Companies Need to ‘Comply or Explain’

Thursday, December 15, 2011 Print Email

The Financial Reporting Council (FRC) says that companies need to demonstrate their commitment to its ‘comply or explain’ approach or risk greater regulation.

The warning comes in an FRC report, The Impact and Implementation of the UK Corporate Governance and Stewardship Codes, which is the regulator’s first analysis of how the two codes are operating.

The FRC says both codes have seen strong take up, with 80% of FTSE 350 boards now putting all their directors up for annual re-election, and over 230 asset managers, asset owners and service providers signing up to the Stewardship Code in its first year.

It says there is evidence of behavioural change as a result, and that the quality of engagement between investors and company boards is improving, particularly in areas such as corporate risk.

However, the FRC notes that the quality of explanations in annual reports varies, and says it will be looking at this more closely over the coming year. In particular, it singles out problems with reporting by audit committees which it describes as ‘often unenlightening’.

The FRC says there will be limited changes to the codes during 2012, including a requirement to articulate policies on board diversity, and they will then be left unchanged for two years, to encourage wider adoption.

The report cautions that in the current environment there is a need to demonstrate that ‘comply or explain’ is taken seriously by companies and investors and says that ‘failure to do so could result in an approach which could be more prescriptive about the way companies organize themselves, and could give more power to regulators at the expense of shareholders.’

Grant Thornton's 10th annual FTSE 350 Corporate Governance Review has found that only 43% of chairman use their annual report statement to make reference to the company's governance practice, and only 10% provide any meaningful insights into how they and their boards set and embed an appropriate governance culture throughout the organisation.

GT’s research shows only one in 10 of the FTSE 350 currently having the suggested 25% female representation on their boards, while 72% of the FTSE 350 make no public reference to their policy on gender diversity.

Overall, GT estimates full compliance has been around 50% for the last two years, compared to 28% in 2004.

GT partner Simon Lowe said: ‘Compliance does now appear to have plateaued, with the balance choosing to explain. As such, governance practice now has to switch from looking for compliance to focusing on the quality of explanations. While the board, and ultimately the chairman, has responsibility for embedding good governance practice in the organisation, institutions also have a significant role.’

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