Is ‘Comply or Explain’ Corporate Governance Outdated?
Out with ‘comply or explain’, in with ‘apply and explain’! With this message, the National Committee on Corporate Governance of Mauritius recently presented its 2016 draft proposal for a new Corporate Governance Code – the widespread and increasingly popular instrument in corporate governance regulation. In the published proposal, the committee touts Mauritius’ pioneering role as regulatory innovator, stating that:
“This is a departure from the ‘comply-or-explain’ approach associated with the Cadbury Report in the UK (1992) and the ‘apply-or-explain’ approach associated with the Dutch Tabaksblat Code of Corporate Governance (2004) and the King III Report of South Africa (2009)”.
As Robert Goddard has pointed out in his recent blogpost on the matter, the Mauritian approach is not as novel as they have presented it to be: South Africa’s first draft of the King IV Code on corporate governance, published before the Mauritian initiative, already contained a so-called ‘apply and explain’ philosophy. Close, but no cigar.
Corporate governance regulation is, of course, not an innovation race. All proposals should be judged on their merits, not on the swiftness of their publication. The question, then, is what it is that these two committees on corporate governance are proposing. What is this path breaking form of regulation? Could the now well-known ‘comply or explain’ approach, first introduced by the Cadbury Committee in 1992, be outdated?
The current rules of the game
Let us take a step back and review the array of principles already in force. The main regulatory mechanisms on which Corporate Governance Codes are based are (i) the original ‘comply or explain’ approach, (ii) the limited ‘comply or disclose’ approach, (iii) the two-pronged ‘apply’-then-‘comply or explain’ approach, and the (iv) ‘apply or explain’ approach. ‘Comply or explain’, the first flavour, is the principle associated with the first corporate governance code, the Cadbury Report on Financial Aspects of Corporate Governance of 1992. According to this mechanism, companies should in principle comply with the code’s provisions, and explain any deviations. This principle underpins both the current UK Corporate Governance Code and (second Mauritian slip!) the Dutch Corporate Governance Code, and is the strictest of the four principles.
The second principle – ‘comply or disclose’ – holds that companies must comply with the code’s provisions, or disclose any deviations without any explanation. This was the approach initially adopted in Germany, which later moved on to a ‘comply or explain’ principle, too. The third, most complex principle, is the French ‘apply’-then-‘comply or explain’ principle. It holds that companies must first decide whether to subject themselves to the code. If they do choose to ‘apply’, a Cadbury-style ‘comply or explain’ mechanism kicks in. Lastly, there is the ‘apply or explain’ approach, adopted in the current King III Code of South Africa. It seems that this principle is only slightly different from the ‘comply or explain’ approach, in that the different wording was meant to emphasise that boards consider the manner in which the King III principles can be applied carefully, rather than to engage in a ‘tick the box’ exercise.
The Mauritian proposal: innovation or self-coronation?
How does the Mauritian innovation differ from these already existing principles? Essentially, what the National Committee on Corporate Governance is proposing is a move away from soft law in the direction of hard law. “The Code”, according to the committee, “comprises eight principles on just two pages”, and “[t]he principles form the core of the Code”. Companies, in short, are expected not to deviate from any of these principles. The only explanation allowed, is an explanation of how the company has succeeded in doing so. This provides a stark difference with the principles already in force, all of which – although to differing extents – allow companies to tailor their governance policy via deviations from the code. ‘Apply and explain’ is thus stricter than the strictest principle currently in force. A regulatory novelty indeed.
It still remains to be seen how hard exactly the standards adopted in the Mauritian and South African codes will prove in practice, as this depends in large part on the main enforcement actors in this regard: the shareholders. Nonetheless, the ambition of corporate governance code committees such as the Mauritian and South African committees is noteworthy. Are corporate governance committees – in true Napoleonic fashion – crowning themselves as corporate regulators?
For a more in-depth analysis of the Dutch ‘comply or explain’-principle, see K.H.M. de Roo, ‘De Corporate Governance Code en het drijfzand van de open norm’, Ars Aequi 2015/4, pp. 257-265.
 National Committee on Corporate Governance, (Draft) The Corporate Governance Code for Mauritius (2016), p. 6.
 L. 225-37 and L.225-68 Code de Commerce.