The California state legislature on August 30, 2018 approved SB 826, a bill which, if signed into law by the state governor, will require public companies headquartered in California to have a minimum number of female directors, with a quota of three women on boards with six or more directors by December 2021. Boardroom gender diversity in the United States for public companies has been trending towards an average of two female directors for some time now even though there has been regulatory silence on the issue, but legislation like SB 826 may kick the diversity process into a higher gear.

The gender quota bill, introduced in January of this year and approved by both the state assembly and the state senate, would require public companies headquartered in California to have at least one woman on their boards by December 31, 2019. By December 31, 2021, the mandatory minimum increases to two women on boards with five or fewer directors and three women on boards with six or more directors. Noncompliant companies face a US$100,000 fine for the first violation and a US$300,000 fine for every subsequent violation.

SB 826’s definition of female is tied to a director’s self-identified gender (regardless of designated sex at birth) and its application is limited to companies, whether or not incorporated in California, whose shares are listed on “a major United States stock exchange” and whose principal executive offices, “according to the corporation’s SEC 10-K form,” are located within the state of California. Other states, including Pennsylvania, Massachusetts, Illinois and Colorado, and various municipal governments, including the city councils of both Philadelphia and New York, have passed nonbinding resolutions aimed at increasing female representation on boards. The successful enactment of binding gender quota legislation in a high-profile jurisdiction such as California may well have a nationwide ripple effect.

The proposed California legislation is a further development in current global trends: Institutional investors and organizations such as the Thirty Percent Coalition have been pushing for increased boardroom gender diversity for some time now, and several European countries, including Germany, France, Italy, Spain, Iceland, Norway and the Netherlands, already have gender quotas in place. In the United States, private ordering has successfully initiated a trajectory towards an average of two female directors per board, with the current average for Russell 3000 companies being 1.75 according to the Equilar Gender Diversity Index. However, many feel that the pace of progress has been too slow even though women make up just shy of half the American workforce, only 17.7% of Russell 3000 company directors are women as of the second quarter of 2018. Proponents argue that government intervention such as SB 826 and its progeny could accelerate the rate of change in this area considerably, which many believe may in turn result in economic gains for companies: One study cited by SB 826 found that U.S. companies with three or more female directors reported 45% higher earnings per share on average than peers companies with all male boards.

The next step for SB 826 is to be presented to Governor Jerry Brown, who will have until the end of September to sign, approve without signing, or veto it.

The proposed legislation is controversial. If enacted, SB 826 may face legal challenges—the California Chamber of Commerce has argued that it violates both Article I of the state constitution (which prohibits disqualifying a person from employment on the basis of their sex) and the Fourteenth Amendment equal protection clause of the U.S. constitution. Because the proposed legislation applies to companies headquartered in California regardless of where they are incorporated, the Chamber of Commerce has also argued that SB 826 violates the common law internal affairs doctrine.

In addition to raising possible legal issues, opponents have put forth a number of other arguments against these types of legislative mandates, including espousing their lack of necessity in light of current marketplace trends, the superiority of private ordering and the availability of shareholder avenues to redress diversity concerns, potential inefficiencies in board size and mix, and concerns about adverse precedent for further legislative initiatives which address underrepresented corporate constituencies. These arguments are hotly disputed by the legislation’s proponents, who claim the concerns raised are misplaced or overblown and contrary to the track record in other countries where similar provisions are already in place.

It remains to be seen whether the California initiative is a harbinger of future state or federal legislation. Whatever the particular outcome, the spotlight on board diversity is here to stay. Companies may need to factor this attention into their considerations for board composition now if they haven’t already done so. Otherwise, they may face adverse director votes at the corporate director ballot box later.