Bringing Diversity to Californian Boardrooms

Historically, corporate boards in the United States have been largely white, heterosexual, and male. But through recent legislation, the state of California has sought to bring different voices to the table.

Although the Golden State may rank as the most diverse state in the country, its corporate boardrooms have long failed to reflect its varied population. In 2018, about one-third of public companies headquartered in California had no female directors, and one-third were run by all-white boards.

But in recent years, California has taken steps to remedy this lack of diversity in corporate governance, which has opened a Pandora’s box of compliance questions and legal challenges.

In September 2020, California Governor Gavin Newsom signed Assembly Bill 979 into law, requiring the boards of public corporations headquartered in California to include at least one director from underrepresented communities by the end of 2021. Additional directors are mandated for larger corporate boards. The law also tasks the California Secretary of State with tracking compliance and corporate movement in and out of the state. Notably, the law applies to companies incorporated in other states, as long as a principal executive office is located in California.

Assembly Bill 979 defines individuals from “underrepresented communities” in terms of race, ethnicity, gender identity or orientation, and Indigenous status. Across the country, many of these groups are underrepresented in high-level corporate leadership; in 2018, only 15 percent of directors at Fortune 500 companies identified as African American, Black, Hispanic, Latino, Asian, or Pacific Islander.

Assembly Bill 979 builds on the framework of another diversity law, Senate Bill 826. Passed in California in 2018, Senate Bill 826 required public companies headquartered in state to have at least one woman on their boards by 2019, and also mandated future increases depending on board size. Penalties for violating Assembly Bill 979 and Senate Bill 826 are also similar: fines that span into six figures.

The effectiveness of Senate Bill 826 may have inspired legislators to model Assembly Bill 979 after its design. In 2018, 180 of the 650 public companies in California had zero women on their boards; after the passage of the law, that number shrank to just 15 as of October 2020. This propelled the total number of women on California corporate boards upward by 66.5 percent, although gender equity still remains a distant goal.

Despite having a role model in Senate Bill 826, Assembly Bill 979 may be hampered by new compliance complexities. For example, the law refrains from clarifying whether the same individual can satisfy both female and underrepresented community member director requirements.

In addition, public companies are not currently required to disclose the racial, ethnic, or personal characteristics of directors—which clashes with the law’s data collection provisions and may complicate enforcement efforts. To use Senate Bill 826 as a reference point, in 2019 only about half of California public corporations filed reports indicating their compliance with the law; much of the data reflecting the law’s efficacy was gathered separately by a nonprofit group.

In addition to these difficulties in enforcement, Assembly Bill 979 is also vulnerable to legal challenges, similar to those raised against Senate Bill 826.

Both Assembly Bill 979 and Senate Bill 826 have been attacked in California state court. In 2019, a conservative organization challenged Senate Bill 826, claiming that the law’s gender mandate is an “unconstitutional quota” that violates the equal protection provisions of the state constitution. In June 2020, a state court overruled the California Secretary of State’s initial attempt to dismiss the lawsuit.

Conservatives’ success in court so far has inspired the same group to file a similar lawsuit against Assembly Bill 979, claiming that requiring companies to “appoint a specific number of directors based on race, ethnicity, sexual preference, and transgender status is immediately suspect and presumptively invalid” under the state constitution. The group argues that such mandates are affirmative action policies that require heightened scrutiny by the courts, and that “general societal discrimination” is not sufficient to justify the government’s use of quotas.

Analogous federal challenges to Assembly Bill 979 may also be looming. In 2019, another organization challenged Senate Bill 826 as unconstitutional under the Equal Protection Clause of the Fourteenth Amendment, arguing that the law “puts equal numbers above equal treatment” and that the state government has insulted women by “coercing businesses to hire them.” Although a federal district court dismissed the lawsuit, that dismissal is now pending on appeal. For now, it is anticipated that the law will be enforced at least until the end of 2021.

These legal challenges have come as no surprise to California legislators. When former California Governor Jerry Brown signed Senate Bill 826 into law in 2018, he acknowledged that there were “serious legal concerns” that “may prove fatal to its ultimate implementation.” The California Senate also discussed constitutional issues posed by Assembly Bill 979 when debating the legislation.

But as Governor Brown also noted, corporations have been protected as “corporate persons” with “special privileges” under U.S. Constitution for over a century—and if such “persons” can seek shelter under the Fourteenth Amendment, perhaps actual, diverse “persons” underrepresented on corporate boards should be protected as well.

Furthermore, groups that support corporate diversity laws report that more diverse boards result in “enhanced financial performance, stronger corporate governance, and increased innovation sustainability.” If a state or federal court finds that the positive results of increasing diverse representation constitute a compelling state interest, California only bears the burden of showing that both of its laws are necessary, and “narrowly tailored,” to achieve those ends.

Given the dearth of diversity on corporate boards up to this point, the California government may have a colorable argument that such laws are necessary—even if provisions of the bills cause legal concerns or invite constitutional objections. As the co-author of Senate Bill 826 has noted, “sometimes in order to change culture, you need to have legislation.”