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Time to Re-tune the Tone from the Top?

More diverse board-level representation recognised as an advantage as firms face up to new systemic challenges.

As the Covid-19 pandemic and climate change demand new responses from many companies, the composition of boards of directors is coming under increasing scrutiny by asset owners and managers. For many, these significant challenges can be met only by boards that can draw on a wide range of expertise.

“The resourcefulness and adaptive capacity needed for businesses to address these challenges demands innovation at the very top of the organisation,” says Mark Chambers, Associate Director, Governance, at the Institute of Business Ethics (IBE), a London-based non-profit professional organisation. “The difficult times ahead represent a much more challenging landscape for board decision-making.”

IBE examines diversity, group think and the need for “fresh thinking and wider life experience on boards” in a recently published report. Deborah Gilshan, an independent advisor on investment stewardship and ESG, and a joint author of the report along with Chambers, says the Covid pandemic has “brought urgency to the board diversity agenda that we could not have imagined previously”. In the wider population, growing perceptions of social inequity – notably the response to injustices such as the death of George Floyd in the US and the sexual harassment exposed by the #metoo movement – have also contributed to the calls for greater diversity both at the board and wider company level.

Board appointments that are unrepresentative of a company’s employees, customers or supplier base will not bring the different perspectives required to counter group think, says the IBE report. “Only through systemic change will better decisions be reached by individuals who look and think differently and whose life experiences are more varied and more representative of the communities that the company serves,” says the report.

Speaking during a panel discussion on the IBE report, Ruth Cairnie, Chair of UK-based engineering services group Babcock International, said greater diversity on company boards was a pre-requisite for effective transition to net-zero business models in the energy sector. Different business models, business partners and relationships with consumers that are inherent in the transition to a low-carbon economy require new and different people in the board room, she said.

Board expertise in areas that carry significant risks and opportunities is important, says Yousef Abushanab, ESG Analyst, Corporate Governance and Responsible Investment at RBC Global Asset Management (RBC GAM). “All sectors and industries are impacted by climate risks and opportunities and it is important for companies to have the skills and experience to assess these issues and provide the appropriate strategic direction.” According to a study by BloombergNEF and Sasakawa Peace Foundation, companies with more than 30% women on the board are more likely to set clear climate governance strategies and demonstrate greater transparency in the release of climate-related data.

Board diversity as differentiator

Jo Holden, Global Head of Investment Research at Mercer, says “genuine” cognitive diversity as a result of an inclusive board selection process brings a range of voices and views that are critical to solving today’s problems. “There is rarely a one-size fits all answer to any business issue and that’s particularly true as we work through transition to net zero.”

The broader perspectives that are brought to a boardroom by greater diversity, says Abushanab, add value by improving strategy and risk oversight, enhancing board and company performance and advancing relationships with investors. “Research shows that people with similar backgrounds and experiences tend to make decisions from similar perspectives, resulting in overlooked opportunities,” he says. “One example is gender diversity on the board, where recent research and studies show that increased gender diversity on boards enhance financial performance and returns.”

Caitlin McSherry, Director of Investment Stewardship on the ESG Investing Team at Neuberger Berman, says companies with high levels of diversity and inclusion on the board have more “robust discussions” leading to better decisions. “A growing body of research shows that companies with higher board diversity tend to outperform those without and also tend to be less susceptible to corporate scandals,” she says. “Greater board diversity also makes a company a more attractive place to work from an employee point of view. Board diversity is becoming increasingly competitive as companies try to attract the best and most appropriate directors.”

Most current directors, it seems, are on board with diversity. In its 2020 Annual Corporate Directors Survey of 693 directors from US public companies, PwC notes that 94% of directors say board diversity brings unique perspectives to the boardroom. More than four out of five directors agree that it improves relationships with investors (85%) and that it enhances board performance (83%). Seventy-two percent also agree that board diversity enhances company performance.

Challenging diversity as a ‘box-ticking’ exercise

While the directors surveyed by PwC believe companies largely met the early challenge of the Covid crisis and have been more focused on ESG themes of concern to institutional shareholders, there is still work to be done. “Boards continue to be plagued by seemingly intractable problems,” says the survey commentary. “Board refreshment still lags as leadership frequently avoids both the tough conversations with directors who should be replaced and the hard work of long-term board succession planning. Boardroom discussions suffer as directors, keen to maintain a collegial atmosphere, avoid sharing dissenting views. And even while making some improvements in boardroom diversity, directors aren’t always convinced of the importance of that diversity.”

Boardroom diversity as a ‘box-ticking’ compliance exercise, sometimes referred to as a ‘one and done’ approach whereby just one director post is filled by a woman or representative of an ethnic minority, is an approach that asset owners and managers are addressing.

The IBE report states that companies that approach diversity focused only on targets and with a “compliance mindset” will not achieve the sustainable business benefits that diversity offers. “They will also find themselves under increasing pressure from stakeholders. Investors have already raised the bar for businesses and are holding those that are lagging accountable; greater transparency is allowing customers to make better informed choices; and employees increasingly want to work for businesses whose values they recognise and share.”

A compliance mindset is more likely to lead to appointments to positions that hold no particular power, a point highlighted by both McSherry and Cairnie as one of which asset owners and managers should be aware.

Spotting the ‘fakers’

Investors are already demanding greater transparency around board-level – and wider workforce – diversity, equity and inclusion. Shareholder organisation As You Sow recently noted that US investors had shown “dramatic support” for shareholder resolutions during the recent round of AGMs, asking that companies report on the effectiveness of their diversity, equity, and inclusion (DEI) programs.

“Investors see diversity, equity, and inclusion as a material issue because it’s directly linked to corporate performance,” says Andrew Behar, CEO of As You Sow. “It’s long overdue that we have corporate transparency so we can get to work on the next phase of this journey, defining best practices and measuring outcomes. We all know that inclusive workplaces attract and retain the best and brightest employees, have a better understanding of their markets, a wider mix of leadership skills, and other qualities that help drive success.”

Meredith Benton, Principal of the consultancy Whistle Stop Capital and Workplace Equity Program Manager for As You Sow, says: “Investors are no longer willing to accept feel-good stories about diversity and inclusion programmes. Just as investors do not accept vague promises about revenue or operating expenses, they do not want vague promises about DEI results, either. They want hard numbers.”

Investors raising expectations

Engagement remains the main tool asset owners and managers can use to encourage greater board and workforce diversity. In its recent stewardship expectations report, investment company BlackRock states that for 2021 it is asking companies to demonstrate board and workforce diversity “consistent with local best market practice”.

The company says 41% of the firms where it voted against directors for diversity reasons in 2019 increased their board diversity in the following year. “We are raising our expectations, in the context of regional norms, on board and workforce ethnic and gender diversity,” the report states. “In our view, diverse personal and professional experiences support the diversity of mindset that contributes to board effectiveness.”

This view aligns with Blackrock’s conviction that tone from the top matters as companies aim to develop workforces that more closely resemble the customers and communities they serve. An inclusive, diverse, and engaged workforce contributes to business continuity, innovation, and long-term value creation, it says, and one way to ensure diversity is greater disclosure from companies.

In advance of AGMs, McSherry says Neuberger Berman publishes its vote intentions on particular proposals and also gives a rationale of its thinking. Clear disclosure from companies about the board selection process is important, she says.

Investors can also ensure questions about diversity of the board become common practice during engagement, thus building momentum and helping companies to understand it is a priority issue for shareholders. “Five years ago, board diversity was not a question investors asked about frequently. Once investors do ask about it on a regular basis, companies will allocate resources towards it,” she says.

Abushanab says the use of active stewardship to encourage investee companies to improve board diversity policies, metrics and targets is helping to increase diversity. “This may take the form of engagement with boards on the benefits of board diversity, either directly or collectively with other investors,” he says. “One high-profile and widely recognised campaign is the 30% Club, which campaigns for greater representation of women on the boards of companies.”

This kind of active stewardship is increasingly accompanied by a clearer voting policy. At RBC GAM, custom proxy voting guidelines stipulate that if a board has less than 30% women and lacks an adequate diversity policy, the manager will vote against members of the nominating or governance committee. “In terms of their own diversity, asset managers and owners are becoming much more active in ensuring that they have diverse and inclusive work forces,” he notes.

Mercer’s Holden also raises the point of the diversity of asset managers and owners themselves. “It is perhaps worth noting that as asset managers and asset owners look at their own approaches to D&I, they are able to engage from a much more genuine and informed position than they have done in the past,” she says.

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