Corporate Governance: Theory, Practice and the Persistent Gap Between Them

The emergence of corporate governance

Debates about the nature and purpose of the company have existed since the earliest partnership regulations.

Liberal theorists argue for minimal state intervention, viewing regulation as a threat to economic freedom. Marxist perspectives emphasise the conflict between labour and capital, advocating stronger protections for workers. Between these poles lies a wide spectrum of views, each shaping how corporate regulation has evolved.

English regulators recognised early the need to protect separate corporate personality, limited liability, directors’ duties, shareholder rights and basic accounting transparency. As markets expanded and business structures diversified, corporate governance increasingly took the form of soft law, required only for companies with premium listings.

The need for protection

The rise of dispersed ownership in the UK and USA created a structural divide between ownership and control.

Shareholders, often holding small stakes as part of diversified portfolios, became less engaged in internal management. Managers gained significant autonomy with limited supervision. Corporate governance emerged as a mechanism to regulate the relationship between these groups.

More recently, attention has shifted beyond managers and shareholders.

Companies are increasingly viewed as quasi‑public institutions expected to contribute positively to society. Sustainability reporting has become common, and institutional investors are withdrawing from ethically problematic sectors such as coal mining.

In January 2020, the Financial Times reported that BlackRock adopted a sustainable investment strategy incorporating climate‑related assessments alongside traditional risk analysis. Larry Fink, BlackRock’s chairman, has advocated multistakeholderism, arguing that companies must serve a broader social purpose.

This long‑term approach challenges the short‑term focus associated with shareholder primacy.

The current form of corporate governance

Corporate governance codes typically emerge after significant market failures or financial crises. Committees produce recommendations, some of which become part of the final Code.

The first major UK report was the Cadbury Report (1992), produced by the Committee on the Financial Aspects of Corporate Governance chaired by Adrian Cadbury. It followed high‑profile corporate failures, including the collapse of the Bank of Credit and Commerce International, Polly Peck and the disappearance of approximately £460 million from Mirror Group pension funds.

The Cadbury Report introduced principles concerning:

• the role and composition of the board
• guidance for institutional investors
• disclosure of audit and accounting statements

Its most influential contribution was the comply‑or‑explain principle. Companies adopting the Code are not required to comply with every provision, but must explain any departures in their compliance statement. This approach preserves flexibility while encouraging transparency.

In theory, comply‑or‑explain allows shareholders to review board decisions and hold directors accountable. In practice, the mechanism raises critical questions: who reviews the explanations, and why should shareholders care?

The divorce between theory and practice

Lack of guidance

Compliance is straightforward when a company follows a provision.

Problems arise when a company chooses not to comply. There is no clear definition of what constitutes a “sufficient explanation.” Boards can provide minimal or boilerplate statements without consequence. Without guidance or enforcement, the quality of explanations varies widely, undermining the effectiveness of the Code.

Shareholder disinterest

Shareholder passivity is the central weakness of comply‑or‑explain. Dispersed ownership means few shareholders have a large enough stake to justify active oversight. Most investors focus on financial performance within a broader portfolio. Reviewing compliance statements requires time, expertise and motivation that many shareholders do not possess.

Academic Andrew Keay observed that shareholders are unlikely to intervene as long as the company performs well, suggesting that comply‑or‑explain often functions as “perform‑or‑explain.”

The UK Corporate Governance Code today

The UK Corporate Governance Code 2018 applies to public companies with premium listings and continues to rely on comply‑or‑explain.

Additional codes apply to smaller public companies, private companies and institutional investors. However, the voluntary nature of explanations casts doubt on their practical value.

Other jurisdictions offer alternative models. The Netherlands, for example, has introduced an independent oversight body. Some countries impose minimum explanation standards to improve the quality of compliance statements.

Despite decades of corporate governance development, failures persist. The 2018 collapse of Carillion is a recent example, highlighting once again the limitations of current oversight mechanisms.