Increasingly, in the United States, laws and mandatory regulations impose corporate governance requirements. The 2002 federal Sarbanes-Oxley Act (SOX), which grew out of the Enron and WorldCom scandals, marks the first federal foray into the subject, which previously had been the exclusive province of state laws.1
The 2010 Dodd-Frank Act2 then layered upon SOX’s requirements a host of additional mandatory governance requirements.3 Thus, U.S. public companies must have a review by independent accountants of internal accounting controls; CEOs and CFOs must certify quarterly and annual financial reports; companies must have an audit committee staffed by independent directors; audit committee rosters must include at least one director who is a “financial expert”; if accounting results have to be restated due to misconduct, corporate officers must repay incentive-based compensation; loans of corporate funds to directors or officers are now forbidden, and much more. These are mandatory requirements.
Much of the rest of the world goes about corporate governance in a different, softer way. Rather than laws passed by the parliament or legislature, codes of best practices govern the area. Rather than legislatures and regulatory agencies such as the SEC, foreign stock exchanges, either directly or through corporate governance councils, promulgate codes of best practices that are aspirational rather than mandatory. The Organization for Economic Cooperation and Development (OECD) in Paris also maintains a corporate governance code that has become the starting point for the evolution of many country-specific codes.4
The approach is further softened by the adoption in many of these codes of a “comply or explain” regime rather than absolute, mandatory rules and requirements. For example, the Swedish Corporate Governance Board explains this feature of its code of rules and recommendations: “Companies that are obligated to apply the Code do not always have to comply with every rule in the Code.”5 The board continues, explaining the rationale behind the approach: “If a company finds that a certain rule is inappropriate . . . it can choose another solution than that found in the Code. The company must, however, clearly state that it has not complied . . . along with an explanation for the company’s preferred solution.”
The Australians refer to such a regime as the “if not, why not” approach.6 From time to time, the approach pops up in U.S. regulation. For instance, rather than requiring that corporate boards have a compensation committee, Dodd-Frank requires only that companies disclose when they do not have one and state the reasons they do not have such a committee.7 Sarbanes-Oxley requires similar public corporation disclosure in the case of boards’ audit committees or the adoption of a code of ethics for financial executives. U.S. laws and regulations, however, do not incorporate a broad, across-the-board comply or explain regime.
Actually, Dodd-Frank is more indirect than that. The statute requires the SEC to direct the various stock exchanges to adopt comply or explain rules in their listing requirements.8 “Requiring individuals to give reasons for particular actions [or inactions] improves decision-making quality, reduces reliance on stereotypes, and helps level the playing field for underrepresented groups [e.g., the gender diversity comply or explain requirements of the London and Australian stock exchanges].”9 But the United States has chosen not to go down the comply or explain road.
Comply or explain exists in the United Kingdom, Germany, the Netherlands, much of the rest of the European Union, Hong Kong, Singapore, Australia, and New Zealand, to name a few.10 In particular, many of those countries, or at least those without quota laws, single out diversity, most particularly gender diversity on corporate boards and among senior management, for comply or explain treatment.
One can theorize at least four types of regulatory schemes that would compete with the notion of “comply or explain.”
First, in contrast to mandatory requirements, discussed below, a regulatory regime may consist wholly of disclosure requirements. Beginning with the Securities Act of 1933, the U.S. securities law regime governing the issuance and trading of investment securities follows the disclosure approach. If a company seeks to raise capital to put a person on a celestial body, say, Pluto or Mars, the company may do so, provided it makes full disclosure about the difficulties and risks in the mission it has set out for itself.
Second, a comply or explain scheme is very much about disclosure as well, but inherent in it also is an imperative. Circumstances being normal, the governance code expects, but does not require, that companies will comply. If not, the company not only can but must explain the “why not.” If the “why not” explanation is flimsy or off-the-wall, adverse publicity and peer pressure will result. Scholars have written about the effects of shaming that results from adverse publicity and its effects on corporate behavior.11
Third, a comply or explain regime could have definite consequences that flow from noncompliance or compliance with the letter but not the spirit of the recommendation. Stock exchanges, for instance, could levy a fine or suspend a listing for disingenuous or egregious noncompliance with the explain dictate.
Fourth, as noted above, corporate governance directives can take the form of mandatory commands. The “Thou shall do X” or “Thou shall not do Y” phrases found in statutes and regulations are substantive requirements, in contrast to disclosure regulations.12 A further dichotomy is the division of statutory and legal commands into hard law and of stock exchanges’ and codes of best practices’ provisions into soft law, as discussed in the previous chapter.13 This chapter deals with comply or explain regimes and, tangentially at least, with the option of comply or explain with consequences.
I once heard a law student speaker compare the use of Socratic questioning in legal education with caning in the Singapore judicial system: “It’s hard, it hurts while they’re doing it, and the British invented it.”14 So, too, with the idea of a pervasive, wall-to-wall “comply or explain” corporate governance approach. The British invented it.
The Institute of Chartered Accountants in England and Wales (ICAEW) describes its breadth:
Comply or explain is an approach that covers much of the content of the UK (Corporate Governance) Code. Today, the Code contains over 50 provisions which set out over 110 instances of what companies, boards, directors and others “should do.” And yet there is no requirement to comply with these provisions and companies can decide not to do so provided that they give an explanation for any non-compliance.15
In a paean to the wisdom of the British approach, a commentator outlines a few of its perceived advantages (“where comply or explain can serve businesses and investors and have advantages over other alternatives”):
The United Kingdom Corporate Governance Code emphasizes that “the comply or explain approach is the trademark of corporate governance in the UK. It has been in operation since the Code’s beginnings [in 1993]. It is strongly supported by companies and shareholders and has been widely admired and imitated internationally.”17 In 2010 the council folded a gender diversity statement into the comply or explain regime. The Corporate Governance Code now provides that “the search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard to the benefits of diversity in the board, including gender.”18
Thus, in the United Kingdom, two solutions to the paucity of women in corporate leadership work side-by-side: the Davies pledge program, discussed in the previous chapter, and the London Stock Exchange/Financial Reporting Council Corporate Governance Code provision, as supplemented by the comply or explain principle that modifies the gender diversity recommendation.
I taught the intensive course in corporate governance at the University of Melbourne School of Law each May from 1994 to 2009 and have lectured in Australia and New Zealand since that time, mostly on the subject of gender diversity in corporate governance.19 From a late start, female leadership both in director positions and as senior managers has become a hot-button issue in Australia (by contrast, it remains on low heat in New Zealand).
In 2010 the Australian Stock Exchange (ASX) stepped up its efforts to add women to corporate boards. Effective January 1, 2012, the ASX required that listed companies comply or explain with regard to diversity. The ASX provided that “companies should establish a policy concerning diversity and disclose the policy or a summary of that policy.”20 Further, “the policy should include requirements for the board to establish measurable objectives for achieving gender diversity for the board to access annually both the objectives and the progress in achieving them.”
The Australian guidelines, unlike the British ones, reach beyond the boardroom to recommend disclosures on the proportion of women in the company’s workforce overall and in the ranks of senior management.21 Most corporations, or at least the larger ones, have complied, disclosing what steps they have taken and their progress toward the goals they have set, adding to the pressure to enlarge the pool from which women candidates for board positions and senior management positions may be chosen.
Along those lines, in 2012 the ASX appointed KPMG, the international accounting firm, to canvas the field to test compliance. ASX Listing Rule 4.10.3 supplies the comply or explain component: listed entities are required to benchmark their corporate governance devices and practices or to disclose why the company has not complied. The good part: KPMG found that of 211 listed corporations, all had either reported that they had established a gender diversity policy or explained why they had not done so. The not-so-good part: only 76 of the 211 companies reported that they had established measureable objectives for achieving gender diversity.22
Since the time of its original pronouncements, the ASX has firmed up its gender diversity approach, incorporating gender diversity in the listing standards themselves (but still heading them as a “Recommendation”):
A listed entity should:
- (a) have a diversity policy which includes requirements for the board or a relevant committee . . . to set measurable objectives for achieving gender diversity and to assess annually both the objectives and the entity’s progress in achieving them [and] . . .
- (b) disclose at the end of each reporting period . . . the respective proportions of men and women on the board, in senior executive positions, and across the whole organization (including how the entity has defined “senior executive”).23
In 2014 the ASX commissioned another audit of compliance with its comply or explain requirements. In April 2014 KPMG reported its findings. Among the largest companies (198 of the ASX 200 surveyed), compliance was excellent. All corporations in the ASX list had either adopted a diversity policy or explained why they had not done so. Nearly all of that group (98 percent of 198) actually had adopted a policy. Eighty-six percent (170 companies) had set measurable objectives as a component of their policy. Those objectives pertained the most to the company as a whole (92 percent) and in relation to senior executive positions (91 percent). Paradoxically, companies were not as diligent when setting measurable objectives for board membership (86 percent).24
Compliance, however, was demonstrably lower among midsize and smaller companies. KPMG reported that only 56 percent of ASX 201–500 companies (200 surveyed) had set measurable objectives, although 85 percent had adopted a diversity policy. Among smaller companies (ASX 501+, 200 surveyed) compliance trailed off still more: 66 percent had adopted a policy but only 20 percent had set objectives.
This latter KPMG finding is crucial. Smaller companies play a key role in supplying women who enter the pool from which midsize and larger companies choose directors and senior managers. With this in mind, larger companies and organizations such as the ASX, the AICD, and women’s groups should place more emphasis on encouraging smaller companies’ compliance with the initiative.
Australia, too, has a two-pronged approach to the issue of women in corporate leadership: a comply or explain requirement spearheaded by the Australian Stock Exchange and a mentorship/sponsorship programs headed up by the Australian Institute of Company Directors (AICD) (discussed in chapter 12). The United Kingdom has a two-pronged approach as well, albeit a differing one: the London Stock Exchange comply or explain regimen and the Davies Committee pledge scheme.
By contrast, the New York Stock Exchange (NYSE) has done nothing to improve gender diversity in corporate leadership. The closest the NYSE has come (which was not close at all) was to adopt Listing Rule 303A in 2005.25 The rule requires that a majority of the directors be “independent” (neither insiders nor “gray insiders,” such as the company’s outside lawyer or investment banker). In theory, the rule would create more space for appointment of women and other diversity candidates to the board of directors.
Would such a regime work here, in the promotion of gender diversity among directors and senior management positions?
Where it has been adopted, specifically in the United Kingdom, “it is not without difficulties. Investors often say that the explanations provided [for noncompliance or a differing approach] are perfunctory and do not do a good job of explaining how a company’s alternative arrangements support the corporate governance principle.”26
Then too the United States has a much more freewheeling or even swashbuckling business community, or at least in certain quarters such as information technology or among elements within those quarters. Against such a background, the explain prong could become what the English term a “coach and horses exception” and what we might describe as a “loophole big enough to drive a truck through.” Companies and their lawyers would obfuscate, offering gibberish by way of explaining difficulties in compliance.
With regard to senior management positions, U.S. boards might consider a comply or explain requirement to be an overreach. The chief executive of a company has as one of her most central prerogatives the power to hire and fire the executives and managers on her team. The central role of a CEO consists of getting “the right people on the bus, the wrong people off the bus, and the right people in the right seats.”27 Any attempt, even an indirect one such as a comply or explain requirement, would be regarded by CEOs and boards as an intrusion on the CEO’s central role.
Last of all, comply or explain is a cultural artifact that infuses most facets of corporate governance in the United Kingdom, Australia, New Zealand, Hong Kong, Singapore, and elsewhere. We in the United States have no experience in or facility with it. In fact, we have gone down quite a different path, namely, that of a few mandatory requirements and commands at the core, layered with increasing latitude for private ordering (“unless otherwise provided” statutory provisions), and disclosure requirements that are devoid altogether of mandatory or substantive content. Companies and their representatives would in all probability view comply or explain gender diversity guidelines as in effect mandatory requirements. The pushback against the imposition of any such comply or explain regime would be long lasting and significant. A prevalent view would be that it constitutes a de facto quota system.
Overall, and in the last analysis, one senses that a comply or explain regime would not be a good fit here in the United States or for the information technology industry.