In Short

The Background: The NYC Pension Funds, which led the largely successful campaign to implement proxy access rights across corporate America, have launched a new crusade to improve the diversity of corporate boards.

The Issue: Beginning in 2014, the NYC Funds and other investors campaigned to convince public company boards to grant to shareholders proxy access rights that would give them greater influence on the process of adding and replacing corporate directors. The Funds' new diversity campaign aims to augment those efforts by creating a more structured role for public funds in the process of nominating corporate directors.

The Outcome: Improving the diversity of corporate boards is a laudable objective, and campaigns like this may help spur additional efforts. However, the NYC Funds' proposed approach, particularly its check-the-box reporting of directors' attributes and skills, is overly simplistic and could have unintended side effects.

New York City Comptroller Scott Stringer announced in September 2017 that the NYC Pension Funds have launched a campaign to promote board diversity and to increase the participation of significant, long-term shareholders in identifying new director nominees. The NYC Funds requested meetings with more than 150 companies to discuss the companies' policies and processes relating to board composition and refreshment. Sample discussion topics indicate that the NYC Funds would like the companies to ask the NYC Funds and other significant shareholders for suggested director candidates on an ongoing basis, giving them a structured and more permanent role in the board nominations process. The NYC Funds also asked the companies to disclose the qualifications, skills, and attributes of their directors in check-the-box format on a standardized "qualifications matrix," a summary table that would include each director's age, gender, race/ethnicity, and sexual orientation, in addition to the director's skills, experience, and board tenure. The NYC Funds asked for the qualifications matrices "as soon as practicable" and would like that they be updated annually.

This new initiative follows the "Boardroom Accountability Project," which successfully established proxy access rights at most of the companies targeted in the new campaign. The NYC Funds frame this new campaign as a second phase to the Boardroom Accountability Project, to "ratchet up the pressure" on companies and to "give investors a real voice in who sits on corporate boards." The NYC Funds state that the goal of the "Boardroom Accountability Project 2.0" campaign is to create more diverse boards that will "deliver better long-term returns for investors," but the ultimate result, if the NYC Funds' recommended approach were strictly followed, could be to shift companies' director nomination processes away from a balanced, portfolio approach toward a shareholder litmus test free-for-all.

Most companies and investors agree that diversity on corporate boards is an important goal. CEOs of major U.S. companies concur: the 2016 Principles of Corporate Governance published by the Business Roundtable acknowledge the value of board diversity and the need for processes to ensure that female, minority, and other diverse candidates are identified for proper consideration to fill open board seats. The NYC Funds' success in establishing proxy access rights makes them a credible advocate for change on this meaningful issue. While we applaud their proactivity and leadership on this issue, the substantive changes and process they request are unworkable.

The NYC Funds' request for boards to meet with them and other significant long-term shareholders is not unusual in an era of proactive shareholder engagement. The NYC Funds' letter to companies and their press release suggest, however, that the requested meetings may go beyond standard engagement practices. The letter's sample topics show that the NYC Funds desire a far more hands-on role in the nomination of corporate directors than can realistically be afforded all outstanding shareholders. The meetings are to include discussion of companies' specific board composition strategies and goals, management succession planning, risk oversight, and director evaluation.

Most notably, the NYC Funds wish to discuss with targeted companies how to "establish a process" through which director search firms would ask significant shareholders for suggested director candidates and engage organizations specialized in providing diverse director candidates, and to establish another process for the NYC Funds and other shareholders to provide potential director candidates directly to governance committees on an ongoing basis. In addition, although the NYC Funds' letter does not directly address "board exit" tools, enhancing board diversity will generally entail adding more directors to boards, which in turn will require open board seats. Accordingly, it seems likely that the Funds or other shareholders may request that boards adopt director age and term limits, or other board tenure limitations, in order to force board turnover to make room for more director candidates of their liking. The levels of involvement and influence sought may of course be inappropriate for shareholders who may have agendas and investment goals not shared by the shareholders at large. Such detailed consultation and day-to-day involvement may also be impractical.

If voluntary company disclosure of the gender and ethnicity of directors promotes greater transparency and truly acts as a "starting point" for discussion as the NYC Funds intend, a qualifications matrix of some kind may well be a valuable tool. In fact, many companies already include charts of this type in their proxy statements. Unfortunately, as designed, the Funds' proposed matrix may drive suboptimal behaviors. While the matrix is useful for quick comparison among companies, it fails to capture the full picture of a director's experience and potential value to a company. It reduces a highly individualized company-by-company and director-by-director evaluation and recruiting process to a mechanical and simplistic table. Depth of directors' experience and skills are entirely lost, replaced by a binary mark in a box in a table. In addition, each reported category may be interpreted as carrying roughly equal weight, as each category has equivalent treatment in the matrix. Any value that a director might bring to the company that is not "reportable" in matrix categories may be overlooked or unidentified. Further, if the qualifications matrix becomes standard practice, investors and special interest groups may leverage the form to drive boards toward more checked boxes to the detriment of thoughtful, company-tailored board composition.

In fact, the matrix disclosure will not enhance investors' ability to evaluate board candidates; its real value is data generation and, perhaps more important, driving behavior of corporate boards. The information within it is already typically included in a company's proxy statement as a part of the greater narrative about corporate governance and in director biographies. Individual shareholders, particularly institutions with full-time staff dedicated to research, already have an opportunity to review directors' skills, attributes, and experience and the board's composition. The design of the matrix will facilitate a quick-and-dirty assessment and comparison of many companies at once, possibly promoting social positions that may not be appropriate. Tables of data with binary markers sacrifice nuance for standardization to enable analysis of data at scale. Worse, a punchy one-page table may be the only information about directors that retail investors review while thumbing through a proxy statement, decreasing the likelihood that investors understand the full board composition analysis.

The NYC Comptroller's press release says that "[d]iversity isn't a box to be checked," and we strongly believe that one-size-fits-all and check-the-box approaches to corporate governance issues are to be avoided. At the same time, we agree with the Comptroller's goals, and continue to believe that companies must take greater steps to improve the diversity of background, skills and experience on their boards as a means to advance the long-term best interests of their shareholders. As such, we hope that the NYC Funds' letter serves as a starting point for additional discussion on board diversity and as a catalyst for change. We caution companies, however, to take a nuanced approach tailored to their particular circumstances when considering changes to established processes for director nominations and board refreshment.

Three Key Takeaways

1. The form of disclosure regarding director diversity requested by the NYC Pension Funds reduces a highly individualized company-by-company and director-by-director evaluation and recruiting process to an overly generalized and simplistic table.

2. While the NYC Funds' intentions and goals have value, the substantive changes and the process they request are unworkable.

3. Companies are advised to take a cautious, nuanced approach when contemplating alterations to established processes for director nominations and board refreshment.