Beginning this year, asset management giant State Street Global Advisors (SSGA) will vote against chairs of nominating and governance committees at companies in the S&P 500 that do not disclose the racial and ethnic composition of their boards, it announced earlier this month. By 2022, SSGA will vote against nom-gov chairs at companies in the S&P 500 that do not have at least one director from an “underrepresented community” on the board, according to a letter penned by SSGA president and CEO Cyrus Taraporevala.
SSGA is just one of several large institutional investors that have made plans to move beyond engagement. They are telling companies that if they see a lack of disclosure about the racial makeup of the board and a lack of progress in bringing ethnically and racially diverse members onto the board, nom-gov committee chairs will lose votes.
“The risk for companies [in] not diversifying materialized last year in many different ways, and when we try to look at the data, it’s not there. We felt it was our responsibility to call for action for enhanced disclosures to push companies to provide investors with more information,” says Ben Colton, global cohead of asset stewardship at SSGA.
“There is a clear risk for not addressing [diversity and inclusion] in the workforce and board level, and there is a need to have board oversight of these issues, because material risks are impacting companies, but there is currently not enough action or disclosure.”
What Investors Want to ‘Hang Their Hats On’
For many investors, disclosure is the first ask when they want to see companies make progress on a certain issue. SSGA has held more than 70 engagements with companies on racial and ethnic diversity since August 2020, according to the firm, and now SSGA expects robust disclosure on board composition beyond photographs in proxies. Colton says SSGA is calling for self-identification, and if a director chooses not to self-identify, the firm expects disclosure about that, too.
“If 10% of the board chooses not to self-identify and the other 90% do, we respect that choice but want to see that aggregation. We want the numbers,” Colton says.
SSGA is focusing on five specific disclosure areas for the S&P 500 companies the firm is engaging with. The firm wants boards to articulate the strategy when it comes to the role diversity plays in human capital management practices, lay out specific diversity goals and time lines and describe how those goals contribute to the overall business strategy. Also, the firm is looking for diversity metrics, goals and strategies related to racial and ethnic representation on the board of directors and how boards are overseeing them.
Similarly, at BlackRock, this year the firm raised expectations on diversity. According to its 2021 stewardship expectations, BlackRock is encouraging boards to disclose demographics related to board diversity, including gender, ethnicity, race, age and geographic location “in addition to measurable milestones to achieve a boardroom reflective of multi-faceted racial, ethnic, and gender representation,” according to the firm’s 2021 proxy voting guidelines. And the firm wrote that it may vote against members of the nom-gov committee for a lack of commitment to board effectiveness when boards have not “adequately accounted for diversity in its board composition within a reasonable timeframe.”
Similarly, Vanguard released updated expectations late last year, noting that beginning this year, the firm may vote against directors at companies where progress on board diversity “falls behind market norms and expectations,” which the firm defines as companies with no gender diversity on the board, no racial or ethnic diversity or “a lack of board diversity disclosure and policy,” according to a white paper put out by the firm.
Specifically, Vanguard wrote that boards need to focus on long-term planning to add diverse members to boards, broadening searches “beyond the corner office,” strategic increases to board size and “board cultures that foster difference and debate.”
“We encourage boards to step up their diversity efforts, invest in a prospective-director pipeline and make progress and show outcomes,” a Vanguard spokesperson writes in an e-mail. “It’s our expectation that boards have clear, long-term plans in place for how they intend to add diverse voices to their board, conduct broad searches for director candidates, and to consider increasing their board size in service of greater diversity.”
Meanwhile, major proxy advisors have also updated guidelines on diversity. Starting in 2022, ISS will recommend votes against nom-gov chairs at Russell 3000 and S&P 1500 companies if the board has no “apparent racially or ethnically diverse members,” according to its 2021 policy updates.
At Glass Lewis, beginning this year, the firm will look at the board’s current percentage of racially and ethnically diverse members, whether the board’s definition of diversity explicitly includes gender and/or racial and ethnic diversity, whether the board has adopted a recruiting policy that requires the initial candidate pool to include women and minorities — i.e., the Rooney Rule — and a board skills disclosure, according to the firm’s 2021 proxy guidelines. The firm wrote that it will not make voting recommendations on this assessment this year, but “such ratings will help inform our assessment of a company’s overall governance and may be a contributing factor in our recommendations when additional board-related concerns have been identified.”
Stephen Brown, senior advisor at KPMG’s board leadership center, says investors “know they have the power and most importantly, realize the efficacy of their vote.” With board recruitment, Brown notes, many future directors are recommended by those already on the board, and he doesn’t think “investors [appreciate it when] boards are focusing on their own Rolodexes and not expanding that.”
“Investors are more willing to pull that lever because they know how to get a response,” Brown says. “They want to know what the process is and a very clear discussion around the written policies [on diversity]. That is what investors want to be able to hang their hats on.”
Sources say numerous directors may be impacted by these voting guidelines if they don’t take action.
Dr. Curtis Crawford, board director at Chemours and president and CEO of XCEO Inc., says companies often point to issues in the workforce pipeline when it comes to diversity. But, in his experience, “it is difficult to be motivated and attracted to a company if they don’t see people to look up to at the top.”
“I think the activities of 2020 have had a significant impact on the awareness in the boardroom about the issue of diversity,” Crawford says. “I am not at a point yet where I think it has had a positive impact, but I am hopeful that the impact is one that turns into moving from interest to action. Recognize what you need at the board level today so that the board can be on top of senior management for the overall diversity of the firm. Starting at the top, I think, can have a positive impact on the desired outcome.”
Sources say boards have a long way to go. Of the 413 new directors named to S&P 500 boards between May 2019 and May 2020, 22% were people of color, compared to 23% of 432 new directors named to S&P 500 boards in the same year-long period between 2018 and 2019, according to Spencer Stuart’s latest board index.
Julie Daum, leader of Spencer Stuart’s North American board practice, says almost half of the new directors in 2020 were women, and she expects to see a similar percentage of minorities added to boards this year given the increased focus on racial and ethnic diversity from companies, investors and regulators.
Colton says that back in August when the firm began engaging companies, “the disclosure landscape was pretty grim.” According to the EY Center for Board Matters, 50% of the Fortune 100 disclosed their boards’ racial and ethnic diversity in 2020, up from just 24% in 2017.
Ron Schneider, director of corporate governance services at Donnelly Financial Solutions (DFIN), writes in an e-mail that in his experience advising companies on proxy design, “each year more companies include graphics highlighting different aspects of diversity, whether gender (binary or otherwise), race, ethnicity, national origin, age and tenure.”
“We expect to see a significant uptick in disclosure around director attributes this spring, but that information will likely be company specific,” writes Allie Rutherford, partner at PJT CamberView, in an e-mail. “Some companies may elect to provide disclosure specific to each director and others may aggregate across all directors.”
Colton says he expects that a “critical mass” of companies will disclose board-level diversity information in proxies and sustainability reports this year. Generally, there has been “very little pushback” from companies. Those that do push back say the data may not paint a good picture of the diversity of the company or that the company has legal concerns from disclosing data — arguments Colton says “don’t have merit.”
“We truly believe we are going to see companies [that are] not disclosing this information in the next six to 12 months become outliers and laggards, which is why we felt confident integrating it into voting guidelines,” Colton says.
For directors sitting on and chairing nom-gov committees, Colton recommends doing a deep dive on best practices and how to better source candidates, as well as making commitments to publicly enhance the diversity of the board and clarify who on the board is accountable for this in a formal way, through committee charters or otherwise.
“It’s an access-to-talent issue at the board level,” Colton says. “There are qualified directors out there to add value and provide skill sets needed for the board, and that can be found by broadening the scope for your search.”
Indeed, Daum says she’s seen a “huge uptick” in companies deliberately recruiting people of color to boards. And with this comes more flexibility on other search criteria, such as a requirement for C-suite experience, Daum adds.
Meanwhile, Crawford says private ordering is preferable to regulation in this area.
“If you care about it, understand it and have the courage to do what is inherently what most board members would say is the right thing to do, we don’t need more regulations and more laws directing us to diversify,” Crawford says.
“It is a good thing for investors to do as much as they can to encourage board members to do what we should do, and I think it’s also fair and important for us to share with our investors what we are doing and to discuss the strategies we have in place to show improvements where there is opportunity for improvement.”