeks, Mr. DiNapoli will announce specific voting positions against boards lacking racial or ethnic diversity, spokesman Matthew Sweeney said.

Calvert Research and Management has spent the past three decades filing "hundreds" of shareholder proposals to get better insight into racial and gender data of boards and workforces, said John Wilson, a vice president and director of corporate engagement in New York, who sees investors and corporate leaders increasingly recognizing the value of diversity as a driver of financial performance over the long term.

"We are pleased to see that we are now in a moment and we don't have to make that case. There was a recognition that boards and companies were missing out on talent. We now have data that backs that up," he said. Calvert's own industry analysts model all ESG issues, including diversity, that might affect a company's long-term value.

Investors like Mr. Stringer of New York City often cite research by McKinsey & Co. connecting gender and ethnic or cultural diversity on executive teams to stronger financial performance.

McKinsey's most recent analysis in 2019 found that companies in the top quartile for gender diversity on executive teams were 25% more likely to have above-average profitability than companies in the bottom quartile — up from 21% in 2017 and 15% in 2014.

The connection between diverse boards and corporate performance prompted Nasdaq in December to seek approval from the Securities and Exchange Commission to require listed companies to publicly disclose the diversity of their boards and eventually to have at least two diverse directors.

Former SEC Commissioner Roel Campos, chairman of the Latino Corporate Directors Association, thinks the Nasdaq approach "goes a long way" to addressing investors' push for more diverse corporate environments. "Investors want better returns. It also shows whether a company is forward-thinking," Mr. Campos said.

Many investors also expect that the current SEC will eventually consider mandating diversity disclosure.

Kathryn McDonald, a founding partner of Radiant ESG, a consulting firm based in Oakland, Calif., expects data on racial and ethnic diversity to improve as major providers of ESG data get involved, driven in part by regulators in Europe.

"Most large investors have been convinced of the economic benefits of diversity,'' she said. "Some of the largest investors are also public funds, and they are also under scrutiny. They are being asked a lot of questions and they are passing those questions on to their companies."

Board diversity does act as a proxy for other aspects of diversity and "everyone is really interested in getting a handle on this issue," said Courteney Keatinge, senior director of ESG research for proxy advisory firm Glass Lewis & Co. in New York. Glass Lewis plans to backtest S&P 500 companies on how well they did in 2021 in four areas: racial disclosure, having a board skills matrix, whether proxy statements require that diversity is clearly defined and if they have adopted the Rooney Rule for director and executive searches. Borrowed from the NFL, the corporate version of the Rooney Rule requires that the initial pool of candidates include women and minorities.

Improving board diversity "really is job No. 1 now at many nominating committees," said Patrick McGurn, special counsel for proxy firm Institutional Shareholder Services Inc., who sees it moving over to executive positions as well. "A lot of the activism we are seeing this proxy season is calling for diversification," he said.

ISS data indicates that as of January 2021, approximately 88% of S&P 500 and 54% of Russell 3000 companies have at least one racially and/or ethnically diverse board director. Companies with no racial or ethnic diversity on boards a year from now could face an ISS recommended vote against relevant committee chairs.

States are also jumping in, with a dozen adopting laws or considering legislation tied to gender or racial/ethnic diversity on corporate boards. The trend started by California, with quotas for representation by women and underrepresented communities, has since spread to Illinois, Washington, Colorado, Maryland, New York, Hawaii, Massachusetts, Michigan, Ohio, New Jersey and Pennsylvania.

Mark Rogers, president, CEO and founder of BoardProspects, a Boston firm advising boards on recruitment and governance issues, expects the pace of racial and ethnic diversification of corporate boards to accelerate, as boards listen to investors and others. "I guarantee you that every single public board is looking at this. They need to diversify before they are told to do it," Mr. Rogers said.

State officials are also taking a page from other institutional investors by joining coalitions like the Russell 3000 Board Diversity Disclosure Initiative. Its 21 investor organizations with a collective $3 trillion in assets called on the companies in the index to voluntarily disclose gender, racial and ethnic board diversity data, given the correlation with long-term performance.

The initiative is part of a broader alliance promoting more diverse boards, including the Midwest Investors' Diversity Initiative, the Northeast Investors' Diversity Initiative, and The Thirty Percent Coalition.

Russell 3000 initiative co-Chairman Shawn Wooden, the Connecticut treasurer and principal fiduciary of the $37 billion Connecticut Retirement Plans & Trust Funds, Hartford, said that investors continue to push for increased corporate board diversity because of "the mounting body of evidence" connecting it to long-term shareholder value.

"With a president in the White House whose economic agenda includes racial equity and who understands how diverse leadership enhances our overall economic performance, I am encouraged that more companies will continue to utilize the tools at their disposal to create more inclusive, effective boards that produce better investment returns," Mr. Wooden said.