Image by Hans Braxmeier from Pixabay

It’s no secret that the smaller a company’s market cap, the less likely it is to be concerned with governance “nice-to-haves,” such as independent board leadership, annual elections of directors, and board diversity.  Over the years, I’ve heard time and time again, “next year is the year when all these things will begin to trickle down to the smaller-cap companies.”  After a while, these assurances began to sound like the old line about quitting smoking – “I can quit whenever I want – after all, I’ve done it many times.”

Perhaps the great governance trickle-down has begun.  On December 1, 2020, Nasdaq announced that it had filed with the SEC a proposed change in its listing standards that “would require all companies listed on Nasdaq’s U.S. exchange to publicly disclose consistent, transparent diversity statistics regarding their board of directors [and] to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+.”  An “underrepresented minority” is “an individual who self-identifies in one or more of the following groups: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander or Two or More Races or Ethnicities.” If adopted, the proposal would be implemented based on a company’s listing tier and would eventually apply to the roughly 3,000 companies listed on Nasdaq.

The announcement emphasizes that the proposal is based on the  “comply or explain” model – in other words, a Nasdaq-listed company need not have the requisite degree of board diversity as long as it explains why not.  For example, companies that can’t meet the diversity standards within the required timeframe “will not be subject to delisting if they provide a public explanation of their reasons for not meeting the objectives.”  However, there’s no doubt that Nasdaq’s goal is diversity, not disclosure; the announcement is clear that “all companies will be expected to have one diverse director within two years” following SEC approval of the new listing standard.  And it’s worth remembering that “comply or explain” models usually lead to the former rather than the latter.  For example, public companies are not required to have at least one “audit committee financial expert” as long as they explain why not, but I’ve yet to hear of a public company that doesn’t have one.

Nasdaq’s announcement stresses the importance of board diversity, and its proposal cites various studies finding an “association” between board diversity and “better financial performance and corporate governance.”  And improved disclosure of directors’ gender, race, ethnicity or minority status doesn’t strike me as such a bad idea; for example, if a company doesn’t have photographs of its board nominees, how can investors know whether the board includes people of color?  Even gender can be hard to know, if there are no photos and a director’s name is gender-neutral.  However, not all interested parties agree.  For example, an editorial in The Wall Street Journal, citing Warren Buffett’s criteria for board members, concludes with the words “Nasdaq is nuts.”

Even before Nasdaq’s announcement, we heard that many companies are adding questions about self-identification to their annual director and officer questionnaires – although we were not aware of any companies asking about directors’ sexual orientation.  My hunch is that most companies won’t go there yet, but I hear a “drip-drip-drip” in the background.