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

To argue the principle of ‘comply or explain’ has over
time undermined the effectiveness of the UK corporate governance regime would
be overly simplistic. ‘Comply or explain’ provides the framework for the UK
Corporate Governance Code1,
Stewardship Code2  and equivalent codes in 84% of OECD,
G20 and Financial Stability Board member jurisdictions.3
Rather than setting mandatory legislation, it aims to create a dialogue encouraging
boards to comply with code provisions or, where it is not in the best interest
of the company to do so, allow them to explain why they have not complied to
shareholders and more broadly, the market.4 In
doing so it claims to allow companies a degree of ‘freedom within a framework
of effective accountability.5 However,
following the financial crisis
this claim has been brought into question and debate has emerged as to whether a
hard law approach, as adopted in the US,6
would be more effective.7
This essay argues ‘comply or explain’ is a double-edged sword in the UK
corporate governance regime. The sui
generis flexibility underpinning ‘comply or explain’ has been effective in
improving engagement, albeit this is often over-emphasised. On the contrary,
the failure to create a real obligation to make adequate disclosures and to incentivise
shareholders has reduced its effectiveness as a mechanism to challenge
non-compliance. Nonetheless, by analysing the principle in the context of the
current UK economy, it will be submitted ‘comply or explain’ is fighting a
losing battle. Increased share ownership by institutional investors and short-termism
in financial markets have reduced the principle to a superficial conception.
Thus, we must also recognise institutional arrangements have contributed to the
overall ineffectiveness of ‘comply or explain’.8


Improving engagement

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It would be overly simplistic to argue the principle
of ‘comply or explain’ has undermined the effectiveness of the UK corporate
governance regime, when it’s inherent flexibility has improved engagement. However,
this should not be over-emphasised. By allowing companies to deviate from the
code, where an alternative practice would also achieve good governance, it has
been possible to apply corporate governance codes to an extremely diverse
business community without ‘stifling innovation and enterprise’9 or
overburdening companies with regulation. Moreover, Stiles and Taylor argue that
the flexibility afforded to companies by ‘comply or explain’ has provided an
attractive and ‘cooperative route’,10 encouraging
companies to engage with corporate governance codes. This is convincing; a
recent report by Grant Thornton found that 66% of FTSE 350 declare full
compliance with the UK Corporate Governance Code and 95% comply with all but
one or two of the 55 provisions. 11 

Arcot and Bruno argue the inherent choice to ‘comply or explain’, as opposed to
a ‘one size fits all’ hard law approach, has a greater impact on board
behaviour, as directors must evaluate implications for the company and
stakeholders before arriving at their final decision.12 This
was exemplified in the Marks and Spencer’s fallout over the dual leadership
role of the CEO and Chairman in 2008, when the company’s chairman prepared a five-page
letter to shareholders outlining reasons for adopting this unusual governance policy.13

However, the academics aforementioned fail to
highlight 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 resulted
in an interpretation of the principle by directors as a legal duty. 14
Moore argues that shareholders also tend to interpret the code formalistically.15
For example, Peter Chambers, a
major shareholder during the M&S fallout stated, ‘we don’t think M&S
should be explaining why they are not complying – they should be complying’.16 Thus,
the principle’s effectiveness should not be overemphasised, as not
all 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, as
interests of shareholders and directors
are aligned by compliance with the provisions, not the underlying principles.
it is inaccurate to argue ‘comply or explain’ has undermined UK corporate
governance, as its flexible approach has
facilitated engagement, a clear reason for its international acclaim.18 Albeit, the quality of engagement
depends on the commitment of the boards and shareholders themselves.


Inadequate disclosure obligation


Though ‘comply or explain’ has been effective in improving
compliance, as the European Commission criticised, the principle’s failure to
mandate adequate disclosures has undermined the effectiveness of the UK
corporate governance regime in tackling non-compliance. 19 Moore
argues many boards provide brief and uninformative ‘boilerplate’ justifications’.20 For
example, in 2017 Grant Thornton found that only 33% of companies provide good
or detailed explanations.21
Moreover, despite FRC guidance published in 2012,22 one-third of companies continue only
to provide basic information.23
Thus, ‘comply or explain’ undermines the UK corporate governance regime
at tackling non-compliance as soft law becomes soft compliance, whereby boards
are able to frustrate the disclosure
process, ignore recommendations and continue to operate with poor governance

Furthermore, the principle fails to create a dialogue
with shareholders who do not have sufficient information to judge whether
non-compliance is in the best interest of the company. Ultimately, this
undermines the legitimacy of an
explanation in lieu of compliance.
Most worryingly, research by MacNeil and Li shows that the principle has turned
into ‘comply or perform’,24 as investors result to using the
company’s performance to determine whether any deviations from the code can be
excused. Therefore, not only has ‘comply or explain’ failed to effectuate the transparency
needed in an effective corporate governance regime, but it has led shareholders
to wrongly rely on financial performance as an indicator of good corporate
governance. For example, Enron’s net income reached a record $1.3 billion in
2000 just before its collapse, due to mismanagement.25

As Kershaw notes, the FCA has not issued
any sanctions for listed companies’ failure to give an adequate explanation.26 Thus,
‘comply or explain’ does not create a framework which responds to the divorce
of ownership and control in a way that safeguards the interests of shareholders.
Instead, it merely creates an
imbalance of power and a significantly weaker role for shareholders than they
have in company law. Further, the introduction of regulatory oversight has been
criticised by the UK government,27 who
argue it would lead to a restricted role for shareholders. However, Keay’s
recommendation 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, ‘comply
or explain’ has undermined the effectiveness of the UK corporate governance
regime by allowing it to be abused by directors and shareholders are left unable
to hold boards to account.



to incentivise shareholders


combination of an inadequate disclosure obligation and the failure to incentivise
shareholders has undermined the effectiveness of the UK corporate governance
regime, where non-compliance, which is not in the best interest of the company,
goes unchallenged.  Since the financial
crisis, Deakin argues the stresses have very much been on getting shareholders
to be more responsible and active.29
Without a fiduciary obligation to other shareholders or to the company, non-compliance
may be ignored as shareholders
do not invest time, resources and exercising their rights by engaging
with every single investee company and instead favour portfolio diversification.
For example, in 2008 the average shareholder in a mutual fund owned a portfolio
of 91 stocks.30 As
a result, the market-based sanction of ‘comply or explain’ often does not take
effect, as non-compliant companies are no longer seen as riskier investments
and there is no fall in share price to incentivise directors to change their governance arrangements. Furthermore,
a vicious circle is created
whereby 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 engage
shareholders, ‘comply or explain’ has undermined the effectiveness of the UK
corporate governance regime, as not only does poor governance remain
unchallenged but confidence in the regime is lost by stakeholders, who do not
have the right to hold directors to account under ‘comply or explain’.

shareholders who do engage, do so in an apathetic manner. For example, Morrisons
did not comply with most of the UK Corporate Governance Code up until a profit
warning in 2004 triggered increased pressure from shareholders to appoint the
company’s first non-executive director.32
As such, many companies only challenge directors when there is poor financial
performance. Thus, the initial
task set for the Cadbury committee, to respond to concerns of mismanagement and
lacking accountability, was incomplete.33 By only
focusing on board disclosure, ‘comply or explain’ undermines the
effectiveness of the UK corporate governance regime, by failing to engage shareholders
in their crucial role of holding directors to account.


A losing battle?


when analysed in the context of the current UK economy, ‘comply or explain’ is
fighting a losing battle, as current institutional arrangements have a barrier to its overall effectiveness.34
Firstly, the increasing
prominence of institutional investors in the UK is problematic. From 1992 to
2016, the number of shares on the UK stock market owned by the ‘rest of the
world’ and ‘financial institutions’ has risen from 13% to 62%.35 Cadbury
identified institutional investors would play an important role in challenging
non-compliance under ‘comply or explain’, as they have large voting blocks and significant
power.36  Nonetheless, Lord Myners argument is more
convincing that in practice they act as ‘absentee landlords’.37 For
example, the FRC reported that the quality of statements against the Stewardship
Code was ‘not sufficient’ to demonstrate commitment to governance responsibilities.38 Thus,
with diverse portfolios in multiple jurisdictions, institutional investors do
not have the time to devote to engage in corporate governance with individual
companies as required under ‘comply or explain’. Moreover, Moore argues that
institutional investors and proxy voters often employ a ‘box-ticking’ approach.39
This is exemplified in the comments of the Association of Certified Accounts on
the Walker Review.40
Thus, institutional arrangements have increased the divergence of ownership and
control, not only dispelling the dialogue that ‘comply or explain’ seeks to
create between shareholder and director but reduces a detailed examination of
corporate governance to a superficial

Secondly, short-termism in financial markets
has reduced
the task of engaging in ‘comply or explain’ as a collateral concern. The
average holding period of shares on London Stock Exchange has decreased from
over eight years in 1966 to seven and a half months in 2007.41
Thus, shareholders no longer see themselves as owners of a company with an
interest in its sustainable success, rather as traders focused on short-term gains.
Furthermore, shareholders are more
likely to be indifferent to non-compliance statements if their shares retain
their value. Even if non-compliance is criticised, market liquidity
makes it easier to sell shares than engage in corporate governance. Fundamentally, markets built on a shareholder
primacy model42,
which prioritise companies as profit-making organisations, make it difficult
for ‘comply or explain’ to have an impact encouraging directors to consider the
wider implications of their decisions. Therefore, increased institutional
investment and short-termism in financial markets have contributed to the
ineffectiveness of ‘comply or explain’ by distancing shareholders from their
ultimate responsibility as stewards of companies.




conclusion, to argue the principle of ‘comply or explain’ has overtime undermined
the UK corporate governance regime would be overly simplistic. ‘Comply or
explain’ is a double-edged sword. The flexibility underpinning ‘comply or
explain’ has been effective in improving engagement and compliance with UK
corporate governance codes, albeit this should not be over exaggerated.
However, the failure to create a real obligation to make adequate disclosures
and to incentivise shareholders has reduced its effectiveness as a mechanism to
challenge non-compliance. Nonetheless, by looking at the context of the current
UK economy, ‘comply or explain’ is fighting a losing battle. Increased share ownership
by institutional investors and short-termism in financial markets have reduced
‘comply or explain’ to a superficial conception. Thus, even where the principle
has been ineffective, it should not be held solely to blame.


UK Corporate Governance Code 2016.

UK Stewardship Code 2012.

3 OECD, ‘Corporate Governance Factbook’ (2017) 15
6 January 2018.

4 Glen Moreno, ‘A basis for dialogue’ in Financial
Reporting Council (eds), Comply or
Explain: 20th Anniversary of the UK Corporate Governance Code
(FRC 2012) accessed 6 January 2018.

5 Committee on the Financial Aspects of Corporate Governance,
Report of the Committee on the Financial
Aspects of Corporate Governance (Gee, December 1992) para 1.1.

Sarbanes-Oxley Act of 2002.

Mark Moore, ‘The End of Comply or explain’ in UK corporate governance?’ 2009
60(1) NILQ 85.

Charlotte Villiers, ‘Legal Ambiguity in Corporate Governance’ in M Fenwick, M
Siems and S Wrbka (eds), The Shifting
Meaning of Legal Certainty in Comparative and Transnational Law (Hart 2017)

9 P
Stiles and B Taylor, ‘Benchmarking Corporate Governance: The impact of the
Cadbury Code’ 1993 26(5) Long Range Planning 61, 69.


Grant Thornton, ‘Corporate Governance Review’ (2017) 26

accessed 6 January 2018.

SR Arcot and VG Bruno, ‘One size does not fit all, after all: Evidence from
Corporate Governance’ (2007) London School of Economics Research Paper, 9
accessed 6
January 2018.

Marc T Moore, ‘Whispering Sweet Nothings: The Limitations of Informal
Conformance in UK Corporate Governance’ 2009 9 Journal of Corporate Law
Studies 95, 110-112.

14 Villiers (n 8) 252.

Moore (n 13) 118.

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

accessed 6 January 2018.

Adam Smith, An Inquiry into the Nature
and the Cause of the Wealth of Nations (first published 1776, Oxford 2008)
586. See also M Jensen and W Meckling, ‘Theory of the Firm: Managerial
Behaviour, Agency Costs and Ownership Structure’ 1976 3 Journal of Financial
Economics 305.

18 S
Arcot, V Bruno and AF Grimaud, ‘Corporate Governance in the UK: is the
Comply-or-Explain Approach Working?'(2005) Corporate Governance at LSE
Discussion Paper Series No 001, 1
accessed 6 January 2018.

Commission, ‘Green Paper: Corporate Governance in Financial Institutions and
Remuneration Policies’ COM (2010) 285 final, 6.

Moore (n 13) 125-129.

21 Grant Thornton (n
11) 7.

22 Financial Reporting Council ‘What constitutes an
explanation under “comply or explain”?’ (February 2012)

accessed 6 January 2018

23 Financial Reporting Council, ‘Developments in Corporate
Governance and Stewardship 2016’ (January 2017) 7
accessed 6 January 2018.

24 I MacNeil and X Li, ‘Comply or Explain: market
discipline and non-compliance with the Combined Code’ 2006 14(5) Corporate
Governance 486, 492.

25 Enron, ‘Annual Report’ (2000)
accessed 6
January 2018.

David Kershaw, Company Law in Context:
Text and Materials (OUP 2012) 253.

Department for Business Innovation & Skills, UK Government Response to the European Commission Green Paper on the EU
Corporate Governance Framework (Department for Business, July 2011) 17 
accessed 6 January 2018

Andrew Keay, ‘Comply or explain in corporate governance codes: in need of
greater regulatory oversight?’ 2014 34(2) Legal Studies 279.

29 Simon Deakin, ‘Corporate Governance and Financial
Development’ (University of Cambridge
Cadbury Archive, 8 August 2013)

accessed 6 January 2018.

30 T
Sapp and X Yan, ‘Security Concentration and Active Fund Management: Do Focused
Funds Offer Superior Performance?’ 2008 43(1) The Financial Review 27.

31 Alice Belcher, ‘Regulation by the market: the case of
the Cadbury code and compliance statement’ 1995 Journal of Business Law 321,

32 S Arcot, V Bruno and AF Grimaud (n 18) 16.

33 Committee
on 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 Quotes
Shares 2016’ (2017)

accessed 6 January 2018.

Committee on the Financial Aspects of Corporate Governance (n 5) para 6.10.

37 Paul Myners, ‘Speech by the Financial Services
Secretary’ (Association of Investment Companies, London, 21 April 2009) para
accessed 6 January 2018.

Financial Reporting Council (n 23) 7.

39 Moore (n 13).

40 Association of Chartered Accountants, ‘A Review of
Corporate Governance in UK Banks and Other Financial Industry Entities’
(October 2009) 4

accessed 6 January 2018.

41 John
Kay, ‘The Kay Review of UK equity markets and long-term decision making’
(European Corporate Governance Institute, July 2012) para 3 accessed 6 January 2018.

Adolf Berle, ‘Corporate Powers as Powers in Trust’ 1931 44 Harvard Law Review
1049, 1049.