The UK and the Federal Republic of Germany both oppose requiring regulators to monitor company explanations as to why a provision of the corporate governance code was not complied with. In letters to the European Commission, the governments said that review of the efficacy of a company’s reason for not complying with a code provision was best left to the markets and the shareholders. The governments were responding to an EC Green Paper on reforming corporate governance. Both Germany and the UK have comply or explain corporate governance codes that require an explanation when a company does not comply with a code provision.
While compliance with the Corporate Governance Code is monitored by investors and private sector organizations that scrutinize compliance with the Code, noted the UK, ultimately it is the shareholders’ responsibility to determine whether an explanation offers sufficient information to make an informed investment decision.
It is important that shareholders continue to make these decisions, said the UK letter, and it is not for government or regulators to interfere in these relationships. For this reason monitoring bodies should not take on the role of checking the quality of explanations, emphasized the UK, and comply or explain statements should not become regulated information under the terms of the Transparency Directive.
While sharing the Commission’s concern about the informative quality of explanations, the UK believes that the best way to allay these concerns is through guidance rather than regulatory oversight. If guidance could be given to those writing and receiving the explanations, reasoned the UK, it is possible that the quality of explanations may improve significantly and shareholders themselves may become more adept at questioning an explanation. In this spirit, the UK Financial Reporting Council will shortly develop a consensus about what constitutes a proper explanation.
In its letter to the Commission, the Federal Republic was highly skeptical of requiring regulators or other authorities to monitor the comply or explain responses of German companies under the corporate governance code, which is a job best left to the markets.
German public companies are required to declare annually whether or not they have complied with the recommendations of the German Corporate Governance Code. Since the Accounting Law Modernization Act went into effect, companies are required not only to disclose divergences from the code recommendations, but also give a reason for these divergences.
The idea of a corporate governance code with a comply or explain arrangement is based on the concept that non-mandatory statutory arrangements are developed by industry itself, reasoned the Federal Republic, and compliance or non-compliance with them is subject to the oversight of the capital market. The German corporate governance code works with a comply or explain mechanism, said the government, because the capital market evaluates the statements, and where appropriate draws its conclusions from them. If the statements are not convincing or are incomplete or are not authoritative, the capital market will draw its conclusions from this.
In addition, a state monitoring authority would entail a major organizational effort. Monitoring would have to be very careful and be carried out with a uniform standard. Even worse, said the Federal Republic, an undesirable standardization of comply or explain statements could result from regulatory monitoring since the monitoring agency would make it known what responses were acceptable in what form, and companies would employ these in a formulaic manner.