In 2020, the Nasdaq stock market filed a proposal with the U.S. Securities and Exchange Commission seeking permission to adopt a board diversity-related disclosure requirement for its listed companies. In 2021, the SEC approved the proposal, making Nasdaq the most significant stock exchange to date to mandate listing rules that reflect the intention of diversifying corporate boardrooms.
Nasdaq’s support for diversity is not the first attempt to address homogeneous boards in the U.S. In 2009, the SEC adopted a rule requiring publicly traded firms to report whether they consider diversity in identifying director nominees. More recently, California mandated diversity quotas. Between these two approaches – the light touch of the SEC’s “pure disclosure” and the heavy hand of California’s quota – Nasdaq’s new listing rule reflects a principles-based philosophy that is implemented through a “comply-or-explain” formulation. It requires listed companies to state whether they adhere to a particular standard of behavior (“comply”) and, if not, they must provide reasons for their lack of compliance (“explain”).
Despite its increasing popularity, little is known about how comply-or-explain regimes work in practice. In a new article, we attempt to fill that gap and to inform policy conversations by providing lessons from the initial years of another jurisdiction’s experiment with this approach. Comply-or-explain disclosure requirements for gender diversity on corporate boards have existed in Canada since 2014. We discuss the initial findings from our on-going project to analyze the effects of Canada’s regulation. Our qualitative content analysis of the texts of Canadian corporate disclosures involves a four-year period and entails over 3,000 firm-year observations. With a focus on firms’ explanations for non-compliance, our results suggest that firms avoid the costliest actions, that they rely on obfuscation and other approaches to make it difficult for evaluators to interpret the disclosures, and that they offer thin, weak, or otherwise suboptimal explanations for failure to make progress that draw on tired tropes about meritocracy and pipeline limitations.
At a time when international regulators and private actors are contemplating, developing, and refining ways to diversify corporate governance, comply-or-explain holds great promise. While quotas are certainly a more robust and effective form of regulatory change, it is also the case that quotas present various challenges, including political and legal viability. And while comply-or-explain rules, unlike quotas, will not ensure that specific representation levels are achieved within specific timeframes, these rules afford corporations, regulators, and stock exchanges like Nasdaq the benefit of flexibility and the possibility of deep institutional learning.
That said, we show that comply-or-explain’s effectiveness can be compromised when firms, for example, provide weak explanations for non-compliance and, as a result, miss opportunities to learn from their shortcomings. While comply-or-explain’s flexibility allows firms to tailor their approaches in ways that more formal approaches would not, balance is key. Without effective oversight, comply-or-explain risks giving firms too much discretion to define what it means to comply, and compliance, while following the letter of the law, may be merely performative.
We recommend that oversight entities like Nasdaq – either individually or in partnership with other organizations – —should: 1) monitor and review corporate disclosures; (2) provide nonbinding guidance to issuers on how to improve their reporting; (3) educate and advise issuers so they can better understand the topic at issue; (4) verify that disclosures conform with corporate practices; and (5) design disclosure to make it more accessible to stakeholders.
Steps such as these will help shape the norms for comply-or-explain diversity disclosure rules and to foster diversity in corporate leadership.
This post comes to us from professors Aaron A. Dhir at the University of Connecticut School of Law and Sarah Kaplan, at the University of Toronto’s Rotman School of Management, and Maria Arabella Robles at the law firm of Sotos LLP. It is based on their recent article, “Corporate Governance and Gender Equality: A Study of Comply-or-Explain Disclosure Regulation,” published in the Seattle University Law Review and available here.