Board Diversity Developments

Arthur H. Kohn is partner and Elizabeth K. Bieber and Maria I. Maldonado are associates at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Kohn, Ms. Bieber, and Ms. Maldonado.

Over the last few years, boards have come under mounting pressure to focus on board composition and refreshment, including length of tenure, individual and aggregate skills mix and diversity. A few years ago, CalPERS’ revised its Global Governance Principles to call for companies to conduct rigorous evaluations of director independence after twelve years’ service, and ISS’ QualityScore metric rewards companies where the proportion of non-executive directors with fewer than six years tenure makes up more than one-third of the board, in addition to scrutinizing boards where average tenure exceeds 15 years. Companies also face demands to justify the contributions of individual directors and to conduct rigorous evaluations to ensure that the board functions effectively and with the right mix of skills. Correspondingly, refreshment is one of the top areas of continued governance focus from other investors and advocates. This update is intended to provide boards with data that brings them up to date on developments in this area, since it is certain to be an area of continuing focus for various constituencies in the near future.

Companies have responded to the recent focus on board composition and refreshment by onboarding new directors. According to the 2017 Spencer Stuart U.S. Board Index, 397 new independent directors were elected to S&P 500 companies in 2017, representing a 15% increase over the same period in 2016. Meanwhile, companies are expanding the kinds of attributes and skills in these searches, evidenced by a significant increase in the number of first-time directors, as well as an expansive view of C-suite experience as a prerequisite to services. In addition, companies are carefully reviewing the attributes they need to reflect a growing and changing business environment and as a response to societal pressures.

In the past few years, diversity in particular has become increasingly important to institutional investors, pension funds, employees and other stakeholders. Companies over the past few proxy seasons have been receiving shareholder proposals, often from small coalitions or groups of investors, regarding board diversity and, in 2017, BlackRock indicated its support for a number of those resolutions. State Street Global Advisors announced that it voted against the chair or the entire nominating and governance committee at nearly 400 companies that lacked a single female director. In the 2018 proxy season, State Street indicated it voted against directors at more than 500 companies that failed to address board diversity, while simultaneously noting gender diversity improvements at over 150 companies that it addressed through either a withhold vote or engagement. In addition, in 2018, BlackRock amended its proxy voting guidelines to include an expectation of at least two women directors on each board and noted that it will continue engagement efforts, coupled with the threat of withhold votes for companies that ignore its comments. Further, CalSTRS, CalPERS and the California Treasurer are increasing pressure, through both engagement and withhold votes, on companies to address refreshment. Glass Lewis has also indicated that it will factor diversity on the board into its voting recommendations. Echoing some of the trends in other governance areas, coalitions of investors are also forming with the goal of promoting board diversity. In July 2018, the 10-member investor coalition with a combined $300 billion in assets, under management known as the Midwest Investors Diversity Initiative, publicly announced efforts to increase racial, ethnic and gender diversity through model checklists and best practices.

This pressure for more diversity in boardrooms follows recent notable corporate scandals, and responds to the historic under-representation of women and people of color on public-company boards. According to the 2017 Spencer Stuart U.S. Board Index, women represent 22% of the directors and minorities represent 17% of directors in the largest 200 companies. As of the first quarter in 2018, there remains 585 companies in the Russell 3000 with all-male boards. [1]

A number of the shareholder proposals received by companies in the 2018 proxy season, including Amazon, concerned the “Rooney Rule”, named for Dan Rooney, former owner of the Pittsburgh Steelers. The Rooney Rule originated as a National Football League policy requiring teams to interview ethnic minority candidates for the most senior positions. Within three years, the percentage of African-American coaches was 22%, a 16% increase. [2] Amazon had three women directors, but lacked racial or ethnic minority representation on its board. Amazon initially opposed the proposal, but after receiving negative feedback on its stance, including from employees, reversed course and adopted a board-level diversity policy.

As investors champion these changes, their tactics have evolved. While shareholder proposals and strategic voting remain key tools for investors, some investors and investor coalitions have taken a more active approach. Probably most notably, the Office of the New York City Comptroller has pushed for increased transparency and comparability among companies through their Boardroom Accountability Project 2.0. [3] The 2.0 Project encourages companies to improve the quality of their board with an emphasis on diversity of gender and race and climate competence, with the continued goal of putting companies in a position to deliver better long-term returns for investors. In order to challenge refreshment and make boards more transparent in their disclosure practices, the 2.0 Project sought to cause companies to adopt a prominent disclosure matrix in the proxy statement.

The New York City Comptroller’s Office sent letters to the nominating/governance chairs of 151 companies (of which 92% have adopted a proxy access bylaw and 80% are in the S&P 500). The letter requested and argued for adoption of a skills matrix including race and gender, as well as engagement on the companies’ processes for board refreshment and evaluation. It also included a model matrix for companies to use. This departed from the strategy the New York City Comptroller’s Office used in their initial Boardroom Accountability Project. While the New York City Comptroller’s Office recommended terms in that Project, it ultimately left the drafting of proxy access bylaws to companies. In negotiations with individual companies, the New York City Comptroller’s Office would withdraw shareholder proposals with significant variations in so-called “secondary terms”, so long as companies adhered to the standard “3/3/20” [4] provisions.

Similarly, the Midwest Investor Diversity Initiative developed the “Diverse Search Company Toolkit” for companies adopting a diverse candidate search policy. [5] The toolkit was designed to assist boards and nominating committees with implementing a comprehensive diverse search process. This toolkit includes best practice language, board assessment, succession planning, skills matrices and other resources.

Both the model board skills matrix from the New York City Comptroller’s Office and the toolkit the Midwest Investor Diversity Initiative created are examples of investor involvement in the implementation of the processes they wish to change, and potentially make it more difficult for companies to justify an unwillingness to amend practices.

Some companies have been reluctant to adopt a “one-size fits all” model for disclosure of board diversity metrics, particularly those that, for instance, provide information about director skills and diversity in textual form, or, as is becoming increasingly popular, in infographics or other pictorial forms. While there are good reasons for such reluctance, companies analyzing these investor-generated models should consider some of the practical limitations of investors which drive the push for commonality across companies. One of the benefits of these formats is the ease of digestibility and comparability. While a number of large investors have increased their resources in governance areas, many investors still note that they are resource-challenged in their efforts to consider thousands of voting decisions in a compressed timeline, and that a standardized disclosure format can help companies ensure that their efforts are recognized.

At the end of June 2018, the New York City Comptroller’s Office released information about the status of its project. The response level was robust; approximately 80% of the companies in receipt of a letter responded, resulting in substantive engagement with management teams and dozens of directors at over 85 companies. Engagement topics included how companies related their business and long-term strategy with director qualifications; the ways in which companies use a diverse pool of potential candidates; the robustness of the board evaluation processes, including individual director evaluations and the importance of gender and racial diversity, among other types of diversity, as to avoid “group-think” among the board. The New York City Comptroller’s Office also submitted six shareholder proposals to companies that did not initially respond, ultimately withdrawing five proposals after engagement and a commitment from the companies to adopt what the New York City Comptroller’s Office classified as “satisfactory meaningful disclosure”. [6] Shareholders at the sixth company, ExxonMobil, voted on the proposal, which ultimately did not pass.

As a result of the engagements, more than 85 companies changed their processes and increased transparency regarding board quality, diversity and refreshment and more than 35 companies adopted a board matrix disclosing individual director qualifications and gender and racial/ethnic diversity in their 2018 proxy statement. In addition to change in proxy statements regarding board diversity, over 25 companies provided meaningful disclosure about their annual evaluation processes. In addition, since the engagements began, 49 targeted companies have elected 59 new directors who identify as a woman or person of color. Additionally, 24 companies have publicly committed to include women and people of color in the candidate pool for every board search going forward. [7]

The practice of honestly assessing the skills and attributes of individual directors is important for companies, whether or not they disclose it publicly. In addition to being a key to good refreshment practices, the absence of this governance feature is a weakness that can be exploited. As activists continue to use access to the boardroom as a key tenet of their strategy, they are making the same kinds of assessments of boards. Activists continue to be strategic about the directors they target in their proxy contests and are savvy about nominating a candidate who can provide that perspective. It is equally important that companies that disclose key skills do so in a way that highlights directors’ strengths. Skills matrices that have each director satisfying each substantive skill are not meaningful, nor is attributing expertise to areas of mere familiarity. This can be a sensitive conversation. Companies engaging in matrix-style disclosure have adapted to the inclination to expertize directors in all areas in a variety of ways, including listing a maximum number of skills per director, or attributing only skills which are evidenced by the director’s biography. Companies should also be mindful that their investors are not only measuring a company’s changes in disclosure against itself, but against the improvements of their peer companies in these areas, as well. [8]

Companies should continue to expect that the New York City Comptroller’s Office, State Street and others will continue to seek dialogue, engagement and disclosure on diversity and other important social issues. Based on the 2018 proxy season results, with more than 40% of environmental and social shareholder proposals receiving greater than 30% support, investors’ voting decisions are becoming more complex and votes may increasingly become a referendum on social concerns.

Endnotes

1Though this figure is an improvement; it is the first quarter in which that percentage is below 20%. See http://www.equilar.com/reports/55-gender-diversity-index-q1-2018.html. According to the most recent Spencer Stuart Board Index, just 18 of the top 200 S&P companies, 8.5%, were led by African-American, Hispanic/Latino or Asian CEOs, although that is four more than in 2016.(go back)

2Collins, Brian W. (June 2007). “Tackling Unconscious Bias in Hiring Practices: The Plight of the Rooney Rule”. New York University Law Review. 82 (3): 870–912. Notably, the initial rule covered the most senior coaching and operations jobs, but proved to be so successful that after six years it was expanded to include general manager positions and equivalent front-office positions.(go back)

3The Boardroom Accountability Project launched in 2014 and partially focused on encouraging companies to adopt proxy access bylaws to permit investors to nominate directors directly on a company’s proxy card without the administrative and financial burden of a proxy contest. Today more than 60% of S&P 500 companies have adopted proxy access bylaws.(go back)

4Refers to bylaws which allow for shareholders representing 3% of the stockholders, holding continuously for a period of at least three years to nominate up to 20% of the board through proxy access.(go back)

5See http://uawtrust.org/AdminCenter/Library.Files/Media/501/About%20Us/MIDI/Diverse-Search-Tool-Kit-070218.pdf.(go back)

6See https://comptroller.nyc.gov/newsroom/comptroller-stringer-nyc-funds-unprecedented-disclosure-of-corporate-boardroom-diversity-following-groundbreaking-campaign/.(go back)

7Engagement also resulted in some of the targeted companies exceeding the initial requests. Some of these companies provide in-depth disclosure explaining the significance of the directors’ qualifications to the company, and in some cases, provide a connection to this disclosure throughout the director biographies. Other enhanced disclosure practices emerging from these engagements include concrete disclosure regarding board evaluations and refreshment, including conducting “honest and difficult conversations” with directors about their continued service as a director, when necessary. See the Unum Group’s 2018 proxy statement iterating its board evaluation process: https://www.sec.gov/Archives/edgar/data/5513/000000551318000042/def14a2018proxy.htm.(go back)

8Companies also should be mindful about how investors identify “peer companies”, which may be different than how companies identify their peers. For instance, for investors with small holdings, the peer group may be the disclosure of the other companies they hold, whether or not those holdings are in any meaningful sense comparable. Benchmarking against similarly sized companies within an index is common.(go back)

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