Boardroom Diversity: Now it's Mid-Caps' Turn
The demand for corporate talent diversity has swelled into a powerful social tide that no business leader today can ignore. The arguments for wider diversity throughout the workforce are compelling. While diversity is now a social and moral imperative, a wide range of studies indicate that companies with more diverse boards perform better.
Companies in the top quartile for racial and ethnic diversity are 35% more likely to outperform their industry competitors. Those in the top quartile for gender diversity are 15% more likely to outperform their industry medians, according to McKinsey & Co.
According to an MSCI study of 1,649 companies, firms with “strong female leadership” generated a return on equity of 10.1% per year versus 7.4% for those lacking such leadership. Diversity in leadership also correlates with higher levels of innovation, success in global markets, and ability to attract top talent, according to a number of studies. Bruce Lisman, a seasoned board and committee pro, and a DHR client, finds that “diverse boards are more open minded, leading to informed rigorous debate that shapes quality decisions.”
Yet the “secret sauce” for success of diversity goes beyond management. A gender and ethnically-diverse board of directors is proving a powerful strategic tool. A more diverse boardroom accesses the broader networks of these fresh faces. Their careers and expertise inject personal and market insights that the “pale, stale, male” board of directors lacks. “If the board lacks diversity they limit the opportunity to provide appropriately balanced insights to management,” notes DHR client Philip K. Ryan, chairman of Swiss Re Americas.
Investors have taken notice of this potential boardroom boon. Last year, $2.8 trillion asset mega-manager State Street Global Advisors sent a letter urging 800 worldwide companies with no women on their boards to increase their boardroom diversity. State Street backed this call with action -- it voted against board or committee slates at 511 of those companies who failed to boost their board diversity.
Top companies such as Macy’s, Aetna, Pfizer, and Target have drawn notice for their strong diversity programs -- efforts that extend into their boardrooms. Major advocacy groups, such as 2020 Women on Boards, publicize annual lists of corporations whose boards are leading (or lagging) on diversity.
However, most of the statistics and media attention to diversity in the boardroom still focuses on the world’s largest companies. Diversity progress (and failings) at firms in the S&P 500, the Russell 2000, the FTSE 100 make headlines -- but mid- and small-cap companies are largely ignored. Too little solid information is available on the status and progress of their board diversity, and the unique challenges they face in making diverse boardrooms a reality.
Some mid-cap executives and board members may like it that way. The diversity battles facing Fortune 500 giants might seem like the distant thunder from storms that will safely bypass the mid-caps. Yet our research at DHR shows that not only are these proxy and media clouds headed for the mid-caps, but that their present weak boardroom diversity is costing them.
Research shows the benefits of board diversity are at least as strong for mid-caps as for the corporate giants. Indeed, access to the broader networks of diverse directors and their fresh personal and market insights are even more crucial to smaller firms, who often lack these resources.
The numbers show a distinct boardroom diversity gap by company size. While large-cap U.S. corporations average 26% women on their boards, at mid-caps, the percentage falls to 22%, and for small cap firms only 18% of directors are women. Focusing in, just 12% of Russell 2000 company directors are female, compared to 20% among S&P 500 firms, according to an Ernst and Young study.
DHR research finds that factors other than inertia are keeping women out of the small- and mid-cap boardroom. Diversity board recruiting has long targeted a fairly narrow circle of “name” candidates. These diverse “superstars” meet the established criteria for board roles, but they now serve on multiple boards and are hard-pressed to take on new directorships -- all these easily-identified candidates are over-boarded.
This boardroom “seller’s market” proves even more vexing for mid-caps. Smaller companies must compete for this cadre of high-demand board talents against the big-cap firms, who typically offer greater status (and compensation).
The end result is a frustrating quandary for small- and mid-cap firms. They are now aware of the benefits board diversity can bring, and pressures to diversify boards within their own sectors are growing more urgent. Yet these companies will be hard pressed to find strong, diverse, board-ready candidates… if they continue to rely on existing processes and networks.
At DHR, we’ve studied this boardroom dilemma, and offer several diversity strategies that meet the unique challenges of smaller corporations:
The “big guy’s” board diversity success didn’t happen without a plan. In recent years, the diverse talents that met traditional criteria screens were aggressively recruited by large companies under the most pressure to diversify. Their urgency paid off. Board diversity among Fortune 500 companies is now at an all-time high. Diverse people hold 35.9% of the directorships at Fortune 100 companies and 30.8% of the directorships at Fortune 500 companies.
“Diversity thrives in a board where the culture (and the chairman’s leadership) encourages bringing out the diversity that exists,” notes Phillip Ryan. Top companies such as Chicos, General Motors, Best Buy and Herman Miller have leaders who actively championed board diversity, pushing for a gender mix of up to 50%.
There are practical tools for shaping a boardroom diversity mindset. These include leveraging major “disruptive” triggers (mergers, IPOs, spinoffs) as a moment to add women to the board; and a board search version of the NFL’s “Rooney Rule” by mandating any search must include at least one diversity finalist (as recently adopted by Amazon). Smaller companies can make use of these helpers as well.
Most U.S. corporations have long had two criteria for directors: Prior board experience, and a successful tenure as a CEO, chief operating officer or chief financial officer. Recommendations typically came from existing board members, the “friend of a friend” approach.
No doubt companies place a premium on experience and good chemistry with other directors. Most boards considered it risky to appoint candidates that fell outside these established criteria.
But this clubby approach is breaking down under its own limitations. This traditional board selection process perpetuated a lack of diversity. Across corporate America, the vast majority of board members are older, white males -- and their networks, not surprisingly, consist largely of other older, white males.
The good news is that there are diverse people with the experiences, skills, and leadership abilities to make valuable contributions to boards. Your board just needs to shake up its prerequisites. One of the first qualifiers to rethink -- previous board tenure. “All directors have been on a board for the first time,” Lisman observes. “First time directors will generally function best on a board well established in its own identity.”
Suzanne Nora Johnson, a former vice chair of Goldman Sachs whose board experience includes AIG, Pfizer, Visa, and Intuit, agrees. “New board members with understanding of technology and the attendant opportunities and risks are particularly valuable at the current time.”
Board diversity transcends gender and race and should include fresh thinking on age and background. Notes Johnson, “While much has been rightly written of the value of gender and ethnic diversity in the boardroom, multigenerational and global diversity can also inform strategic discussions and board deliberations. Younger directors and global directors may provide critical and differentiated perspectives on the potential adoption and use of new technologies, products and services around the world.”
While these outside-the-box prospects lack formal board experience, they typically bring some or all of the following attributes:
- Service on non-profit, community, or subsidiary boards.
- Experience in giving presentations to boards.
- Success in leading a variety of businesses and a track record of creating value.
- They are on a CEO career track within their company and serving and contributing to a board is part of their developmental plan.
Even for Fortune 500 boards, talent hunts that tap outside search firms remain uncommon. However, they are on the increase. The big companies have learned that, when seeking a woman or minority candidate with targeted talents, search firms are well worth the modest cost. Their talent portfolios are huge, they know the candidates well, and can help nudge your board search outside “the usual suspects.”
Mid- and small-cap board searches that tap headhunters are even rarer, but the benefits are crucial. Search professionals have much larger networks that extend far beyond those of your current directors, and they are experts in working with customized talent needs. Better still, search professionals know how to fine tune the search needs of clients (and offer a valuable reality check on who might be available). Finally, a search partner is of real benefit to the mid-cap firm seeking big-cap board prospects. The search firm can help pitch the company and its governance to the boardroom target, vital in today’s seller’s market.
The pressure to build boards with greater diversity, a wider range of experiences, and innovative thinking will only increase in the years ahead. Shareholders, customers and other constituent groups are demanding it. This tide of governance change is striking large-cap companies today… but is headed straight for the mid- and small-caps tomorrow.