HomeBusiness DigestThe Human Capital Telescope: Comply-or-else or comply-or-explain?

The Human Capital Telescope: Comply-or-else or comply-or-explain?

Brett Chulu

LAST week we started a debate on which corporate governance enforcement mechanism is suitable for Zimbabwe. We highlighted that there are three key approaches to enforcing corporate governance, namely: comply-or-else, comply-or-explain and a hybrid approach. This week we analyse the suitability of the last two regimes.
Comply or explain
Some critics of the comply-or-else regime, mainly from Europe, advocate for a comply-or-explain regime. Under the comply-or-else regime, corporates enforce adherence to corporate governance standards through self-regulation. Corporates are required to comply with the provisions of a well-accepted corporate governance code.

If a corporate entity chooses not to comply with any specific corporate governance standard, they are required to provide an explanation in their official corporate reports. For instance, the UK code, which is a comply-or- explain code, requires the chief executive not to double up as the chairperson of the board.

Thus a London Stock Exchange-listed entity can choose not to comply. However, they would be required to explain why they chose to settle for the chief executive-cum-chairperson option. The defenders of comply-or-else argue that a one-size-fits-all approach is undesirable as circumstances differ across industry sectors.

The UK is known to be the staunchest defender of the comply-or-explain regime. A survey by Grant Thornton has shown that about 50% of LSE-listed firms comply fully with the UK code. The Financial Reporting Council (FRC), the UK’s custodian of the UK code, has cited this as evidence that the flexibility resident in the comply-or-explain UK code is justified. The Grant Thornton survey showed that 96% of the FTSE 350 firms that did not comply gave explanations for deviating from the UK code.

The FRC is worried that the 4% who do not comply are not providing explanations at all, thus arming critics at the European Commission who want Europe to move towards comply-or-else. Critics of comply-or-explain have argued that the quality of explanations for non-compliance is not satisfactory.

In a move calculated to sway the decision of the European Commission to retain the comply-or- explain regime, the FRC has crafted guidelines to improve the quality of explanations.

Three guidelines have been suggested. First, an explanation has to provide the context and historical background. Second, the explanation should ‘give a convincing rationale for the action’. Third, the non-compliant entity should describe how it intends to mitigate the risks associated with deviating from the provisions of the UK code. That was before the recent interest rate-fixing scandal involving Barclays Plc, which has claimed the scalps of the former chief executive Bob Diamond and the ex-chairman Marcus Agius.
Critics of the comply-or-explain approach argue that self-regulated compliance does not have the power to punish serious offenders, leaving the market to punish the company. Currently, many corporates in Zimbabwe cherry-pick which corporate governance practices to adopt, choosing the path of least resistance, hiding behind a profession of subscribing to international best practices – an attempt to paint their entities as going beyond local standards of governance.


Does the evident tendency to domesticate best-in-class corporate governance standards in a minimal fashion and the argument that comply-or-explain is not deterrent enough to off-put criminal elements point to the non-suitability of a comply-or-explain regime for Zimbabwe?
Apply or explain
The South African school of thinking led by Mervyn King has advanced the apply-or-explain regime. The current King III Code (South Africa) hinges on the apply-or-explain regime to promote compliance with the code. The apply-or-explain advocates, like their comply-or-explain compatriots, share a fierce aversion to the rigidity of comply-or-explain.


However, the apply-or-explain campaigners dislike the word ‘comply’, arguing that it promotes an uncritical application of corporate governance practices. Instead, they replace comply with explain to underline their chief argument that for high standards of governance to occur, the emphasis should be more on the application of principles rather than specific recommendations.

The King III code is primarily made up of overarching principles and recommended practices underpinning the practical application of the underpinning principles. For instance, Principle 2.16 states: “The board should elect a chairman of the board who is an independent non-executive director. The CEO of the company should not also fulfil the role of chairman of the board.”


This principle is exemplified by nine recommended practices. For instance, Recommended Practice 2.16.8 states: “The chairman, together with the board, should consider the number of outside chairmanships held.” According to Mervyn King, the code’s principles supersede the recommended practices. This means that the board can choose either to apply any recommendation differently or apply another practice. However, in doing so corporates should proffer an explanation as to how their choices result in complying with the spirit and intent of the code.
King’s argument is that, “In reality, the ultimate compliance officer is not the company’s compliance officer or a bureaucrat ensuring compliance with statutory provisions, but the stakeholders.’’ Herein lies the challenge with domesticating the apply-or-explain regime to Zimbabwe’s corporate governance.
The apply-or-explain regime implicitly assumes that a country’s institutions and key stakeholders such as shareholders are competent enough to play an effective ‘watch-dog’s role.

Events of the past three months, if anything, point to arguably weak corporate governance policing institutions in Zimbabwe. For starters, stakeholders do not have adequate information to gauge corporate governance compliance due to limited disclosures in corporate reports.


Matters are not helped by the fact that the majority of public companies issue corporate governance statements instead of corporate governance reports. There is a world of difference between a corporate governance statement and a corporate governance report.
Suitable regime for Zimbabwe.
Perhaps, a more suitable approach for Zimbabwe is a code that is partly legislated. Under such an approach some aspects of a national corporate governance code could work on a comply-or-else basis and some on a comply- or-explain basis.
My argument is that without a combination of well-articulated rewardsand punishments, there is no incentive to meeting performance expectations. Besides, rewards by the market, a deliberate programme to recognise poor and good corporate governance is needed. One way is to publish a corporate governance ranking for corporates in Zimbabwe.

Equally important is meting out commensurate punishment to serious corporate governance violations such as de-licensing and blacklisting individual offenders. Professional bodies could assist to this end by de-recognising offenders.

  • Let’s discuss at brettchulu@consultant.com.

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