Corporate Governance: An Analysis of the Explain or Comply Principle

This report provides an in-depth analysis of corporate governance, with a specific focus on the 'explain or comply' principle, which is a crucial aspect of legal disclosure in the European Union. The report explores the principle's origins in the Cadbury Committee and its evolution, examining the debate surrounding voluntary compliance versus rigid legislation. It delves into various national corporate governance codes, including those in the United Kingdom, France, and Germany, and their alignment with OECD principles. The report discusses the significance of corporate governance in addressing agency costs, particularly in organizations with dispersed ownership. It also examines the key issues addressed by corporate governance codes, such as transparency, board composition, and executive remuneration, while highlighting the Danish management structure as a case study. The report further investigates compliance studies, disclosure studies, and the complexities associated with the 'explain or comply' principle, including the potential for poorly rationalized explanations. It also covers statutory mechanisms, legitimacy theory, and the impact of CEO characteristics and firm performance on corporate governance practices. The report concludes by assessing the impact of soft statutory initiatives and the importance of monitoring and enforcement in ensuring effective corporate governance.

Running head: CORPORATE GOVERNANCE
CORPORATE GOVERNANCE
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Introduction
The explain or comply principle is the compulsory rule of legal disclosure in 28 member
nations of the European Union from the provisions of legitimate corporate governance code, and
the same is drafted by the autonomous bodies. Therefore explain or comply principle that is
originally placed by the Cadbury Committee in the country of the United Kingdom as the
method of establishment of optimum corporate governance1. However, evading the rigid hard
legislation framework. Though the national legislation establishes upon flexible law, it is
debating issue if the volunteer scope of compliance is adequate in the advancement of a high
range of optimum practice among the listed companies for the argument and overview that
voluntary nature of codes may restrict the capability to enhance practices of corporate
governance.
The nation has its own corporate governance codes wherein various structures have
created a particular recommendation that rests on the notion of explaining or comply. The codes
are initiated by several entities with the lesser or greater grade of the participation of the state.
For instance, the Combined Code in the country of the United Kingdom is delivered by an
autonomous regulator that is the Financial Reporting Council2. The French codes of corporate
1 Rose, Caspar. "Firm performance and comply or explain disclosure in corporate governance." (2016) European
Management Journal 34.3 202-222.
2 Rejchrt, Peter, and Malcolm Higgs. "When in Rome: how non-domestic companies listed in the UK may not
comply with accepted norms and principles of good corporate governance. Does home market culture explain

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governance that are drafted by the private bodies, the German code of corporate governance are
issued by the government commission.
Principles of OECD
Therefore the national codes are stimulated by the functioning of a worldwide
organization such as the European Governance Forum and Observance of Standards and Codes.
The principles of OECD are emerged to guarantee the worldwide economic stability of the
Financial Stability Board. The principles of OECD are recently under reconsideration for the
purpose of guaranteeing the ongoing relevance, high standards, utilization of the notion by taken
in regard to the current changes in capital markets, and corporate sectors. Corporate governance
is significant in a situation where there exists demarcation in between control and ownership,
particularly in the organization with the dispersed ownership. Nevertheless, due to the issue of
free-rider that is connected with the dispersed ownership, the stakeholders do not hold a reward
to encounter management of incumbent that allows top management the substantive quantum of
authority. The dispersed ownership indicates that the individual stakeholders only possess the
minor stake ownership in the corporation. The achievement from the active ownership should be
demarcated among the passive stakeholder irrespective of the fact that cost is incurred by the
active stakeholders. The incentives encounter the executory or supervisory board that can be
restricted.
Separation between control and ownership
Corporate governance can be defined as the mechanism and method by which the cost of
the agency is reduced, so the concern among the members of the executive or supervisory board,
as well as the shareholders, are inclined3. It is argued by Vishny, Tirole, and Shleifer that
extensive description that involves broader series of shareholders such as creditors, employees,
these corporate behaviours and attitudes to compliance?." (2015) Journal of Business Ethics 129.1: 131-159.
3 Ho, Virginia Harper. "Comply or Explain and the future of nonfinancial reporting." (2017) Lewis & Clark L.
Rev. 21: 317.

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local community, and customers. Nevertheless, the cost of the agency is minimized; it is
significant that financiers are in place to assess as to whether directors board monitor approvable
policies of corporate governance. The codes of corporate governance comprise of the
recommendation that can be complicated to separate and quantify. Nevertheless, it is relevant for
the investor and financers to ascertain as to whether the positive impact of the economy
connected with the recommendation of corporate governance.
Code of corporate governance
The code of corporate governance tackles the issues that involve transparency, board
composition, and remuneration. They may differ in structure and size; nonetheless, they
concentrated on the significant zones. The optimum corporate governance stresses the
shareholders and investors are self-assured that top managerial cater to the best concentration of
corporation. This self-assurance reduces agency premiums that may lower the cost of the firm
concerning capital. The reporting of the codes of corporate governance cater to transparency;
however, the standards can be particular to the viewpoint of the corporation. It may be argued
that the corporation must be penalized if it invites the explanation as to why it takes a decision
not to carry out a specific recommendation. This provides a high standard of flexibility rather
than extreme rigid legislation that is emphasized, for instance, the code of corporate governance
of the United Kingdom.
Danish Management
The Danish management structure comprises the executive board and supervisory board4.
The supervisory board is accountable for the management of the executive board. The
supervisory board should allow all decisions that are highly important. The initial Danish
Corporate Governance Code was issued in the year 2001 and, after that, undergone several
revisions. It explains principles or complies that indicate that the corporation should comply with
certain recommendations else the corporation must demonstrate as to why it takes the decision
not to carry out what is deemed as best practice.
4 Tricker, RI Bob, and Robert Ian Tricker. Corporate governance: Principles, policies, and practices. (Oxford
University Press, 2015).

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LITERATURE
Most portion of the literature concentrates on compliance. Nevertheless, it must be
marked that compliance is something more in comparison to disclosure. The corporation may
disclose as to whether they comply or not. The most dangerous condition is when the corporation
does not reveal as they did not comply—therefore resulting in which the following provisions of
literature are categorized in succeeding subsections. It involves disclosure studies, compliance
studies, and other contributors.
Compliance studies
The corporate governance code f United Kingdom that was revised in the year 2003
facilitates more prominence to the character of non-executive directors who are intended in the
corporate governance body of the company in addition to that the process of decision making5.
Pass 2006 studied the rank of compliance along with the novel code. He discovered that in 50
major firms of the United Kingdom, 11 of them remained in infringement of code on several
occasions. The author categorized it into offered “acceptable” explanation, fully complied,
breach of code. The studies examine the association between the compliance and performance of
the corporation is Mendes and Alves (2004), who considered the listed firms of Portuguese. The
Portuguese code that was issued in the year 1999 and modeled on the guidelines of OECD. It has
been illustrated by relevant studies that the manner of soft legislation may receive a
comparatively higher standard of approval among the firms that were listed, which emphasize
the character of “best practice” of the recommendation of corporate governance. The code
facilitates developing the practices of corporate governance as the corporation starts adapting to
recommended standards that were not implemented in the past. The standard of corporate
governance can be made by several methods. The corporation may comply with a specific
recommendation. The companies may demonstrate as to why they were not complying. The
corporation may make no mention of it. The research implemented in Germany and the UK,
examining the magnitude to which the significant public corporation comply with specific
5 Griffith, Sean J. "Corporate governance in an era of compliance." (2015) Wm. & Mary L. Rev. 57: 2075.

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recommendations6. They observed positive conformance along with the codes rest on elements
as the degree to which the firm that is listed engaged in revision and formation of code.
Complexities with explain or comply principle
One of the difficulties with “explain or comply” norm is some companies may facilitate
explanation, and the same are deemed to be poorly rationalized7. The concern is settled by Arcot,
who research the efficiency of norm applying the exclusive database of about 245 non-financial
firms of the United Kingdom for the age of six years. Nevertheless, they observed the enhancing
trend of compliance; they emphasize the common applicability of the poor language at the time
the explanation was provided. They contend that the “explain” portion of code is unproductive.
In particular, they mix the ratio of the frequency of the specific explanation to the frequency of
the non-explanation for about eight provisions. The ratio is implemented to ascertain the
comparative importance of “comply or explain” norm in comparison to the statutory initiative.
They reveal that the ratio that had been estimated is lowermost for provisions that are connected
to one-third of the non-executive directors. Furthermore, the major portion of autonomous non-
executive directors, the composition of the committee of remuneration, proposing the
significance of elasticity is lowermost for the particular provisions—the affirmative relationship
between compliance governance and performance8. The methodology settles the issue of
classical endogeneity that is spread to the studies of corporate governance by the application of
instruments as well as 2SLS. The tool is interlinked with endogenous variables; however, it is
6 Elmagrhi, Mohamed H., Collins G. Ntim, and Yan Wang. "Antecedents of voluntary corporate governance
disclosure: A post-2007/08 financial crisis evidence from the influential UK Combined Code." (2016) Corporate
Governance .
7 Aguilera, Ruth V., et al. "Connecting the dots: Bringing external corporate governance into the corporate
governance puzzle." (2015): The Academy of Management Annals 9.1 483-573.
8 Aguilera, Ruth V., et al. "Connecting the dots: Bringing external corporate governance into the corporate
governance puzzle." (2015): The Academy of Management Annals 9.1 483-573.

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not connected with fault term that is exogenous. The variable that is independent and exogenous
of disturbance is reserved to cater as an instrument. The study of compliance of 126 firms of
Dutch examines none categories of stimuli concerning non-compliance9. They observed that the
company frequently provides justification for deviation from the external principles by
disclosing the internal practices. The uniform method o adopting standards concerning upright
corporate governance that is not in stroke with the meaning or logic of code in addition to that
cast disbelief of efficiency of soft legislation.
Statutory mechanism
Therefore the restrictive statutory mechanism may be required to establish company
confirm to the spirit of corporate governance codes. It is documented by Gutierrez and Surroca
that the recommendation that is monitored by 25% of the corporation comes within the category
of application of diverse board committees, data about the commercial transaction by board
independence, executive committee, board members, gender issue and disclosure of
remuneration of individual CEO. The examination of 257 listed companies in Germany and the
UK reveals underlying logic as well as determines several legitimacy tactics and the
implementation of the same for policymakers. The legitimacy theory is the connection between
audiences and the organization. The legitimacy theory is not regarding the action or structure of
the corporation rather regarding the specific relationship with the audience. It enumerates that
corporations will ensure or endeavor that audiences recognize structures and actions as desired
by them and also appropriate or proper10. The legitimacy theory is the generalization of the
phenomenon, the explanation of why or how something occurs. The legitimacy is the assumption
9 Das, Arindam, and Sourav Dey. "Role of corporate governance on firm performance: a study on large Indian
corporations after implementation of Companies’ Act 2013." (2016) Asian Journal of Business Ethics 5.1-2: 149-
164.
10 Glass, Christy, Alison Cook, and Alicia R. Ingersoll. "Do women leaders promote sustainability? Analyzing the
effect of corporate governance composition on environmental performance." (2016) Business Strategy and the
Environment 25.7: 495-511.

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ore general perception that the action of the individual is proper, desirable, or appropriate among
the socially constructed structure of principles, beliefs, values, and definition. Therefore on
analysis of the combined code of UK along with that The German Cromme Code, it is observed
that two codes comprise 48 and 82 code provisions.
Disclosure entities
The connection between CEO characteristics, firm performance in addition to that
changes in the practice of corporate governance rest on a large sample of the firm of the US from
the period 1980 to 1995. The stakeholders are likely to approve the enhancement of authority of
the board of directors in respect of an effective performing company. However, the board of
companies that were conducting poorly is probable to start changes to governance as poison pills
that evade the approval of the shareholder. The connection between the value of the firm and
corporate governance features before and recommendation in the manner of soft legislation in
the Netherlands. The soft statutory initiatives of the private sector had no impact on firm value or
corporate governance characteristics. It is argued that initiatives are effective; monitoring should
be assisted by enforcement11. The concern of compliance of corporate governance from the
European viewpoint has settled by Willekens and Vander Bauwhede, who research compliance
disclosure rest on the sample of FTSE Euro top 300 corporations. The final sample involves 130
corporations and relies on a compliance rating that is provided by the firm of private rating.
Transparency
The executive remuneration becomes a matter of concern amongst the media and
investors. The transparency concerns executive remuneration is regarded as chief characteristics
in the code of corporate governance. The company that paid greater average remuneration to
members of the executive board was probable to compliance with the recommendation to reveal
remuneration on an individual basis. Therefore the company with high Tobin’s Q’ was probable
11 Adams, Michael. "Board diversity: More than a gender issue." (2015) Deakin L. Rev. 20: 123.
Larcker, David, and Brian Tayan. Corporate governance matters: A closer look at organizational choices and their
consequences.( Pearson education, 2015).

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to comply. In addition to that, the methodologies evade the conceptual complexities of assessing
the quality of disclosure as well as connecting it to the effectiveness because they restrict the
research to the simply verifiable disclosures. They examine the German code principles that
recommend the disclosure of individualized remuneration.
Disclosure
The disclosure of individualized remuneration is to simplify verifiable and not reported
remuneration amounts and remuneration. Dia and Bozec discover the practices of corporate
governance of Canadian corporation concentrates on as to whether convergence phenomenon
proof in prior research is restricted to the mandatory requirements implicate by the regulators or
whether it replicates the actual behavioral transformation. It is revealed that Canadian company
enhances the practices of corporate governance in post-Enron period primarily in zones
authorized by the guidelines such as attributes12. Composition and operation of board committees
and the board of directors. There is no significant enhancement in the best practices of non-
regulated governance, proposing no change of behavior amongst corporate leaders.
Independence of board
The regular deviation in the United Kingdom concerned with following that involves the
requirement of board majority to be autonomous non-executive directors, audit composition as
well as remuneration committee, and also the necessitates forb majority members of nomination
group to that is necessitating be autonomous. The section with the higher grade of deviation in
the country of Germany was diverse from that of companies of the United Kingdom that is the
individualized reveal of the compensation to board members of management. It is followed upon
by approving appropriate deductible for the insurance policy in addition to that necessitating the
individualized disclosure of the compensation to the board members of the supervisory
committee.
Other contribution
12 Lakhal, Faten, et al. "Do women on boards and in top management reduce earnings management? Evidence in
France." (2015) Journal of Applied Business Research (JABR) 31.3: 1107-1118.

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In a Traditional manner, the categorization of the structure of corporate governance has
been designated as belonging either to shareholder or market model in the Anglo-American
nations or stakeholder or bank oriented model to the non-Anglo American nations. The outcome
of the legitimate foundation on economic changes has explored extensively within corporate
governance. It discovers the national principles codes of corporate governance and legal
foundation in between the civil and common law countries13. They explore the code issuance in
the countries of common law that can be prompted by legal reasoning rather than the
identification to enhance governance practice of the national firms. Furthermore, the good
corporate governance codes encompass the principles on the composition of the board as well as
autonomy with the exemption of the role of employee, interest conflict, director’s deontology,
and directorship of the board. The principles through the compliance disclosure determine the
drawbacks that stopping them from becoming efficient methods to particular self-control
category of behavior. Therefore specifically, it can be argued that explain or comply principle
can amount to the frontage of commercial conformity or cater as tick box exercise as an
alternative of disclosure of corporation’s bonafide calculation of norm the application or
proposal to an individualized situation of corporate.
Objective
The main objective is that it seeks to create a connection between firm performance and
the quality of disclosure of corporate governance. It is argued by some authors that initiatives
may be problematic to create. Henceforth in a statement, it is argued by Bolton, Bhagat, and
Romano that the efficiency of implicating corporate governance guides the performance of
prediction can agonize from the methodological drawbacks. Thus in a specific manner, there is
no consistent connection as there is no preeminent measurement of the corporate governance in
addition to that structure of efficient governance rest on specific circumstances and context of the
firm14. Furthermore, there is no uncertainty that it is complicated to create a relationship.
13 Miglani, Seema, Kamran Ahmed, and Darren Henry. "Voluntary corporate governance structure and financial
distress: Evidence from Australia." (2015) Journal of Contemporary Accounting & Economics 11.1: 18-30.
14 Dobija, Dorota. "Exploring audit committee practices: oversight of financial reporting and external auditors in
Poland." (2015) Journal of Management & Governance 19.1: 113-143.

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Nonetheless, it seeks to establish an attempt to describe the connection by application of the
novel methodology to the disclosure of quantifying compliance.
ROE and ROA
The article pursues to fill the gap in between the level of compliance of corporate
governance infirm or demonstrate disclosure, as well as financial performance of firm, is
assessed by ROE and ROA15. The fiscal performance is not complicated to assess however the
relationship in between the grade of compliance of corporate governance or to demonstrate
performance and disclosure is inadequately changed as the initial provision of the literature
reveals. One reasoning is it is not vibrant in the literature on the method the corporate
governance comply or demonstrate the disclosure can be appropriately quantified. ROE and
ROA are the fiscal performance that is assessed in literature as they ascertain the profit of
corporation in the connection to aggregate employed assets or resources in addition to that equity
of the stakeholders.
Critical analysis
The proponents of the soft legislation argued that the initiative, in contrast to the stringent
legislation, identifies that “one size does not fit all” by facilitating corporate with the higher
grade of the elasticity16. The others are skeptical that the advantage of elasticity as well as the
self-regulatory standard of codes is exaggerated in addition to that code must be assimilated in
the mainstream corporation law17. The study conduct on the compliance of British corporate with
Combined code concentrates on the scope of explanation provided by corporation with establish
15 Alfraih, Mishari M. "The effectiveness of board of directors’ characteristics in mandatory disclosure
compliance." (2016) Journal of Financial Regulation and Compliance.
16 Jo, Hoje, Moon H. Song, and Albert Tsang. "Corporate social responsibility and stakeholder governance around
the world." (2016) Global Finance Journal 29: 42-69.
17 Ntim, Collins G. "Corporate governance, corporate health accounting, and firm value: The case of HIV/AIDS
disclosures in Sub-Saharan Africa." (2016): The International Journal of Accounting 51.2 155-216.

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a record of the non-compliance as well as character of market in approving the deviations. They
observed that the tolerance of investors of non-compliance connect to the magnitude with the
superior fiscal performance in context of the changes of share price18. Nevertheless the authors
discourse the chief concerns that is connected with non-compliance that is the method the issue
is excused and regulated. In majority of cases the assignment is put in hands of individualized
stock exchanges19. In Copenhagen Stock Exchange the corporate with low grade of compliance
are communicated informally in addition to that motivate to enhance their compliance20. The
official authorizations have not been executed for severely insufficient compliance of corporate
governance.
Sarbans Oxley Act
The non-compliance in Netherland is in manner of silence concerning the best practice is
unlawful. The enhance compliance envisages greater cost as the companies should devote effort
as well as time to cohere principles of the “ best practice”. Langendijk and Sneller conduct case
study wherein they examine the expense of compliance in pursuance to Section 404 in Sarbans
Oxley Act. They observed that internal time that is spend on calculation are 12 times greater than
initial estimation by SEC in the year 2002. It is suggested that 50% of audit fee of the firm in
initial year under Section 404 compliance21. It is suggested that the corporation can minimize
compliance cost by invoking programmed management applying auditors from the nations with
18 Otieno, Kennedy, et al. "Effect of corporate governance on financial performance of SACCOS in Kenya."
(2015) Research Journal of Finance and Accounting 6.2 48-58.
19 Balachandran, Balasingham, and Robert Faff. "Corporate governance, firm value and risk: Past, present, and
future." (2015) Pacific-Basin Finance Journal 35: 1-12.
20
21 Marquardt, Carol, and Christine Wiedman. "Can shareholder activism improve gender diversity on corporate
boards?." (2016) Corporate Governance: An International Review 24.4: 443-461.