Reserving board seats for women doesn’t empower them — or help companies

Is it appropriate for the government to mandate that companies reserve seats on their boards for women? California sure thinks so — it became the first state to compel public companies to have at least one woman on their board of directors by 2019. Although one doesn’t cavil with the idea that true merit and inclusion of all talent is good for corporate governance, a mandatory quota for women is likely to be both unconstitutional and bad policy.

In his signing statement, Gov. Jerry Brown seems to acknowledge as much: “There have been numerous objections to this bill, and serious legal concerns have been raised. … I don’t minimize the potential flaws that indeed may prove fatal to its ultimate implementation. Nevertheless, recent events in Washington, D.C. — and beyond — make it crystal clear that many are not getting the message.” Respectfully, Gov. Brown’s concerns about “recent events in Washington” have little to do with whether private entities should reserve board seats for women. And setting aside the constitutionality issue, the quota law is wrong-headed for several reasons.

{mosads}First, consider the purported reason for the quota. The sponsors claim that “gender diversity brings a variety of perspectives to the table that can help foster new and innovative ideas. … It’s not only the right thing to do, it’s good for a company’s bottom line.” This claim boils down to the business case: that shareholders would benefit from gender diversity. The argument is dubious on several counts. If diversity is good because it “brings a variety of perspectives,” surely perspectives brought by transgenders, gays, disabled people, ethnic minorities, et. al. also would be valuable? Then why impose a quota solely for one group?

Next, the business case argument about diversity being “good for a company’s bottom line” is based on several studies that purport to show correlations between diversity and various financial metrics. These studies suffer from methodological limitations and don’t show causality. Any association between financial performance and diversity may be explained by other causes — good companies may have greater diversity, economic cycles, geopolitical events, etc. The research on gender diversity and the bottom line is too thin to sustain a government-compelled mandate.

The bottom line argument doesn’t work for an even more powerful reason: those who have most to gain from a better bottom line — shareholders — are not asking for a government mandate. Moreover, shareholders possess the ability to elect diverse candidates to the board if they desire. The quota’s proponents seem to be assuming either that shareholders are unable to determine on their own that diversity is in their financial self-interest, or that they are powerless to achieve that outcome. Neither is true; shareholders are perfectly capable of making financial decisions without the assistance of government, and they possess the levers to make changes.

This is especially true because large institutional investors who are the biggest shareholders have large armies of professionals who are capable of assessing how to improve profitability and possess the voting power to elect their preferred candidates on to the board. And large institutional investors such as CalPERS already advocate for diversity — at least in public statements.

More fundamentally, the quota law focuses on the wrong problem and misunderstands the role of the board, which is to mitigate the principal-agent problem. Shareholders (the principals) and management (the agent) may have divergent incentives; the board is one of the means to reduce this divide. And merely mandating a quota for women doesn’t reduce agency costs or empower women.

The real problem is the lack of diversity in leadership ranks in management — where the real power and money lies. For example, only 24 women hold CEO roles in the Fortune 500 in 2018. The number is even worse for African-Americans: they accounted for a mere 4 CEO positions in the Fortune 500 in 2017. The numbers for other racial groups are not encouraging either. And this is surprising, considering the significant numbers of Asian-Americans attending top business and engineering schools that would have been expected to populate the pipeline for CEO roles. Clearly, in many sectors, entry-level diversity is not translating into diversity in upper echelons of management.

If activists desire to make a difference in how corporations function, they should target this deficit of women and minorities in management roles. And if they really believe that shareholders desire to elect more women but are powerless to do so, there is a superior alternative to a quota. This could be a tool to empower shareholders: a mandatory vote on diversity. Such an intervention has precedent — the “say on pay” laws gave shareholders greater voice in CEO compensation. Asking shareholders whether they wish to require a certain percentage of the board to be composed of women or other minorities is less intrusive than a quota. And it is more palatable under the business case argument because it preserves the autonomy of the supposed beneficiaries.

There is a diversity deficit at the top of American corporations, but a women-only quota may not be legally sustainable or justified by the research. The fallacy of the primary argument — good for the bottom line — is exposed by a line buried in Gov. Brown’s signing statement: “It’s high time corporate boards include the people who constitute more than half of the ‘persons’ in America.” This seems like an argument for representation, not bottom line. It is an interesting idea that public corporations, which are private actors, should be representative of the community. A quota must wait until advocates make a strong case for that idea. Conflating the business case with representation doesn’t cut it.

The low representation of women and minorities in corporate leadership roles makes for distressing reading because talent and aspiration are not the exclusive preserve of one gender or race. There are plenty of talented women and minorities who could sit on boards. Activists could focus on helping that talent succeed, instead of mandating quotas.

Sandeep Gopalan is a professor of law and pro vice chancellor for academic innovation at Deakin University in Melbourne, Australia. He previously was co-chairman or vice chairman of American Bar Association committees on aerospace/defense and international transactions, a member of the ABA’s immigration commission, and dean of three law schools in Ireland and Australia. He has taught law in four countries and served as a visiting scholar at universities in France and Germany.