Loyola University School of Law, JD 2022
California signed SB 826 (“Act”) into law on September 20, 2018, requiring all publicly-traded California companies to have at least one female on their board of directors by the end of 2019. The law was enacted to create more diversity in corporate governance and expedite the slow movement toward gender parity in the boardroom. Now that each company should have at least one female member on their board of directors, the California Secretary of State (“SOS”) has released a document showing which companies complied and which companies will be facing fines.
SB 826 requirements
The Act requires companies to include at least one female member to the board of directors for any corporation that is subject to the law. Companies that are subject to the law are corporations, regardless of where they are incorporated, who have a principal executive office located in California as disclosed on their 10-K form for the Securities and Exchange Commission and “with securities listed on a major United States stock exchange.” The recent report issued by the SOS reveals that 43 companies reported that they failed to comply with the Act by not appointing a woman to their corporate board. Additionally, 300 companies failed to disclose their status of compliance.
The Act also calls for corporations to add additional female board members in the coming years if the board is large enough. “Female” is defined in the Act as anyone who self-identifies as a woman. The Act calls for at least two females on a five-person board and three female members on a board of six or more. Rather than waiting to vote a female into an already established board position, most companies are simply adding a seat to their board to comply with the Act, which may impact their required quota in the coming years. If a company failed to comply this first year, they are subject to a $100,000 fine, and if they are non-compliant in subsequent years, or with the new quotas imposed by 2021, they can face up to a $300,000 fine. However, these penalties may not be harsh enough to justify adding a director who, on average, gets paid $181,000 in California not including travel expenses to attend board meetings.
Incentives to diversify boards
The financial incentive is only one motivation though. The Act itself cites several studies that demonstrate, through statistical data, the benefits of increasing gender diversity on a board of directors. These reports included statistics demonstrating higher earnings, higher return on equity, and a greater likelihood of a sustainable future when boards include female directors. In January, Goldman Sachs CEO David Solomon announced that the bank will stop taking companies public unless they have diversity on their board because the performance of the Initial Public Offering is significantly better. Left to their own devices, corporations have historically shown that the natural progression of corporate governance is slow to evolve. Because positions on boards are often a coveted job with part-time hours, but powerful connections and substantial compensation packages, the few vacancies that do open are usually filled by former or current executives who have personal connections with sitting members of the board. Those connections and executive prerequisites disproportionately select male board members even though corporate executives are becoming more diverse. If the Act is not ruled unconstitutional, it could create 692 seats for women in California, and if it was extended to the rest of the country, more than 3,000 board seats would need to be filled by women.
Challenges and criticism
The act is not without criticism or challenge though. A shareholder from OSI Systems Inc. has brought suit against California arguing that the law is unconstitutional. OSI argues that the Act violates the Equal Protection Clause of the 14th Amendment because it discriminates on the basis of sex. There has also been speculation that this Act might violate the “internal affairs doctrine” which mandates that the laws of the state of incorporation govern corporations’ internal affairs. The Act excludes the law of another jurisdiction because it is based on the company’s principal executive offices and not the state of incorporation. It has also been criticized because it doesn’t address intersectional representation, that is candidates who represent more than one underrepresented group simultaneously. There is concern that although 39% of California’s population is Latinx, only 3.3% of the new female directors were Latinx while 77% were white women.
Even still, the Act has made some important headway that will not be completely undone by a possible court injunction or amendment of the Act. When the Act initially took effect 29% of California companies had all-male boards. This number has decreased to around 4%. Women accounted for 45% of new California board seats in the Russell 3000 index instead of the 31% of the national average of women in new board seats. It is also important to note that these opportunities are not going to the same women who are serving on multiple boards either. 69% of the new women serve on only one board and 94% came onto the board as an outside director. So, although there may be questions of its legality, the Act seems to be doing the job it set out to do – getting more female membership on boards of directors and making California corporate governance more diverse.