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Comply or explain in corporate governance codes: in need of greater regulatory oversight?

  • Andrew Keay (a1)

Abstract

At the heart of the voluntary corporate governance code in the UK and elsewhere is the concept of ‘comply or explain’. It provides that a company is to comply with a code's provision; but if it does not do so, then it is to state that it does not and explain why it does not. There is no provision in the UK for any statements by companies to be assessed by any regulatory body. It is incumbent on the markets generally and the company's shareholders specifically to determine whether the response of the company to code provisions does enough, and then to take some action if they do not. The aim of comply or explain is to empower shareholders to make an informed evaluation as to whether non-compliance is justified, given the company's circumstances. This paper assesses whether the present scheme, which relies on the stewardship of shareholders and the efficiency of the markets, should continue, or whether a regulatory body should be empowered to determine whether companies are in fact complying with code provisions or, if not, whether they are providing adequate explanations for not complying.

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Corresponding author

Andrew Keay, School of Law, University of Leeds, Leeds LS2 9JT, UK. Email: a.r.keay@leeds.ac.uk

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*

Professor of Corporate and Commercial Law, Centre of Business Law and Practice, School of Law, University of Leeds and Barrister, Kings Chambers and 13 Old Square Chambers. A previous version of this paper was presented at the 4th Cambridge International Regulation and Governance Conference, held at Queen's College, University of Cambridge, on 6 September 2012. I am grateful to the Legal Studies reviewers and for their comments. All errors remain my responsibility.

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1. Karlsson-Vinkhuyzen, S and Vihma, AComparing the legitimacy and effectiveness of global hard and soft law: an analytical framework’ (2009) 3 Reg & Gov 400. ‘Soft law’ is defined by Francis Snyder as ‘rules of conduct which, in principle, have no legally binding force but which nevertheless may have practical effects’: Snyder, FSoft law and institutional practice in the European Community’, Law Working Paper 93/5 (Florence: European University Institute, 1993) at 2.

2. Weil, Gotshal and Manges, LLP International Comparison of Selected Corporate Governance Guidelines and Codes of Best Practice (New York, 2003).

3. Seidl, DStandard setting and following in corporate governance: an observation-theoretical study of the effectiveness of governance codes’ (2007) 14 Org'n Stud 705 at 708; Aguilera, R and Cuervo-Cazurra, ACodes of good governance’ (2009) 17 Corp Gov Int'l Rev 376.

4. 1 December 1992; Gee, under the chairmanship of Sir Adrian Cadbury (and known as ‘the Cadbury Report’).

5. Coombes, P and Wong, SWhy codes of corporate governance work’ (2004) 2 McKinsey Q 48.

6. S Arcot and V Bruno ‘One size does not fit all, after all: evidence from corporate governance’ (15 January 2007), available at http://ssrn.com/abstract=887947 (accessed 20 February 2012).

7. Ibid.

8. It must be noted that there have been some interesting developments in other EU Member States. Some of these are discussed later in the paper.

9. For a broad discussion, see above 7 Moore, M ‘“Whispering sweet nothings”: the limitations of informal conformance in Uk corporate governance’ (2009) 9 J Corp Law Stud 95 at 101.

10. Arcot, S, Bruno, V and Faure-Grimaud, ACorporate governance in the Uk: is the comply or explain approach working?’ (2010) 30 Int'l Rev Law Econ 193; an earlier version of the paper (July 2009) is available at http://ssrn.com/abstract=1532290 (accessed 9 March 2012).

11. Financial Reporting Council (FRC) Uk Corporate Governance Code (September 2012) at 4; available at http://www.frc.org.uk/getattachment/a7f0aa3a-57dd-4341-b3e8-ffa99899e154/UK-Corporate-Governance-Code-September-2012.aspx (accessed 28 January 2013).

12. Ibid, at 4.

13. The Cadbury Report has been regarded as ‘the cornerstone of the comply-or-explain framework in Europe, long before this system was introduced in European law’: EU ‘Study on monitoring and enforcement practices in corporate governance in the Member States’ conducted by RiskMetrics Group for the EU (23 September 2009) at 22, available at http://ec.europa.eu/internal_market/company/docs/ecgforum/studies/comply-or-explain-090923_en.pdf (accessed 27 April 2012).

14. See eg Company Law Review Modern Company Law for a Competitive Economy: Completing the Structure (London: DTI, 2000) para 12.50; Company Law Review Modern Company Law for a Competitive Economy: Final Report (HMSO, London, 2001) para 3.49.

15. EU, above 14, at 11.

16. The Directive has been implemented by the vast majority of Member States.

17. Statement of the European Corporate Governance Forum on the comply-or-explain principle (22 February 2006) para 1, available at http://ec.europa.eu/internal_market/company/docs/ecgforum/ecgf-comply-explain_en.pdf (accessed 19 June 2012).

18. Above 16, pp 12, 167.

19. See eg European Company Law Experts’ Response to the European Commission's Green Paper ‘The EU Corporate Governance Framework’ (22 July 2011) p 22, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1912548 (accessed 12 September 2012).

20. FRC Uk Stewardship Code (July 2010), available at http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf (accessed 16 April 2012).

21. Cadbury Report para 8 under ‘Preface’ at 3.

22. FRC, above 12, para 8.

23. Easterbrook, F and Fischel, D The Economic Structure of Corporate Law (Cambridge, MA: Harvard University Press, 1996); A Anand ‘Voluntary vs mandatory corporate governance: towards an optimal regulatory framework’ (2005) at 10, available at http://law.bepress.com/15th/baszaar/art44 (accessed 12 September 2012);

24. Gregory, H and Simmelkjaer, R IiComparative study of corporate governance codes relevant to the European Union and its Member States’, Final Report (Brussels: European Union – Internal Market Directorate General, Weil, Gotshal and Manges LLP, 2002) at 6869, available at http://ec.europa.eu/internal_market/company/docs/corpgov/corp-gov-codes-rpt-part1_en.pdf (accessed 8 March 2012).

25. SeidlD, SandersonP and RobertsJ ‘Applying the ‘comply-or-explain principle’: discursive legitimacy tactics with regard to codes of corporate governance’, paper presented at the 4th Cambridge International Regulation and Governance Conference, Queen's College, Cambridge, 6 September 2012. Any reduction in the share price of a company is known as an ‘illegitimacy discount’: Zuckerman E. ‘The categorical imperative: securities analysts and the illegitimacy discount’ (1999) 104 Am J Sociol 1398).

26. SeidlD and SandersonP ‘Comply or explain: the flexibility of corporate governance codes in theory and in practice’ (12 September 2007), available at http://www.cbr.cam.ac.uk/pdf/Seidl_Sanderson_Paper.pdf (accessed 5 March 2012).

27. Mallin, CCorporate governance and the bottom line’ (2001) 9(2) Corp Gov Int'l Rev 77.

28. Hooghiemstra, R and Ees, HUniformity as response to soft law: evidence from compliance and non-compliance with the Dutch corporate governance code’ (2011) 5 Reg & Gov 480 at 483.

29. SandersonP etal ‘Flexible or not? the comply-or-explain principle in Uk and German corporate governance’ Working Paper 407, Centre for Business Research, University of Cambridge (June 2010), available at www.cbr.cam.ac.uk/pdf/wp407.pdf (accessed 22 June 2012).

30. ThorntonGrant ‘A challenging climate’ at 6, available at http://www.grant-thornton.co.uk/pdf/corporate_governance.pdf (accessed 21 June 2012).

31. Seidl etal, above 24. Interestingly, the study found that only 15% of the 130 largest German companies were fully compliant with the German code (Cromme Code).

32. Above 29, p 491.

33. The Swedish approach is somewhat of an exception, as it provides that if a company does not comply, then it must explain the reasons for not doing so, and describe the solution that has been adopted instead (‘Response to the European Commission Green Paper on the EU Corporate Governance Framework’ (2011) at 6, available at http://www.frc.org.uk/images/uploaded/documents/FRC%20response%20to%20the%20Green%20Paper%20on%20the%20EU%20corporate%20governance%20framework%20July%202011.pdf (accessed 15 March 2012).

34. MacNeil, I and Li, X ‘“Comply or explain”: market discipline and non-compliance with the Combined Code’ (2006) 14 Corp Gov Int'l Rev 486 at 488; an earlier version is available at http://ssrn.com/abstract=726664 (accessed 5 March 2012).

35. Seidl etal, above 24.

36. Rule 12.43A.

37. ArmourJ ‘Enforcement strategies in Uk corporate governance: a roadmap and empirical assessment’ (April 2008), available at http://ssrn.com/abstract=1133542 (accessed 21 June 2012) at 1; above 16, p 66. This accords with the views expressed by the then Chief Executive of the FSA, SandsH ‘The crisis: the role of investors’, NAPF Conference 2009 (11 March 2009), available at http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/0311_hs.shtml (accessed 20 June 2012).

38. Gregory and Simmelkjaer, above 25; Moore, above 10, pp 135–136.

39. FRC ‘Regulatory impact assessment: Combined Code on Corporate Governance’ (July 2003) at 6, available at http://www.ecgi.org/codes/documents/regulatoryimpact.pdf (accessed 29 January 2013).

40. Coombes and Wong, above 6, p 51.

41. Andres, C and Thiessen, ESetting a fox to keep the geese – Does the company-or-explain principle work?’ (2008) 14 J Corp Finance 289.

42. Above 18, para 2.

43. See Keay, A and Adamopoulou, RShareholder value and Uk companies: a positivist inquiry’ (2012) 13 Eur Bus Org Law Rev 1.

44. Sands, above 38.

45. To improve shareholder engagement, Eva Micheler has suggested that the establishment of an Internet-based review and rating facility would be a way to facilitate shareholder engagement: above 24.

46. International Corporate Governance Network ‘G20 Leaders’ Summit: the role of corporate governance in restoring stability’ (23 March 2009), originally available at http://www.icgn.org/files/icgn_main/pdfs/news/icgn_letter_to_the_ukpm_24_march_09_pdf (accessed 20 June 2009).

47. Sands, above 38. Mr Sands was the Chief Executive of the Financial Services Authority at the time.

48. Above 16, p 17.

49. Ibid, p 71.

50. See http://www.manifest.co.uk/what-we-do/vote-agency/ (accessed 19 June 2012).

52. Moore, above 10, p 103.

53. Ibid, p 123.

54. MacNeil and Li, above 35, p 492. This view appears to be affirmed by ArcotS and BrunoV ‘In letter but not in spirit: an analysis of corporate governance in the Uk’ (May 2006), available at http://ssrn.com/abstract=819784 (accessed 22 February 2012).

55. FRC ‘Response to the European Commission Green Paper on the Eu Corporate Governance Framework’ (2011) at 28 (Executive Summary), available at http://www.frc.org.uk/images/uploaded/documents/FRC%20response%20to%20the%20Green%20Paper%20on%20the%20EU%20corporate%20governance%20framework%20July%202011.pdf (accessed 15 March 2012).

56. According to the latest available report from the Office for National Statistics in Ownership of Uk Quoted Shares 2010 (28 February 2012) p 3, available at http://www.ons.gov.uk/ons/dcp171778_257476.pdf (accessed 13 April 2012).

57. See Cheffins, BThe stewardship code's Achilles’ heel’ (2010) 73 MLR 1004, 1013, 1016.

58. For instance, above 16, pp 47–52. Also, see Goergen M, Renneboog L and Zhang C ‘Do Uk institutional shareholders monitor their investee firms?’ [2008] 8 J Corp Law Stud 39; Santella P etal, ‘Legal obstacles to institutional investor activists in the Eu and in the Us’ [2012] Eur Bus Law Rev 257.

59. Above 16, p 11.

60. Ibid.

61. Arcot and Bruno, above 55.

62. In fairness, the researchers do recognise these reasons.

63. For greater discussion, see Keay A ‘Company directors behaving poorly: disciplinary options for shareholders’ [2007] JBL 656.

64. This might well be embraced by small investors, but those holding larger volumes might not be able to do so because of specific investment policies, contractual limitations or because disposing of a significant block of shares could lead to a substantial loss that the investor is not willing to sustain. See above 16, p 71.

65. But unless a shareholder is a substantial investor or able to cobble together a coalition of like-minded shareholders, then this is not likely to be very effective.

66. But shareholders might feel that their shareholding is too small to warrant a monitoring strategy to enable them to exercise their voting rights to their advantage.

67. This provision states that directors have a duty to act in accordance with the company's constitution.

68. But to continue a derivative action, shareholders need the permission of the court, and the case-law suggests that obtaining the permission of the court is not an easy task. See Keay A and Loughrey J ‘Derivative proceedings in a brave new world for company management and shareholders’ [2010] JBL 151.

69. Wymeersch, EEnforcement of corporate governance codes’ (2006) 6 JCLS 113 at 118; an earlier version of the paper is available at http://ssrn.com/abstract=759364 (accessed 21 June 2012).

70. PIRC Corporate Governance Annual Review (2004).

71. ThorntonGrant Ftse 350 Corporate Governance Review (2003).

72. ThorntonGrant, above 31, at 6.

73. A study of 257 listed UK companies by David Seidl, Paul Sanderson and John Roberts seems to have found something similar: above 26.

74. Ibid.

75. Arcot and Bruno, above 62.

76. Arcot etal, above 11, p 193.

77. Ibid.

78. Seidl etal, above 24.

79. Arcot and Bruno, above 62.

80. Ibid.

81. Ibid.

82. Ibid.

83. Seidl etal, above 24. This also seems to be the case in Belgium: De ClynS ‘Compliance of companies with corporate governance codes’ (2008) 3 J Bus Systems, Gov & Ethics 1 at 12–13.

84. ThorntonGrant, above 31, at 6.

85. Above 16, p 13.

86. Ibid. Both the RMG Study and director institute and business associations studies found the UK to be in the top four countries as far as disclosure was concerned.

87. FRC ‘Review of the effectiveness of the Combined Code: summary of the main points raised in responses to the March 2009 Call for Evidence’ (July 2009) at 37, available at http://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_2009/Web_changes_to_2009_Review_of_the_Combined_Code_July_2009/FRC%20Summary%20of%20responses%20to%20March%202009%20consultation.pdf (accessed 22 March 2012).

88. Ibid. The respondent was the Investment Management Association.

89. Ibid, p 38. The respondent was Railpen Investments.

90. Moore, above 10, p 103; above 16, p 152.

91. FRC, above 88, p 38.

92. Moore, above 10, p 127.

93. Arcot etal, above 11.

94. FRC, above 88, pp 37, 38.

95. FRC ‘Developments in corporate governance 2011’ (December 2011) at 3, available at http://www.frc.org.uk/images/uploaded/documents/Developments%20in%20Corporate%20Governance%2020116.pdf (accessed 15 March 2012).

96. Above 16, p 181.

97. Ibid, p 83.

98. TaylorP ‘Enlightened shareholder value and the Companies Act 2006’, unpublished PhD thesis, Birkbeck College, University of London (May 2010) at 186; VilliersC ‘Narrative reporting and enlightened shareholder value under the Companies Act 2006’ in LoughreyJ (ed) Directors’ Duties and Shareholder Litigation in the Wake of the Financial Crisis (Cheltenham: Edward Elgar, 2012) at 118.

99. Taylor, above 99, p 196.

100. Hooghiemstra, RWhat determines the informativeness of firms’ explanations for deviations from the Dutch corporate governance code?’ (2012) 42 Account & Bus Res 1 at 6–7.

101. Healy, P and Palepu, KInformation asymmetry, corporate disclosure and the capital markets: a review of the empirical disclosure literature’ (2001) 31 J Account & Econ 405.

102. MacNeil and Li, above 35, pp 489–490.

103. FRC What Constitutes an Explanation under Comply or Explain? (February 2012), available at http://www.frc.org.uk/images/uploaded/documents/FRC%20explanations%20paper%200301121.pdf (accessed 28 June 2012).

104. Ibid, p 6.

105. Above 16, p 12.

106. Ibid, p 13.

107. Ibid, p 155.

108. Arcot etal, above 11.

109. Ibid.

110. Seidl etal, above 24.

111. Belcher, ARegulation by the market: the case of the Cadbury code and compliance statement’ [1995] JBL 321 at 331.

112. FRC ‘Revisions to the Uk Corporate Governance Code and Guidance on Audit Committees’ (April 2012) at 7, available at http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/April_2012/Cons%20Doc%20UK%20Corp%20Gov%20Code%20and%20Guidance%20on%20Audit%20Committees.pdf (accessed 28 June 2012).

113. Draft Plan and Budget 2012/13 (March 2012) p 4, available at http://www.frc.org.uk/images/uploaded/documents/FRC%20draft%20plan%20and%20budget%202012-131.pdf (accessed 28 June 2012).

114. Above 116, p 1.

115. FRC, above 104.

116. Arcot and Bruno, above 62.

117. EC The Eu Corporate Governance Framework, COM(2011) 164 para 3.2, available at http://ec.europa.eu/internal_market/company/docs/modern/com2011-164_en.pdf#page=2 (accessed 16 April 2012).

118. Arcot etal, above 11.

119. ‘Corporate governance in financial institutions and remuneration policies’ COM(2010) 84 at 86, available at http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf (accessed 27 April 2012). Also, see the comments of MooreMarc, above 10.

120. Arcot etal, above 11, p 194.

121. Above 16, p 18.

122. FRC ‘Regulatory impact assessment: Combined Code on Corporate Governance’ (July 2003) at 6, available at http://www.ecgi.org/codes/documents/regulatoryimpact.pdf (accessed 9 March 2012).

123. Ibid, p 6.

124. FRC ‘The Combined Code on Corporate Governance’, June 2006, para 4, available at http://www.slc.co.uk/media/78872/combined_20code_20june_202006.pdf (accessed 25 March 2013).

125. For instance, see A Keay ‘Company directors behaving poorly: disciplinary options for shareholders’ [2007] J Bus Law 656.

126. FRC ‘Uk Corporate Governance Code’, September 2012, para 4 at 4, available at http://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-September-2012.aspx (accessed 25 March 2013).

127. Above 16, p 178.

128. ECO 3722/2003 of 26 December. See Spanish Unified Good Corporate Governance Code (2006) at 7, available at http://www.cnmv.es/DocPortal/Publicaciones/CodigoGov/Codigo_unificado_Ing_04en.pdf (accessed 28 January 2013).

130. Above 16, p 179.

131. Ibid, p 166. The regulator acts under the Securities Markets Act, available at http://www.ebrd.com/downloads/legal/securities/slovsm.pdf (accessed 28 January 2013).

132. Abma, R and Olaerts, MIs the comply or explain principle a suitable mechanism for corporate governance throughout the Eu? the Dutch experience’ (2012) 9 Eur Company Law 286 at 298.

133. Above 88, p 3. The comment was made by Timothy Boatman.

134. EC, above 118.

135. Ibid, para 3.1.

136. Ibid, para 3.2.

137. Ibid.

138. Ibid.

139. Department of Business Innovation and Skills ‘Uk government response to European Commission Green Paper: the Eu Corporate Governance Framework’ (July 2011) at 17, available at http://www.bis.gov.uk/assets/biscore/europe/docs/u/11-1097-uk-government-response-eu-corporate-governance-framework (accessed 12 September 2012).

140. FRC ‘Response to the European Commission Green Paper on the Eu Corporate Governance Framework’ (2011), available at http://www.frc.org.uk/images/uploaded/documents/FRC%20response%20to%20the%20Green%20Paper%20on%20the%20EU%20corporate%20governance%20framework%20July%202011.pdf (accessed 15 March 2012). It reiterated its opposition in a later report: FRC, above 104.

141. Ibid, p 5.

142. Ibid, p 3.

143. MacNeil and Li, above 35, p 488.

144. Ibid, p 5.

145. Ibid, p 6.

146. Ibid.

147. Ibid.

148. Ibid, p 28 (Annex 1).

149. European Company Law Experts’ Response to the European Commission's Green Paper (DaviesP etal) ‘The Eu Corporate Governance Framework’ (22 July 2011) p 23, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1912548 (accessed 12 September 2012)

150. Ibid, pp 23–24.

151. FRC, above 104.

152. FRC ‘Revisions to the Uk stewardship code’ (April 2012) at 1, available at http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/April_2012/Cons%20Doc%20UK%20Stewardship%20Code.pdf (accessed 27 April 2012).

153. Interim Report (February 2012), available at http://www.bis.gov.uk/assets/biscore/business-law/docs/k/12-631-kay-review-of-equity-markets-interim-report (accessed 27 April 2012).

154. These included Grant Thornton and the Chartered Institute of Management Accountants.

155. FRC, above 88, p 39.

156. See Winter, RState law, shareholder protection, and the theory of the corporation’ (1977) 6 J Legal Stud 251 at 258.

157. Above 18.

158. Above 16, p 16.

159. Ibid, p 64.

160. Ibid, p 60.

161. Ibid, p 64.

162. Ibid, p 179.

163. See eg AnandA ‘Voluntary vs mandatory corporate governance: towards an optimal regulatory framework’ (2005) at 10, available at http://law.bepress.com/15th/baszaar/art44 (accessed 12 September 2012).

164. ‘Corporate governance in financial institutions and remuneration policies’ COM(2010) 285 at 286, available at http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf (accessed 27 April 2012).

165. Hooghiemstra and H van Ees, above 29, p 481.

166. Above 16, p 62.

167. Ibid, p 64.

168. Armour, above 38. This approach has been successful in Australia: Welsh M ‘New sanctions and increased enforcement activity in Australian corporate law: impact and implications’ (2012) 41 Common Law Wld Rev 134 at 140.

169. For discussion of the pyramid, see AyresJ and BraithwaiteJ Responsive Regulation: Transcending the Deregulation Debate (New York: Oxford University Press, 1992).

170. A measure supported in the European Company Law Experts’ Response to the European Commission's Green Paper: Davies etal, above 150, p 24.

171. Karlsson-Vinkhuyzen and Vihma, above 2, p 406.

172. This is something that was raised in the ‘Study on monitoring and enforcement practices in corporate governance in the member states’: above 16, p 69.

173. ThorntonGrant, above 31, at 6.

174. See the comments of SandsHector in his speech ‘Delivering effective corporate governance: the financial regulators [sic] role’, Merchant Taylors’ Hall, London (24 April 2012), available at http://www.fsa.gov.uk/library/communications/speeches/20120424-hs.shtml (accessed 21 June 2012).

175. Welsh, above 173, p 136.

176. Hooghiemstra and van Ees, above 29, pp 481, 493.

177. Above 16, p 16.

178. Above 18.

179. Above 16, p 150.

180. Ibid, p 165.

181. Ibid, p 166.

182. Ibid, p 12.

183. Ibid.

184. Ibid, p 13.

185. Ibid, p 166.

186. MacNeil and Li, above 35, p 489.

187. EC ‘The Eu: Corporate Governance Framework’ (2010), available at http://ec.europa.eu/internal_market/company/docs/modern/com2010-284_en.pdf# (accessed 16 April 2012).

188. Cadbury, A Corporate Governance and Chairmanship: A Personal View (Oxford: Oxford University Press, 2008) p 28.

* Professor of Corporate and Commercial Law, Centre of Business Law and Practice, School of Law, University of Leeds and Barrister, Kings Chambers and 13 Old Square Chambers. A previous version of this paper was presented at the 4th Cambridge International Regulation and Governance Conference, held at Queen's College, University of Cambridge, on 6 September 2012. I am grateful to the Legal Studies reviewers and for their comments. All errors remain my responsibility.

Comply or explain in corporate governance codes: in need of greater regulatory oversight?

  • Andrew Keay (a1)

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