Comply or Explain

It sits between binding law and pure voluntary guidance. A code sets out good practice, for example on board independence or committee structure. A company that departs from it does not break the law, but it must disclose the departure and explain why, usually in its annual report. Investors then decide whether the explanation is reasonable. The model is most closely associated with the UK, which popularised it, and is now used across Europe and in many other markets. It accepts that one size does not fit all, since a small firm or a founder-run company may have a good reason to differ. Its weakness is boilerplate explanations that say nothing. Investors handed a boilerplate explanation have little to judge, which is where the approach weakens.

A listed manufacturer's code says the audit committee should have a majority of independent directors. The company has a small board and only two of its four audit committee members qualify. The annual report names the departure, explains that it is hiring another independent director within a year, and describes interim safeguards. Shareholders accept the explanation at the meeting.