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DIVERSITY AND DIRECTORS AND OFFICERS LITIGATION

Published

2020

Wed

02

Dec

 

Diversity awareness is more important than ever before for senior management in all companies, as more and more investors, activists and shareholders, not to mention regulators, begin taking it more seriously. Those companies who put the correct emphasis on it can reap a number of different benefits. But, for those who don’t, a flurry of recent lawsuits should raise concerns that directors and officers might be impacted.

Diversity should be at the top of the agenda of all organizations, for ethical reasons, as well as for the financial benefits. Not only is it a metric to strive towards, but it is part of a successful revenue-generating business.

Companies putting emphasis on diversity are more likely to outperform their peers in terms of profitability, are more attractive to skilled talent and improve customer orientation. A lack of diversity is negatively perceived by investors, activists and shareholders and is also highly relevant to directors and officers (D&O) litigation. Changes in diversity legislation create additional pressure on companies to address the composition of their board and management team.

 

FINANCIAL PERFORMANCE

Diversity is directly correlated with better financial performance. A 2019 study by McKinsey & Company confirms that companies in the top quartile for gender, ethnic and cultural diversity on their executive team are 25% more likely to have above-average profitability of outperformance on the earnings before interest and taxes (EBIT) margin than companies in the fourth quartile.

What is more, the greater the representation, the higher the likelihood of outperformance. The study also analyzes how companies navigated the Covid-19 pandemic, concluding that diverse and inclusive companies are likely to leverage those factors to more quickly recover.

TALENT MANAGEMENT

Diversity has an advantage in talent recruitment. Dynamics in leadership can help a company to secure more sources of talent and subsequently have the upper hand in competitive recruitment, improving its global relevance. It is widely recognized that the pool of skilled experts and leaders has not kept pace with demand, hence increasing competition for talent in emerging markets.

Diversity management means that it addresses talent shortages – giving an advantage in competing for the best talent. As they are usually underrepresented, the diversity groups are often good sources of desirable talent.

A 2017 Gallup poll found that only 13% of employees are actively engaged at work, and that the management behavior most likely to affect active engagement was to “demonstrate strong commitment to diversity”. Multiple surveys have indicated that diversity is important to Generation Y (the millennials), the current working generation.

 

CUSTOMER ORIENTATION

By committing to diversity within management boards, companies can align their own organizations more closely with a wider customer base. In other words, diversity gives improved customer orientation. This enables companies to form a tighter bond with customers of different backgrounds, specifically relating to customers by defining a clearer customer perspective and reaching key purchasing decision-makers.

Corporations with diverse leaders holding a customer-centric perspective can adapt to market development more creatively by reacting more effectively to market shifts and customer needs. Many industries are now looking at the management board from the perspective that it is crucial for a company’s employees to reflect the people they serve.

Diverse management boards whose composition more closely mirrors the demographics of the general population also can more effectively reach key decsion-makers among their clients and customers. For example, in the UK, 80% of purchasing decisions are made by women. According to McKinsey, by 2025 women are estimated to own 60% of all personal wealth and control ₤400mn ($510mn) more per week in expenditures than their male counterparts.

DECISION-MAKING AND INNOVATION

Managers working on tough problems often assemble a diverse team in order to challenge one another and improve the quality of their deliverables. With a diverse input of opinions, multiple objections and alternatives can be explored in order to solve problems more efficiently and be adopted with greater confidence. Research has shown that the presence of women and minority members on a leadership team enhances the problem-solving capability as they each contribute perspectives from their different background and experiences. Ethnic- and gender-diverse leaders provide companies with a different set of problem-solving tools, broader thinking and better solutions.

DIVERSITY-RELATED LAWSUITS

In the wake of ‘Black Lives Matter’ protests over racial inequality, companies including Oracle, Facebook, Qualcomm, Norton LifeLock, Gap and Danaher have been hit by racial board diversity-related lawsuits.

Essentially, the complaints in each of these lawsuits are very similar. In each case, shareholders, acting derivatively on behalf of the subject company, allege that the company's board of directors violated their fiduciary duties by their inaction on diversity issues, abuse of control, unjust enrichment and also violation of Section 14(a) of the Securities Exchange Act of 1934 in the US, which outlines requirements that the company govern disclosures during proxy contests, when various parties might solicit an investor's vote on a corporate action or for certain board members.

Some of the complaints seek a number of actions by the respective defendant companies by way of relief. These vary broadly but are related to the return of board members’ remuneration, nomination of new black board directors, creation of a company fund to hire blacks and other minorities or the aim to tie executive compensation to diversity-related goals.

While it might be too early to talk about a D&O claim trend, the frequency of diversity lawsuits brought since the beginning of July 2020 should raise the concern that any company lacking racial, gender and age diversity in its board of directors might be impacted by similar lawsuits. This applies also to companies headquartered in other countries, particularly those listed in US.

A recent study shows that the US is the country with the lowest percentage of foreign board members (8%). However, in terms of percentage of women on the board, the US, at 26%, is actually more advanced than other countries, such as The Netherlands (22%) or Brazil (11%).

The increased public attention to the topic of diversity is impacting companies’ internal managerial practices and recent D&O claims should intensify the momentum. The awareness of how the lack of diversity may impact the image and reputation of the company is increasing substantially.

”Businesses are increasingly globally interconnected and this trend is not going to reverse itself,” says Claire-Marie Coste-Lepoutre, CFO of AGCS. “For AGCS, as we are starting our transformation journey into the ‘New AGCS,’ it is tremendously important to actively promote and take advantage of the variety of perspectives, minds and skills that a diverse employee base and management board can only bring.

“We have recently rejuvenated some of our collective steps on diversity and inclusion, with a particular focus on anti-racism, and I’m a strong believer that our collective engagement will create a stronger and better place for all of us to thrive and belong.“

 

IMPACTS OF DIVERSITY NEGLECT ON D&O

Which impact can be expected in the D&O market following the recent lawsuits related to the lack of board diversity? While the ultimate financial impact of these D&O lawsuits remains to be seen, there will be substantial legal defense costs involved in their settlement. This growing D&O liability threat may further drive the increase in frequency and severity of US securities class actions noted over recent years. This risk is further girded by the US Securities and Exchange Commission (SEC) disclosure requirements obligating companies to be more transparent concerning diversity.

One other expected impact on the D&O market is the type of information underwriters will be looking for and questions that can be expected at customer/carrier meetings. D&O underwriters will increasingly be interested to understand how important diversity, equity and inclusion are to the management team and how this is reflected in key related key performance indicators.

Does a Chief Diversity Office (CDO) role or a Diversity Council exist in the organization? How these key values are lived across the company and reflected in key processes such as training and recruiting, is also a key component of inclusion. At any rate, underwriters will want to know whether the organization has a CDO or Diversity Council and, if so, the scope of authority and responsibility for such role or office.

D&O litigation risk will also increase with potential changes in regulation and legislation on diversity. For example, in the US, the State of California recently passed a bill which, once signed, will require any publicly-traded company in the state to have at least one director from “an underrepresented community” by the end of 2021. Other federal states such as Illinois or New York may adopt similar board diversity legislation. Also in Europe, the European Commission (EC) is proposing in its European 2020 strategy a gender diversity requirement for country governance codes.

Racial, age and gender diversity should be on the top of the agenda of all organizations driven by the resulting beneficial impacts as illustrated through topical literature. How the lack of diversity is perceived by investors, activists and shareholders, the threat of D&O litigation and changes in diversity legislation create additional pressure on companies to address the composition of their board and management team as early as possible.

OUR EXPERTS

 

Claire-Marie Coste Lepoutre

Joana Moniz Vergho

 

 
Source: Allianz Global Corporate & Specialty (AGCS) Africa
 
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