Risk & Economy » Diversity » The case for diversity: Why institutional investors are using their proxy votes to leverage greater board diversity

The case for diversity: Why institutional investors are using their proxy votes to leverage greater board diversity

Greater diversity and inclusion in corporate leadership enhances a company’s culture and its profitability, says Lisa Hayles, principal, Boston Common Asset Management.

A new survey of investors released this month confirms what many finance directors will already know, thatdiversity is of increasing importance to shareholders.

The survey, conducted by Boston Common Asset Management in collaboration with the Thirty Percent Coalition, found that almost half (43%) of investors would vote against boards not composed of at least 30% diversity on gender, race and ethnic background. It follows an AGM season in 2019 in which companies as diverse as Exxon and Skechers have faced shareholder proposals at their AGM on diversity.

Why investors are increasingly interested in diversity

A core reason for the increasing investor interest in diversity is the compelling correlation between increasing board diversity and the positive effects on shareholder value.

A team of directors from diverse backgrounds can help combat groupthink and thereby mitigate excessive risk-taking. A 2017 McKinsey study supported this belief, revealing that companies with the most ethnically diverse executive teams — not only in absolute representation, but also a variety or mix of ethnicities — are 33% more likely to outperform their peers on profitability.

Institutional investors are also now realising the multitude of tools at their disposal to leverage greater board diversity.

Shareholder proposals that request companies to disclose steps taken to create greater diversity on the board have been on the rise in recent years and more than 80% of respondents affirmed that they would vote in favor of such proposals. The survey also found that 75% of respondents had a public proxy voting policy, which demonstrates that a majority of these institutions have created a formal framework for casting their votes.

Diversity is also an issue that is proving responsive to a strategy of long-term engagements. For example after two years of outreach to Mohawk Industries, a board diversity resolution was withdrawn after the company publicly augmented its Board Diversity search criteria.

Industry-wide collaboration is also another approach institutional investors are employing to speak with a louder voice, which has been aided by the establishment of the Thirty Percent Coalition. Since 2012 the Coalition’s Institutional Investors have collaboratively engaged with close to 300 companies that have added a woman to their board of directors following the Coalition’s landmark initiative, ‘Adopt a Company Campaign’.

The coalition’s members now represent more than $5 trillion in assets under management and the organisation has magnified the voice and streamlined the process for public and private companies, professional services firms, institutional investors and advocacy groups to achieve common goals.

Still a long road ahead

We are moving in the right direction on boardroom diversity, but there is still a long way to go, particularly concerning racial and ethnic diversity. Only 2% of respondents in the survey stated that they look specifically at race and/or ethnicity only, voting strictly against racially homogenous boards.

This is echoed by the fact that among the boards of 2,175 Russell 3000 companies (including 401 members of the S&P 500) only 10% of directors are people of color. This is compounded by a sluggish growth rate, with just 15% of new directors ethnically diverse compared to 45% of new Russell 3000 board seats filled by women in 2019.

While there’s a better outlook for women, there’s still much to be done to address gender inequality in the boardroom. Just 19% of all Russell 3000 seats are held by women. Similarly, only 23% of companies surveyed relied only on a gender screening, voting against boards that had no women.

That is not to say though that frameworks are not in place. More than 2,000 businesses have endorsed the Women’s Empowerment Principles promoted by the United Nations, which aim to establish high-level corporate leadership for gender equality. It is high time more companies walk-the-talk and tackle gender inequality at the board level.

Gender diversity is also being augmented by government legislation. New regulation in California mandates that all boards of companies headquartered in the state should have at least one woman on their boards in 2019, while at least three women board members are required by 2021 for boards with six members or more.

The move is expected to have a domino effect with New Jersey recently introducing legislation modeled after the California law, while Illinois is debating a bill that will require both gender and ethnic diversity on corporate boards.

Where do we go from here?

Although it may only be small steps, institutional investors are increasingly stepping up in their call for more diverse and inclusive boards. The journey towards racial and ethnic equality in the boardroom is perhaps the next battleground for Financial Directors to consider. People of color are underrepresented in boardrooms across the US and it is imperative that this imbalance is corrected, particularly as America is expected to be a majority-people-of-color nation by 2044.

The business case for improving diversity in boardrooms is plain and simple — greater diversity and inclusion in corporate leadership enhances a company’s culture and its profitability. Although there is still much work to be done, responsible, prudent investors are quickly getting this message and are increasingly using their proxy votes to deliver a win for inclusion and profitability.

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