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Forcing companies to diversify their boards of directors is effective

Before a judge found it unconstitutional, a California law mandating diversity was a success.

California has become the epicenter of a debate over how businesses should address the lack of diversity on their boards of directors: should they actively seek out members who aren’t White males, or should they simply treat all applicants equally? A Superior Court judge has ruled in favor of the latter method, ruling that a law requiring publicly traded corporations based in the state to add up to three board members from under-represented groups is unconstitutional.

This is a pity, because the law was genuinely doing its job.

In the case of California, no one questioned the value of diversity.

As the judge rightly said it:

A homogenous board is vulnerable to stagnant thinking and common assumptions; it is also less flexible in responding to challenges. This results in poorer business practices, less innovation, and ultimately less profit. 

The legal challenge, brought by the conservative group Judicial Watch, focused on whether the state constitution allowed the legislature to favor some groups over others in its efforts to address the problem.

The legislation demonstrated how successful a mandate can be in reversing long-entrenched discrimination during its brief period in force, which began on September 30, 2020. According to a Latino Corporate Directors Association review of Equilar data, the share of California corporations with at least one Black or one Latino director was 30% and 17%, respectively, in July 2021, up from 16% and 13% a year earlier.

According to Equilar, nearly a third of boards had at least one woman as of September 2021, up from less than a quarter a year earlier.

Companies who wanted to be known for their social responsibility tried to stand out. In its most recent proxy statement, Apple Corp. used the word diverse or diversity 70 times, up from 20 the year before. It also inserted a piece near the top praising its board diversity: it’s possible Apple would have done so even if the 2020 law hadn’t been passed. In the absence of an official requirement, it’s difficult to picture the other 700 or so publicly traded California companies doing the same.

California Secretary of State Shirley Weber, who recently submitted a full report on board diversity as required by law, hasn’t announced whether she plans to appeal the Superior Court’s decision. In the meantime, Judicial Watch is contesting a 2018 law focused on increasing female board representation. If the group succeeds, much of the progress made in putting women on boards of directors could be lost.

A Nasdaq rule approved by the Securities and Exchange Commission last year might serve as a backup. It mandates that at least one female and one person from an under-represented group defined by race or sexual preference serve on the boards of most companies that trade on the exchange.

However, the regulation is being legally challenged, as well as by a conservative activist in California and attorneys general from 17 Republican-led states.

The board-diversity regulations were mostly fashioned after similar requirements in Europe, most notably in Norway, where a 2005 law effectively encouraged the country’s publicly traded corporations to reach a mandate for 40% female presence on boards. Officials and politicians in the United States are likely to find a method to make them work as well. If the Secretary of State decides not to appeal, the state legislature in California could change the law to meet the issues presented by the judge.
Better yet, businesses can diversify their boards on their own.

After all, why should people need to be told to do what’s best for them?

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