“Comply or Explain”: market discipline and non‐compliance with the Combined Code

The “comply or explain” principle adopted by the UK’s Combined Code on Corporate Governance has now been in operation for 12 years. In this paper we focus on two aspects of this regime. The first is the nature of the explanations that have been given by companies with an established record of non‐compliance (“serial non‐compliers”) and the role of the market in permitting deviations from the Combined Code. In particular, we consider the significance of share price performance as a factor that is relevant in justifying non‐compliance and the extent to which investors appear to rely on this indicator rather than engage in the more difficult task of judging the relative merits of the Code provisions against alternatives. Our approach differs from much of the research linking corporate governance with financial performance in that it focuses on the potential influence of financial performance (as measured by share price) on governance structure rather than vice versa. Our study of FTSE 100 serial non‐compliers suggests that there is a prima facie link between share price performance and investors’ tolerance of non‐compliance with the Combined Code. The second issue we examine is the link between the principle of “comply and explain” and the self‐regulatory status of the Code. We conclude that the benefits of flexibility generally associated with the self‐regulatory status of the Code are overstated and that the Code could be integrated into mainstream company law.