The limits of flexible regulation: Managers’ perceptions of corporate governance codes and ‘comply-or-explain’ (CBR WP No. 439)

Over the past few years regulatory regimes have become more flexible, adopting risk-based approaches and shifting from rules to principles where regulatees are given a degree of discretion in how they comply. In this way “one size fits all”. Flexibility such as this is however under threat. The current financial crisis has given rise to calls for more and stronger regulation. Policymakers have to respond but are well aware there are limits - lack of flexibility can hinder innovation and economic growth. So, when does flexible regulation work and when does it not? In what circumstances are regulatees likely to strive to comply with underlying regulatory principles and when are they not? What factors affect regulatee ‘buy-in?’ To address these questions we examined the use of comply-or-explain in corporate governance. This mechanism can be considered the ultimate in flexible regulation. It allows noncompliance, but only where regulatees provide a convincing explanation acceptable to shareholders. Previously we analysed the compliance records of 260 of the largest UK and German companies (Seidl et al. 2012). For this paper we analyse the accompanying interviews with selected senior managers and directors. We conclude the lessons for policymakers are that successful application of flexible regulation mechanisms such as this is contingent on the presence of powerful and influential monitors and that regulatee buy-in to flexible regulation depends primarily on the extent to which (i) ‘soft’ regulation is understood as a traditional means of control and, (ii) regulatees are involved in the design, implementation and evaluation of regulation. However, whatever the conditions or circumstances, large companies tend to believe they are under considerable pressure to be seen to fully comply which may ultimately render any in-built operational flexibility redundant. This is more likely to be the case under conditions of uncertainty.