What is Comply or Explain?

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.

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How is Comply or Explain Used?

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.