Board Diversity by Term Limits?

Yaron Nili is Assistant Professor of Law at the University of Wisconsin-Madison Law School; and Darren Rosenblum is Professor of Law at Pace University Elisabeth Haub School of Law. This post is based on their recent article, forthcoming in the Alabama Law Review.

Gender diversity in the U.S. corporate world is shockingly low. As The New York Times reported, fewer women run large corporations than CEOs named John. Boardrooms also lack diversity. While 86% of directors participating in PwC’s annual director survey stated they felt that women should comprise between 21% and 50% of the board, only 28% of Russell 3000 boards have more than one-fifth of their board comprised of women. Some U.S. boards do not even try to include women: 76 of the largest 1,500 Russell 3000 companies have not had any female directors in the past decade.

The investor community has made board diversity a recent point of emphasis. State Street, Vanguard, and Blackrock have all voiced their commitment to gender diversity, followed by recent support from proxy advisors. California has ventured even further, passing legislation that mandates specific quotas for women on Californian corporations. New Jersey and Illinois may soon follow suit. Diversity mandates, however, confront substantial legal, economic and societal challenges.

What if companies could advance gender diversity without explicitly regulating diversity at all? Our recent article, Board Diversity by Term Limits? forthcoming in the Alabama Law Review, explores how the use of director term limits can promote gender diversity in boardrooms, avoiding quota controversies altogether. While term limits have often been invoked as a tool to improve director independence and board oversight, they may be also effective in improving diversity. We demonstrate the negative correlation between incumbency and diversity to support our findings. Director turnover in the U.S. remains very low. Firms hesitate to force out incumbents, who typically believe they contribute to the firm in unique and essential ways. Furthermore, although perhaps not averse to the idea of hiring a woman, these leaders will eventually search among potential replacements for people whose skills mirror their own. The cycle self-perpetuates, locking women out of opportunities.

Our article explores this aforementioned connection between term limits and board diversity. Drawing upon quantitative data on director turnover in the S&P 1500 and qualitative data on S&P 500 firms with term limits, our research shows that firms experiencing higher board turnover have more gender diversity. A regression analysis of the S&P 1500 companies over the 2010-2016 period shown in Table 1 below depicts how a decrease in average board tenure correlates significantly with an increase in gender diversity. Conversely, a one-year increase in average board tenure results in a 0.24 percentage point decrease in female board percentage.

Table 1: Board Tenure and Gender Diversity in the S&P 1500 (2010-2016)

Female Board Percentage

Female Board Percentage Female Board Percentage
Average Tenure -0.0024*** -0.0012*** -0.0032***
Year 0.0108*** 0.0107*** 0.0108***
More than 30% of Board with fewer than 6 years of Tenure 0.0163***
More than 50% of Board with fewer than 6 years of Tenure -0.0117***
Constant 0.1302*** 0.1097*** 0.1402***
N 9,416 9,416 9,416
R2 0.0511 0.055 0.0528

We also examine the effects of a tenure shock, which we define as a situation in which the board’s aggregate average tenure has dropped by more than one full year, on gender diversity. Tenure shocks often signal the departure of multiple directors in the same year. When such a shock occurs—for whatever reason—firms experience improvement in their gender diversity ratio. Though the tenure “shock” may arise out of various reasons, firms that experience a significant departure of directors subsequently generally improve their diversity compared to those who do not. While we do not endeavor to identify causality, we do add color to the finding of a negative correlation between tenure and diversity by showing that following a tenure shock, diversity is improved.

Table 2: The Effect That Tenure Shock Has on Board Gender Diversity

Diversity in 2015-2016 after tenure shock in 2015 Diversity in 2014-2015 After a tenure shock in 2014 Diversity in 2013-2014 After a tenure shock in 2013 Diversity in 2012-2013 After a tenure shock in 2012 Diversity in 2011-2012 After a tenure shock in 2011
Improved Diversity 0.008***

(0.001)

0.005***

(0.001)

0.006***

(0.001)

0.004***

(0.001)

0.004***

(0.001)

Constant 0.021***

(0.002)

0.018***

(0.001)

0.016***

(0.001)

0.012***

(0.001)

0.010***

(0.001)

Note: *P<0.1; **P<0.05; ***P<0.01

While an increase in director departures seems to be a prerequisite to diversity improvement, nothing prevents companies from tapping their existing network to fill these new openings. For that reason, we credit the correlation between board turnover and greater gender diversity to both external and internal shifts in the governance landscape. External forces include the overall market pressure, as well as the rise in investor and advocate activism, for increased diversity. Internal shifts include the entry of a newer generation of directors, which both includes more women and men more familiar with diverse work environments. This generation may look beyond the old network that has mainly produced male directors in the past.

Policy Implications

In addition to the quantitative analysis, showing the value of turnover, our work also introduces a number of policy paths available to improve the gender diversity of corporate boards in the United States. An easy first option is voluntary firm-wide remedies, which includes reporting and disclosure rules, requiring an overall averaged tenure limit, limiting service on certain committees after a certain period, limiting board members’ independent status, and having strict tenure limits on all individuals. Another option is industry-wide regulation, which involves mandated rules on tenure by different elements, whether by imposing an average limit, committee service, independence, or blanket limits, as a result of proxy advisor demands or development of industry best practice guides. Finally, regulatory actions constitute a more stringent action imposed by the state, but may vary considerably as well in their mandate.

A. Term Limits at the Firm Level

Regarding term limits, firms whose boards choose to implement such policies may experience greater benefits. Indeed, the number of firms with term limits has grown from 19 to 26 from 2017 to 2018. Some firms without an official term limit policy have a general good governance practice of keeping tenure relatively low. Imposing an average cumulative tenure ceiling would be a next step. This softer measure would not force firms to send a uniquely skilled expert board member away, but would force the firm to decide among board members longer to keep the overall tenure below the limit. A third firm-wide option is a limit on long-standing board members serving on key board committees. This would ensure that the core governance of the firm reflects the board’s fresher perspectives and independence. All of these softer, less onerous remedies would allow firms to be flexible in how they structure such policies.

B. Term Limits at the Market Level

Industries could also set norms as part of their corporate social responsibility policies to encourage firms to self-regulate. Proxy advisors and institutional investors could target specific industries that may particularly require board refreshment. Such norms could create a positive snowball effect: when one firm within an industry adopts a specific limit, similar companies may follow suit as part of healthy competition or to avoid state regulation. Finally, investors and proxy advisors may choose to tighten the already existing broad tenure policies to ensure higher turnover of directors.

C. Regulating Term Limits?

Finally, states, federal regulators and stock exchanges could impose these or even more stringent requirements. Heightened mandatory reporting requirements fall in line with other regulatory remedies already imposed on firms. Regulators could impose limits, similar to those suggested at the firm-wide level, on overall average board tenure and committee service. These policies would provide more flexibility for firms and keep regulators from directly interfering in the structure and composition of the board, respectively. Legislative mandates of rebuttable limits on individual tenure would be a more onerous requirement but one that is likely to induce faster refreshments of boards.

Investors and regulators increasingly call on firms to prioritize gender diversity in order to realize both good firm governance and social equality. Term limits may prove useful to promote such goals. Importantly, while vacant board seats are an essential first step to achieving more diversity, a critical mass of board turnover may be needed to achieve improved board diversity. In that respect the external push for diversity and the internal shift that significant board refreshment enables in the boardroom dynamics work in tandem. Effectively designed term limits, combined with external pressure to diversify, could provide a more organic route to improving board diversity without quotas.

The complete article is available here.

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