The UK Corporate Governance Code (formerly the Combined Code) is primarily a best practice standard of governance for the quality of a company’s board leadership, effectiveness, accountability, remuneration process and investor relations. Apart from references to relevant statutory regulations, the code itself has no legal force but it does require a company to comply with the provisions of the code or explain why it has not done so.
The “comply or explain” approach recognises that good governance cannot be constrained by ever-increasing statutory regulations which tend towards a “one size fits all” solution.
Sometimes, an alternative to following a provision of the code may be justified in particular circumstances. A condition of doing so is that the reasons for it should be explained to shareholders who may wish to discuss the position with the company and whose voting intentions may be influenced as a result
The code requires that a company’s explanation in its annual report “should aim to illustrate how its actual practices are both consistent with the principle to which the particular provision relates and contribute to good governance.” The principle of “comply or explain” means that companies are accountable to shareholders who can exercise sanctions rather than being accountable to a regulator such as the Securities and Exchange Commission (SEC) in the US.
The UK Financial Reporting Council claims that the ‘‘comply or explain’’ approach is the “trademark of corporate governance in the UK ” and is strongly supported by both companies and shareholders. The EU Statutory Audit Directive 2006 now requires all member states to adopt the “comply or explain” approach for its listed companies.