The Promise of Diversity, Inclusion, and Punishment in Corporate Governance

Abstract

Governance inclusion mandates require that a corporate board include diverse individuals (such as members of under-represented communities under California’s AB 979) or representatives of a constituency (such as employees under Senator Warren’s Accountable Capitalism Act), and are largely intended to change corporate behavior in a more pro-social direction. This article applies the economic insights of the Coase theorem to determine when and if such inclusion mandates will result in desirable changes to corporate activities. The main promise of inclusion mandates is that they allow the corporation to make its own decisions, based on private information, rather than depend on ex post liability or command-and-control regulation to enforce optimal corporate behavior. The boardroom is a “Coasian bubble” in which the abilities to bargain and contract are greatly enhanced; inclusion of interests in the boardroom allows those interests to be taken into account. Inclusion also results in some transfer of corporate surplus from shareholders to the newly included. This implies that corporate behavior may not change, since all those represented in the boardroom have incentives to maximize corporate surplus. Exceptions are where inclusion enables efficient contracting that was otherwise infeasible, or if the included group has significant interests that are subject to corporate externalities. The latter channel is most likely to result in more pro-social corporate behavior, since such interests represent significant “skin in the game” for avoiding corporate malfeasance. Skin in the game can also be manufactured through ex post liability, such as by making a represented constituency liable for corporate failures or misbehavior; further, such liability may be necessary so that incentives are not degraded where the constituency receives benefits that are not in the nature of residual claims. Viewed through this lens, constituency mandates, in which directors are accountable to groups with significant interests, show some promise for promoting socially beneficial corporate behavior; diversity mandates, in which diverse but atomistic directors generally lack such accountability (at least as proposed), are unlikely to effect such change.