Sunday, September 04, 2011

European Directors Confederation Endorses Comply or Explain Approach to Corporate Governance in Comments on Green Paper

Joining a growing consensus on the efficacy of the comply or explain doctrine, the European Confederation of Directors’ Associations urged the European Commission to retain the comply or explain approach to corporate governance as it begins a consultation on an EU corporate governance code. In a comment letter submitted in response to the recent Green Paper on corporate governance for listed companies, the association said that the comply or explain doctrine should remain a key feature of the European corporate governance landscape.

The confederation’s comments are in line with a growing chorus of support for the comply or explain corporate governance code in the wake of the financial crisis. In its comments on the Green Paper, the UK Financial Reporting Council, said that the flexible comply-or-explain doctrine is an important central principle in EU corporate governance, albeit one that needs more reliable monitoring and a better quality of explanations. Similarly, German officials recently reaffirmed their confidence in the comply or explain nature of the German Corporate Governance Code. In remarks on the tenth anniversary of the Code’s initiation, Klaus-Peter Müller, Chair of the Government Commission on the German Corporate Governance Code said that the comply or explain principle at the core of the Code allows for the needed transparency and provides a flexible framework for good corporate management.

The Green Paper rightly observes that comply or explain could work better in certain instances, conceded the directors’ group, particularly in relation to the quality of company explanations and shareholder engagement. However, the group emphasized that comply or explain is far preferable to a corporate governance regime which embeds mandatory governance requirements into legislation. They advised the Commission not to follow this route. Governance flexibility and plurality are preferable to a legalistic, box-ticking approach, said the association.

Another key point made by the association is that significant shareholders continue to play a useful but underestimated role in European corporate governance. They often underpin companies in adopting a longer-term investment perspective. In contrast, greater thought must be given to the internal governance of institutional investors, whose diffuse shareholdings, short-term performance horizon and reliance on market trading can translate into weak corporate governance in their investee companies.

Minority shareholder protection, particularly the control of related party transactions, is still an issue of concern in certain EU member states. However, in most EU countries, said the association, encouraging institutional shareholders to carry out their governance responsibilities is a more important objective than the granting of additional rights to minority shareholders

Both corporate governance and corporate social responsibility are key elements in building societal trust and improving the sustainable competitiveness of the EU. They should not be viewed as separate issues, but within an integrated policy framework.

Noting that proportionality is a key component of good governance, the group said that corporate governance practices should also reflect the size and complexity of individual companies. Smaller listed companies and unlisted companies are likely to require a different type of corporate governance regime than large listed companies.

Diversity in board membership is also an important component of board effectiveness. Companies should disclose their diversity policies, both in terms of gender and with respect to other dimensions of diversity. However, the issue of gender quotas should be determined at national level, reflecting the political context of individual EU member states.

Finally, the group noted that two major contributors to board effectiveness in the future will be the greater use of external board evaluations and improved board training. Both offer the potential to significantly improve the performance of directors and supervisory board members in the carrying out of their board-level responsibilities.

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