From principles to prosperity The time has come to 'apply and explain'

Principles have been at the heart of the UK’s governance and stewardship codes since the Cadbury Committee enshrined them in its seminal report on the financial aspects of corporate governance in 1992. They have played an important part in the UK’s global pre-eminence. However, in recent times, the UK’s corporate governance crown has been slipping.

The Cadbury Committee also promulgated the concept of ‘comply or explain’ to enable companies to give reasons for non-compliance, noting that the Code was to be followed by companies ‘in the light of their own particular circumstances’ 1.

What goes around, comes around. At the very outset of its report the Cadbury Committee pointed out that the country’s economy depends on ‘the drive and efficiency of its companies’, noting that ‘the effectiveness with which boards discharge their responsibilities determines Britain’s competitive position’. It stated that boards must be free to drive their companies within a framework of effective accountability, this being the essence of any system of good corporate governance 2. I would not demur. Nor it seems would today’s UK Government, which is desperately seeking economic growth and have required financial regulators – notably the Financial Reporting Council (FRC) and the Financial Conduct Authority – to take this and international competitiveness into account.

But things, of course, have changed since 1992. In particular, the ownership of UK plc has shifted from being dominated by UK long-term institutions with actively managed portfolios to globally focussed indexed funds, the largest being managed by powerful US investment managers. Between 1990 and 2020 the ownership of UK listed companies by UK insurance companies and pension funds fell from 52% to just over 4% 3. They were able to exercise the constructive influence envisaged by the Cadbury Committee when engaging with the boards of their portfolio companies. In contrast, the large index funds of today struggle to engage so effectively – they have thousands of companies in their portfolios and their resources for engagement are limited.

This seismic shift in ownership and the consequential dilution of accountability and influence has squeezed the spirit out of comply or explain. Any company not complying with any of the 2024 UK Corporate Governance Code’s 41 provisions 4 risks invoking the wrath of shareholders, stakeholders, and the media – so why bother?

When I was at Standard Life Investments, I was an ardent supporter of ‘comply or explain’, but now I recognise that it has passed its ‘sell by date’. Rather, the time has come for future UK Corporate Governance Codes to provide that companies ‘apply and explain’ how they have been governed by reference to the Code’s Principles.

This approach reflects that taken in the Wates Principles of Corporate Governance for Large Private Companies 5, which was published by the FRC in December 2018. It gives companies and their boards more flexibility than ‘comply or explain’ to tailor their governance to their circumstances, whilst meeting the spirit and purpose of the Code. This subtle yet significant change to UK corporate governance should be welcomed by companies whose shares are listed on the London Stock Exchange and make a London listing more attractive for them.

The evolution to ‘apply and explain’ would require a change in behaviour and mindset by all the players in the corporate governance and investor stewardship eco-systems.

First, it would embolden boards to promote their company’s long-term success, having regard to its circumstances. This would not put boards on ‘easy street’.  Quite the reverse. Rather than complying submissively with the Code’s provisions, which are given to them on a plate, they would need to give careful, considered thought about how they maintain good standards of corporate governance by applying the Code’s principles in a bespoke way.

Second, the explanations would need to be substantive and granular, not least to rightly satisfy those asset owners and asset managers who are signatories to the UK Stewardship Code, to whom the directors are accountable. Importantly, to help mitigate the risks of reduced accountability arising from the shift in the ownership patterns, the auditors could provide reasonable assurance to shareholders and stakeholders that the explanations provided by companies are presented fairly in all material respects.

Third, ‘apply and explain’ could reduce the scope for box-ticking, which for too long has been the scourge of corporate governance and investor stewardship. It might also encourage asset owners and asset managers to take a more holistic approach to their voting and stewardship responsibilities. They should not ignore the circumstances of the company by blindly following the recommendations of proxy voting agencies – some don’t but many do.

To conclude, Darwin taught us the importance to survival of adjusting and adapting to changing environments; the changing corporate governance environment, particularly as it relates to the concept of ‘comply or explain’, is no exception.

I believe the time has now come for the FRC, with purposeful intent, to prepare the way for parting company with ‘comply or explain’ and adopting ‘apply and explain’ to restore the prominence of principles in the next edition of the UK Corporate Governance Code, if not before. This would seem to be aligned with the direction given to it recently by the UK Government.

With a sharper focus on how generally accepted UK corporate governance principles have been applied in a tailored fashion, the boards of UK listed companies should have greater flexibility to drive and direct their companies in a way that may help to unlock entrepreneurial potential. This change in mindset away from compliance could help to unleash improved productivity and the sustainable economic growth that would contribute to the long-term prosperity for which we all yearn, individually and collectively. The public interest deserves nothing less.

The views expressed in this blog are Guy’s own and may or may not reflect those of the organisations with which he is affiliated.

(1) Report of the Committee on The Financial Aspects of Corporate Governance, 1 December 1992, paragraph 3.10

(2) Report of the Committee on The Financial Aspects of Corporate Governance, 1 December 1992, paragraph 1.1

(3) The Investor Forum Annual Review 2022, page12



About the author

Guy R Jubb

Honorary Professor at the University of Edinburgh Business School

Guy R Jubb, CA, Honorary Professor at the University of Edinburgh Business School, Co-Director of the Conference Board’s European Corporate Governance Council, and former Global Head of Governance & Stewardship at Standard Life Investments.

Guy is also a Non-Executive Director of The European Corporate Governance Institute, an Independent and Audit Non-Executive of Mazars LLP.

Better directors for a better world

The IoD supports directors and business leaders across the UK and beyond to learn, network and build successful, responsible businesses.

Enhancing transparency and accountability

Browse valuable governance resources from the IoD.
Internet Explorer
Your web browser is out of date and is not supported by the IoD website. It is important to update your browser for increased security and a better web experience.