The Securities and Exchange Commission’s decision to instill changes to proxy disclosure rules for public companies’ compensation and governance practices includes a focus on diversity.
The rules, effective for the 2010 proxy season, require disclosure from companies’ nominating committees, ensuring that the committees consider diversity when selecting candidates for board positions. However, the rule does not define diversity, leaving it open to each company’s own interpretation.
Companies are unaware if the SEC plans to specify future diversity requirements going forward. Specific conditions to the rules related to gender and ethnicity are not expected. “It would be difficult for the SEC to go further with this diversity initiative until we see fallout after the first strike,” says Jessica Lochmann Allen, partner at Foley & Lardner. “The backlash from the corporate community would be very strong.” The SEC’s ruling highlights the fine line between overstepping into private practice and keeping a watchful eye as a regulator.
“The SEC has recognized the diversity issue, but it’s up to companies to determine the means and the mechanisms used.” – Deborah M. Soon, Catalyst
The new rules do not define what denotes a well-diversified board, but the move is seen as another step in the right direction. “The SEC is allowing corporations to really look holistically to what makes business sense,” says Deborah M. Soon, vice president of executive leadership initiatives at Catalyst. “I think the SEC was smart in taking the first step,” Soon adds. “It will allow investors to then decide if what the company reports is satisfactory.”
Highlighting diversity in the boardroom without providing specific guidelines allows companies the flexibility to reflect upon their own diversity practices. Recently, a study by Amy Dittmar, associate professor of finance at the University of Michigan’s Ross School of Business, and Kenneth Ahern, assistant professor of finance, focused on Norway’s decision to require that women occupy 40 percent of board seats at the 130 publicly listed Norwegian firms.
The study, which took place from 2001 to 2007, showed that the stock price of an average firm dropped 2.6 percent during the three days after the announcement and 5 percent for firms that had no women on their boards at the time of the February 2002 announcement. “Firms that were required to make the most drastic change to their boards also suffered the largest negative returns,” said Ahern in a statement. “…Constraining the selection of board members has a large negative impact on value.”
“Companies will fight back against any sort of quotas,” says Allen. “I’d be surprised to see any mandatory quotas in the U.S.—U.S. companies are not interested in finding candidates that fit into a mold.” Allen also notes that such mandatory policies could impede progress and such “policies might create a barrier and make interactions between directors more difficult,” suggesting that a director’s insights might not be regarded as highly if thought to occupy the seat due to company quota fulfillment requirements.
“Catalyst has already gotten requests asking what good diversity policies might be,” Soon adds. The Catalyst executive insists that many companies are aware that “independence, creativity and innovation comes from having diverse perspectives.”
The study of Norway’s public companies can be viewed as an insight into another country’s corporate culture. While practices in the U.S. and Norway are different, for example, the unions in Norway are extremely strong with numerous labor representatives on many of their public boards, the U.S. corporate culture is unlikely to adopt any strict regulations on diversity.
Still, Norway’s example holds as a modern example of some of the pitfalls of “forcing” diversity by specifying percentages. “When firms were free to choose directors before the rule, they tended to choose women that were similar to [the qualifications of] men directors,” said Dittmar said in a statement. “This is consistent with the idea that the large demand and small supply for women directors after the adoption of the 40 percent quota forced firms to choose directors that they would not have chosen otherwise.”
“The SEC has recognized the diversity issue, but it’s up to companies to determine the means and the mechanisms used,” says Soon. “The SEC has recognized that this is something that can no longer be either not talked about or shunted to the side—it has to be addressed and that’s progress.”
My question is simple:
Do regulators like SEC also make mistakes? Where would such mistakes come from and how are the SEC board of directors blamed and when are they blamed? Who audits their gaps?
What actually must the boards of directors do in order to harness an ideal and prosperous business environment.
Nevertheless, we need more of due diligence,transparency, accountability and best of it all, directors must be all focused, business oriented and should understand their roles and legal implications for not performing in their respective portfolios.
Richard Gudoi Gid’Agui
Research student of corporate governance
University of Witwatersrand
South Africa