1.2.3 Strengths and weaknesses of the comply or explain principle

This study intends to contribute to this necessary common understanding of the comply or explain principle. Whenever examining the principle's scope and then the conditions necessary to make it work effectively, its strengths and weaknesses should be acknowledged. In addition thereto, this discussion gives more insight into the reasons why Europe has chosen for the comply or explain principle as a central element in the EU corporate governance. The principle's main benefits which resulted in its embracement by the EU are:

According to the supporters of the EU corporate governance model, corporate governance codes and the comply or explain principle are highly effective in stimulating discussion on corporate governance issues. They educate the general public and investors about common and legal corporate governance practices. Furthermore, they prepare the grounds for changes in company law and securities law, where such changes are deemed necessary. Moreover, it is believed by its supporters that the codes provide a more efficient approach than detailed regulation does. The attraction of the codes lies in their flexibility (EU Green Paper 2011, p. 18). Legislating every aspect of good corporate behaviour seems impossible, the more so since companies need to have room to manoeuvre and prefer compliance 'made to measure'. Adopting a 'one size fits all' approach is impossible since the companies the codes are applicable to, differ materially (e.g. in structure, organisation and size) (MacNeil and Li 2006, p. 486). This flexibility also implies that codes can be amended much faster than legislation (Coombes and Wong 2004, p. 50). In addition, investors, market analysts, monitoring groups and rating agencies make use of the codes and the compliance therewith to benchmark companies and their management (EU Comparative Study 2002, p. 68 and 69). Another advantage is that ' reputational' and market forces result in a higher level of compliance, since the capital markets will monitor the compliance and will penalise non-compliance through lowering share prices or accept that non-compliance is justified in the specific circumstances (MacNeil and Li 2006, p. 493). By practising this monitoring role the capital markets assess the adequacy of the company's corporate governance. In addition, improvements in enforcement and compliance are more often the result of bottom-up approaches (e.g. corporate governance codes), rather than top-down efforts (e.g. SOX) (Berglof and Cleassen 2004). The comply or explain principle has yet another positive - however doubtful - side effect: companies do not want lengthy explanations in their annual accounts and therefore they might comply except as regards those few points on which they have strong justification for deviation (EU Comparative Study 2002, p. 69). A final important advantage of the comply or explain principle is that it has made the corporate governance practices much more transparent (Coombes and Wong 2004, p. 51). Due to the mandatory disclosure of the corporate governance statement, the transparency regarding corporate behaviour of the company and its directors has improved a lot. Besides transparency, these disclosures improve the accountability of directors towards their shareholders as well. Especially since accountability is regarded as an important aim of the corporate governance codes (MacNeil and Li 2006, p. 487).

The supporters of the current European corporate governance policy acknowledge the weaknesses of the comply or explain principle which must also be overcome:

The material compliance with the code is hard to measure and monitor; a problem which is inherent to the chosen model (Boot and Wallage 2006, p. 212). The comply or explain principle helps with regard to formal compliance concerning corporate governance codes; companies mention in their corporate governance statement that they comply with the provisions of the applicable code. However, it is difficult to control whether - in practice -the company really does materially comply with these provisions. Moreover, from the point of view of the stakeholders such as creditors and investors a certain amount of confidence in the board is necessary; they have to rely on the honest and complete nature of the corporate governance statements (Wy-meersch 2005, p. 8). Likewise for the shareholders, as a result of the corporate scandals and the financial crisis it can still be difficult nowadays for the shareholders to summon their confidence in the board once again. The comply or explain principle offers a weaker role for the shareholders and a stronger role for the management board than in the case of corporate governance legislation. MacNeil and Li claim that the code could also have been integrated in company law as default rules that would be open to ' disapplication' through shareholders' resolutions; the shareholders have the opportunity to decide ex ante. If the code has the status of a default rule of law,1 then the rules would apply unless 'disapplied' ex ante by a shareholders' resolution (MacNeil and Li 2006, p. 493). Having a corporate governance code and comply or explain principle means that the board decides on the code compliance and the contents of the corporate governance statement. The shareholders are now only able to review the compliance with the code ex post; after the publication of the statement by the board. MacNeil and Li find this strengthening of the role of the board somewhat ironic since the objective of the codes is to control the principle/ agent tension within the companies (MacNeil and Li 2006, p. 493). The success of the codes also gives rise to several threats. 'Regulation creep' is considered one of those threats (Coombes and Wong 2004, p. 52). New versions of the already existing codes are much lengthier and add more and more detail. As a result thereof, ' made to measure compliance' becomes increasingly difficult. Another threat is overemphasis on complying rather than on explaining.A tendency to ' comply or breach' exists; good corporate governance within a company is judged by ticking off boxes instead of a deeper analysis of 'made to measure' deviations. According to Coombes and Wong, this threatens the flexibility of codes which is one of their fundamental virtues, and can even lead to a ' one size fits all' mentality (Coombes and Wong 2004, p. 53).