Comply or Explain?

Countries around the world have had little reservations about adopting the well known ‘comply or explain’ approach to corporate governance codes. The phrase become famous following its inclusion in the Cadbury Code of 1992, and has since been replicated in Germany, France, Belgium and Greece in the West, and countries as far away as Pakistan and Malaysia. Despite this, Nigerian corporate governance codes have steered away from this approach, alongside the United States. 

Under the comply or explain model, companies have an obligation to ‘comply or explain’ with their respective corporate governance codes, by retaining the choice to abide by the set rules or deviate from them, as long as they subsequently explain why they did not comply. Put another way, it is akin to voluntary regulation. Most business regulation‎ is either compulsory, as is the case with laws regarding bribery, money laundering and tax evasion or self regulating, as seen in relation to employee incentives and yearly bonuses. When an entity contravenes compulsory regulation, it is either fined or has its license revoked, as was the case with South Africa’s MTN, but when it deviates from self regulating practices, the loss tends to be reputational.

In spite of the lack of a clear punitive element, the ‘comply or explain’ approach has persisted in corporate governance circles. It is neither strictly compulsory, nor strictly self-regulating – its seasonal and works until the entity involved no longer finds it beneficial.

Nevertheless, it would be wrong to view this approach as having no fixed requirements. This is because it provides flexibility to companies in how they reach their governance targets, by focusing on the spirit of law, not the letter. Failing to observe the code is therefore not a breach, as long as accompanying explanations provide insight on how the company went about achieving good governance.

Yet how does this work in practice?

In the UK, the Corporate Governance Code requires that no one person can be the Chairman and Chief Executive Officer at the same time. Regardless, a company may still choose to combine the role of the Chairman and CEO, as long as it discloses in its annual reports why it chose to do so. While theoretically questionable, the Code has flourished in many Western nations.

As for Nigeria, it is apparent that we believe it is better to fail in our originality than succeed in imitation. Only the Nigerian Communications Commission (NCC) Code adopts this approach to governance, and quite rightly so.

On Friday 19th November, Thistle Praxis Consulting hosted its Annual Roundtable and Conference on Corporate Social Responsibility and Corporate Governance in Lagos. One of the speakers, Dr Nat Ofo, Sub Dean at Igbinedion University, Okada, tackled the notion of comply or explain, clearly stating why its relevance to Nigeria remains limited by our business environment.

Dr Nat Ofo remained insistent in his presentation that while the approach serves the more established nations such as the United Kingdom, Germany and even South Africa, it is not an approach that best serves Nigeria. It is difficult to disagree with his logic. He argued that countries which adopt the comply or explain model have adopted it over time, in a manner which suits the level of disclosure and transparency their markets are accustomed to. The same cannot be said for Nigeria. The Corruption Perceptions Index, which tracks disclosure levels around the world, ranks Nigeria very poorly in relation to these counterparts, a signal to regulators about Nigeria's compliance standards. Nigeria’s culture of compliance is relatively low, with little appreciation for the overarching benefits of any regulation. On that note, a governing system which gives Nigerians the flexibility to decide whether or not to abide by a law is unlikely to serve the interests of the market or state.

Yet, the problem does not end there. Comply or explain is an approach that recognises alternatives to its aims, by assuming the existence of business norms which drive and encourage companies or businesses to prioritise the interests of stakeholders, and justify their choices to depart from the business norm. If it is to work, the market must trust companies to show commitment to good governance, and develop market based solutions without regulatory intervention. This requires shared beliefs and institutional arrangements that are geared towards prioritising stakeholders, therefore forcing companies to serve the shareholder’s interests.

In Nigeria, this incentive is absent for a number of reasons.

Nigerian companies are rarely owned by a wide base of concerned or activist investors. Instead, company directors make up a large percentage of its shareholders, thus destroying the ability of the board to think strictly in favour of its shareholders. In our environment, the directors have no one to explain to but themselves. This is in contrast to the UK, where market forces allow shareholders depress share prices by dumping stocks in reaction to corporate scandals or shareholder dissatisfaction. This power is lacking in many Nigerian companies, where director-shareholders are prevalent.

It is quite clear that the comply or explain principle is hailed by Western regulators as a tool for engendering innovation and new thinking, without the need for burdensome and inflexible rules. It provides companies the flexibility to develop practices that work at their own pace, and can be tailored to individual boards. The approach is taken so rarely departed from, that South Africa's King III Code of 2009 sought only to improve but not amend this flexibility when it rephrased it ‘apply or explain’ – a linguistic change to allow companies deviate from the code’s benchmark without shame or negative market perception.

Professor King, who was guest speaker at the conference, reminded Nigeria why the flexibility of the Code promises Nigerian businesses an alternative path to growth. Yet the people remain unconvinced. Perhaps at the next Thistle Conference, we stand a better chance of embracing this new concept, but as for now, what is good for the goose, is not always good for the gander.

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