Shining a light on boardroom diversity: Lessons from comply-or-explain regulations

Recognizing the predominance of men in boardrooms, regulators worldwide are increasingly working to address this gender disparity. In Europe, several governments have responded by enforcing diversity quotas due to inadequacies in firms’ self-regulation. While quotas offer advantages in terms of clarity of implementation, measurement, and monitoring, some decision-makers argue that they disrupt the functioning of the market system. Consequently, comply-or-explain policies have gained popularity as an alternative to quotas across the globe. This regulatory approach requires organizations to either adhere to specific guidelines (“comply”) or provide a rationale for taking an alternative course of action (“explain”).

Unlike “hard law” quotas, comply-or-explain policies operate as a “soft law,” aiming to bolster organizational transparency and accountability to its stakeholders in the hope that this will guide corporate action. While recent data suggest that comply-or-explain policies are associated with increases in diversity in boardrooms, implementation remains problematic. Aaron A. Dhir, Sarah Kaplan (founding director of GATE), and Maria Arabella Robles set out to analyze the experience of comply-or-explain regulations around the world along with a deep dive into the Ontario Security Commissions implementation of this approach for women on boards in Canada starting in 2015. In doing so, they showed why firms’ explanations in the disclosure statements indicate a missed opportunity for real change. The regulator’s justification for taking a comply-or-explain approach in Canada rather than setting quotas was that it would “shine a light on things, and things will change,” Kaplan explained. The research question was whether this approach has had the intended impact.

Comply-or-explain policies have legal precedents in Australia, Canada, Hong Kong, Singapore, South Africa, Thailand, the United Kingdom, and numerous European Union countries. Studies examining these legal precedents all reach a similar conclusion: that firms do comply—the compliance rate may be as much as 50%—but they tend to only take the actions that are the lowest cost to implement. However, nearly half of the firms still choose not to comply.

The researchers’ primary observation was that results fall short of the intentions behind the regulations. Canada is no exception. “When we compiled the statistics for Canada and compared them to similar countries, I was surprised by how significantly Canada lags behind in board diversity,” Kaplan stated. Canada falls far behind nations that have adopted quotas and is even behind other peer countries that have not.

Canada falls far behind nations that have adopted quotas [for boards] and is even behind other peer countries that have not.

To gain deeper insights into why the intended outcomes of the regulation were not achieved in Canada, the researchers collected and analyzed all disclosure statements released by approximately 750 firms subject to the comply-or-explain regulation from 2015 to 2018. This regulation asked firms to disclose the number and percent of women on the board along with information on their diversity practices, including whether they had set targets, whether they had a written diversity policy, whether they considered gender representation when appointing new board members and if they had a board renewal practice such as term limits. Their analysis of the texts of the disclosures found that firms often did not provide sincere or satisfactory explanations for why they did not comply with the regulations. Furthermore, the actions they reported to have taken were often vague. Firms would, for example, state that they would consider diverse candidates for an open board seat but shied away from setting a target for the number of women on the board. Explanations also frequently relied on tired or inaccurate statements related to meritocracy and “pipeline” limitations as excuses for not increasing diversity.

“I was not necessarily surprised by these findings,” Kaplan comments. “But I was surprised by how little regulators tried to learn from other jurisdictions to improve their comply-or-explain implementation. Because the devil is always in the details, and our research shows that the details are crucial for comply-or-explain policies.”

For regulators aiming to implement or revise comply-or-explain policies, Kaplan recommends focusing on transparency and the cost of action. First, transparency is critical. As she puts it, “If you are going to go through the effort of putting in a comply-or-explain regulation – which really is based on disclosure and transparency – then truly make it transparent.” What does that mean? According to Kaplan, regulators should “avoid allowing firms to bury the disclosure within complex documents like the Information Circular or the 10-K. Instead, they should create a separate web form that firms could fill out and that is publicly accessible for search. Anyone should be able to search for a specific company, or all companies in a particular sector, and compare them easily. Again, make it genuinely transparent to facilitate the work of stakeholders and reporters and, of course, to enable businesses to benchmark against their peers.”

She notes that Canada already has some precedents for such a database: the Sunshine List. In Ontario, the Sunshine List discloses salary information for all public sector employees earning CAD 100,000 or more, as governed by the Public Sector Salary Disclosure Act, and users can access it through an interactive tool or downloadable file.[1] Similarly, the Canadian Federal government’s Equi’Vision employment equity tool allows any user to look at company wage and employment gaps at different levels of the organization for women, people with disabilities, Indigenous people, and members of visible minorities.[2]

“Anyone should be able to search for a specific company, or all companies in a particular sector, and compare them easily…make it genuinely transparent to facilitate the work of stakeholders and reporters and, of course, to enable businesses to benchmark against their peers.”

Secondly, the researchers observed that firms tended to avoid more costly actions. Amongst firms subject to the comply-or-explain regulation, a substantial proportion of firms were willing to formulate a diversity policy (60%) or affirm that they consider gender diversity in board nominations (74%). However, firms showed more reluctance to take actions they could be held accountable for, such as establishing specific diversity targets (32%) or appointing women to their boards (only 35% of boardroom seats were filled with women in 2021). The results varied across sectors, firm sizes, and approach to the comply-or-explain regulation: companies in biotechnology, technology, and mining, as well as smaller firms, were less likely to have women on their boards. Federally regulated companies such as banks were more likely to have adequate gender representation. Boards of firms with disclosed diversity targets had, on average, 28% women on their boards, compared to an average of 18% at firms that did not.

Comply-or-explain approaches present considerable potential as a soft-touch approach for enhancing gender diversity on boards that aligns with the market system. However, the mixed results from the Canadian experience signal room for improvement. Regulators can benefit from insights gleaned from past shortcomings and adopt a more intentional approach in future actions. The researchers suggest that meaningful explanations, standardized data accessibility for stakeholders, and targeted support for firms—especially smaller ones—in setting and achieving internal diversity targets are crucial features to consider. Importantly, there is still much to be learned. Kaplan emphasizes that their effort to place comply-or-explain within a broader context represents just a preliminary step. How this policy’s “explain” component improves organizational diversity is still unclear. And we have yet to learn whether groups other than women can benefit from the comply-or-explain policy.

References

[1] Government of Ontario (2023, March 24). Public sector salary disclosure 2022: All sectors and seconded employees. Ontario.ca. Retrieved January 30, 2024, from https://www.ontario.ca/public-sector-salary-disclosure/2022/all-sectors-and-seconded-employees/

[2] https://equivision.services.gc.ca/?GoCTemplateCulture=en-CA

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Research brief prepared by:

Manuela R. Collis