One Size Doesn't Fit All

In Europe, corporate-governance rules are not in the details


LONDON -- When Congress passed a law requiring every company that's publicly traded in the U.S. to have at least one "financial expert" on its board audit committee, the Securities and Exchange Commission needed 75 pages to define who qualifies.

A British government-backed panel writing its own corporate-governance code wrote its definition in two sentences. A separate panel working in tandem laid out an entire set of recommendations for British audit-committee practices in half the space it took the SEC to spell out "financial expert."

In the wake of spectacular collapses like Enron Corp.'s and WorldCom Inc.'s, governments around the world are getting tougher on corporate governance. All are freely borrowing from one another. But while the U.S. has turned to explicit rules -- 3,000 pages written by the SEC to flesh out the Sarbanes-Oxley Act, and still going -- many other countries have let industry lay out new guidelines and left enforcement to peer pressure.

In an ironic twist, it's the Europeans, not the Americans, who are now arguing that corporate-governance changes are best left to market forces. Many European governments have asked independent commissions to recommend new industry guidelines and self-policing measures that are then adopted into local law or stock-exchange listing rules. Companies don't have to comply with the new rules, however, so long as they explain their reasons for noncompliance in their annual reports. Investors, such thinking goes, will either accept that noncompliance or pressure companies to change. Variations of this approach, which has come to be known as "comply or explain," have also been adopted by many countries outside Europe, including Australia, Brazil, Canada, Malaysia, South Africa and South Korea.

Perplexed in Paris

The U.S. emphasis on detailed rules has perplexed many European political and business leaders, who criticize Sarbanes-Oxley as poorly written legislation drafted in haste. In America's lawyer-dominated culture , what isn't expressly forbidden becomes permissible, these critics say. Using comply-or-explain, the Europeans maintain, ensures companies will be more likely to obey the spirit, rather than just the letter, of the law. The more flexible approach also will allow best practices to evolve as times change.

The man behind Britain's first corporate-governance code a decade ago, Adrian Cadbury, a former U.K. corporate chieftain and director of the Bank of England, says of the U.S. approach: "Sarbanes-Oxley, for reasons I can understand, sets out the way in which you should respond to the regulations -- it's all about the means. What we really ought to be saying is, 'What about the ends?'"

In Britain, says Derek Higgs, a former investment banker who wrote Britain's report on the role of independent, or nonexecutive, directors in January, "we're dealing with grown-up, intelligent people who can certainly benefit from guidelines and knowledge of best practice, but they have to make up their own mind" on how to apply them. "It's better to set out description and examples rather than to wag the finger," says Mr. Higgs.

U.S. officials defend their approach, saying it shows that they're facing up to problems and solving them. "Some other economies ... don't have the political will" to change, Michael Oxley, the Republican congressman and co-author of the act, said last month during the World Economic Forum in Davos, Switzerland.

European Union officials have asked the U.S. to grant exemptions from some provisions of Sarbanes-Oxley, citing conflicts with the laws of individual member countries. The SEC says the rules have been softened to allow companies based abroad to argue for exemptions.

A 2002 corporate-governance report written for the European Commission made recommendations for the EU as a whole, such as the full disclosure of executive pay, but concluded that sweeping rules wouldn't make sense given the different legal systems and company shareholder bases. Instead, it, too, recommended the philosophy of "comply or explain."

Many European corporations, particularly on the Continent, have big blocks of shares controlled by one company or family -- sometimes even by the national government. Some laws limit the room for outsiders on corporate boards; Germany, for example, requires that workers make up as much as half of the supervisory board. That makes it impossible to come up with a standard rule governing, for example, how many of a company's directors must be independent. Under Germany's dual-board structure, the supervisory board appoints the management board, reviews the financial results and approves the company's business strategy.

Market 'Will Punish'

"Under 'comply or explain,' some companies will withstand market pressures," concedes Jaap Winter, a Dutch lawyer who headed the committee that wrote the EU corporate-governance report. "Is that so bad? They might not change, or change quickly enough. But the market will punish them."

Generally, the U.K. is moving faster to improve corporate governance than its counterparts on the Continent. But even in Britain, holdouts remain who opt to explain rather than comply. Ten years after the Cadbury Report responded to a series of corporate scandals with the recommendation that the jobs of chief executive and chairman be split -- an issue that still arouses heated debate in the U.S. -- five of Britain's 100 biggest companies still combine the jobs. Fulfilling its obligation to "comply or explain," one of those companies, William Morrison Supermarkets PLC, a regional supermarket chain trying to acquire the larger Safeway PLC, explains briefly in its annual report that it has no outside directors or a separate chairman because it believes "there is no commercial benefit in the appointment of nonexecutive directors." Shareholders say the company has gotten away with it until now because of its strong performance but that pressure to change is nonetheless growing.

A recent battle in the U.S. over the same issue shows that sometimes a rules-based system can lag behind one that relies on principles -- and that there's no substitute for shareholder pressure, whatever system of enforcement is in place: General Electric Co. shareholders earlier this month forced the company to agree to a proxy vote on separating the jobs of chairman and chief executive. GE has opposed such a vote, arguing to the SEC that it had no obligation to include it in the annual-meeting materials. A GE spokesman said the SEC staff disagreed with the company's position, and the proposal is now expected to be one of several presented to shareholders for a vote.

Another example of shareholder-driven change in Britain: a campaign to reduce severance pay for fired chief executives. In Britain a decade ago, the standard employment contract for chief executives was for three years. Hermes Pensions Management, one of the most vocal U.K. money managers on corporate-governance practices, began railing against the practice because it meant that a CEO fired in the first year of a new contract would end up with a payoff equal to three years' salary. Since then, the idea has been incorporated in one of the country's corporate-governance codes. Today, a handful still have three-year contracts, but one-year contracts are becoming standard, says Alastair Ross Goobey, a former Hermes CEO and now chairman of the International Corporate Governance Network, a London-based group launched in the mid-1990s by major pension funds around the world.

Change can be much slower on the Continent, where many of the largest fund-management groups are owned by banks and insurance companies, which constrains their ability to independently push for corporate reform. And while many of the recent reports recommending change have gotten some teeth by being incorporated in the listing requirements of that country's stock exchange, some lack even that.

France's Bouton Report, published last year, was written at the behest of two French business federations, not the government, which has merely said it backs efforts by business to regulate itself.

In Germany, the insurance group Allianz AG, one of the country's biggest companies, sent a strong signal to the rest of the German business world when it said it wouldn't comply with a recommendation in the Cromme report on corporate governance, issued last year and backed by the government, to disclose the individual pay of senior executives, because it believes they're entitled to privacy. The country's mutual-fund association, Bundesverband Investment & Asset Management, hasn't commented on the decision. A spokesman said its priorities currently are tax and pension issues.

Meanwhile, some codes may even be going backward. Spain's Aldama report lacks recommended limits on board sizes and ages of chief executives and chairmen -- matters addressed in an earlier code. Nor does the report recommend a minimum percentage of independent board members. Jordi Canals, dean of the IESE Business School in Barcelona and one of the report's 15 government-appointed authors, defended the panel's decision to be deliberately general. "The pattern of the decision-making processes within a board of directors doesn't have anything to do with the structure of a board," he says. Whether board members are outspoken or the chief executive stifles debate has more to do with the personalities involved, he says.

-- Ms. Ascarelli is a staff reporter in The Wall Street Journal's London bureau.

Write to Silvia Ascarelli at

Updated February 24, 2003 10:43 a.m. EST