Ethical Boardroom: Boardroom diversity critical for institutional investors

Published By Ethical Boardroom and authored by Raj Tulsiani – Chief Executive Officer and Co-founder, Green Park

We operate in a time when boardroom practices are increasingly scrutinised and impact customer satisfaction, as well as trust in company performance. The recent tribulations faced by the likes of taxi firm Uber represent a paradigm shift that will be repeated across the corporate world.

We live in an age of the potential activist – be it an investor trying to shape the board, such as at the London Stock Exchange, or activist consumers reacting to the views of the board, as with John Schnatter at Papa John’s. The composition and behaviour of company boards is under focus and it’s a trend that is only set to increase as investors, customers and employees demand greater accountability.

The transparency movement is also underpinned by increasing regulatory scrutiny. The UK government’s Race Disparity Audit highlighted differences in the treatment of people from different ethnicities across the country’s public services, while the government-commissioned Hampton-Alexander Review looked at ways to ensure that talented women at the top of businesses are recognised, promoted and rewarded equally. Even the Financial Reporting Council has included diversity as part of its view on good governance.

The government is now seriously examining how to increase Hampton-Alexander’s remit to the number of women in senior positions in all FTSE 350 companies. A boardroom that is male, stale and pale will simply create difficult brand risks in the future.

How diversity is perceived

Against this backdrop, Green Park commissioned research examining institutional investors’ perceptions of boardroom diversity. It revealed that investors believe that by 2022 the ethnic composition of company boards will be an important consideration when determining investment strategy, while more than half (56 per cent) believe the diversity of company boards will be a key factor in determining an investment case.

Although we can identify cultures and factors driving change and reinforcing the need for diversity of board composition, many firms remain intransigent. Despite working with companies for more than 20 years to improve the way businesses think about talent and diversity, I still regularly see this problem and wonder sometimes if we are dealing with organisations that have ‘group-think’ so deeply engrained in their culture that they will never allow successful or sustainable change in the composition of their leadership, regardless of how customers change.

It was exciting to see our research reveal investment professionals are anticipating a significant shift in the position of the industry. However, when only six per cent of the researched investors thought that ethnic diversity is currently a major consideration, this is obviously not seen as an important, immediate issue – and that’s not good enough. Almost four in 10 institutional investors felt boards do not fully appreciate or understand the financial value of having a diverse board and therefore change is not being instituted now. Regressive companies with mono-cultural leadership approaches are not representative of their employees, business partners or customers and act as a barrier to future inclusion. But why would investors ignore the opportunity for advancement?

Unlike initiatives designed to move towards gender parity, those in control of increasing ethnic diversity cannot simply turn the dial up to tackle the perceived issue. Instead, a new equation needs to be formed whereby people understand both supply and demand. Boards will need to look outside the internal talent pipeline and beyond their current parameters if this is to be delivered, as the pipelines just aren’t as developed after years of failing to tackle the issue. This is largely due to a decade of being a net importer of BME (black and minority ethnic) board talent to the UK.

Sluggish approach

The lack of urgency for the investment industry to value diversity is further reinforced by our findings that show one in five investment managers believes their own company board lacks diversity. If the industry is not addressing the challenge internally, the wider approach required to properly solve the issue is perhaps a long way off.

Green Park undertook further research to understand what would have the biggest impact on diversity. Of course, we all have our own opinions on this, but inside, unique industry insight is always the most efficient way for combatting intransigence and identifying barriers to change and developing meaningful co-created interventions to counter them.

Proactive lobbying (36 per cent) was perceived to be the most likely way forward to change opinions of the board, followed by direct action using the threat of reduced, or complete removal of, investment accounting for a quarter (25 per cent) of responses. A further 13 per cent believed that voting against remuneration reports is a strategy that would affect business change.

Our research shows a need for greater education among sections of the investment management community when it comes to existing global benefits realised through diversity. Only half (52 per cent) thought a diverse board helps people understand the requirements of a diverse customer base, while only 39 per cent believe they are better placed to understand the changing requirements of an international customer base.

Despite results that explicitly show companies in the top quartile for racial, gender and ethnic diversity are 35 per cent more likely to have financial returns above their respective national industry medians, a quarter (25 per cent) of institutional investors did not necessarily think that boards need to be more diverse – and almost a third (30 per cent) believe that an ethnically diverse board has no bearing on a firm’s commercial success. So, while these investors know boardroom diversity will be a key future consideration, they don’t appear to fully understand why themselves.

Stepping outside the boundaries of the investment industry, last year’s Hampton-Alexander Review, which established a target of 33 per cent women on FTSE 100 boards by 2020, found that the number of women sitting on the boards of the country’s largest companies has more than doubled since 2011. However, this adds up to only 28 per cent of all board positions; for the 33 per cent target to be met within the deadline set out by the report, 40 per cent of all senior appointments made in FTSE 350 companies will have to be filled by women for the next three years. While, at first, this sounds achievable it must be put in context: according to the annual Green Park Leadership 10,000 study, statistically, female representation went backwards in more than half of industries in 2016.

In addition, the report, looking at the diversity backgrounds of those in leadership positions within FTSE 100 companies, revealed that, despite a net average increase in diversity since the previous report, there is still a ‘concrete ceiling’ stopping many talented minority candidates reaching the upper echelons of management.

It also found that gender diversity is moving backwards at the pipeline level beneath the board in some sectors – worryingly, previous progress and momentum seems to be reversing.

Time to take action

Of course, the issue of boardroom diversity is not just limited to the institutional investment industry – we all need to pull together and turn future intentions into immediate action. Diversity is only one method of making businesses sustainable and ensuring they have the relevance needed to survive, but it is one that can be leveraged right now by all. The UK has a fantastic opportunity to open itself to the world post-Brexit, but our claims to be outward-looking and open to expanded trade with the non-European world are hardly enhanced by closing our own pathways to talent.

Committing to increasing board diversity is a choice, but it is a choice all business leaders should be considering, if for nothing other than self-interest. How quickly will diversity impact future decisions on funding, debt facilities, analyst ratings and board performance?

Investors are obviously coming around to the importance of diversity and those that have future-proofed against governance or brand backlash may avoid the potentially damaging impact of activist investors and marginalised customers alike. The firms likely to thrive are the ones that are ahead of the diversity curve, not lagging behind it.

This article was published by Ethical Boardroom in February 2018. For the full Ethical Boardroom article, please click here.