Comply or explain

Comply or explain is a regulatory approach used in the United Kingdom, Germany, the Netherlands and other countries in the field of corporate governance and financial supervision. Rather than setting out binding laws, government regulators (in the UK, the Financial Reporting Council (FRC), in Germany, under the Aktiengesetz) set out a code, which listed companies may either comply with, or if they do not comply, explain publicly why they do not.

The purpose of "comply or explain" is to "let the market decide" whether a set of standards is appropriate for individual companies. Since a company may deviate from the standard, this approach rejects the view that "one size fits all", but because of the requirement of disclosure of explanations to market investors, anticipates that if investors do not accept a company's explanations, then they will sell their shares, hence creating a "market sanction", rather than a legal one. The concept was first introduced after the recommendations of the Cadbury Report of 1992.

Usage

The UK Corporate Governance Code, the German Corporate Governance Code (or Deutscher Corporate Governance Kodex) and the Dutch Corporate Governance Code 'Code Tabaksblat' (nl:code-Tabaksblat) use this approach in setting minimum standards for companies in their audit committees, remuneration committees and recommendations for how good companies should divide authority on their boards. Swedish company law requirements expect companies to identify any code rules which they have not complied with, explain why they have not complied, and describe their alternative solution.[1]

Under the revised Shareholder Rights Directive of 2017 (SRD II), companies must develop and publish a policy stating how voting rights operate and how shareholders are engaged in the running of the company, subject to the "comply or explain" principle.[2]

Benefits and drawbacks of the Comply or Explain approach

The approach has both benefits and drawbacks.

Enforcement and supervision

Due to the drawbacks to the comply or explain approach, several studies have proposed that an increased level of (public) enforcement and supervision is necessary in order to monitor inadequate explanations of non-compliance. (Lu 2021;[6] Hooghiemstra 2012;[14] Keay 2014;[20] Seidl et al. 2013;[21] Boiral 2013[19]). Since the explanation for non-compliance is the cornerstone of the comply or explain approach, authors are specifically calling on public enforcement authorities to take a more active role. (Lu 2021;[6] Hooghiemstra 2012;[14]

See also

• UK company law
• German company law