How to Read a Governance Code — The Discipline of "Comply or Explain"

A code is not a law. You either comply, or you explain why you do not — and that choice is itself assessed by the market. This piece reads what it means for the Corporate Governance Code to be soft law, and the discipline of comply or explain, by laying it over the in-house standards of materials review.

01Setting Out Principles — Principles-Based, Not Rules-Based

The Corporate Governance Code is not a rules-based scheme that enumerates in fine detail what may and may not be done. It is built on a principles-based approach: it states the principles to be observed and leaves their concrete form to each company. That is why "not complying" is also a choice. But once you make that choice, accountability follows.

There is a reason for the principles-based design. Listed companies differ widely in size, in business, and in the history of their governance; impose a single set of detailed rules and they will be excessive for one company and idle for another. So the Code states only principles and permits each company the answer that best fits its circumstances — in exchange for which it must explain why it chose that form, securing transparency. The freedom to avoid uniformity and the duty to explain are designed as a pair. The in-house standards of materials review are built the same way: a deviation is not banned across the board, and in some situations what decides the matter is whether you can explain the grounds.

02Not Statute — The Standing of Soft Law

The Code is not statute. Breaching it carries no direct penalty of its own. It is what we call soft law. So where does its binding force come from? From the Tokyo Stock Exchange's Securities Listing Regulations. Through those regulations, listed companies are asked to comply or explain — to implement each principle, or, where they do not, to explain why.

What is easy to mistake here is the purpose. Formally complying with every item is not the goal. The point is to choose a form of governance that fits your own company and to be able to explain it. A report that says "we complied with everything" does not necessarily mean good governance. The three below are the coordinates for reading the Code.

03The Quality of the Explanation Decides Trust — Toward the In-House Standards of Materials Review

What comply or explain truly tests is the quality of the explanation. If the "reason for not implementing" is hollow, you lose the trust of investors and shareholders even where, formally, you have complied. Conversely, where you can give a substantive account grounded in your own circumstances, the very choice not to implement a principle can be assessed favorably. The constructive dialogue mindful of the cost of capital that the Ito Review urges also rests on this culture of explanation.

The same structure runs through materials review. "Why was this expression allowed?" "Why was this claim ruled out?" The substance of that explanation is what divides the quality of the review. Beyond issuing a yes or no against the standard, leave the grounds of the judgment on record and keep them ready to be articulated. This is the same thinking by which the independence of outside directors and the design of the nomination, remuneration, and audit committees seek to secure what can be verified from the outside. The way a review record becomes evidence that governance is at work is taken up again in materials review as seen from the board.