The ”comply-or-explain” model of corporate governance should be softened to demand fewer explanations, in response to calls in some circles for the UK Corporate Governance Code to be abolished.
The reform agenda comes from academics arguing there is still mileage in corporate governance codes, despite criticism that they encourage “box-ticking” and overlap with laws and regulation elsewhere.
Writing for the Oxford University business law blog, Piergaetano Marchetti and Maria Lucia Passador refute the need to abolish codes, saying they have been “flexible, swift and innovative” and often had the “merit of facilitating considerable experimentation,” and these are features that are necessary in a world adapting to ESG.
But the pair do claim that the comply-or-explain principle, at the heart of codes in the UK and across Europe, may need modification.
They say the principle needs a “refinement”, so that explanations about deviation from the code are necessary only when a company itself decides they are useful or when they are “requested by a qualified minority of shareholders at the annual meeting”.
The proposals may leave some investors cold, given their reliance on governance codes to help overcome the age-old “agency problem” of companies being owned by shareholders yet run by management.
The argument for abolition of the code was outlined by Cambridge profs Bobby Reddy and Brian Cheffins in an article which asked Board Agenda to consider: “Would corporate governance really be less effective without the UK Corporate Governance Code?”
They claim expansion of the code since it was first introduced 30 years ago means expectations are now that companies will comply rather than explain.
That in turn, they say, has led to box-ticking and leaving scope for “governance innovation” by “high-growth companies”. This is problem for the London Stock Exchange, which has seen its cohort of listed companies drop from around 2, 429 in 2015 to 1,963 (as of November this year).
Reddy and Cheffins write that much of what the code demands is repeated elsewhere in UK practice and law, leaving what has become a key component of the UK market somewhat redundant.
They also argue the code is ill suited to deal with ESG issues. Policymakers, they say, have used the code as a dumping ground for issues that should be catered for elsewhere. The code is currently undergoing fresh renovation, which will result in new provision on internal controls, board and audit committee responsibility for ESG, audit tendering, as well as beefed-up measures for “malus and clawback arrangements”.
“With most UK Corporate Governance Code guidelines being well-entrenched as governance norms,” write Reddy and Cheffins, “now is the time to move away from a comply-or-explain code to a streamlined set of mandatory governance disclosures that will give shareholders the governance information they really need.”
While there may be concern about the ever-expanding nature of the code, the fact it is viewed as a model for markets elsewhere in the world will be a major obstacle to its abolition. Familiarity will be another. And as Marchetti and Passador point out, it’s not a given that the code is a major block to more listing in London. Work is under way to introduce dual class shares, matching markets elsewhere, as well as a number of other measures to make listing more attractive.
As Brexit, inflation and higher interest rates bite ever deeper into the UK economy, the hunt will be on to make the country more competitive. Government is already proposing to reform financial markets in the so-called Edinburgh reforms which would see the relaxation of rules put in place after the 2008 financial crisis. It’s not beyond all speculation that the governance code could also become a target.