justifying board diversity by james fanto, larry …...april 9, 2010 fanto, solan darley draft...

April 9, 2010 Fanto, Solan Darley draft

Justifying Board Diversity

By

James Fanto, Larry Solan and John Darley*

* Respectively, Professor of Law, Brooklyn Law School, Don Forchelli Professor Law and Associate Dean, Brooklyn Law School, and Warren Professor of Psychology, Princeton University. © All rights reserved. [preliminary draft; please do not cite]

1


I. Introduction

The basic test for many advocates of board diversity is to show that gender, racial, ethnic

or other diversity improves the performance of boards of public companies. Today’s standard

(and almost exclusive) measure for the performance of firms, and thus of boards, is shareholder

value, which refers to the market value of a firm’s common shares and which originates from the

discipline of finance.1 Thus, if proponents of board diversity feel compelled to make their case

within the standard framework (as many of them do), they would have to show, as an empirical

matter, that boards with diverse members outperform less diverse boards with respect to

shareholder value.

To our knowledge, the empirical studies to date have not supported the case for board

diversity on shareholder value grounds.2 This result may be due to issues related to the empirical

studies; further refinement of empirical approaches may in time produce better evidence for the

diversity case. However, proponents of board diversity may not want to pin all of their hopes on

empirical results, for it has been notoriously difficult to show that the design or composition of

corporate boards improves or decreases a firm’s performance.3 It must be remembered, as

discussed in more detail below,4 that a board of a U.S. public company is generally a collection

of busy executives from other firms who (except in a crisis) gather together once a month to

review and approve the broad strategic direction of a firm and to make decisions that have been

presented to them by the chief executive officer (“CEO”) and his/her team, who actually set the

1 See, e.g., MICHAEL C. JENSEN, FOUNDATIONS OF ORGANIZATIONAL STRATEGY 51-102 (1998). 2 See infra notes [/ /]. 3 See generally Renee B. Adams, et al., The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey, 48 J. ECON. LIT. 58 (2010). 4 See infra [ / /].

2


strategies and operate the firm. Much of the relevant literature on boards, therefore, suggests that

a board’s contribution to firm value is likely to be minimal at best and hard to establish

empirically.

Even if a board has limited influence on firm value, it still has some impact, and one

could justifiably inquire as to methods of improving its functioning. Social psychological and

organizational literature (areas that we are familiar with) identifies characteristics of well-

performing decision-making groups, like boards, as well as the pathologies of such groups. To

cite only one well-known, and sometimes controversial, example,5 cohesive groups have been

found to engage in “groupthink,” which is a social phenomenon whereby group members adopt a

group identity that excludes other, different perspectives. This cognitive and even emotional

closure can result in disasters for the group and the organization that it advises and supervises.6

By contrast, a group whose social identity is defined by openness to other perspectives and to

internal debate may avoid these pathologies and perform well in novel situations, which are often

those that public company boards face.7 The social psychological and organizational literature

also suggests that having diverse members in decision-making groups, without more, does not

5 See IRVING L. JANIS, GROUPTHINK: PSYCHOLOGICAL STUDIES OF POLICY DECISIONS AND FIASCOES (2d ed. 1983). Groupthink is by no means a theory accepted in all its aspects in social psychology and organizational studies. But, it is clearly viewed as a useful perspective, although in need of refinement and testing. See James K. Esser, Alive and Well after 25 Years: A Review of Groupthink Research, 73 ORG. BEHAV. & HUM. DECISION PROCESSES 116 (1998); Paul B. Paulus, Developing Consensus About Groupthink After All These Years, 73 ORG. BEHAV. & HUM. DECISION PROCESSES 362, 370-71 (1998). But see Sally Riggs Fuller & Ramon J. Aldag, Organizational Tonypandy: Lessons from a Quarter Century of the Groupthink Phenomenon, 73 ORG. BEHAV. & HUM. DECISION PROCESSES 163 (1998) (criticizing the theory as erroneous, without empirical support, and simplifying complex group processes). 6 See JANIS, supra note __, at 174-77. 7 See id., at 260-76. On the basics of social identity theory, see Michael A. Hogg, A Social Identity Theory of Leadership, 5 PERSONALITY & SOC. PSYCHOL. REV. 184, 186-87 (2001).

3


remedy group decision-making problems and transform the social identity of a group, like a

board.8

Yet we believe that the lack of strong empirical support for board diversity with respect

to shareholder value, as well as the lack of similar evidence for improvements in group decision-

making, does not have to doom the cause of diversity advocates. Indeed, we think that part of

the problem here lies with the framing of the issue, which reaffirms the shareholder value rubric

in the evaluation of anything (like board composition) associated with a public firm. Accepting

this perspective means that diversity advocates must justify board diversity in its terms, such as

value improvement resulting from diverse boards attracting customers or incentivizing

employees. In fact, the advocates may feel compelled to make their arguments within this

dominant perspective because it is also accepted as the norm that orients public firms by the

kinds of people who become public company board members, including women and ethnic and

racial minorities. This acceptance is not surprising, for it has been inculcated in them in their

business school training and professional experience.

We argue that diversity advocates should not neglect other justifications and thus

normative frameworks to support diverse boards. As is well known, the law allows for norms,

other than shareholder value, to play some role in firm matters, such as board composition.9

Moreover, we feel that it is important as a social and political matter to counter the dominance of

finance as the undisputed provider of norms for public firms. We do not mean to be utopian here

or to suggest that business firms cannot be operated for a profit. Rather, we believe that

recognizing alternative justifications for board composition provides scholars of boards

8 See generally Ann E. Tenbrunsel & David M. Messick, Ethical Fading: The Role of Self-Deception in Unethical Behavior, 17 SOC. JUST. RES. 223 (2004). 9 See infra [/ /].

4


(including diversity advocates) with the opportunity to think innovatively about board

composition, such as from organizational and social psychological perspectives. Indeed, we feel

that having diverse individuals on boards could improve board decision-making, or at least

prevent group pathologies, in certain circumstances, but that these improvements will likely not

occur if the financial perspective narrows the focus of board member selection.

The Article proceeds as follows. Part II briefly reviews the basic legal structure and

obligations of the public company board and the dominance of the finance perspective. It also

surveys, again briefly, several basic conclusions on board purpose and function drawn from the

organizational and social psychological literature (particularly social identity theory) and it

highlights, from the perspective of this literature, problems associated with decision-making

groups. In Part III, we discuss our understanding that board diversity has not been conclusively

shown to increase shareholder value as an empirical matter, which has put diversity advocates on

the defensive. We draw parallels between this situation and recent anti-discrimination law

jurisprudence, which, in discriminatory impact settings, makes business necessity determinative

of the outcome, and we thus suggest that the application of this law to corporate boards would

not increase board diversity. In this Part, we also refer to findings in the organizational and

social psychological literature suggesting that problems in group decision-making are not

ameliorated by the addition of a few “outsiders,” especially if they share the same perspectives

and background (i.e., the same social identity) as do those who are already group members. In

Part IV, we argue that diversity advocates should continue to offer different normative

frameworks than finance-based shareholder value to justify board diversity and take advantage of

the flexibility of corporate law for this advocacy. We also recognize the difficulties of this

advocacy and explain that the burden for it must not rest solely on diversity advocates. We

5


conclude by observing that recognition of other normative perspectives in firms allows for the

transformation of board social identity that may actually improve board functioning. Part V

concludes.

II. The Board and its Problems

A. Legal Structure and Obligations of Boards

A few words are in order on the legal structure and foundation of the public company

board. The board’s structure and the obligations of board members are primarily determined by

the corporate law of the state of incorporation of the firm and by the jurisprudence of the courts

of that state.10 Thus, the law establishes the board as the primary supervisory body for the

corporation, the manner of nomination and election of board members, and the minimum

qualifications for directors.11 It then lays out in broad terms the duties of the board, as well as of

individual board members. Jurisprudence, primarily in equity, further elaborates upon the duties

of the board and its members in the different circumstances facing them.12 For example, as is

well known, a detailed jurisprudence dictates the board’s conduct when it is faced with a change

of control transaction.13 It is fair to say that corporate law jurisprudence, particularly that of the

influential state of Delaware, has been influenced by the discipline of finance with its focus on

shareholder value. Thus, while boards are entitled to make decisions on the basis of the firm and

its constituencies, such as employees and the communities in which it operates, the message of

the jurisprudence is for them to base their decisions on the financial benefits to shareholders.14

10 See JAMES A. FANTO, DIRECTORS’ AND OFFICERS’ LIABILITY (2d ed., Release No. _, 2010); [other basic citations] 11 [basic citations] 12 See, e.g., Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). 13 [cite to Revlon jurisprudence] 14 [cite Stone v. Ritter, 911 A.2d 362 (Del. 2006).]

6


In the complicated legal world in which public companies operate, other laws add

obligations on directors. Since public companies are regulated participants in the securities

markets, the federal securities laws and related exchange rules also affect the structure,

composition, and duties of a public company board.15 For example, as a result of these laws and

rules, public company boards are today composed primarily of independent directors16 and have

audit, compensation, and nominations committees, composed of such directors, with defined

tasks and procedures.17 In addition, board members must oversee any public offering of the

firm’s securities, avoid trading on inside information, and be careful about disclosing non-public

material information either publicly or privately.18 As scholars have noted, directors have also to

be concerned about not violating the almost countless criminal laws applicable to their conduct

as board members.19 This list of legal obligations could go on and on and could frighten anyone

from becoming a board member unless he or she realized that, outside the criminal context, the

law limits board members’ liability20 and their firms purchase comprehensive directors’ and

officers’ insurance policies.21

Boards and firms do not exist in a vacuum and are thus also subject to, or at least feel the

pressure of, social norms relating to their conduct. There are codes of conduct and “best

practices” for board member behavior promulgated by interested associations, such as the

15 The basic duties of public companies are found in the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78nn (2006), and its accompanying SEC rules, which regulate the securities markets. To simplify things, companies whose securities are traded in these markets are participants therein and thus are subject to regulation under that Act. A public company has multiple disclosure obligations, including the filing of an annual report on Form 10-K, the filing of quarterly reports on Form 10-Q, the filing of “special” reports on Form 8-K whenever one of the events enumerated in the Form occurs, and the filing of a proxy statement for the annual shareholders’ meeting. 16 See SPENCER STUART, BOARD INDEX 2008, at 10-11. This means directors who are “outside” directors (i.e., non-employee directors) and who have no material financial or other relationship with the firm or its executives. [citation] 17 [citations, e.g., 15 U.S.C. § 78j-1(m)(3) (for audit committee members)] 18 [provide citation support] 19 [See Samuel W. Buell, Criminal Procedure Within the Firm, 59 STAN. L. REV. 1613 (2007).] 20 [See, e.g., DEL. CODE ANN. tit. 8, § 102(b)(7) (2010)] 21 [See generally TY R. SAGALOW, DIRECTORS AND OFFICERS LIABILITY INSURANCE: A DIRECTOR’S GUIDE (2000).]

7


National Association of Corporate Directors,22 and by institutional shareholders and their

advisors.23 These codes no doubt influence board conduct, but are of no legal significance.24 In

addition, there are director codes or practices designed and pushed by groups that are attempting

to establish their norms in the boardroom; this may well occur in the environmental, labor or

diversity areas.25 As in the case of anti-discrimination laws, these advocated norms may be

enshrined in the law and applicable to public firms, but might not apply to the typical director of

a firm.26

B. The Functions of Boards

Corporate boards are also the subject of organizational research because, frankly, the law

identifies only part of what boards do. Under the law boards are the supervisors and monitors of

the firm, which function essentially involves approving major strategies and actions proposed by

the chief executive officer (“CEO”) and his or her executive team and ensuring that the overall

control system of the firm, again as instituted by the executives, is adequate for the firm’s

business.27 From an organizational studies perspective, the board here acts as a monitor of

executives and the firm.28

The board has other, non-legal functions, as discussed in the organizational literature, and

they are significant in the selection of board members. These are the advising, networking and

22 [citations] 23 [RiskMetrics] Again, as is well known, the institutions wish to improve board conduct across firms since they diversify their investments across firms. 24 See In re The Walt Disney Co. Derivative Litig., 907 A.2d 693, 697, 745 (Del. Ch. 2005), aff’d, 906 A.2d 27 (Del. 2006). 25 [citations] 26 See infra [/ /]. 27 [cite Caremark, Stone] 28 See generally Daniel P. Forbes & Frances J. Milliken, Cognition and Corporate Governance: Understanding Boards of Directors as Strategic Decision-Making Groups, 24 ACAD. MGT. REV. 489, 492 (1999); COLIN B. CARTER & JAY W. LORSCH, BACK TO THE DRAWING BOARD 67-68 (2004).]

8


signaling functions.29 Board members serve as advisors to the CEO and other major executives

on significant, often strategic issues related to the firm. It is clear how this function could limit

board membership. Individuals who could offer advice on such issues that is based upon their

experience must generally be those who are current or former CEOs, or who have had other

significant executive responsibilities (e.g., president of a non-profit). Too much should perhaps

not be made of the experience, because it is conceivable that individuals without executive

experience, such as a management scholar, could offer good advice. What appears to matter for

board selection on this point is that CEOs are believed to take seriously the advice only of those

who have had this executive experience and whom they consider to be their peers.30 Executive

background also gives a board member credibility with his or her fellow board members, for

board members also advise the board on issues within their areas of expertise. Indeed, one

reason given for the lack of adequate representation of women and racial and ethnic minorities

on public company boards is that members of these groups have not had the necessary executive

experience to qualify them for the advisory function.31 Firms will go lower in the executive

ranks to find diversity candidates, but they risk undermining a director’s advisory role or

relegating the director to an insignificant board function.32

As its name suggests, networking means that board members provide the board and

executives with useful connections to other industries and activities.33 A board member with

numerous connections can be a valuable resource to a firm. A typical director, it must be

remembered, is often a CEO of another firm, a director of several other firms, and a director of

29 the literature sometimes groups two of these functions together. [citation] 30 [cite to literature, such as Lorsch] 31 [citation] Nancy M. Carter & Christine Silva, Women in Management: Delusions of Progress, HARVARD BUS. REV. 19 (Mar. 2010). 32 See SPENCER STUART, 2006 BOARD DIVERSITY REPORT [support and reference to human resources] 33 [networking citation]

9


non-profit organizations. These connections can be useful to the firm, for a director with them

brings along knowledge of practices and strategies at other firms and may be useful for

identifying acquisition targets and financing options.34 A particularly useful networking

characteristic today comes from a director’s government “connections,” which can arise from

government service, generally in the executive branch. These connections can be particularly

significant for firms in highly regulated industries or for those doing considerable business with

the government.35 For example, a director with a government network can assist executives with

regulatory issues and advise them and the board on relevant legislative and regulatory changes,

and even act as an indirect lobbyist for a firm. This function can be an avenue to the board for

women and ethnic and racial minorities who have not had the experience as business executives

to qualify them for board service.36

The networking function is related to the signaling function, which is what one could call

the “symbolic capital” function of a director.37 Signaling means that a board member enhances

the firm simply by his or her membership on the board. How this enhancement occurs, of

course, depends upon the observer and is difficult to measure.38 A high-profile female former

government regulator, who becomes a director, may, for example, raise a firm’s reputation

among current regulators, as well as among women customers and employees who appreciate

female representation on the board. If, to take another example, Warren Buffett were to join a

board, he would bring to it his prestige of being the “master” investor and would signal to the

investment community his belief that the firm is valuable. Since symbolic capital is a broad

concept and since a board member can send all kinds of signals, including a firm’s commitment 34 [Academy of Mgt. article on how firm practices spread through board interconnections] 35 [example; Haliburton, Enron] 36 (e.g., Vernon Jordan, Carla Hill). 37 [cite Bourdieu for this] 38 [cite Broome, et al. for this point]

10


to gender, racial and ethnic diversity, it is not always easy to understand how it translates into

economic capital, i.e., shareholder value.39

C. Board Pathologies

A major complaint about public company boards is that they go along with value

destroying strategies pushed by the CEO and his or her executive team and that they are not

active enough in detecting fraud or overreaching, generally by executives. The examples come

readily to mind: boards approve mergers that prove to be ultimately destructive,40 rubber-stamp

outsized compensation packages,41 or do not question suspicious transactions.42 After a firm

disaster or scandal, the question is always raised why the board did not see and prevent the

problem, or why the board passively approved of a destructive strategy.

There is considerable jurisprudence on the legal responsibility of directors in different

circumstances as well as a voluminous legal literature on improving board performance.43 This

jurisprudent and literature understandably focuses on the board’s monitoring or supervisory

function. As the literature recognizes, many problems arise from the somewhat unique position

of board members, who are the ultimate supervisors of a public firm, but generally have full-time

high-level positions elsewhere and thus only limited time to devote to their board work.44 Since

they are outsiders, moreover, they are highly dependent for information upon executives, who

can manage the information flow to a board. As is well known, board reform through corporate

and securities law, as well as through board best practices, has sought to encourage board

members to spend more time with the firm and to provide them with their own sources of

39 [Guiso, Zingales, on Civic Capital] 40 [Fanto on mega-mergers] 41 [Disney case] 42 [Enron situation and case] 43 [representative citations] 44 See SPENCER STUART, BOARD INDEX 2008, at 24 (average 9 meetings per year).

11


information about the firm, independent of executives.45 To take only one example, the board

audit committee has a direct relationship with a firm’s outside auditors, who report to it.46

Boards are decision-making and advisory groups, even if the decisions made are more

typically in the nature of approval of executive proposals. They are likely prone to many of the

group pathologies that social psychologists and organizational theorists have identified in

decision-making groups.47 One well-known group pathology is “groupthink.”48 In its classic

description, groupthink appears when group members embrace a group perspective (generally

pushed by a strong leader), enforce conformity among fellow group members, react hostilely to

anyone challenging their views (whether insiders or outsiders), and maintain the perspective in

the face of contrary evidence.49 Groups in the thrall of groupthink are found to make disastrous

decisions, often because they ignore conflicting viewpoints and evidence, and these decisions

often appear to be inexplicable to an outsider and even to a group member, once he or she is free

from the group’s influence.50

It is difficult to speculate as to what exactly occurs in board rooms, since boards are an

elite, closed environment accessible to few persons (and few academics).51 However, if one

45 [e.g., corporate practice of restricting a board member’s other director positions, see CORPORATE BOARD MEMBER, WHAT DIRECTORS THINK 2 (2004)] 46 [15 U.S.C. § 78j-1(m)] 47 [See generally John M. Darley, How Organizations Socialize Individuals into Evildoing, in CODES OF CONDUCT: BEHAVIORAL RESEARCH INTO BUSINESS ETHICS 13 (David M. Messick & Ann E. Tenbrunsel eds., 1996).] 48 [See supra__] 49 [See Randall S. Peterson et al., Group Dynamics in Top Management Teams: Groupthink, Vigilance, and Alternative Models of Organizational Failure and Success, 73 ORG. BEHAV. & HUM. DECISION PROCESSES 272 (1998); Ronald R. Sims, Linking Groupthink to Unethical Behavior in Organizations, 11 J. BUS. ETHICS 651 (1992); Marlene E. Turner & Anthony R. Pratkanis, A Social Identity Maintenance Model of Groupthink, 73 ORG. BEHAV. & HUM. DECISION PROCESSES 210, 220-21 (1998).] 50 [Challenger/Man Gulch] [Perhaps refer to Emily Pronin on bias blind spots and the introspection fallacy, whereby people look into their own prior thinking and find nothing wrong, but they look at the actions of others and discover bias.] 51 [cite exceptions; Broome, et al. work]

12


were to evaluate boards from a social identity perspective,52 one could propose that the social

identity associated with board membership can cause problems in board functioning. Under this

theory, directors assume a particular social identity when they become board members, leaving

other identities at the door of the boardroom. Each board, of course, has its own particular

version of this identity, for boards are all idiosyncratic groups to some extent. However, it

appears that, on the basis of insider reports about boards, the social identities of all boards share

certain features.53 To put things simply, the social identity today would include a belief structure

and a code of conduct. The belief structure would accept that the firm exists primarily for

shareholder value, and thus that board decisions must promote this goal.54 This structure would

also involve an awareness of and a pride in the elevated social position that goes along with

board membership and that carries with it a concept of infallibility in decisions.55 The code of

conduct would include deference to the CEO and the executive team, as well as to long-standing

board members and a collegiality that requires conflict avoidance.56 In addition, this board

social identity is over-determined for board members come from contexts where the identity

reigns. Indeed, a person known for being “different” (i.e., not adequately embracing this social

identity) would not be selected for (or renominated to) a board, under the euphemism that he or

she would not be the right “fit.” Social psychological research suggests that groups with this

52 [S. ALEXANDER HASLAM, PSYCHOLOGY IN ORGANIZATIONS: THE SOCIAL IDENTITY APPROACH (2d ed. 2004)] 53 [cite reports] 54 Sumantra Ghoshal, Bad Management Theories Are Destroying Good Management Practices, 4 ACAD. MGMT. LEARNING & EDUC. 75, 76-77 (2005); Dennis A. Gioia, Business Education’s Role in the Crisis of Corporate Confidence, 16 ACAD. MGMT. EXECUTIVE 142, 143 (2002). Board members have been inculcated with the shareholder perspective so that it has become part of their identity, since they have been taught it in business school and it has been reinforced throughout their professional experience. Of course, part of the social identity of boards and of business more generally, which is also part of business school education, is that diversity is irrelevant for job performance and that success in business is gender neutral. See Elisabeth K. Kelan & Rachel D. Jones, Gender and the MBA, ACADEMY MGT. LEARNING & EDUC. 26, 38 (Mar. 2010). 55 [See David M. Messick & Max H. Bazerman, Ethical Leadership and the Psychology of Decision Making, SLOAN MGMT. REV., Winter 1996, at 9, 17-18; KARL E. WEICK, MAKING SENSE OF THE ORGANIZATION 370-71 (2001).] 56 [Lorsch]

13


kind of social identity are prone to decision-making errors, since the social identity does not

allow for cognitive conflict and encourages a self-censorship on the part of its members.57

III. The Failed Empirical Case for Board Diversity

A. Shareholder Value Perspective

We find that proponents of board diversity often feel obligated to justify this diversity on

the basis of shareholder value. That is, they wish to show that an increase in board diversity

correlates with an increase in shareholder value. A central problem for this approach is that, so

far at least, the proponents have been unable to provide firm empirical support for board

diversity. Existing studies provide inconclusive evidence of the benefit, from a shareholder

value perspective, of increasing the number of women, and ethnic and racial minorities on public

company boards.58 Of course, as more women and such minorities become directors, there will

be further data for the studies, which may show more positive results.

This lack of strong empirical evidence is not surprising, for empirical studies with respect

to board structure and composition have generally had inconclusive results. For example,

although the predominance of independent board members on public company boards has

become a legal and practical reality in U.S. companies, that independent board members increase

shareholder value is subject to debate as an empirical matter.59 Similar debates have occurred as

to empirical evidence for a board structure that has not yet become a reality: having an

independent Chair in the board position who is not the CEO.60 Again, these results, including

57 [Blake E. Ashforth & Vikas Anand, The Normalization of Corruption in Organizations, 25 RES. ORG. BEHAV. 1, 10 (2003); Vikas Anand et al., Business as Usual: The Acceptance and Perpetuation of Corruption in Organizations, 19 ACAD. MGMT. EXECUTIVE 9, 11 (2005)]] 58 [Broome et al. citations; Aaron Dhir, Towards a Race and Gender-Conscious Conception of the Firm: Canadian Corporate Governance, Law and Diversity (reviewing studies); Joo; Nielsen et al.] 59 [cite Black, et al.] 60 [cite debate; evidence]

14


those on board diversity, are understandable because board members are a relatively insignificant

part of a firm, even if they have an important place in corporate governance.

As a legal matter, since boards are paramount in the governance of public firms, any

board could decide (as no doubt many of them have) to propose to the shareholders to increase

the diversity of itself. A board could justify this decision on general business-related grounds

(e.g., improvement in customer and employee relations, demonstration of compliance with social

norms that will create a favorable media view of the company), even if it has no hard empirical

evidence for the decision. Under established law, if challenged, this kind of judgment would be

sustained by the courts as an appropriate “business judgment” by the board, for, as is well

known, courts accord considerable deference to boards on “business” matters.61 In sum,

diversity advocates do not need a failsafe empirical case for the benefits of board diversity in

order to promote their cause; they just need to make persuasive, business-related arguments and

have them adopted in board circles.62

Why then cannot diversity advocates be content with winning the diversity war without

winning the empirical battle? Certainly, one answer is that, if the advocates are scholars, they

would like to base their advocacy on solid empirical grounds.63 More significantly, they no

doubt realize that there are probably limits to how far generalized business justifications, which

have no unassailable empirical support in shareholder value, will take them in financial and

investment circles. That is, when push gets to shove, the bottom-line focus of members of these

circles on any significant matter with respect to a firm is shareholder value.64 To take an

61 [basic citation; Smith] 62 This is no doubt what many “norm” entrepreneurs try to do with respect to business firms. 63 [general empirical trends in scholarship] This seems to be especially true if the advocates subscribe to a shareholder value perspective. 64 Of course, in certain circumstances, the shareholder value norm may be trumped by law, such as the anti-discrimination laws.

15


extreme example, suppose that a firm adopted a significant board diversity policy, such as

suggesting to shareholders that membership reflect gender, ethnic, and racial percentages in the

United States, and justified this policy on general business grounds. The board has realistically

to fear that investments might be suspicious of this policy, not because of a discriminatory

animus, but because its adoption shows that the board does not have an appropriately strong

enough shareholder value focus. This board is likely to be punished gradually, as share price

falls and investor pressure builds for the board to get its eyes back on the appropriate focus.

Given that diversity advocates fear that this is the likely outcome for boards proposing

significant board diversity initiatives, they conclude that they are left with the status quo for the

time being unless they can bring forward stronger empirical support. And the status quo appears

to mean a slow moving, incremental diversification.65

B. Parallels with Antidiscrimination Jurisprudence

Justifying director diversity in terms of shareholder value asks both too much and too

little of diversification. It asks too much because, as noted above, it is unlikely that

diversification will affect corporate performance significantly. It asks too little of diversification

because, almost a half century after the enactment of the Civil Rights Act of 1964 (the “Civil

Rights Act”), there is something offensive about accepting a mostly white, mostly male work

force only in positions of high power and prestige. In fact, we contend that the principal

inspiration for board diversification comes from the insulation of corporate board selection from

the civil rights values widely adopted by society. If we are right, it really should not matter

whether a corporation becomes more profitable by diversifying its board, as long as it is not

measurably hurt, since that harm would make the social value difficult to sustain.

65 [statistics]

16


The Civil Rights Act makes it illegal to discriminate in employment practices. However,

it does not apply to corporate board membership, because board members are usually not

employees, with the exception of the few executives on a board. In fact, courts routinely hold

that the statute does not apply to corporate directors.66 The Civil Rights Act prohibits not only

the disparate treatment of those whom the firm employs or those who seek employment at the

firm, but also prohibits practices that have a disparate impact on protected groups, unless these

practices can be justified by a legitimate business reason.67 Yet there is a peculiar island in the

business world—the island of corporate boards—not directly affected by this Act.

We believe that the advocates’ concern about board diversity is primarily motivated by

the perception of, and unhappiness with, this gap in the law because the board outcome runs

counter to the intent of the Act. This motivation makes the arguments about the business

advantage of diverse boards somewhat irrelevant and beside the point. Moreover, somewhat

ironically and as discussed below, the Supreme Court has emphasized the “business” limitations

argument in the interpretation of the civil rights laws. This means that the intent of these laws is

pushed into the background and business purpose is validated, which actually reinforces the

shareholder value perspective. We think that it is useful to explain this outcome in more detail.

1. The Exclusion of Directors from Civil Rights Laws

Under Title VII of the Civil Rights Act, an employee is defined as “an individual

employed by an employer,”68 and an employer is defined as “a person engaged in an industry

affecting commerce who has fifteen or more employees for each working day in each of twenty

or more calendar weeks in the current or preceding calendar year, and any agent of such a

66 [citation] 67 See 42 U.S.C. § 2000e-2(k)(1)(A). 68 42 U.S.C. § 2000e(f)(2010). The statute further excludes certain government employees and elected officials.

17


person...”69 The statutory language says little about who should be considered an employee as a

general matter and is of virtually no help in determining whether a director should be considered

an employee of a company under the civil rights laws. That question, however, has received

attention from the Supreme Court. In Clackamas Gastroenterology Associates, P.C. v. Wells,70

decided in 2003, the Court considered the issue whether physicians who were

director/shareholders of a professional corporation operating a medical clinic should be deemed

to be employees of the firm. If they were employees, this status would cause the firm’s total

number of employees to exceed fifteen and would make the firm subject to the Americans with

Disabilities Act. In deciding the case, the Court articulated a six-factor test as to determining

whether an individual is an employee, taking its lead from the EEOC Compliance Manual:71

Whether the organization can hire or fire the individual or set the rules and regulations of the individual's work

Whether and, if so, to what extent the organization supervises the individual's work

Whether the individual reports to someone higher in the organization Whether and, if so, to what extent the individual is able to influence the

organization Whether the parties intended that the individual be an employee, as

expressed in written agreements or contracts Whether the individual shares in the profits, losses, and liabilities of the

organization.72

The Court thus adopted a perspective on employment that is consistent with the common

law concerns of whether the individual exercises control in the organization. It summarized its

approach:

69 42 U.S.C. § 2000e(b)(2010). The statute further exempts government employees and employees of private membership clubs. 70 538 U.S. 440 (2003). Prior to Clackamas, the Court had addressed other issues concerning the definition of “employee.” See Walters v. Metro. Educ. Enters., Inc., 519 U.S. 202 (1997)(adopting “payroll method” to determine whether an individual was an employee during the statutory period to be considered an employee); Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318 (1992)(applying common law agency principles to determine whether an individual is an employee or independent contractor). 71 EEOC Compliance Manual § 605:0009 (2001). 72 538 U.S. at 449-50.

18


As the EEOC's standard reflects, an employer is the person, or group of persons, who owns and manages the enterprise. The employer can hire and fire employees, can assign tasks to employees and supervise their performance, and can decide how the profits and losses of the business are to be distributed. The mere fact that a person has a particular title -- such as partner, director, or vice president -- should not necessarily be used to determine whether he or she is an employee or a proprietor. Nor should the mere existence of a document styled “employment agreement” lead inexorably to the conclusion that either party is an employee. Rather, as was true in applying common-law rules to the independent-contractor-versus-employee issue confronted in Darden, the answer to whether a shareholder-director is an employee depends on “’all of the incidents of the relationship . . . with no one factor being decisive.’”73

While the Court remanded the case for further proceedings, it observed that the

director/shareholders should not be considered to be employees under these guidelines, and thus

the organization would not be subject to the anti-discrimination laws.74

Since 2003, the lower courts have continued to develop the law in this area. For

example, in De Jesus v. LTT Card Services, Inc.,75 the Court of Appeals for the First Circuit

applied Clackamas to a closely held corporation in an employment discrimination case. The

court further held that the Clackamas factors are to be added to the inquiry whether the

individuals are on a company’s payroll, a consideration that the Supreme Court had employed in

a 1997 case.76

Prior to these decisions, the courts had by and large excluded directors from the civil

rights laws. For example, in 1986 the Court of Appeals for the Seventh Circuit held that

members of a transit worker union local’s 25-member executive board, which met twice monthly

to address employee grievances, should be considered not to be employees of the local, and

therefore should not count toward the 15-employee threshold needed to trigger application of the

73 Id. at 450-51 (internal citations omitted). 74 Id. at 451. 75 474 F.3d 16 (1st Cir. 2007). 76 Walters v. Metro. Educ. Enters., Inc., 519 U.S. 202 (1997).

19


civil rights laws.77 While the board members were compensated for their meetings, they were

otherwise employed by the transit authority itself. The court noted in conclusion:

Directors are traditionally employer rather than employee positions. Although a director may accept duties that make him also an employee, a director is not an employee because he draws a salary. Rather, the primary consideration is whether an employer-employee relationship exists. The record here fails to establish that the board members perform traditional employee duties. The union officers manage the daily operations of Local 241 under the direction of the board. Although the board undertakes investigations of all grievances and disputes between union members and the company, it reports to no one other than itself.78

Thus, being on the payroll was not sufficient to establish the board members as employees.

Rather, the absence of a traditional employer-employee relationship was the most relevant

consideration.

A 1987 district court case from California illustrates the distinction. In Martinez v.

Oakland Scavenger Company,79 black and Hispanic employees of a garbage hauling business

argued that the employer, Oakland Scavenger, was liable for disparate treatment of its minority

workers. The plaintiffs contended both that that there were no minority shareholders and the best

jobs only went to white workers. The court held that there was no business justification for

having employment practices that favor white employees over minorities,80 permitting a class

action to continue both on theories of disparate impact and disparate treatment of the employees.

The court also stated, however, that “Title VII does not require minority representation on the

elected board of directors or the elected senior corporate offices. The shareholders may elect

whom they want to lead their enterprise.”81 That is, within the same case, a court permitted a

class action to go forward in connection with discrimination against employees, but permitted

77 787 F.2d 1154 (7th Cir. 1986). 78 Id. at 1157 (citations omitted). 79 680 F. Supp. 1377 (N.D. Cal. 1987). 80 Id. at 1392. 81 Id. at 1393.

20


shareholders to elect directors who would then appoint officers without any scrutiny under the

civil rights laws.

Of course, an individual can be both a director and an employee under these tests. Thus,

the Court of Appeals for the Second Circuit held that the Age Discrimination in Employment Act

applies to a company’s mandatory retirement policy for members of the Board of Directors when

a director is also full-time employee.82 This status will be commonplace among inside directors.

However, since our principal concern here is with the failure of firms to diversify their boards by

recruiting insufficient numbers of outside directors, this application of the civil rights laws is not

helpful to the board diversity argument.

2. The Requirements of Civil Rights Laws for Firms The civil rights laws might not lead to greater diversity even if they did apply to

corporate boards. The Act states: “It shall be an unlawful employment practice for an employer-

-(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against

any individual with respect to his compensation, terms, conditions, or privileges of employment,

because of such individual's race, color, religion, sex, or national origin.”83 This covers cases of

disparate treatment and disparate impact. Not only may an employer not discriminate in its

employment practices because of a person’s race, sex, etc., but it must justify practices that result

in prima facie discriminatory effects even when the employer did not intentionally discriminate.

Were the statute to apply to corporate boards, it would disallow intentional efforts to deny board

membership to the various protected groups, and result in the scrutiny of practices that result in a

lack of diversity as a side effect.

82 EEOC v. Johnson & Higgins, Inc., 91 F.3d 1529 (2nd Cir. 1996). 83 42 U.S.C. 2000e-2(a)(1).

21


The situation is complicated because of the relationship between the disparate treatment

and disparate impact claims. Efforts to remedy past discrimination resulting from disparate

impact risk disadvantaging white males in a manner that might be considered disparate treatment

of them. That is exactly what the Supreme Court held was the case in Ricci v. DeStefano,84 a

2009 case discussed extensively in the context of Justice Sotomayor’s confirmation hearings for

her appointment to the Supreme Court.85 The case involved the New Haven, Connecticut Fire

Department’s use of a test to certify employees for promotion. The result of the test given in

2003 was that the ten lieutenant positions would all go to white candidates, and the seven captain

positions would go to members of a group consisting of seven whites and two Hispanics.86 No

black person would be promoted. While a number of black firefighters had passed the test,

promotions were scheduled to be offered in order of the test scores, and the available positions

would be taken before any African American would be eligible.

As a result of the apparent racially disparate consequences or “impact” of the test results,

New Haven’s Civil Service Board held hearings, which included discussion of whether testing

methods used by other cities should have been employed since they might have resulted in less

racial disparity. The Board ultimately decided not to certify the results of the test. As a

consequence, certain white firefighters who would have been promoted because of their test

scores brought an anti-discrimination lawsuit. This litigation made its way to the Supreme

Court. The question there was whether a potentially meritorious disparate impact claim

threatened by African American firefighters if the results were certified allowed New Haven’s

Board not to certify the test results, but to promote black candidates who passed the test, but who

did worse than white firefighters. In a 5-to-4 decision, the Court held that the disparate treatment 84 129 S.Ct. 2658 (2009). 85 [citation] 86 Id. at 2666.

22


claim by the white firefighters trumped the threatened disparate impact claim of the black

firefighters.

In its opinion, the Court first held that the threat of a disparate impact lawsuit can justify

disparate treatment of white candidates only when there is a “strong basis in evidence” that a

disparate impact case would prevail.87 In this case, the Court held, that standard could not

possibly be met. Although the black firefighters had easily demonstrated that the test resulted in

disparate impact, this prima facie case was not enough under anti-discrimination law. As the

Court explained:

The problem for respondents is that a prima facie case of disparate-impact liability -- essentially, a threshold showing of a significant statistical disparity, and nothing more -- is far from a strong basis in evidence that the City would have been liable under Title VII had it certified the results. That is because the City could be liable for disparate-impact discrimination only if the examinations were not job related and consistent with business necessity, or if there existed an equally valid, less-discriminatory alternative that served the City's needs but that the City refused to adopt. We conclude there is no strong basis in evidence to establish that the test was deficient in either of these respects.88

Thus, whether a disparate impact claim will prevail depends upon questions of business

necessity, and in this case strong evidence that such a claim would prevail was a prerequisite for

overcoming a countervailing claim of disparate treatment.

What all of this means for the diversification of corporate boards is that it really makes

little difference that the civil rights laws do not apply to them (i.e., because board members are

not employees). Even if the laws applied, a firm would have only to prove that its current policy

of choosing directors for various business-related reasons (particularly to increase shareholder

value) would likely be good enough to rebut a disparate impact claim. Moreover, only such a

claim with extremely strong evidence would be sufficient to justify a board selection policy that

87 Id. at 2676. 88 Id. at 2678 (citations omitted).

23


explicitly discriminated against the white male board members who would now not be chosen.

We suspect that the present diversity policy of most firms (stated as follows) would survive any

challenge: a board is open to nominate eligible minority board members, provided that the

“right” (i.e., those who will help the firm perform better) candidates can be identified.

There are, of course, other reasons for the civil rights laws not to apply to board selection,

the most practical of which is that membership is highly restricted, and generally by nomination

followed by shareholder election. This makes it unlikely that there will be many plaintiffs who

could bring such suits. Our point, though, is that a review of the civil rights laws, whose values

we believe underlie much of the effort to diversify boards, takes us right back to shareholder

value. With the interpretation of the civil rights laws emphasizing business necessity, it supports

the position that diversifying boards depends upon empirical research strongly demonstrating

that this board composition will help firms better perform. Once again, this supports the status

quo of incremental diversification.

C. Diversity as a Way to Address Board Pathologies

One argument for board diversity would be if it could help address the group pathologies

discussed earlier that arise from the typical social identity of boards. A diverse board member

could introduce “cognitive conflict” within the boardroom and thus reshape a social identity

typified by deference, conformity and stylized conflict. That is, as social psychologists have

explained, group pathologies like groupthink, where decision-making parties are uniformly

pursuing one path or strategy, could be undermined if a group member brings forward other

perspectives that are in direct conflict with the group’s inclinations.89 This resistance could in

89 [Donald Lange, A Multidimensional Conceptualization of Organizational Corruption Control, 33 ACAD. MGMT. REV. 710, 716-22 (2008); Ann E. Tenbrunsel et al., Building Houses on Rocks: The Role of the Ethical Infrastructure in Organizations, 16 SOC. JUST. RES. 285, 295 (2003)]

24


turn spark more discussion and the consideration of alternative strategies, or inquiry into problem

transactions and compensation arrangements, as the case may be. A diverse board member could

be seen as an ideal candidate for this role of catalyst for social identity change of the board, if

one assumes that his or her experiences provide him or her with different perspectives than those

of the typical board member.

There are several, obvious problems with this scenario, however. The social

psychological literature suggests that it is difficult for one person to alter group dynamics,

particularly with respect to cohesive groups.90 Rather, critics are generally marginalized by the

group and ignored, or placed into the innocuous role of being the “house” critic, and they thus

cannot effect any significant change to the decision-making process and the group’s identity.91

Since, moreover, women and ethnic and racial minority board members are already likely to be

marginalized on boards,92 they would incur considerable risks of further marginalization by

taking on this oppositional role. Indeed, they may often be inclined to engage in self-censorship

when on a board with respect to any alternative perspective that they could offer.93 Furthermore,

one could also raise the basic fairness issue of forcing women and other minorities into this risky

confrontational role.

In addition, it has to be recognized that the women and ethnic and racial minorities who,

after an arduous climb up the business hierarchy, are eligible to be nominated as board

candidates, have also been trained and formed, through their education and professional careers,

to find “natural” the social identity of boards, just like their white male counterparts.94 From the

90 [See WEICK, supra note __, at 114.] 91 [See JANIS, supra note __, at 114-17] Indeed, having a house critic may make the group all the more cohesive about its strategies because it can say that it considered alternatives. 92 [citation] 93 [citation] 94 [management article about women in business schools]

25


social identity perspective, when acting as board members, they may bring nothing new to the

table, certainly not their other identities. Thus, board diversity is not likely to address group

pathologies on boards, for it serves only to expand gender and racial makeup of the corporate

elite.

There is evidence that group (and thus board) pathologies can be addressed by the

formation of a significant subgroup within a group that resists, and changes, the dominant social

identity.95 In other words, meaningful cognitive conflict occurs through the formation of a

coalition of resistance where coalition members can support each other in their creation of a

alternative group identity. This phenomenon often appears within a board in a crisis, when a

dominant CEO is overthrown because of a scandal or firm problem.96 In a related vein, literature

on diversity in business settings suggests that diverse individuals are more likely to offer their

perspectives when, in a workgroup setting, the individuals feel comfortable, which is promoted

by signs that their input will be respected and by their having a critical mass of cohorts.97

Therefore, board diversity may turn out to be important in changing board social identity, but it

is likely to be dependent upon having adequate numbers of diversity board members and

transforming board functioning—both difficult to achieve.

IV. Other Justifications for Diverse Boards

A. Countering Finance

95 [citation; Sunstein; Linda K. Treviño et al., Behavioral Ethics in Organizations: A Review, 32 J. MGMT. 951, 962 (2006).] 96 [examples] 97 See Erica Gabrielle Foldy, et al., Power, Safety and Learning in Radically Diverse Groups, 8 ACAD. MGT. LEARNING & EDUC. 25 (2009). [Tyler citation and other literature] Both the social psychological and the diversity literature suggest that there are ways other than pure numbers to bring out these perspectives; one suggestion is that a leader engages cognitive conflict and establishes the “group” ground rule for respect of other identities and perspectives in group deliberations.

26


In our view, diversity advocates should not restrict themselves, or emphasize, justifying

board diversity in terms of shareholder value. As we have noted above, showing that diverse

boards increase shareholder value is difficult as an empirical matter, and it makes the advocates

dependent upon empirical studies for changing the status quo. More significantly, since we

believe that the shareholder value paradigm is problematic, as a normative and policy matter we

would prefer that diversity advocates (or anyone else) not reinforce this normative perspective on

the firm. In addition, it is clear that the case for board diversity, as for diversity in other

contexts, is based upon other normative frameworks than an agency theory of finance (e.g., to

redress past discrimination). As some diversity advocates have well explained,98 it belittles or

cheapens the diversity case to base it upon the shareholder value paradigm. In our view,

diversity advocates should continue to ground their board diversity case upon these frameworks,

just as the frameworks inspire anti-discrimination laws.

One often used example is the signaling effect of a diverse board.99 As is well known,

the argument could be made that a diverse board, as a signal, may increase a firm’s profits, if

customers prefer to give their business to, and if employees are motivated to work harder for, a

firm that values diversity (as shown by its board composition). We do not believe that a diverse

board has to be a signal in this manner, which is based upon shareholder value (and again hard to

establish as an empirical matter). Board diversity also signals to employees, customers and the

community that the firm is inclusive (and thus not exclusive) with respect to all of its participants

and associates (from the lowest-ranking employees to the most senior who are the board

members). Moreover, this diversity would signal the firm’s compliance with the norms

98 [citation; Dhir] 99 [cite Broome, et al.] (their discussion is sophisticated, and takes into consideration “signals” to inside and outside groups. Indeed, the diversity of “signals” is the focus of their article—to employees, to customers, to outside parties, such as regulators).

27


embodied in anti-discrimination laws, which, as discussed earlier, are not literally applicable to

boards. Thus, a diverse board could be justified on the grounds that a firm should demonstrate

acceptance of social values enshrined in the law, with less emphasis upon the shareholder value

perspective.

As noted earlier, the law allows corporate boards, when deciding firm issues such as

board composition, to make a “loose” connection to shareholder value.100 Certainly, such a case

could be made for a diverse board, and in our view there is no reason for diversity advocates not

to take advantage of the law’s flexibility on this point. That is, lip service in offered to finance,

but other normative frameworks are introduced into the discussion. But we understand that

diversity advocates are walking a fine line here, for, as discussed above, considerable resistance

to diversity may surface from existing executives and board members, and from institutional

investors and money managers, steeped as they are in finance and suspicious of anything that

suggests less than true devotion to shareholder value.

Making the challenge even more difficult is the narrow way in which the Supreme Court

has construed the civil rights laws. As discussed above, attempts to remedy the disparate impact

of employment practices on women and ethnic and racial minorities are rebutted by business

necessity or have even been construed as themselves a violation of the disparate treatment prong

of the civil rights statutes. This interpretation is by no means necessary, and is in fact a departure

from prior precedent, as Justice Ginsburg points out in her dissent in Ricci.101 To the extent that

board diversification is an outgrowth of a culture that values racial and gender equality stemming

100 In this case, it would involve a board nominating committee selecting diverse candidates for election by the shareholders. 101 Ricci, at 2701-02 (Ginsburg, J. dissenting).

28


from a half century of employment discrimination legislation, such decisions are likely to place

even more burden on those firms that wish to diversify their boards.102

Diversity advocates may argue that it is inappropriate, and even unfair, to place the

burden of challenging, either directly or indirectly, the shareholder value paradigm upon them,

which might hinder the achievement of the other goals of board diversity. While this is a

concern, we feel that a greater danger is that board diversity is reduced to including a few diverse

directors with the shareholder value perspective on boards, whose position as members of the

corporate and financial elite is reaffirmed. This result, together with current board composition,

reinforces the current politically unsustainable situation of this elite having a disproportionate

share of wealth.103 Moreover, the main obligation for board diversity would be placed upon

current board members, who are primarily not women or members of racial or ethnic minorities.

For they have to nominate diversity directors in meaningful numbers and face the immediate

resistance of shareholder value.

B. Improvements to Board and Firm Functioning

We also hope that a more diverse board with members offering other perspectives could

improve board functioning as to its supervisory and advisory roles and could reduce the harmful

consequences of the shareholder value perspective. To take just one prominent example, much

conduct in public firms that is detrimental both to firms and society arises from executive

102 Of course, legislating a minimum percentage of diverse board members – an approach taken by Norway – would solve this problem in that no firm would have to risk being an unappreciated pioneer in this regard, but such legislation is not likely to be enacted, and might even be considered unconstitutional if it were. Cite Norway legislation. 103 [See Thomas Philippon & Ariel Reshef, “Wages and Human Capital in the U.S. Financial Services Industry: 1909-2006” (NBER Working Paper No. 14644, Jan. 2009); LAWRENCE E. MITCHELL, THE SPECULATION ECONOMY: HOW FINANCE TRIUMPHED OVER INDUSTRY (2007); GERALD F. DAVIS, MANAGED BY THE MARKETS: HOW FINANCE RESHAPED AMERICA (2009).]

29


compensation practices and related issues (i.e., “rents” more generally).104 It is a common place

that compensation practices, which center on the stock option and which have resulted in

extreme pay disparity,105 are creatures of finance’s agency model.106 Moreover, many

prominent abuses in public firms involve compensation and related rent-seeking. Stock option

backdating, which was commonplace in so many firms, comes to mind,107 as do the

compensation arrangements in firms like Merrill Lynch that continued despite massive losses.108

There is little evidence that board members consciously approve of fraud and other

abuses in compensation. However, the social identity shared by the typical board member makes

him or her deferential to finance-based compensation arrangements and inclined to approve (and

now to think as natural) high compensation arrangements. This same social identity prevents

them from focusing on the consequences of their decisions, such that firms appear to exist only

for the wealth creation of the corporate and financial elite.109

The hope is that a diverse board (with suitable numbers of diverse members) could help

alter the dominant, finance-based social identity that now characterizes public company boards.

As in all social situations, this would mean the formation of a new social identity for a particular

board that is influenced by the perspectives of its diverse members and that would not simply

reflect the shareholder value standard. Again to take an example from compensation, a board

with a different social identity might question many compensation assumptions and practices,

104 Of course, there are steadfast defenders of current compensation arrangements. [cite] 105 [citation] 106 [See generally LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION 159-73 (2004)] 107 [citation] 108 [See SEC v. Bank of America, 2009 WL 2916822 (S.D.N.Y. Sept. 14, 2009) (district court refuses to accept $33 million dollar settlement between the SEC and Bank of America on the issue of disclosure violations regarding the bonuses because it is “neither fair, nor reasonable, nor adequate”); SEC v. Bank of America, 2010 WL 624581 (S.D.N.Y. Feb. 22, 2010) (court accepts revised settlement).] 109 [Simon Johnson citation]

30


such as the sheer size of compensation packages, the disparity between executive compensation

and that of other employees, the form of the compensation (i.e., primarily stock-based), and the

beliefs with respect to current practices (i.e., one cannot attract competent executives without

it).110

In addition, a firm with diverse board members can have a salutary effect on corporate

culture. It is our belief that firms with significant numbers of women and ethnic and racial

minorities on their boards will be less likely to tolerate discriminatory conduct in the firms

themselves, and be less ready to offer shareholder value justifications for the discriminatory

impact of their employment practices. Even if such effects are difficult to measure,111 the benefit

of having diverse board members as role models in high positions and the symbolic value of their

presence for the affirmation of other normative frameworks than finance are undeniable.112

V. Conclusion

Gender, ethnic and racial diversity on boards of public companies remains an elusive goal

for diversity advocates. Moreover, these advocates feel the pressure to justify board diversity in

terms of its contribution to shareholder value. This pressure is not surprising, insofar as the

dominant social identity of boards views shareholder value as the ultimate criterion for any

action, including eligibility for the board, with respect to these companies. However, accepting

this criterion poses a problem for diversity advocates, for they are then called upon to justify

increased board representation of women and ethnic and racial minorities with empirical

evidence regarding its contribution to shareholder value, and such evidence is not strong or

definitive. As we have shown, this pressure that makes diversity secondary to shareholder value

110 [note how this argument was used in the crisis] 111 Some such effects are subject to empirical investigation now. 112 [Citation to role models literature.]

31


32

finds its counterpart in anti-discrimination law jurisprudence. Moreover, having diverse board

members, without more, does not appear to improve board decision-making, at least by

addressing some well-known board pathologies.

We have argued that diversity advocates should not limit themselves to the shareholder

value debate, for it obscures the other perspectives and values that they offer to justify board

diversity and it reinforces the shareholder value paradigm. As it turns out, corporate law

provides directors a considerable freedom for their business decisions, which could be used to

accommodate board diversity. We understand that there will be resistance to any questioning of

shareholder value and we do not intend to ask diversity advocates alone to carry this burden. Yet

we feel that, if diversity advocates justify board diversity on other grounds and norms, they could

promote a transformation in the social identity of boards, which could move beyond an identity

centered on shareholder value and which could actually improve board functioning.

justifying board diversity by james fanto, larry …...april 9, 2010 fanto, solan darley draft...

Documents