The myth of the “good governance code”: an analysis of the relationship between ownership structure and the comply-or-explain disclosure

• DOI: https://doi.org/10.1108/CG-08-2017-0197
• Pages: 809-838
• Published date: 13 March 2018
• Date: 13 March 2018
• Author: Luigi Lepore,Sabrina Pisano,Assunta Di Vaio,Federico Alvino
• Subject Matter: Corporate governance,Strategy

The myth of the “good governance code”:

an analysis of the relationship

between ownership structure and the

comply-or-explain disclosure

Luigi Lepore, Sabrina Pisano, Assunta Di Vaio and Federico Alvino

Abstract

Purpose –The purpose of this paper is twofold: first, to assess the degree of disclosure about

compliancewith corporate governance code and the explanations provided by Italianfirms and second,

to analyzethe relationships between this disclosureand different variables of ownershipstructure.

Design/methodology/approach –The sample was composed of 75 non-financial companies listed in

Italy in 2016. Content analysisof the corporate governance statement and ordinaryleast squares (OLS)

multipleregression models were used to test the hypotheses.

Findings –Companies tended to comply with the corporate governance code and to disclose this

information,but when they decided to not comply, they did notprovide adequate explanations. Findings

revealed a negativerelation between ownership concentrationand the disclosure analyzed. Resultsalso

highlight that a more equal distributionof shares among larger shareholders is beneficial for disclosure.

Moreover, the presence of a dominantfinancial shareholder at a high level of ownership concentration

createsinefficiency of the degree of adherence to the comply-or-explainprinciple.

Originality/value –This study examinesin depth the underexplored issue of “explanation”and exceeds

the issue of ownershipconcentration, which has already been examinedextensively, raising the issues of

counterweight power and shareholders’ identities, which remain underexplored. In this way, results

presentedcontribute to explaining some causes of the diversefindings that research has found about the

relationship between ownership concentration and voluntarydisclosure, demonstrating the importance

of counterweightpower and largest shareholder’s identity. Consequently,when self-regulating initiatives

are designed and implemented, legislators, regulators and managers should not ignore the

characteristicsof the firms’ ownership structure.

Keywords Corporate governance, Corporate ownership, Comply-or-explain disclosure,

Dominant shareholder identity

Paper type Research paper

1. Introduction

The financial crises of the past decade, accompanied by several emblematic corporate

scandals, have highlighted the inefficacy of corporate governance (CG) mechanisms,

including good governance codes, causing legislators and financial communities around

the world to reinforce both corporate regulations (hard law) and governance codes (soft

law) (Cuomo et al., 2016;Mallin, 2013;Zattoni and Cuomo, 2008). CG codes, as a form of

soft law, through the comply-or-explain principle, provide firms with a voluntary means for

improving CG practices: companies have the option to comply with a code’s

recommendations or to not comply, disclosing the adoption of recommendations or

explaining the reason in cases of non-compliance. The disclosure of compliance with CG

Luigi Lepore is Associate

Professor, Sabrina Pisano

is Assistant Professor,

Assunta Di Vaio is

Associate Professor and

Federico Alvino is Full

Professor, all at Business

Administration at the

Department of Law,

Parthenope University of

Naples, Naples, Italy.

Received 29 August 2017

Revised 26 January 2018

2 February 2018

Accepted 2 February 2018

The work benefited from the

funding of Parthenope

University.

DOI 10.1108/CG-08-2017-0197 VOL. 18 NO. 5 2018, pp. 809-838, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 809

codes or the explanation can be mandatory or voluntary. The literaturehas emphasized that

the effectiveness of governance codes increases if the disclosure of governance practices

is mandatory because of market disciplinary mechanisms, which can only work well with

informative disclosures about adoption and/or explanations: if the disclosure about

compliance with the CG code is voluntary, problems with the effectiveness of good

governance code could arise when companies do not disclose information about adoption

or provide explanations because investors cannot understand if the company does not

adopt the best practices or adopts the best practices but does not disclose its adoption.

Thus, the external disciplinarymechanisms do not work well (Cuomo et al., 2016).

In recent years, many countrieshave adopted self-regulatory codes to improve CG, sharing

best practices and increasing the legitimationof national firms in the international context. In

Italy, the CG code was issued by Borsa Italiana, and since 2007, listed companies have

been required to draw up a narrativereport known as a CG statement, either as a part of the

directors’ report or as a separate document, to inform investors about CG practices (Article

123-bis Legislative Decree 58/1998, introduced by Legislative Decree 229/2007). This

report, based on the flexibility of the comply-or-explain principle, states whether a company

has complied with the provisions of the CG code, and it provides specific explanations in

cases of non-compliance. Specifically, this powerful tool provides companies with the

opportunity to disclose all of the essential information required by stakeholders to

understand the manner in which firms are governed.

This study has two aims. The first is to assess the degree of disclosure regarding

compliance with CG code and the explanations provided by Italian non-financial listed

firms. The disclosures that we analyzed refer to the composition and functioning of boards

of directors. To achieve this aim, we developed a comply-or-explain disclosure index and

analyzed the CG statements issued by firms by using content analysis. More specifically,

our index considers both the comply and the explain aspects. The majority of the literature

has mainly focused on the compliance aspect (Alves and Mendes, 2004;Renders et al.,

2010;Saad, 2010;Sanderson et al., 2010;Talaulicar and Werder, 2008;Warning, 2011). To

the best of our knowledge, few studies have investigated the explain aspect (Arcot et al.,

2010;Goncharov et al., 2006;Hooghiemstra and van Ees, 2011;Nerantzidis, 2015;Pass,

2006;Rose, 2016;Shrives and Brennan,2015;Werder et al., 2005). Analysis of the comply-

or-explain disclosure is important because, as explained above, the market disciplinary

mechanism can work well only with adequate informative disclosure about adoption and/or

explanation, so if the level of disclosure is low, codes fail as governance mechanisms.

Moreover, as the literature has highlighted (Lepore et al.,2017), each CG mechanism

provides its own effectiveness, contributing to the improvement governance and

performance while interacting with other internal and institutional governance mechanisms.

Therefore, to evaluate the effectiveness of codes as good CG mechanisms, it becomes

essential to analyze the interaction between disclosures regarding comply-or-explain and

other governance variables, particularly ownership concentration. The latter, in fact,

acquires increasing importance as both an internal and an external control mechanism of

CG (Connelly et al.,2010): interacting with other CG mechanisms, ownership concentration

can influence CG effectiveness in protecting shareholder rights (Demsetz and Lehn, 1985;

Shleifer and Vishny, 1997). Consequently, the second aim of this study is to investigate the

relationship between ownership structure and the level of the comply-or-explain disclosure

index to understand whether both ownership concentration/counterweight power and

shareholder identity affect the degreeof comply-or-explain disclosure.

We found that the sampled companies tend to comply with the majority of the

recommendations concerningthe composition and functioning of the board of directorsand

disclose this information; however, when they decide to not comply, the sampled firms do

not provide adequate explanations according to Recommendation 208/2014. The analysis

shows that there is both a negative relationship between ownership concentration and the

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