Corporate Leaders Face Pressure from Investors, Regulators to Act on Diversity

Over the summer, when George Floyd’s horrific death and the disparities of the pandemic combined to spur a new national reckoning with systemic racial injustice, many CEOs issued statements.

Many insisted they would do more than talk – they’d take action in day-to-day business against structural inequalities.

Those loud pronouncements of action are fading fast. The reverberations of their disquietude will soon give way to challenging questions from the intended recipients of those well-crafted statements opposing racism and promising equality.

While the large multinational companies led the way, many smaller companies joined the momentous wave of formal protest that crashed at the feet of those marching the streets in support of BLM, sweeping them along with hope and motivation because “this time was different.”

As the heat of summer subsides, and the mercury falls, the racial justice issue is still burning red-hot. Activists have lost none of the zeal for change. But what action have we seen?

It is too optimistic to hope for immediate change, especially given the historical intractability of the racial issue and the many other difficulties companies currently face.

I do not wish to serve up pre-packed excuses to CEOs. They need to be pressured to follow through with actions. As each day goes by without change, the impatience has undoubtedly intensified. Many ideas for how to bring greater equality aren’t new, so pulling together an action plan should not take too long, but we must allow time for thoughtful and considered action to be implemented.

Very few people would contest that dialogue is crucial to resolving this social tumult. At some point though, words must give way to deeds, and that time has arrived. In an earlier article I wrote for the Timmerman Report, I described the skepticism that follows corporate pledges on diversity. The words, or sentiment, often heartfelt and well-meaning, count for little unless they are linked to direct action.

The NYC Comptroller, Scott Stringer, set out this challenge to CEOs. At the beginning of July, he sent letters to 67 S&P 100 companies, asking the companies to provide evidence of their respective commitments to racial diversity, consistent with the public statements they had made. Among the 67 companies that received the letters were 10 pharmaceutical and biotechnology companies.

The NYC Comptroller, on behalf of the New York City Employees’ Retirement System, Teachers Retirement System of the City of New York and New York City Board of Education Retirement System, requested that the companies publicly disclose their consolidated EEO-1 data. They argue that without this disclosed data, stakeholders are unable to monitor, assess and benchmark a company’s progress and successful practices to hire, retain and promote black employees, other employees of color, and women. After all, it is data they are already obliged to collect under law.

The letters included the request that the companies disclose the consolidated EEO-1 report with the raw data, not percentages, such that it would provide a clear and trackable data set across 10 categories of employment, including senior management.

Investors who evaluate companies on financial metrics wish for this consistent formatting and full disclosure as to enable useful comparisons between periods, and among peer group companies. In response to this letter, about half of the companies — 34, to be precise — have committed to disclose their consolidated EEO-1 report. Abbvie, Amgen, Biogen, Bristol-Myers Squibb, Gilead Sciences, Medtronic and Pfizer are among those following through with disclosure.

This is an encouraging sign of leadership, which others can follow.

This action is in line with a broader effort by institutional investors to get companies to report on a range of human capital metrics and indicators, including diversity and inclusion. One such example is the Human Capital Management Coalition (http://www.uawtrust.org/hcmc) which filed a rulemaking petition with the Securities and Exchange Commission.

This coalition of institutional investors, with $5.9 trillion under management and co-chaired by the UAW Retiree Medical Trust and CalSTRS, are seeking improved reporting and disclosure by companies on human capital metrics, including diversity and inclusion.

“The Coalition has long viewed diversity and inclusion data from portfolio companies as critical to investors’ overall understanding about how well a company is managing its workforce. This is why workforce data – focusing on diversity among senior management – is among the four fundamental metrics we believe every company should report to shareholders. These metrics alongside the number of full-time, part-time, contingent employees, turnover in the workforce and total workforce costs, provide a more accurate view of a company’s human capital management and investment,” said Cambria Allen-Ratzlaff, co-chair of the Human Capital Management Coalition and Corporate Governance Director for the UAW Retiree Medical Benefits Trust. “Decisive data showing financial and performance benefits of a diverse workforce makes sense: Why wouldn’t a company seek talent from the largest pool possible?”  

The regulatory and policy sands are clearly shifting, toward more disclosure on D&I, whether at the board, senior management, or organizational level. Proxy firm ISS (Institutional Shareholder Services) recently reported its 2020 policy survey results, in which they asked if corporate boards should disclose the demographics of the board members including directors’ self-identified race and/or ethnicity.

Nearly three quarters (73%) of investors agreed that companies should do this to the full extent possible.

Despite the winds of change blowing forcefully through the business landscape, and a powerful coalition of backers, this proposal for more transparency has stalled. On Aug. 26, the SEC rejected the opportunity to require companies, under Regulation S-K, to report racial and gender workforce data. The amendment to Regulation S-K does introduce principles-based human capital reporting on issues material to the company, which will not result in widespread and uniform reporting by issuers on D&I.

The Human Capital Management Coalition, along with many other institutional investors, will no doubt continue to push the SEC. More specifically, we can expect investors to press their portfolio companies for improved disclosure, and vote accordingly when they aren’t happy with the results.

Running concurrent with the SECs vote on Regulation S-K amendments, was a legislative process in the State of California where Assembly Bill 979 has been signed into law by Gov. Gavin Newsom. This law amends the Corporations Code and requires corporations to appoint directors from underrepresented groups based on the board size. The statute defines a director from an under-represented community as:

“an individual who self-identifies as black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian or Alaska Native, or who self-identifies as gay, lesbian, bisexual or transgender.”

The new law follows similar legislation on gender which has seen many women corporate directors appointed to the boards of life sciences companies throughout California. Companies will have until between 2021 and 2022 to comply, or face fines ranging from $100,000 to $300,000.

Board composition gets a lot of attention when discussing D&I because there is publicly available information, particularly on gender. This information offers an opportunity for analysis and gives advocates the data on which to base their case. The lack of data on diversity at all corporate levels means the board of directors will continue to be an indicator of an organization’s cultural tone.

While board diversity can only signal a correlation with financial performance, we know that it has specific business implications that show up in a company’s financial results. For example, close to half of women (45%) in biotech will reject a job if there are no women involved in their interview and the employer’s board and management are all males. It is not a massive leap to suggest that the same will be true of prospective candidates from racial minorities when people like them are missing from a company’s hierarchy. These data show a direct effect on recruitment, a material risk for many biotech companies, and value.

Any board of directors should act under the societal context in which the company is active. Diversity and equality are very much part of this current and future context, and the judgments that boards and CEOs take at this time will have long-term implications, possibly long after the directors have all moved on. The time horizon to which a board of directors is looking to formulate strategy has a bearing on material issues, and how highly they are prioritizing diversity. If the board has a long-term view, then it should be conscious of how its own diversity is seeding the firm’s cultural identity, and either enabling or limiting management’s ability to promulgate inclusivity throughout the company. 

But board composition is not only limited to the skills around the table. Investors and proxy firms continue to pay attention to the issue of directors serving on too many boards. The specificity of biotech often demands directors with particular expertise and skills. It is, therefore, not uncommon to see directors serving on multiple company boards, both private and public, calling into question their ability to be effective in the role. Diversifying the candidate pool is seen as an obvious remedy to this over-boarding problem.

The trend of “over-boarding” also concerns institutional investors and proxy firms. Among public issuers, they see evidence of greater over-boarding in biotech, pharma and healthcare than in any other industry.

For example, Glass Lewis recommended against U.S. directors 235 times in 2019 for over-boarding, with over a quarter of these occurring at companies in the pharma, biotech and healthcare sector, double any other sector. While proxy firms are only concerned with directorships for listed companies, there remain significant opportunities in biotech to serve on private company boards. While the demands of board service for a company with a venture investor ownership structure may not prove as onerous as a public company, there are limits to what even the most talented person can manage.

Different conclusions can be drawn from this evidence of over-boarding. One is that biotech and pharma companies still favor appointing highly recognized and well networked directors who they believe to have incomparable experience. Another is that companies are not cognizant of appointing directors who are burdened by competing commitments, or care less about their level of engagement.

Replacing such directors by appointing diverse candidates is part of the solution. While they wait for attrition, companies can also expand their boards and add diversity this way too. But unless companies are adapting their approach for appointing board members, looking further afield and in new places, many diverse candidates will soon become over-boarded themselves.  

As for private companies with venture ownership, they require incentives to do more on ED&I. Perhaps the action by Goldman Sachs to refuse to support any company’s IPO without board diversity, thereby limiting access to capital, will be one such incentive for biotechs.

The most significant current incentive though, is that clear evidence of a company’s diversity and inclusive culture will drive decision making among future employees, and influence employee retention. Companies that fail to hire and retain diverse employees will lose out on key talent, and will be taking on material operating risk.

The board and CEO can provide the first spark needed to light the fire. Their response to ED&I must be multifaceted but should include a series of well-described key measures, such as the adoption of a publicly stated diversity policy, containing a clear recruitment search policy for all board and management appointments.

Companies should expand the number of directors on the board to add diversity; even though the board may reduce in size again as terms expire. Companies should consider their governance structure, including the independence of the Chair of the board.

Research that Liftstream published in 2017 showed a correlation between greater board diversity and a separate CEO/Chair structure. Nomination and Governance committees need to have diverse candidates chairing this committee, or at least as members. Companies nearing IPO, or recently listed, should take advantage of any opportunity to add new independent, diverse directors to the board as investor directors rotate off. And boards and CEOs must look internally at how succession plans and internal promotion processes can be made to equally award black and minority employees. 

There are many ways to act in the short term, and the long term. Let us hope those words begin to transfer to deeds, and that those deeds add up over time to the kind of change our society needs.