Corporate Governance and Comply or explain approach in the UK: evolution, impact, and limitations

Abstract

The UK corporate governance codes date back to the late 20th century. Their beginning is marked by the adoption of the comply or explain approach, which revolutionised corporate governance by giving the codes voluntary character. This approach provides that companies have the flexibility to choose between strict adherence to the code or the provision of justifiable explanations in case of deviations. Thus, comply or explain resulted in a departure from the rigid hard law instruments to regulate corporate governance and was a step forward for the development of internal structures for audit and control. What this study aims to answer is whether the comply or explain has a place in the present corporate governance practice and how it has contributed as a corporate governance approach in the last thirty years. Thus, a conclusion was reached that this principle has both positive and negative features; however, its place in the UK’s corporate governance practice remains crucial for providing guidance on corporate conduct. This study found that the UK corporate governance codes are prominent with their flexibility, accountability and transparency resulting from the application of comply or explain. Consequent to the adoption of this principle, a more dynamic and adaptable corporate governance landscape was formed. Companies are now encouraged to tailor the rules so that they fit their needs, since companies differ dramatically in size, functions, and economic place. This choice between compliance or explanation allowed companies to experiment and innovate, which in turn led to diverse and effective corporate governance practices. Simultaneously, this approach also required clear explanations in case of noncompliance, which fostered accountability and transparency within the company. However, the comply or explain is is not without its downsides. The most detrimental among them is the heavy reliance upon shareholders’ engagement since the latter are the ones responsible for evaluating the quality of explanations given by executive directors. Additionally, it was found that companies provide only formal compliance, as their ‘tick-thebox’ mentality does not allow them to apply the spirit of the voluntary recommendations rather than the text itself. Thus, the reflexivity of the process is under question.