Firm performance and comply or explain disclosure in corporate governance

Abstract

This study investigates the degree of Danish firm adherence to the Danish Code of Corporate Governance and analyzes if a higher degree of comply or explain disclosure is related to firm performance. This article formulates a methodology for quantifying the degree of comply or explain disclosure.The analysis shows that there is a positive link between ROE/ROA and Danish firm total corporate governance comply or explain disclosure scores. Specifically, this is also the case when this level is increased within the following two categories: board composition and remuneration policy, whereas there is no impact on performance when increasing compliance with the recommendations on risk management and internal controls. This article demonstrates that these three areas are the ones where Danish firms show the lowest degree of comply or explain disclosure, although the overall adherence to the Danish code's many recommendations is relatively high.This article relates to the burgeoning literature that deals with listed firm compliance with national corporate governance codes and how compliance can be appropriately quantified. It is suggested that compliance is classified into the following four categories: complies, complies poorly, explains and explains poorly. The article demonstrates that measuring the degree of compliance cannot be done in a mechanical way. Instead, it must be customized to the respective national institutional environment, which suggests country comparisons will be difficult to make. The article contributes to the ongoing discussion of whether firms consider soft law to be a “tick the box” exercise or, alternatively, whether firms should work seriously with the recommendations in order to professionalize and increase competences among board members. The article's findings suggest that soft law may be an efficient way of increasing the quality of corporate governance among listed firms. However, in order to strengthen investor confidence, national code authorities/committees should be more active in penalizing poor explanations as well as cases where firms wrongfully state that they comply with a specific recommendation.