The lack of gender and racial diversity at the highest levels of corporate America has long been an issue. A recent board diversity survey of 3,000 of the largest publicly traded companies yielded disappointing findings. The survey revealed that women make up a mere 21% of corporate board seats and racial minorities only 12.5%.
Nasdaq is one of the largest stock exchanges in the U.S. It recently added a new rule that is one step forward in making corporate boards more diverse. It remains subject to approval by the U.S. Securities and Exchange Commission (SEC) before it can go into effect.
Nasdaq’s Board Diversity Proposals
Nasdaq’s SEC filing declared that it wants companies to have at least two diverse broad members. At least one of them should be a woman. The proposals define broadly define board diversity. Diverse persons include women, Black or African American, Hispanic or Latino, Asian, Native American, or as LGBTQ+. Companies would self-report these categories. Companies would also have to report the names of individual board members to the SEC.
If a company fails to meet Nasdaq’s criteria, it would be required to submit an explanation of why it failed on its website or in a public filing. Failure to provide an explanation could result in delisting from the Nasdaq exchange. Currently, more than 75% of the approximately 3,200 companies listed on the Nasdaq do not presently meet the criteria.
Nasdaq Leading the Way
Nasdaq President and CEO Adena Friedman stated: “We are taking the leadership here because there has been so little action on this front and we do think it’s an important thing for us to do—to create a more inclusive capitalist society and we think this is a step forward.” Friedman previously served as Chief Financial Officer of The Carlyle Group, one of the largest private equity firms in the world.
Chairman of Nasdaq Michael Splinter echoed this sentiment: “Diversity of experience, gender, race, knowledge, and perspective means that a company is more capable of seeing the full picture, assessing risk, and overcoming challenges with forward-looking, innovative solutions.”
Board Diversity Cuts Down on Groupthink
There is another more practical justification behind the Nasdaq’s diversity mandate—by increasing board diversity, it may reduce the likelihood of groupthink getting in the way of corporate decision-making. More specifically, Nasdaq asserted in its official filing with the Securities and Exchange Commission (SEC) that “increased board diversity also may reduce the likelihood of insider trading and other fraudulent and manipulative acts and practices.” In its official statement, Nasdaq asserted that it came to this inference “by reviewing public statements by investors and organizations regarding the impact of groupthink on decision making processes, as well as academic studies on the relationship between diversity, groupthink, and fraud.”
In explaining why the Nasdaq diversity plan don’t also include other categories like veteran or disability status, Nasdaq Vice President Jeff Thomas explained: “the more inclusive you try to make your diversity policies, then frankly, sometimes they don’t have the same impact.”
SEC to Review Proposals
The next step for the plan to become enforceable is approval by the SEC. The SEC’s review is likely to last well into 2021. If the SEC decides to approve the plan, companies will have a designated timeframe to get into compliance. Although the specific timing depends on a company’s listing tier, all companies will be expected to meet the diversity requirements within two years of the SEC’s approval.
Individual companies or firm have previously implemented diversity goals. In January 2020, Goldman Sachs announced limits on serving as an underwriter for taking a company public. The company must have at least one diverse board candidate. BlackRock, one of the world’s largest asset managers, has publicly declared that it will scrutinize the board diversity of the companies it invests in and may pull investments from companies lacking diversity.
It also follows the trend of ESG investing, or looking at a company’s environmental, social and governance factors to evaluate whether to invest in a company. Investors are increasingly focusing on the financial performance of the businesses they invest in. But they also consider whether businesses demonstrate social and environmental responsibility.
Board Diversity Linked to Stronger Business Performance
Countless studies have illustrated the link between greater leadership diversity and stronger business performance. The consulting firm McKinsey found that companies with executive teams in the top quartile of gender diversity were 25% more likely to experience above-average profitability. In its official filing with the SEC, Nasdaq provided an analysis of over two dozen studies. They illustrated the correlation between diverse boards and enhanced financial performance and corporate governance.
It is still to be seen how Nasdaq’s plan will play out in practice. The proposal has also generated a fair amount of criticism. Nonetheless, Nasdaq views it as an actionable step forward. The goal is to champion the inclusive growth of companies and give people from diverse backgrounds a seat at the table.