No More Old Boys’ Club: Institutional Investors’ Fiduciary Duty to Advance Board Gender Diversity

State Street Global Advisors (“SSGA”), one of Wall Street’s “Big Three” asset managers, has very recently been featured in the news for adopting a new policy where its recruiters will need to seek a diversity panel’s approval if they want to hire a white male management candidate over a woman or an ethnic minority. SSGA has been quick to reject these “factually inaccurate” reports that stipulate approval would be required to hire a white man, but they have also emphasized their continued focus on diversity.

The past twenty years have brought a sea of change regarding corporate diversity. Most of the world’s top ten economies have embraced some form of regulation to advance boardroom gender equality, with California being the latest to adopt such legislation. Critics, mostly in the United States, question whether the State should force companies to implement gender diversity on boards.

On October 19, 2021, a federal district court judge held a hearing on a motion for a preliminary injunction in a case challenging California’s board gender diversity statute, SB 826. The motion argued that the legislation is unconstitutional under the equal protection provisions of the 14th Amendment. The 9th Circuit held that the plaintiff has standing to challenge SB 826’s constitutionality because he “plausibly alleged that SB 826 requires or encourages him to discriminate on the basis of sex.” In a 2021 case, the federal district court judge dismissed a lawsuit attempting to invalidate the new California law on the basis of lack of standing, but the decision was reversed by the 9th Circuit.

Despite the substantial challenges SB 826 faces in courts, it has nonetheless inspired widespread compliance. While quotas are generally effective at improving corporate diversity, they also involve the state’s heavy intervention into governance. Yet California is not alone in its legislation—there are other, perhaps “softer” remedies for women’s inclusion. On August 6, 2021, the U.S. Securities and Exchange Commission approved new listing rules regarding board diversity and disclosure in the form of comply or explain mandates. The new listing standards will require each Nasdaq-listed company to have at least two diverse board members or explain why it does not. What will likely prove to be the most effective aspect is the standard’s disclosure requirement—the new listing requires disclosure of corporate board members’ voluntary self-identified gender, racial characteristics, and LGBTQ+ status. While this is a great step forward, more is still needed.

Perhaps we ought to focus on nominating committees and their processes. Many law firms now recommend that clients adopt a process akin to the “Rooney Rule,” which mandates that an National Football League team must interview at least one minority candidate for head coach or manager positions. The rule has provided a blueprint for corporate America to improve its poor hiring record with respect to diversity and equality. Facebook, Pinterest, Intel, Xerox and Amazon are among the major companies that have instituted their own version of the rule. Even the Pentagon has explored using some form of the rule to diversify its officer corps. While the nominating process is critical for diversity, we believe that the way the Rooney Rule is used today is flawed. We therefore suggest a change to the rule, as improvements can result from an increase in disclosure: companies ought to disclose their hiring processes and practices.

Despite these recent efforts in mandating diversity, corporate leadership continues to be a man’s world—an Old Boy’s Club. As of 2019, men constituted 80% of board members and 96% of CEOs. Parity in corporate leadership remains a distant dream.

Amid escalating battles over diversity, activist shareholders are also demanding change. Shareholder derivative lawsuits have recently begun targeting major public and private companies, alleging that boards have breached their fiduciary duties in creating an “old boys’ club” corporate culture. Despite companies making public commitments to diversity, the pursuit of equality, and inclusion, boards are still unwelcoming to diverse directors. These activist shareholder lawsuits unequivocally center on the board’s lack of focus on promoting diversity.

Concurrently, institutional investors have made bold public statements on their commitments to pressure companies to increase board diversity and be more transparent on their current diversity practices. One can question whether institutional investors are concerned that they might be targeted next by such lawsuits. As stakeholders and stockholders will evaluate such investors not merely on their statements, but also on their actions, they may begin to wonder if their boards, and the boards of the firms they invest in, remain largely homogenous.

Regardless of the outcome of such litigation, it raises several questions that corporate law has yet to answer: Is the duty to diversify and push for equality located within the firm and its ownership structure? Moreover, if so, do institutional investors have a duty to focus on corporate culture and specifically push for gender equality in the boardroom? These questions are analyzed in our most recent paper, No More Old Boys’ Club: Institutional Investors’ Fiduciary Duty to Advance Board Gender Diversity.

Institutional investors’ influence on corporate governance is hard to overstate, as they are “universal owners;” therefore, our paper suggests that they can and perhaps should play this oversight role with regard to gender equality. Their weight as market actors could render them more effective in promoting equality than quotas or other controversial State-mandated inclusions. After all, institutional investors are in a unique position to direct firms’ actions. Their influence stems notably from their focus on the long-term value of their investments, drawing them to seek good governance.

Fiduciary duties may seem at first blush an odd location within corporate law for equality requirements. It is unquestionably a novel place. Nevertheless, it is through fiduciary duties that the State articulates the behavior expected of duty holders. Fiduciary duties allow the State to deputize duty holders to act in ways that reflect widely accepted public governance norms.

The following reasons underscore why establishing a fiduciary duty to focus on corporate culture, diversity, and equality may bolster governance. First, and foremost, creating a fiduciary duty for diversity and gender equality establishes equality as a normative goal, reflecting the public value equality already holds. Second, social science underscores how diversity is essential for effective decision-making, risk oversight, and innovation. Third, research demonstrates that companies lacking diversity are prone to underperform in comparison to their peers, take excessive risk, and face reputational harm. Fourth, as long-term investors in public companies worldwide, institutional investors must ensure that they invest in firms with a strong, independent, and effective board that exercises high-quality oversight. Finally, institutional investors are best positioned to uncover exactly how firms should diversify and strive for equality.

Institutional investors monitor corporate governance issues, which include the diversity of the board members of their investee companies. These investors have a fiduciary duty stemming from their power to influence the composition of the corporation’s (investee company) board. They need to select the “best” board members to serve the corporation for its own benefit and that of its shareholders. This fiduciary duty extends to current and future shareholders, investors, and beneficiaries, who invest their money but have no power to choose the company’s directors. The fiduciary duty we propose would require the board to reflect a diverse set of experiences and opinions, but also to work together by committing to a unified leadership.

Our paper promotes diversity and gender equality. Board members can and should hold diverse experiences and knowledge, but they also ought to share values and objectives in leading a corporation. Many institutional investors already behave as if they have a duty to diversify, especially since the summer of 2020 which saw an increase in acknowledgment of such a duty in the wave of mass Black Lives Matter protests across the country.

Firms are also responding to this cultural shift. Illustratively, we have seen a large rise in Chief Diversity Officer (CDO) positions within organizations. This conveys that firms are now responding to pressure from investors, by prioritizing diversity without necessarily being required to legally. In this sense, our argument aims to restate what is already understood as an implicit duty of institutional investors to advance equality. We are going further in asking whether formalizing this duty may hold potential as a means to improve corporate governance.

There is broad agreement among scholars that corporate governance suffers from a lack of diversity. It is not only women who face exclusion from corporate power. One group’s dominance infuses corporate governance with groupthink and deprives it of the critical analysis of opportunity and risk that diversity brings. While many countries have tried various state-driven approaches to regulate inclusion, such approaches face controversy and may not prove as effective as private ordering solutions.

Given the clear data on diversity’s benefits for good governance, institutional investors may hold a fiduciary duty to advance diversity and push for gender equality in the boardroom. This fiduciary duty to change the old boys’ club culture and push for equality presents a practical way to advance inclusion in corporate governance by placing the burden on institutional investors and decision makers to implement diversity. The duty would cross both the duty of care and the duty of loyalty. The duty of care obligates leaders to make informed decisions in a reasonably prudent fashion. The duty of loyalty also encompasses a duty for diversity, equality, and inclusion. Directors must oversee their corporation and can be liable if they fail to act and the failure is “sustained or systematic.”

Many institutional investors already act as if such a duty exists, with many stepping up to ensure diverse leadership teams in the past few years. However, the exact remedy to advance equality is not coherent across investors. For example, David Solomon, Goldman Sachs’ CEO, committed to insisting on at least one “diverse board candidate, with a focus on women” on boards of companies they take public, whereas Vanguard doesn’t advocate for one-size-fits-all mandates.

These initiatives are part of a larger “paradigm shift” in corporate governance, which recognizes the benefits of gender diversity in management. However, this shift’s instigators still face barriers embedded in current selection processes, investment analysis, and due diligence. To help institutional investors push for board equality, we also propose several solutions to these problems. First, to address the lack of accessible information on diversity, we suggest that public companies should have an obligation to disclose, in proxy statements, data relating to diversity within their ranks. Second, we call on companies to adopt new policies compatible with this imperative regarding search committees and selection processes.

Our paper accepts the premise that equality on its own proves necessary and advantageous to investors, businesses, and society. We believe that institutional investors and the companies that they invest in can and must change the “old boys’ club” into a more inclusive and diverse culture that would discourage groupthink and encourage innovation. This is particularly true in our “knowledge economy,” where companies depend on their employees to provide the human capital that helps the firm grow and compete in this dynamic, complex, and ever-changing world.

The complete paper is available for download here.