Comply or Explain (UK) – Definition

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Comply or Explain (UK) Definition

Comply or explain is a regulatory mechanism used in the United Kingdom as part of the codes of cooperate governance. The comply or explain principle stipulates that corporations should company with the Corporate Governance Code (also called “Code”) or explain reasons why they do not comply. The principle of comply or explain is crucial to corporate governance which gives companies the choice to either company to the Code or explains why not. There are more than 50 provisions in the Code that companies are expected to comply with. Comply or explain principle offers flexibility to companies in the sense that they can decide whether to comply with certain directives of the Code or not.

Comply or explain essentially requires that companies hold true to good governance without being compelled by a regulatory body. This principle also demands transparency from companies that comply to the Code and when they breach the code, adequate explanations must be rendered, supported by other alternatives they are exploring to achieve good governance.

A Little More on What is Comply or Explain

The Corporate Governance Code contains what companies, boards, directors and other employees are expected to do. This code forms the basis of good governance in a corporation. Although companies are encouraged to comply with all the provisions of the code, they also have the chance to explain why they could not in certain cases. The effective use of the principle of comply or explain has led to an increase in compliance to corporate governance code and an explanation in the case of any non-compliance.

Comply or explain basically thrives on the absence of requirements for compliance with the Code, it also serves as a recognition and justification that there are other alternative provisions towards achieving good governance outside of the Code.  There are many instances where companies achieve good governance without the need for intervention by a regulatory body.

Explain Governance Choices

Despite the purpose of comply or explain principle, it is not without difficulties. Sometimes, investors claim that the explanations provided by companies when they do not comply with the Code are not sufficient and many companies fail to explain their alternative means of achieving good corporate governance. Another argument by investors is that regardless of the reason for non-compliance or the alternative measures taken by a company, non-compliance leaves a bad impression of the company.

In a bid to sustain the continuity of comply or explain, ICAEW highlights some of the advantages of this principle, and the major areas businesses and investors benefit from it. This includes innovation; when a company introduces new initiatives and changes to company governance. Comply or explain also helps companies prevent box-ticking, thereby them to weigh the provisions before they comply and also give some explanation if the provisions cannot be adopted.

Building Trust

Mutual trust is vital to the use and sustainability of comply or explain principle. Companies and their boards of directors must be committed to achieving good corporate governance and also build trust with investors and shareholders on matters pertaining to good governance. Building mutual trust forms a solid foundation for how an explanation will be considered or accepted by stakeholders. In building mutual trust, the shared beliefs and the institutional arrangements of a company are important.

References for Comply or Explain

https://en.wikipedia.org/wiki/Comply_or_explain

http://lexicon.ft.com/Term?term=comply-or-explain

https://www.financialdirector.co.uk/2014/01/06/comply-or-explain-is-it-sustainable/

Academic Research on Comply or Explain (UK)

Corporate governance in the UK: Is the comply or explain approach working?, Arcot, S., Bruno, V., & Faure-Grimaud, A. (2010). Corporate governance in the UK: Is the comply or explain approach working?. International Review of Law and Economics, 30(2), 193-201. We examine the effectiveness of the “Comply or Explain” approach to corporate governance in the UK. Using a unique database of 245 non-financial companies for the period of 1998–2004, we find an increasing trend of compliance with the Combined Code, but a frequent use of standard explanations in case of non-compliance. We show how the Combined Code has been interpreted and applied, and we discuss the existence of enforcement and monitoring problems. We make recommendations so that the approach could be strengthened with the greatest possible benefits.

Comply or Explain”: market discipline and non‐compliance with the Combined Code, MacNeil, I., & Li, X. (2006). “Comply or Explain”: market discipline and noncompliance with the Combined Code. Corporate Governance: An International Review, 14(5), 486-496. The “comply or explain” principle adopted by the UK’s Combined Code on Corporate Governance has now been in operation for 12 years. In this paper we focus on two aspects of this regime. The first is the nature of the explanations that have been given by companies with an established record of non‐compliance (“serial non‐compliers”) and the role of the market in permitting deviations from the Combined Code. In particular, we consider the significance of share price performance as a factor that is relevant in justifying non‐compliance and the extent to which investors appear to rely on this indicator rather than engage in the more difficult task of judging the relative merits of the Code provisions against alternatives. Our approach differs from much of the research linking corporate governance with financial performance in that it focuses on the potential influence of financial performance (as measured by share price) on governance structure rather than vice versa. Our study of FTSE 100 serial non‐compliers suggests that there is a prima facie link between share price performance and investors’ tolerance of non‐compliance with the Combined Code. The second issue we examine is the link between the principle of “comply and explain” and the self‐regulatory status of the Code. We conclude that the benefits of flexibility generally associated with the self‐regulatory status of the Code are overstated and that the Code could be integrated into mainstream company law.

Applying” comply-or-explain“: Conformance with Codes of Corporate Governance in the UK and Germany, Seidl, D., Sanderson, P., & Roberts, J. (2009). Applying” comply-or-explain”: Conformance with Codes of Corporate Governance in the UK and Germany. The comply-or-explain principle is a central element of most codes of corporate governance. Originally put forward by the Cadbury Committee in the UK as a practical means of establishing a code of corporate governance whilst avoiding an inflexible ‘one size fits all’ approach, it has since been incorporated into code regimes around the world. Despite its wide application very little is known about the ways in which managers apply the principle – in particular, how they make use of the option to ‘explain’ deviations. To address this we analysed the compliance statements and reports of 257 listed companies in the UK and Germany, producing some 708 records of deviations, which we used to generate our empirically derived taxonomy of forms of ‘explanation’. We find these varied forms of ‘explanation’ are based in part on different logics of argumentation. This leads to a broader use of the option to ‘explain’ than envisaged by the Cadbury Committee. In addition our country comparison shows significant divergence in compliance patterns in the UK and Germany which may be explained by differences in experience, culture and legal system.

The UK corporate governance code, Council, F. R. (2012). The UK corporate governance code. London, September.

The End of Comply or Explain in UK Corporate Governance, Moore, M. T. (2009). The End of Comply or Explain in UK Corporate Governance. N. Ir. Legal Q., 60, 85.

Applying the ‘comply-or-explain‘principle: discursive legitimacy tactics with regard to codes of corporate governance, Seidl, D., Sanderson, P., & Roberts, J. (2013). Applying the ‘comply-or-explain’principle: discursive legitimacy tactics with regard to codes of corporate governance. Journal of management & governance, 17(3), 791-826. The comply-or-explain principle is a central element of most codes of corporate governance. Originally put forward by the Cadbury Committee in the UK as a practical means of establishing a code of corporate governance whilst avoiding an inflexible “one size fits all” approach, it has since been incorporated into code regimes around the world. Companies can either comply with code provisions or may explain why they do not comply, i.e., why they deviate from a code provision. Despite its wide application very little is known about the ways in which comply-or-explain is used. In addressing this we employ legitimacy theory by which explanations for deviating can be understood as means of legitimizing the company’s actions. We analyzed the compliance statements and reports of 257 listed companies in the UK and Germany, producing some 715 records of deviation. From this we generated an empirically derived taxonomy of the explanations. In a second order analysis we examine the underlying logic and identify various legitimacy tactics. We discuss the consequences of these legitimacy tactics for code regimes and the implications for policy makers.

Comply or explain in corporate governance codes: in need of greater regulatory oversight?, Keay, A. (2014). Comply or explain in corporate governance codes: in need of greater regulatory oversight?. Legal Studies, 34(2), 279-304. Having a voluntary code as the basis of a corporate governance regime is popular in countries in Europe and around the world. Generally, at the heart of such an approach is the concept of ‘comply or explain.’ This concept originated in the UK with the Cadbury Report in 1992 and provides that a company is to comply with a set code of practice, but if it does not then it is to state that it does not and explain why it does not. The use of this concept is designed to permit flexibility in companies and it is in response to the fact that one size does not fit all as far as companies are concerned, as they are all different and should not be subject to rigid rules.

Management reporting on internal control and accruals quality: insights from a “comply-or-explain” internal control regime, Van de Poel, K., & Vanstraelen, A. (2011). Management reporting on internal control and accruals quality: insights from a “comply-or-explain” internal control regime. Auditing: A Journal of Practice & Theory, 30(3), 181-209. Internal control regulation remains the subject of an ongoing global debate among academics, regulators, and practitioners in terms of costs and effectiveness. This is reflected by different internal control regulations in different countries, resulting in varying management’s incentives across regulatory regimes. Prior research, however, has primarily focused on the U.S. rules-based setting to study the relationship between internal control regulation and financial reporting. The purpose of this paper is to study the relationship between internal control reporting and accruals quality in an alternative internal control regime based on the ”comply-or-explain principle” in The Netherlands. We show that in this setting accruals quality is not associated with the description of the internal control system, while there is evidence of a positive association with an unaudited statement of effective internal controls. Further, we find that the noncompliance rate of providing a statement of effective internal controls is relatively high, and that companies give generic explanations for noncompliance or no explanation at all. Overall, insights from different internal control regulatory regimes may further advance our knowledge on internal control regulation effectiveness.

The Reflexive Properties of Corporate Governance Codes: The Reception of the ‘Comply‐or‐explain‘Approach in Slovenia, Cankar, N. K., Deakin, S., & Simoneti, M. (2010). The Reflexive Properties of Corporate Governance Codes: The Reception of the ‘Complyorexplain’Approach in Slovenia. Journal of Law and Society, 37(3), 501-525. The Slovenian Corporate Governance Code for Public Joint-Stock Companies was adopted in March 2004. We examine how far the implementation of the Code has resulted in the ‘reflexive’ learning processes which the ‘comply-or-explain’ approach to corporate governance aims to bring about. We find that compliance strategies are strikingly uniform across firms in terms of the content of deviations as well as in types of disclosure and explanations for deviations. Moreover, the quality of corporate reporting is low, with effective explanations representing only a small minority of disclosures. Thus there is little evidence that the Code has stimulated organizational learning. We consider the implications of our findings for the development of corporate governance in transition systems and for the comply-or-explain approach more generally.

Good practices in corporate governance: one-size-fits-all vs. comply-or-explain, Nedelchev, M. (2013). Good practices in corporate governance: one-size-fits-all vs. comply-or-explain. There are many studies exploring the effects of hard and soft legislation on good practices. Few studies examine the strengths and weaknesses of particular legislation. These mainly focus on positive results of legislation and justify the application of existing approach for better practices.The study compares the approaches of hard and soft legislation. It finds that both approaches are suitable for implementation despite of state policy. The analysis is developed by using the practices of several countries for latest 20 years.This study explored national legislation and its effects on good practices in corporate governance. It revealed that there was no significant difference between state policy and approaches, and between legislation and corporate governance practices.The objective of the study is to develop deeper insight into pros and cons adoptation of approaches. Comparative analysis shows that state policy determines the good practices. Moreover, the conclusion point out that there is a small freedom of action for companies to attract investors.

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