The Nasdaq composite isn’t just the second-largest stock exchange in the world. It’s also a so-called self-regulatory organization that has been delegated regulatory authority by Congress and by the Securities and Exchange Commission. It imposes and enforces detailed rules on the companies it lists, but these rules must be approved by the SEC. The SEC must take this approval power seriously, as Nasdaq is now taking steps to abuse its authority over listed companies.
Invoking the imperatives of the “social justice movement” and the “benefits to stakeholders of increased diversity,” Nasdaq is seeking SEC approval to impose a corporate governance rule that would require all listed companies to appoint directors based on sex. Many of these companies would also have to appoint directors on the basis of race, ethnicity, or sexual preference.
Specifically, Nasdaq is proposing to require each of its listed companies, subject to certain exceptions, to provide statistical information regarding diversity among the members of its board and either to have or to explain why it does not have at least two “diverse” directors on its board. “Diverse” would mean a director who self-identifies as female, an underrepresented minority, or gay or transgender. Nasdaq defines an underrepresented minority as black, Hispanic or Latinx, Asian, Native American, Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities.
The SEC must refuse to approve this rule, which is both immoral and bad economic policy. Moreover, Congress should act to prevent so-called self-regulatory organizations such as Nasdaq from imposing rules that impose racial, ethnic, or sexual quotas on membership.
The proposed rule is racist and sexist in that it mandates that firms establish quotas based on sex, skin color, ethnicity, or sexual preference rather than making determinations based on individual talent, experience, or competence. It defines diversity entirely in terms of these immutable characteristics instead of the myriad of other kinds of diversity such as a director’s expertise, experience, approach to business or business philosophy, educational background, socioeconomic background, ethical views, political views, integrity, geographic location, and so on.
Morally, it represents a marked step backward. It is a rejection of the principle that people should be judged on the content of their character and their individual achievement rather than their sex, race, national origin, ethnicity, or sexual preference. It is a rejection of the principle of equal protection under the law (or, in this case, regulations promulgated under law). Legal discrimination or quotas on the basis of race or sex should be a relic of the past.
The type of diversity created by the rule will be faux diversity — skin deep, if you will. It is a rejection of the kind of diversity that is most likely to enable a business to understand the true diversity of the nation and actually be relevant to business profitability. There is also strong reason to believe that those chosen under such a rule but who “self-identify” as women, a designated minority, or gay or transgender will have been educated in the same handful of schools and come from the same coastal urban centers as most existing directors.
The Nasdaq proposal represents a forthright rejection of shareholders in favor of “stakeholders.” Traditionally, the purpose of businesses has been to earn a return for its owners by cost-effectively satisfying consumer wants and needs. Operating in a competitive environment, a firm’s officers and directors achieve these goals by skillfully combining the capital of shareholders and the labor and talent of its employees. If they are unsuccessful, they will be replaced.
Stakeholder theory is an attempt to redefine the purpose of business by making management “accountable” not to shareholders but instead to an amorphous, ever-shifting collection of stakeholders and to regulators who define the contours of this new purpose.
A lack of management accountability to shareholders in large corporations is already a large problem. This is known as the agent-principal problem. Introducing a large array of mandatory diversity, environmental, social justice, foreign policy, community support, employment, and other nonfinancial goals to corporate objectives will make management even less accountable to anyone. The metrics for management success or failure will become intractable.
Nasdaq’s proposed rule, and the likely additional social justice requirements soon to follow, would also reduce shareholder returns, including to millions who hold shares in their retirement accounts or whose pensions are funded by returns on equity investments. Unless the shareholders have voted to instruct management to pursue these nonfinancial goals, such requirements are illegitimate. Systematic pursuit of social justice objectives rather than profitability will make businesses a poor steward of scarce resources, reduce their competitiveness and productivity, reduce wages, and cost jobs.
Nasdaq selectively cites the economic literature in support of its position. It claims that its diversity requirement will be good for business profitability. But if that is so, then the rule is not necessary. Boards will adopt such policies to increase returns, and if they do not, shareholders would demand that they do so.
The fact that Nasdaq’s social justice advocates feel compelled to mandate these requirements belies this argument. In fact, the literature and experience abroad are much more ambiguous. Many studies show “socially responsible” investing to have little or negative effects on returns. Diversity other than racial, ethnic, and sexual diversity is of equal or greater importance.
Traditionally, corporate governance is a function of state law and private decision-making. The Nasdaq rule is one more large step toward the federalization of corporate governance. Jurisdictional competition and freedom of action by private actors are much more likely to lead to desirable outcomes than one-size-fits-all mandates by national regulators.
David R. Burton is a senior fellow in economic policy at the Heritage Foundation. Mike Gonzalez is Heritage’s Angeles T. Arredondo E Pluribus Unum senior fellow.
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