To more broadly, the market.[4] In doing so it

To argue the principle of ‘comply or explain’ has overtime undermined the effectiveness of the UK corporate governance regime wouldbe overly simplistic. ‘Comply or explain’ provides the framework for the UKCorporate Governance Code1,Stewardship Code2  and equivalent codes in 84% of OECD,G20 and Financial Stability Board member jurisdictions.3Rather than setting mandatory legislation, it aims to create a dialogue encouragingboards to comply with code provisions or, where it is not in the best interestof the company to do so, allow them to explain why they have not complied toshareholders and more broadly, the market.4 Indoing so it claims to allow companies a degree of ‘freedom within a frameworkof effective accountability.5 However,following the financial crisisthis claim has been brought into question and debate has emerged as to whether ahard law approach, as adopted in the US,6would be more effective.

7This essay argues ‘comply or explain’ is a double-edged sword in the UKcorporate governance regime. The suigeneris flexibility underpinning ‘comply or explain’ has been effective inimproving engagement, albeit this is often over-emphasised. On the contrary,the failure to create a real obligation to make adequate disclosures and to incentiviseshareholders has reduced its effectiveness as a mechanism to challengenon-compliance.

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Nonetheless, by analysing the principle in the context of thecurrent UK economy, it will be submitted ‘comply or explain’ is fighting alosing battle. Increased share ownership by institutional investors and short-termismin financial markets have reduced the principle to a superficial conception.Thus, we must also recognise institutional arrangements have contributed to theoverall ineffectiveness of ‘comply or explain’.8 Improving engagement It would be overly simplistic to argue the principleof ‘comply or explain’ has undermined the effectiveness of the UK corporategovernance regime, when it’s inherent flexibility has improved engagement. However,this should not be over-emphasised.

By allowing companies to deviate from thecode, where an alternative practice would also achieve good governance, it hasbeen possible to apply corporate governance codes to an extremely diversebusiness community without ‘stifling innovation and enterprise’9 oroverburdening companies with regulation. Moreover, Stiles and Taylor argue thatthe flexibility afforded to companies by ‘comply or explain’ has provided anattractive and ‘cooperative route’,10 encouragingcompanies to engage with corporate governance codes. This is convincing; arecent report by Grant Thornton found that 66% of FTSE 350 declare fullcompliance with the UK Corporate Governance Code and 95% comply with all butone or two of the 55 provisions.

11              Furthermore,Arcot and Bruno argue the inherent choice to ‘comply or explain’, as opposed toa ‘one size fits all’ hard law approach, has a greater impact on boardbehaviour, as directors must evaluate implications for the company andstakeholders before arriving at their final decision.12 Thiswas exemplified in the Marks and Spencer’s fallout over the dual leadershiprole of the CEO and Chairman in 2008, when the company’s chairman prepared a five-pageletter to shareholders outlining reasons for adopting this unusual governance policy.13 However, the academics aforementioned fail tohighlight an important caveat; despite evidence of high-quality engagement,this is not guaranteed. For example,Villiers argues the increasingly prescriptiveness of codes over time has resultedin an interpretation of the principle by directors as a legal duty.

14Moore argues that shareholders also tend to interpret the code formalistically.15For example, Peter Chambers, amajor shareholder during the M&S fallout stated, ‘we don’t think M&Sshould be explaining why they are not complying – they should be complying’.16 Thus,the principle’s effectiveness should not be overemphasised, as notall companies engage with the spirit of the code and only use it retrospectively to criticise poor decisions. Fundamentally,this may also only provide a superficial fix to the ‘agency problem’17, asinterests of shareholders and directorsare aligned by compliance with the provisions, not the underlying principles.Therefore,it is inaccurate to argue ‘comply or explain’ has undermined UK corporategovernance, as its flexible approach hasfacilitated engagement, a clear reason for its international acclaim.18 Albeit, the quality of engagementdepends on the commitment of the boards and shareholders themselves.

 Inadequate disclosure obligation Though ‘comply or explain’ has been effective in improvingcompliance, as the European Commission criticised, the principle’s failure tomandate adequate disclosures has undermined the effectiveness of the UKcorporate governance regime in tackling non-compliance. 19 Mooreargues many boards provide brief and uninformative ‘boilerplate’ justifications’.20 Forexample, in 2017 Grant Thornton found that only 33% of companies provide goodor detailed explanations.

21Moreover, despite FRC guidance published in 2012,22 one-third of companies continue onlyto provide basic information.23Thus, ‘comply or explain’ undermines the UK corporate governance regimeat tackling non-compliance as soft law becomes soft compliance, whereby boardsare able to frustrate the disclosureprocess, ignore recommendations and continue to operate with poor governancearrangements. Furthermore, the principle fails to create a dialoguewith shareholders who do not have sufficient information to judge whethernon-compliance is in the best interest of the company. Ultimately, thisundermines the legitimacy of anexplanation in lieu of compliance.Most worryingly, research by MacNeil and Li shows that the principle has turnedinto ‘comply or perform’,24 as investors result to using thecompany’s performance to determine whether any deviations from the code can beexcused. Therefore, not only has ‘comply or explain’ failed to effectuate the transparencyneeded in an effective corporate governance regime, but it has led shareholdersto wrongly rely on financial performance as an indicator of good corporategovernance.

For example, Enron’s net income reached a record $1.3 billion in2000 just before its collapse, due to mismanagement.25As Kershaw notes, the FCA has not issuedany sanctions for listed companies’ failure to give an adequate explanation.26 Thus,’comply or explain’ does not create a framework which responds to the divorceof ownership and control in a way that safeguards the interests of shareholders.Instead, it merely creates animbalance of power and a significantly weaker role for shareholders than theyhave in company law. Further, the introduction of regulatory oversight has beencriticised by the UK government,27 whoargue it would lead to a restricted role for shareholders. However, Keay’srecommendation is convincing, that a monitoring body with well-defined powers would curb the discretion of directors and(indirectly) empower shareholders.28 Therefore,without a real obligation on directors to adequately disclose non-compliance, ‘complyor explain’ has undermined the effectiveness of the UK corporate governanceregime by allowing it to be abused by directors and shareholders are left unableto hold boards to account.

  Failureto incentivise shareholders             Thecombination of an inadequate disclosure obligation and the failure to incentiviseshareholders has undermined the effectiveness of the UK corporate governanceregime, where non-compliance, which is not in the best interest of the company,goes unchallenged.  Since the financialcrisis, Deakin argues the stresses have very much been on getting shareholdersto be more responsible and active.29Without a fiduciary obligation to other shareholders or to the company, non-compliancemay be ignored as shareholdersdo not invest time, resources and exercising their rights by engagingwith every single investee company and instead favour portfolio diversification.For example, in 2008 the average shareholder in a mutual fund owned a portfolioof 91 stocks.30 Asa result, the market-based sanction of ‘comply or explain’ often does not takeeffect, as non-compliant companies are no longer seen as riskier investmentsand there is no fall in share price to incentivise directors to change their governance arrangements. Furthermore,a vicious circle is createdwhereby directors may even be encouraged to produce ‘boiler-plate’statements if they know they go unchecked and ‘can get away with it.’31 Thus, by failing to engageshareholders, ‘comply or explain’ has undermined the effectiveness of the UKcorporate governance regime, as not only does poor governance remainunchallenged but confidence in the regime is lost by stakeholders, who do nothave the right to hold directors to account under ‘comply or explain’.Evenshareholders who do engage, do so in an apathetic manner.

For example, Morrisonsdid not comply with most of the UK Corporate Governance Code up until a profitwarning in 2004 triggered increased pressure from shareholders to appoint thecompany’s first non-executive director.32As such, many companies only challenge directors when there is poor financialperformance. Thus, the initialtask set for the Cadbury committee, to respond to concerns of mismanagement andlacking accountability, was incomplete.33 By onlyfocusing on board disclosure, ‘comply or explain’ undermines theeffectiveness of the UK corporate governance regime, by failing to engage shareholdersin their crucial role of holding directors to account.  A losing battle? Nonetheless,when analysed in the context of the current UK economy, ‘comply or explain’ isfighting a losing battle, as current institutional arrangements have a barrier to its overall effectiveness.34Firstly, the increasingprominence of institutional investors in the UK is problematic. From 1992 to2016, the number of shares on the UK stock market owned by the ‘rest of theworld’ and ‘financial institutions’ has risen from 13% to 62%.35 Cadburyidentified institutional investors would play an important role in challengingnon-compliance under ‘comply or explain’, as they have large voting blocks and significantpower.

36  Nonetheless, Lord Myners argument is moreconvincing that in practice they act as ‘absentee landlords’.37 Forexample, the FRC reported that the quality of statements against the StewardshipCode was ‘not sufficient’ to demonstrate commitment to governance responsibilities.38 Thus,with diverse portfolios in multiple jurisdictions, institutional investors donot have the time to devote to engage in corporate governance with individualcompanies as required under ‘comply or explain’. Moreover, Moore argues thatinstitutional investors and proxy voters often employ a ‘box-ticking’ approach.

39This is exemplified in the comments of the Association of Certified Accounts onthe Walker Review.40Thus, institutional arrangements have increased the divergence of ownership andcontrol, not only dispelling the dialogue that ‘comply or explain’ seeks tocreate between shareholder and director but reduces a detailed examination ofcorporate governance to a superficialexercise.Secondly, short-termism in financial marketshas reducedthe task of engaging in ‘comply or explain’ as a collateral concern. Theaverage holding period of shares on London Stock Exchange has decreased fromover eight years in 1966 to seven and a half months in 2007.41Thus, shareholders no longer see themselves as owners of a company with aninterest in its sustainable success, rather as traders focused on short-term gains.Furthermore, shareholders are morelikely to be indifferent to non-compliance statements if their shares retaintheir value. Even if non-compliance is criticised, market liquiditymakes it easier to sell shares than engage in corporate governance. Fundamentally, markets built on a shareholderprimacy model42,which prioritise companies as profit-making organisations, make it difficultfor ‘comply or explain’ to have an impact encouraging directors to consider thewider implications of their decisions.

Therefore, increased institutionalinvestment and short-termism in financial markets have contributed to theineffectiveness of ‘comply or explain’ by distancing shareholders from theirultimate responsibility as stewards of companies. Conclusion Inconclusion, to argue the principle of ‘comply or explain’ has overtime underminedthe UK corporate governance regime would be overly simplistic. ‘Comply orexplain’ is a double-edged sword. The flexibility underpinning ‘comply orexplain’ has been effective in improving engagement and compliance with UKcorporate governance codes, albeit this should not be over exaggerated.

However, the failure to create a real obligation to make adequate disclosuresand to incentivise shareholders has reduced its effectiveness as a mechanism tochallenge non-compliance. Nonetheless, by looking at the context of the currentUK economy, ‘comply or explain’ is fighting a losing battle. Increased share ownershipby institutional investors and short-termism in financial markets have reduced’comply or explain’ to a superficial conception. Thus, even where the principlehas been ineffective, it should not be held solely to blame. 1UK Corporate Governance Code 2016.2UK Stewardship Code 2012.3 OECD, ‘Corporate Governance Factbook’ (2017) 15

org/daf/ca/Corporate-Governance-Factbook.pdf> accessed6 January 2018.4 Glen Moreno, ‘A basis for dialogue’ in FinancialReporting Council (eds), Comply orExplain: 20th Anniversary of the UK Corporate Governance Code(FRC 2012) < www.frc.org.

uk/Our-Work/Publications/Corporate-Governance/Comply-or-Explain-20th-Anniversary-of-the-UK-Corpo.aspx> accessed 6 January 2018.5 Committee on the Financial Aspects of Corporate Governance,Report of the Committee on the FinancialAspects of Corporate Governance (Gee, December 1992) para 1.1.6Sarbanes-Oxley Act of 2002.

7Mark Moore, ‘The End of Comply or explain’ in UK corporate governance?’ 200960(1) NILQ 85.8Charlotte Villiers, ‘Legal Ambiguity in Corporate Governance’ in M Fenwick, MSiems and S Wrbka (eds), The ShiftingMeaning of Legal Certainty in Comparative and Transnational Law (Hart 2017)263.9 PStiles and B Taylor, ‘Benchmarking Corporate Governance: The impact of theCadbury Code’ 1993 26(5) Long Range Planning 61, 69.10Ibid.11Grant Thornton, ‘Corporate Governance Review’ (2017) 26

grantthornton.co.uk/globalassets/1.-member-firms/united-kingdom/pdf/publication/corporate-governance-review-2017.

pdf>accessed 6 January 2018. 12SR Arcot and VG Bruno, ‘One size does not fit all, after all: Evidence fromCorporate Governance’ (2007) London School of Economics Research Paper, 9 accessed 6January 2018.13Marc T Moore, ‘Whispering Sweet Nothings: The Limitations of InformalConformance in UK Corporate Governance’ 2009 9 Journal of Corporate LawStudies 95, 110-112.14 Villiers (n 8) 252.15Moore (n 13) 118.

16Dominic Walsh, ‘Investor outcry smothers Sir Stuart Rose’s pay rise hope atM&S’ (The Times, 31 March 2008)

uk/article/investor-outcry-smothers-sir-stuart-roses-pay-rise-hope-at-mands-7rmgrw5s7pc>accessed 6 January 2018.17Adam Smith, An Inquiry into the Natureand the Cause of the Wealth of Nations (first published 1776, Oxford 2008)586. See also M Jensen and W Meckling, ‘Theory of the Firm: ManagerialBehaviour, Agency Costs and Ownership Structure’ 1976 3 Journal of FinancialEconomics 305.

18 SArcot, V Bruno and AF Grimaud, ‘Corporate Governance in the UK: is theComply-or-Explain Approach Working?'(2005) Corporate Governance at LSEDiscussion Paper Series No 001, 1

uk/24673/1/dp581_Corporate_Governance_at_LSE_001.pdf>accessed 6 January 2018.19Commission, ‘Green Paper: Corporate Governance in Financial Institutions andRemuneration Policies’ COM (2010) 285 final, 6.20Moore (n 13) 125-129.21 Grant Thornton (n11) 7.22 Financial Reporting Council ‘What constitutes anexplanation under “comply or explain”?’ (February 2012)

frc.org.uk/getattachment/a39aa822-ae3c-4ddf-b869-db8f2ffe1b61/what-constitutes-an-explanation-under-comply-or-exlpain.pdf>accessed 6 January 201823 Financial Reporting Council, ‘Developments in CorporateGovernance and Stewardship 2016’ (January 2017) 7

uk/getattachment/ca1d9909-7e32-4894-b2a7-b971b4406130/Developments-in-Corporate-Governance-and-Stewardship-2016.pdf>accessed 6 January 2018.24 I MacNeil and X Li, ‘Comply or Explain: marketdiscipline and non-compliance with the Combined Code’ 2006 14(5) CorporateGovernance 486, 492.25 Enron, ‘Annual Report’ (2000)

uchicago.edu/Enron/EnronAnnualReport2000.pdf> accessed 6January 2018.26David Kershaw, Company Law in Context:Text and Materials (OUP 2012) 253.27Department for Business Innovation & Skills, UK Government Response to the European Commission Green Paper on the EUCorporate Governance Framework (Department for Business, July 2011) 17 

gov.uk/government/publications/corporate-governance-framework-response-to-the-european-commission-green-paper>accessed 6 January 201828Andrew Keay, ‘Comply or explain in corporate governance codes: in need ofgreater regulatory oversight?’ 2014 34(2) Legal Studies 279.29 Simon Deakin, ‘Corporate Governance and FinancialDevelopment’ (University of CambridgeCadbury Archive, 8 August 2013)

ac.uk/2013/professor-simon-deakin-faculty-of-law-the-effect-of-the-cadbury-code-on-boards-and-stockmarkets/>accessed 6 January 2018.30 TSapp and X Yan, ‘Security Concentration and Active Fund Management: Do FocusedFunds Offer Superior Performance?’ 2008 43(1) The Financial Review 27.31 Alice Belcher, ‘Regulation by the market: the case ofthe Cadbury code and compliance statement’ 1995 Journal of Business Law 321,331.32 S Arcot, V Bruno and AF Grimaud (n 18) 16.33 Committeeon the Financial Aspects of Corporate Governance (n 5) para 2.

1-2.2.34 Villiers (n 8) 263.35 Office for National Statistics, ‘Ownership of UK QuotesShares 2016’ (2017)

ons.gov.uk/economy/investmentspensionsandtrusts/bulletins/ownershipofukquotedowners/2016>accessed 6 January 2018. 36Committee on the Financial Aspects of Corporate Governance (n 5) para 6.10.37 Paul Myners, ‘Speech by the Financial ServicesSecretary’ (Association of Investment Companies, London, 21 April 2009) para38.

htm> accessed 6 January 2018. 38Financial Reporting Council (n 23) 7.39 Moore (n 13).40 Association of Chartered Accountants, ‘A Review ofCorporate Governance in UK Banks and Other Financial Industry Entities'(October 2009) 4accessed 6 January 2018.41 JohnKay, ‘The Kay Review of UK equity markets and long-term decision making'(European Corporate Governance Institute, July 2012) para 3 < http://www.ecgi.org/conferences/eu_actionplan2013/documents/kay_review_final_report.pdf> accessed 6 January 2018.42Adolf Berle, ‘Corporate Powers as Powers in Trust’ 1931 44 Harvard Law Review1049, 1049.