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Comply or explain is a regulatory approach used in the United Kingdom, Germany, the Netherlands and other countries [1] in the field of corporate governance and financial supervision. Rather than setting out binding laws, government regulators (in the UK, the Financial Reporting Council (FRC), in Germany, under the Aktiengesetz) set out a code, which listed companies may either comply with, or if they do not comply, explain publicly why they do not.
The purpose of "comply or explain" is to "let the market decide" whether a set of standards is appropriate for individual companies. Since a company may deviate from the standard, this approach rejects the view that "one size fits all", but because of the requirement of disclosure of explanations to market investors, anticipates that if investors do not accept a company's explanations, then they will sell their shares, hence creating a "market sanction", rather than a legal one. The concept was first introduced after the recommendations of the Cadbury Report of 1992.
The UK Corporate Governance Code, the German Corporate Governance Code (or Deutscher Corporate Governance Kodex) and the Dutch Corporate Governance Code 'Code Tabaksblat' (nl:code-Tabaksblat) use this approach in setting minimum standards for companies in their audit committees, remuneration committees and recommendations for how good companies should divide authority on their boards. Swedish company law requirements expect companies to identify any code rules which they have not complied with, explain why they have not complied, and describe their alternative solution. [2]
Under the revised Shareholder Rights Directive of 2017 (SRD II), companies must develop and publish a policy stating how voting rights operate and how shareholders are engaged in the running of the company, subject to the "comply or explain" principle. [3]
The approach has both benefits and drawbacks.
The main benefits are that the approach offers flexibility to corporations, lowers their compliance burden, and stimulates discussion and for grounds in changes in legislation. (Ho 2017; [4] Galle 2014; [5] Abma and Olaerts 2012; [6] Lu 2021 [7] )
The main drawbacks are that material compliance is difficult to enforce, an overemphasis on ‘tick-the-box’ compliance and, most prominently, that corporations give perfunctory explanations for non-compliance. (Ho 2012; [4] Galle 2014; [5] Abma and Olaerts 2012 [6] ) The lack of meaningful explanations is seen as the biggest drawback.
Many studies point to the low quality of explanations given in comply or explain mechanisms in corporate governance and non-financial reporting regulations (MacNeil and Li 2006; [8] Cuomo et al 2016; [9] FRC 2021 [10] ). In the UK (MacNeil and Li 2006; [8] Shrives and Brennan 2015 [11] ), Germany (Talaulicar and Werder 2008 [12] ), Greece (Nerantzidis 2015 [1] ), Italy (Lepore et al. 2018 [13] ) and the Netherlands (Hooghiemstra 2012; [14] Monitoring Commissie Corporate Governance Code 2020 [15] ) studies find that explanations for non-compliance with corporate governance codes are often inadequate. Similar results are found when studying non-compliance explanations in the realm of European non-financial reporting (Björklund 2021; [16] Monciardini et al. 2020; [17] Szabó and Sørensen 2015; [18] Boiral 2013 [19] ). This collection of research indicates that possible high levels of ‘compliance’ with corporate governance codes and non-financial reporting requirements are in fact much lower due to the large percentage of inadequate explanations.
Due to the drawbacks to the comply or explain approach, several studies have proposed that an increased level of (public) enforcement and supervision is necessary in order to monitor inadequate explanations of non-compliance. (Lu 2021; [7] Hooghiemstra 2012; [14] Keay 2014; [20] Seidl et al. 2013; [21] Boiral 2013 [19] ). Since the explanation for non-compliance is the cornerstone of the comply or explain approach, authors are specifically calling on public enforcement authorities to take a more active role. (Lu 2021; [7] Hooghiemstra 2012; [14] ) Some researchers have found that there are certain qualities of corporations that are associated with higher and lower levels of high-quality non-compliance explanations (2.4). Studies conducted in Germany, Italy and the Netherlands give insights into which qualities often indicate high-quality non-compliance explanations (Talaulicar and Werder 2008 [12] ); Hooghiemstra 2012; [14] Lepore et al. 2018 [13] ). These insights could be useful to stakeholders wanting to monitor compliance and to public enforcement authorities if they are tasked with more stringent supervision.
The FRC has published guidance on "what constitutes an explanation" as a means of comparing the approach of those who prepare businesses' explanations with the expectations of those to whom they are addressed. [22]
The Sarbanes–Oxley Act of 2002 is a United States federal law that mandates certain practices in financial record keeping and reporting for corporations. The act,, also known as the "Public Company Accounting Reform and Investor Protection Act" and "Corporate and Auditing Accountability, Responsibility, and Transparency Act" and more commonly called Sarbanes–Oxley, SOX or Sarbox, contains eleven sections that place requirements on all U.S. public company boards of directors and management and public accounting firms. A number of provisions of the Act also apply to privately held companies, such as the willful destruction of evidence to impede a federal investigation.
An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon." Auditing also attempts to ensure that the books of accounts are properly maintained by the concern as required by law. Auditors consider the propositions before them, obtain evidence, roll forward prior year working papers, and evaluate the propositions in their auditing report.
Corporate governance are mechanisms, processes and relations by which corporations are controlled and operated ("governed").
Corporate social responsibility (CSR) or corporate social impact is a form of international private business self-regulation which aims to contribute to societal goals of a philanthropic, activist, or charitable nature by engaging in, with, or supporting professional service volunteering through pro bono programs, community development, administering monetary grants to non-profit organizations for the public benefit, or to conduct ethically oriented business and investment practices. While once it was possible to describe CSR as an internal organizational policy or a corporate ethic strategy similar to what is now known today as Environmental, Social, Governance (ESG); that time has passed as various companies have pledged to go beyond that or have been mandated or incentivized by governments to have a better impact on the surrounding community. In addition national and international standards, laws, and business models have been developed to facilitate and incentivize this phenomenon. Various organizations have used their authority to push it beyond individual or even industry-wide initiatives. In contrast, it has been considered a form of corporate self-regulation for some time, over the last decade or so it has moved considerably from voluntary decisions at the level of individual organizations to mandatory schemes at regional, national, and international levels. Moreover, scholars and firms are using the term "creating shared value", an extension of corporate social responsibility, to explain ways of doing business in a socially responsible way while making profits.
In general, compliance means conforming to a rule, such as a specification, policy, standard or law. Compliance has traditionally been explained by reference to the deterrence theory, according to which punishing a behavior will decrease the violations both by the wrongdoer and by others. This view has been supported by economic theory, which has framed punishment in terms of costs and has explained compliance in terms of a cost-benefit equilibrium. However, psychological research on motivation provides an alternative view: granting rewards or imposing fines for a certain behavior is a form of extrinsic motivation that weakens intrinsic motivation and ultimately undermines compliance.
A regulatory agency or independent agency is a government authority that is responsible for exercising autonomous dominion over some area of human activity in a licensing and regulating capacity.
Sustainability reporting refers to the disclosure, whether voluntary, solicited, or required, of non-financial performance information to outsiders of the organization. Generally speaking, sustainability reporting deals with information concerning environmental, social, economic and governance issues in the broadest sense. These are the criteria gathered under the acronym ESG.
Clause 49 of the Listing Agreement to the Indian stock exchange that came into effect from 31 December 2005. It has been formulated for the improvement of corporate governance in all listed companies.
The Financial Reporting Council (FRC) is an independent regulator in the UK and Ireland based in London Wall in the City of London, responsible for regulating auditors, accountants and actuaries, and setting the UK's Corporate Governance and Stewardship Codes. The FRC seeks to promote transparency and integrity in business by aiming its work at investors and others who rely on company reports, audits and high-quality risk management.
The Global Reporting Initiative is an international independent standards organization that helps businesses, governments, and other organizations understand and communicate their impacts on issues such as climate change, human rights, and corruption.
Governance, risk management and compliance (GRC) is the term covering an organization's approach across these three practices: governance, risk management, and compliance.
The King Report on Corporate Governance is a booklet of guidelines for the governance structures and operation of companies in South Africa. It is issued by the King Committee on Corporate Governance. Three reports were issued in 1994, 2002, and 2009 and a fourth revision in 2016. The Institute of Directors in Southern Africa (IoDSA) owns the copyright of the King Report on Corporate Governance and the King Code of Corporate Governance. Compliance with the King Reports is a requirement for companies listed on the Johannesburg Stock Exchange. The King Report on Corporate Governance has been cited as "the most effective summary of the best international practices in corporate governance".
The UK Corporate Governance code, formerly known as the Combined Code is a part of UK company law with a set of principles of good corporate governance aimed at companies listed on the London Stock Exchange. It is overseen by the Financial Reporting Council and its importance derives from the Financial Conduct Authority's Listing Rules. The Listing Rules themselves are given statutory authority under the Financial Services and Markets Act 2000 and require that public listed companies disclose how they have complied with the code, and explain where they have not applied the code – in what the code refers to as 'comply or explain'. Private companies are also encouraged to conform; however there is no requirement for disclosure of compliance in private company accounts. The Code adopts a principles-based approach in the sense that it provides general guidelines of best practice. This contrasts with a rules-based approach which rigidly defines exact provisions that must be adhered to. In 2017, it was announced that the Financial Reporting Council would amend the Code to require companies to "comply or explain" with a requirement to have elected employee representatives on company boards.
Review of the role and effectiveness of non-executive directors was a report chaired by Derek Higgs on corporate governance commissioned by the UK government, published on 20 January 2003. It reviewed the role and effectiveness of non-executive directors and of the audit committee, aiming at improving and strengthening the existing Combined Code.
Internal Control: Guidance for Directors on the Combined Code (1999) also known as the "Turnbull Report" was a report drawn up with the London Stock Exchange for listed companies. The committee which wrote the report was chaired by Nigel Turnbull of The Rank Group plc. The report informed directors of their obligations under the Combined Code with regard to keeping good "internal controls" in their companies, or having good audits and checks to ensure the quality of financial reporting and catch any fraud before it becomes a problem.
The Stewardship Code is a part of UK company law concerning principles that institutional investors are expected to follow. It was first released in 2010 by the Financial Reporting Council ('FRC'), and in 2019 the FRC released an updated edition of the Stewardship Code.
Gender representation on corporate boards of directors refers to the proportion of men and women who occupy board member positions. To measure gender diversity on corporate boards, studies often use the percentage of women holding corporate board seats and the percentage of companies with at least one woman on their board. Globally, men occupy more board seats than women. As of 2018, women held 20.8% of the board seats on Russell 1000 companies. Most percentages for gender representation on corporate boards refer only to public company boards. Private companies are not required to disclose information on their board of directors, so the data is less available.
ESG Quant is an investment strategy, developed by Arabesque Partners, which involves quantitative equity investing while utilizing ESG information, often referred to as "non-financial" information. ESG Quant strategies are implemented within systematic trading or quantitative trading approaches that leverage a large and growing collection of commercial ESG, alternative and non-profit or academic datasets. As such, there is no human judgment or discretionary buy-sell decision making; rather, “in a pure quant model the final decision to buy or sell is made by the model” or through the “utilization of an expert system that replicates previously captured actions of real traders.”
Anti-corruption comprises activities that oppose or inhibit corruption. Just as corruption takes many forms, anti-corruption efforts vary in scope and in strategy. A general distinction between preventive and reactive measures is sometimes drawn. In such framework, investigative authorities and their attempts to unveil corrupt practices would be considered reactive, while education on the negative impact of corruption, or firm-internal compliance programs are classified as the former.
The Task Force on Climate Related Financial Disclosures (TCFD) provides information to investors about what companies are doing to mitigate the risks of climate change, as well as be transparent about the way in which they are governed. It was established in December 2015 by the Group of 20 (G20) and the Financial Stability Board (FSB), and is chaired by Michael Bloomberg. It consists of governance, strategy, risk management, and metrics and targets. It will become mandatory for companies to report on these disclosures by 2025 in the UK, although some companies will have to report earlier.
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