A new report from Mazars, EcoDa and ECGCN highlights some of the issues arising from the diversity of corporate governance codes in the EU states. Launched at the European Commission in Brussels, ‘Corporate governance, compliance and monitoring systems across the EU’ reviews how the ‘comply or explain’ principle is being applied across the EU and the potential for the code to drive further improvements in corporate governance.
Speaking at the launch, David Herbinet, UK Head of Public Interest Entities and Global Audit Leader at Mazars, said “Poor corporate governance continues to damage reputations and shareholder value. ‘Comply or explain’ is the key principle behind the implementation of the codes and is designed to improve governance. But the codes are just the tip of the corporate governance iceberg. They should be used to drive better governance by encouraging a longer-term view of business performance, leading to sustainable behaviours which create value for companies, their stakeholders and wider society.”
According to the report, two major problems are that the explanations are of variable quality and that shareholders and proxy advisers prefer a company to comply with its national code, rather than to understand and appreciate why making an exception is sometimes the best option. This can lead to compliance being treated as a ‘tick box’ exercise rather than as a considered approach to implementing good corporate governance.
‘Comply or explain’ can contribute to sustainable success if three conditions are fulfilled:
- Boards should be willing to depart from a particular part of their code, where necessary, rather than taking the easy route and complying rather than explaining. Larger listed companies, in particular, alas seem to be under pressure to comply rather than risk the annoyance of their investors, and particularly the proxy agencies, by departing from a particular code provision.
- National codes must be focused on encouraging businesses to achieve long-term sustainable success rather than being rule-based in a way which permits compliance whilst adopting a short-term profit maximisation approach.
- Thirdly and most importantly, boards and the investors in their business must be committed to the benefits of striving for sustainable success. It is by no means an easy route: it needs the right ‘tone at the top’ and for business leaders to stick to it even when there are short-term challenges. A compelling and lasting purpose and a long-term strategy linked to comprehensive risk assessments should drive decision-making in the business.
The issue of the use of explanations is covered in depth. The authors of the report believe that a well-respected monitoring regime would lead to better acceptance of ‘explanations’ and that the company secretary could have an important part to play. As part of their role in managing relationships with investors, company secretaries could encourage shareholders to understand explanations and be comfortable with them
Higher quality, more standardised explanations would also help investors to accept the value of deviating from the code where appropriate. While the decision to comply or explain must be left with the individual company, and the code is a matter for each country, the quality of explanations could become more standardised and actively monitored, with benefits to the participants.