Comply or explain under threat
Now that investors and the directors of Marks and Spencer appear to have reached a compromise over the elevation of Sir Stuart Rose to executive chairman, it is time to re-examine the sacrosanctity of the UK ‘comply or explain’ corporate governance framework.
The strength of the ‘comply or explain’ framework has always been its flexibility. It is not about regulation or coercion and is anything but a one-size-fits-all framework. The introduction to Sir Derek Higgs’ groundbreaking corporate governance report makes this point very clearly: “The Combined Code and its philosophy of ‘comply or explain’ … offer flexibility and intelligent discretion and allows for the valid exception to the sound rule.”
Nevertheless, in the wake of the furore around Rose’s promotion, questions have to be raised as to whether the ‘comply or explain’ framework is sustainable. Whatever the debate around his executive chairmanship, the Combined Code should have provided the backdrop for an amicable solution.
A properly prepared, crafted and cogent explanation should be the starting point. The investor community should then evaluate the issue paying due regard to the individual circumstances of the company and the risks and challenges it faces. We will probably never know all the facts but the very public battle reported in the media has done little to engender the levels of partnership and trust one would expect.
Most worrying of all has been the suggestion from some investors that bellwether companies should not be explaining why they are not complying – they should be complying. There have, for a long-time, been those that have argued that institutional shareholders are driven by their own structures to force companies to comply – maybe we are now seeing the evidence. Of course companies do have a responsibility to uphold the highest standards of corporate governance – but this doesn’t necessarily mean compliance with every Code provision.
Looking more widely, there is no doubt that institutional behaviour has a big role to play in ensuring the success of the ‘comply or explain’ framework but companies that allow themselves to be pushed into a one-size-fits-all framework, will have to bear part of the blame themselves. The battle will be lost before the first shot is fired if companies seek compliance for compliance sake. This will not be good for boards, business or shareholders.
Boards must choose not to comply with those provisions that they genuinely believe will be detrimental to the business itself. However, this does not mean boards should stretch the spirit of the Code for the sake of their own convenience. Successive surveys have revealed routine non-compliance with certain of the current Combined Code provisions and, on the whole, those companies that have chosen non-compliance have done so without fear of unreasonable shareholder backlash. Hopefully there is no reason to believe that this situation cannot continue – providing non-compliance is properly explained and evaluated objectively.
It is, however, a two way process. Investors are often criticised by the corporate community for interpreting non-compliance as failure but how can they do otherwise when many ‘explanations’ have historically amounted to little more than statements of the blindingly obvious?
It is not sufficient to simply disclose that a course of action has been taken because it is ‘appropriate to the company’s circumstances’. There may be many valid reasons to depart from the Code, but these must be explained fully – after all, if boards make conscious decisions in the interests of their company’s members, then they should not be afraid to articulate their reasoning to those very same people.
Only when corporates make proper disclosure can they criticise investors for taking an unwarranted, and unhelpful, box ticking approach. However, this does not mean that the investor community doesn’t have to look closely at its own responsibilities.
‘Comply or explain’ will not work in an environment where investors or quasi-regulatory bodies are simply telling companies to comply. The principle requires the commitment of institutional shareholders and, in particular, their compliance officers to devote the time necessary to assess each company’s explanation.
Just as non-executive directors are being called upon to behave in an objective, diligent and informed manner, those responsible for interpreting board’s statements regarding their governance practices must be equally accountable. As their caseload continues to grow, the institutions face a significant challenge in applying intelligent discretion in an enlightened manner.
If the ‘comply or explain’ framework is to continue to be successful, it must have the ‘buy-in’ of both the investor and corporate community. parties. However, the rhetoric of the recent debate must also change if confidence in the capital markets is to be restored.
Boards must explain their governance procedures in an open and transparent way and not be ‘bullied’ into Code compliance when compliance is not in the best interests of the company. Likewise, investors must ensure they interpret governance disclosures in an enlightened and objective manner. At the end of the day it all comes down to communication – simple open and transparent communication.
*Timothy Copnell is a director of the Audit Committee Institute at KPMG.
Tags: combined code, corporate governance, compliance officers, investor community, marks and spencer, governance practices, governance procedures, institutional shareholders, derek higgs, stuart rose, chairmanship, timothy copnell, kpmg, compliance,
