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Corporate governance: does ‘comply or explain’ have a future?

The Financial Reporting Council reckons it does, citing research showing 96% of FTSE 350 companies comply with corporate governance codes

The basic tenet of the corporate governance rules that have been nurtured since the early 1990s revolve around the idea of “comply or explain”. A company should comply with the code – for instance not having the same person acting as chairman or chief executive – but can get away with it if they are able to explain their actions convincingly to shareholders.

The European Union, however, is not convinced it works and has raised questions about the reasons companies give for their deviation from the rules set out in the codes.

The Financial Reporting Council – which now polices the UK’s corporate governance codes – has set out why it reckons “comply or explain” should survive. It cites research by Grant Thornton showing that 96% of companies in the FTSE 350 comply with the elements of the codes that apply to them – though it also admits that some egregious deviations can undermine the whole concept.

The FRC has held a couple of discussions on what counts as a convincing explanation. There are three basic elements:

• Set the context and historical background.

• Give a convincing rationale for the action.

• Describe mitigating action to address the deviations from the code.

The explanation should also indicate whether the deviation from the code’s provision was limited and when the company intended to return to conforming with the provisions.

The FRC is now considering whether to incorporate these ideas into future consultations on the code. It might be one way to ensure that the principle of “comply or explain” survives another 20 years or so.

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