**2. Theoretical background**

Self-interested managers as agents of shareholders (principals) have the opportunity to take actions that benefit themselves, and shareholders are those that bear the costs of such actions (i.e. agency costs) [1, 2]. In many countries, not only managers but also controlling shareholders can expropriate minority shareholders and creditors [3, 4]. Several mechanisms are proposed to resolve principal-agent problems such as monitoring by boards of directors or large outside shareholders, equity-based managerial incentives or the market for corporate control [1, 2, 5]. These different types of control and monitoring in companies are referred to

Many cases of corporate fraud, accounting scandals and other organizational failures leading to lawsuits, resignations or even bankruptcy have made corporate governance as especially important and often discussed topic among professionals and scholars. The main feature of many of these cases is the assumption that the system of checks and balances designed to prevent potentially self-interested managers from engaging in activities detrimental to the welfare of shareholders and stakeholders failed [2]. Several formal regulations and informal guidelines, recommendations, codes and standards of corporate governance have been established or improved in order to determine good corporate governance. These efforts to improve corporate governance practices have raised an important dilemma within the corporate governance field, whether to develop hard law (i.e. mandatory requirements, hard regulations and regulatory approach) or soft law (i.e. voluntary recommendations, soft regulations and market-based approach) in order to improve corporate governance across countries [7, 8]. In this contribution, we explore governance codes that are a form of soft regulations (i.e. soft law) presenting a set of voluntary best governance practices without the force of law [7, 9, 10]. The issue of the Cadbury Report and the Code of Best Practices in the UK importantly affects the diffusion of codes around the world after 1992 [7], and similar effects on new codes' creation or revision of the existing ones can be observed after 2008 due to the

The number of research studies on codes of good governance has considerably expanded after 1992 and especially in the early 2000s [7, 10]. Because of the voluntary nature of the majority of codes, there has been a considerable debate in the literature on whether the code recommendations affect the corporate governance quality [7, 8]. Research studies demonstrate that the introduction of corporate governance standards in the form of a code has positive effects on the evolution of governance practices [10] and especially on transparency and

The aim of this contribution is to broaden our understanding on the role of corporate governance codes in improving corporate governance practice. We explore how the introduction of corporate governance code influences the corporate governance quality in the case of Slovenia. We selected the case of Slovenia due to the lack of research that would address codes' evolution and their adoption in the transition economies [12]. Slovenia is one of the transition countries that present a large sub-category of emerging economies [13]. As a new European state, it was founded in 1991, and has been in last decades under several transition processes [12, 14, 15]. Even though some authors [16] claim that Slovenia is no more a transition countries since it joined the European Union (EU), several indicators show that economic

as corporate governance [2, 6].

54 Corporate Governance and Strategic Decision Making

global financial crisis [10].

disclosure [8, 11].

#### **2.1. Institutional environments and corporate governance systems**

A universal model outlined by principal-agent theory dominates the corporate governance research field. Its central premise is that shareholders and managers have different interests and objectives as well as different access to specific information of a company. That is a way self-interested managers have the opportunity to take actions that benefit themselves, and shareholders are those that bear the costs of these actions. Such costs are referred to as agency costs [1, 2]. In many countries, it has been noted that not only managers but also controlling shareholders (both are also referred as insiders) can expropriate minority shareholders and creditors (referred also as outsiders) [3, 4].

Several scholars [1, 5] criticize the closed-system approach within agency theory that implies a universal and direct linkage between corporate governance practices and performance and devotes little attention to the distinct contexts in which companies function. They claim that the structure of governance systems is influenced by several external forces such as efficiency of local capital markets, legal tradition, and reliability of accounting standards, regulatory enforcement, and societal and cultural values [2, 19, 20]. Research studies show that there are substantial variations in institutional environments that shape the degree and nature of agency conflicts and the effectiveness of corporate governance mechanisms [21, 22].

Schiehll et al. [22, p. 180] suggest that corporate governance system should be viewed as 'bundles of interrelated or even intertwined external (country-level) and internal (firm-level) forces, which provide structures and processes of the relationship between firm's management and stakeholders'. They also apply the term national governance bundles, which are 'configurations of governance mechanisms that simultaneously operate at the firm and national levels to govern firms within an overall economy or collection of economies' (p. 180). The historical path dependence among country- and firm-level mechanisms results in a variety of country- and organization-specific governance systems that are effective within the institutional environments in which they have been developed [23].

Therefore, we believe that understanding of attempts in distinguishing and describing different institutional environments and corporate governance systems enables us to more appropriately asses the role of corporate governance codes in improving corporate governance practices.

When distinguishing corporate governance systems, two perspectives should be considered based on the role of companies in the society [2, 24]. Taking a shareholder perspective, where a company's primary obligation is to maximize shareholder value, effective corporate governance should protect shareholders from being expropriated by the management [2, 24]. The system of corporate governance in the Anglo-Saxon countries is characterized as a shareholder-based system [2, 24] and the law strongly protects shareholders [20]. Anglo-Saxon countries' firms are relatively widely held (low ownership concentration). It is estimated that in the USA and the UK, the largest five shareholders hold on average 20–25% of the outstanding shares. Due to this fact, on one hand less mechanisms shareholders can use effectively to influence managerial decision-making in a direct manner [24], but on the other hand 'interdependence among institutions may lead to substitution among functionally equivalent corporate governance mechanisms' [5, p. 980]. Examples include takeover markets in the USA and the UK, where external governance in the form of the market for corporate control with the takeover threat presents disciplining mechanisms for managers [5].

In most European and Asian countries, the stakeholder-based systems prevail [2, 24]. From stakeholder perspective, where a company has a societal obligation that goes beyond increasing shareholder value, effective governance should 'support policies that produce stable and safe employment, provide acceptable standard of living for workers, mitigate risk for debt holders, and improve the community and environment' [2, p. 9]. In the majority of these countries, ownership concentration is significantly higher than in Anglo-Saxon countries [25]. For example, in Germany the largest five shareholders hold on average 41% of the outstanding shares [24]. Concentrated ownership on one hand may reduce agency costs stemming from the separation of ownership and control, but on the other hand may induce new conflicts that arise between majority and minority shareholders. The primary agency problem in this institutional context is the possible expropriation of minority shareholders by the controlling shareholders such as related-party transactions [5]. Therefore, in countries where a vast majority of companies has a concentrated ownership and control structure, the function of corporate governance regulation is to minimize the extent of agency problems between majority and minority shareholders and that between shareholders and creditors [24]. As noted by Larcker and Tayan [2, p. 9] 'the governance system that maximizes shareholder value might not be the same as the one that maximizes stakeholder value'.

In relation to the previously discussed perspectives, scholars often made division of corporate governance systems between the Anglo-American and the Continental European system. While short-term equity finance, dispersed ownership, stronger shareholder rights, active market for capital control and flexible labour market characterize the first one, the Continental European corporate governance system is characterized by long-term debt financing, concentrated block-holder ownership, weak shareholder rights, inactive markets for capital control and rigid labour markets [19].

Combination of the Continental European capitalism characterized by large controlling shareholders and elements of entrepreneurial or founders capitalism mostly associated with the USA is characteristic of new emerging capitalism not only in the transitions economies of Central and Eastern Europe but also in other parts of the world [26]. Many transition economies (i.e. former socialist countries) are characterized by a relatively high level of ownership concentration leading to the agency problems between majority and minority shareholders. Concentration of ownership in the hands of a few or even one block-holder assures a significant control and direct influence on the nomination and control of management team, which for this reason cannot be expected to be independent [26, 27].

A legal system and tradition also has important implications for corporate governance system [2]. According to institutional theory, legal rules and norms are important component of national institutional systems [5]. In terms of legal origins, common-law and non-common-law (i.e. civil-law) countries are distinguished [2], even though this corporate governance research stream has been criticized due to its simplistic theoretical and empirical grounds [5]. Noncommon-law countries (such as Germany, Scandinavia and French countries) are countries with poorer investor protection, and have smaller and narrower capital (both equity and debt) markets and less widely held companies (more ownership concentration) than common-law countries (such as UK). Countries whose legal system is based on a tradition of common law afford more rights to shareholders and more protection to creditors than countries whose legal systems are based on civil law (or code law) [28].

In common-law countries, there are mainly information asymmetry and agency problems between managers and (majority) shareholders; in non-common-law countries, these are mainly information asymmetry and agency problems between minority and majority shareholders. The research findings of Bauwhede and Willekens [29] showed that the level of corporate governance disclosure was significantly lower in non-common-law countries than in common-law countries due to the greater pressure that shareholders can put on managers in comparison to the pressure minority shareholders can put on majority shareholders.

#### **2.2. Corporate governance codes**

The historical path dependence among country- and firm-level mechanisms results in a variety of country- and organization-specific governance systems that are effective within the

Therefore, we believe that understanding of attempts in distinguishing and describing different institutional environments and corporate governance systems enables us to more appropriately asses the role of corporate governance codes in improving corporate governance

When distinguishing corporate governance systems, two perspectives should be considered based on the role of companies in the society [2, 24]. Taking a shareholder perspective, where a company's primary obligation is to maximize shareholder value, effective corporate governance should protect shareholders from being expropriated by the management [2, 24]. The system of corporate governance in the Anglo-Saxon countries is characterized as a shareholder-based system [2, 24] and the law strongly protects shareholders [20]. Anglo-Saxon countries' firms are relatively widely held (low ownership concentration). It is estimated that in the USA and the UK, the largest five shareholders hold on average 20–25% of the outstanding shares. Due to this fact, on one hand less mechanisms shareholders can use effectively to influence managerial decision-making in a direct manner [24], but on the other hand 'interdependence among institutions may lead to substitution among functionally equivalent corporate governance mechanisms' [5, p. 980]. Examples include takeover markets in the USA and the UK, where external governance in the form of the market for corporate control with the

In most European and Asian countries, the stakeholder-based systems prevail [2, 24]. From stakeholder perspective, where a company has a societal obligation that goes beyond increasing shareholder value, effective governance should 'support policies that produce stable and safe employment, provide acceptable standard of living for workers, mitigate risk for debt holders, and improve the community and environment' [2, p. 9]. In the majority of these countries, ownership concentration is significantly higher than in Anglo-Saxon countries [25]. For example, in Germany the largest five shareholders hold on average 41% of the outstanding shares [24]. Concentrated ownership on one hand may reduce agency costs stemming from the separation of ownership and control, but on the other hand may induce new conflicts that arise between majority and minority shareholders. The primary agency problem in this institutional context is the possible expropriation of minority shareholders by the controlling shareholders such as related-party transactions [5]. Therefore, in countries where a vast majority of companies has a concentrated ownership and control structure, the function of corporate governance regulation is to minimize the extent of agency problems between majority and minority shareholders and that between shareholders and creditors [24]. As noted by Larcker and Tayan [2, p. 9] 'the governance system that maximizes shareholder value might

In relation to the previously discussed perspectives, scholars often made division of corporate governance systems between the Anglo-American and the Continental European system. While short-term equity finance, dispersed ownership, stronger shareholder rights, active market for capital control and flexible labour market characterize the first one, the Continental

institutional environments in which they have been developed [23].

56 Corporate Governance and Strategic Decision Making

takeover threat presents disciplining mechanisms for managers [5].

not be the same as the one that maximizes stakeholder value'.

practices.

#### *2.2.1. Codes as a form of soft governance regulations*

Several authors [7, 8] identified as an important dilemma within the corporate governance field on whether to develop *hard law* (i.e. mandatory requirements, hard regulations and regulatory approach) or *soft law* (i.e. voluntary recommendations, soft regulations and marketbased approach) in order to improve corporate governance across countries. Hard laws are legal requirements regarding governance mechanisms in a country issued by a government in order to improve governance practice and prevent conflict of interests [2, 30]. According to the opinion of several researchers, one of the most important pieces of formal legislation is the Sarbanes-Oxley Act of 2002 (Sox) issued in the USA as a reaction on several cases of failure along many legal and ethical dimensions [2, 7, 30]. Regarding corporate governance legislation, Larcker and Tayan [2] identify an important issue on how such legislation is prepared whether it has its origins in rigorous corporate governance theory and empirical research or it is more the product of political adequacy. Berglöf and Pajuste [26, p. 182] also address this issue by claiming that large controlling owners 'tend to get involved in politics influencing the legislative and regulatory processes as well as the enforcement of adopted laws and regulation'.

*Corporate governance codes* are a form of soft regulations or the so-called soft law. They comprise a set of voluntary best governance practices and do not have the force of law [7, 9, 10]. Governance codes are established to 'address deficiencies in the corporate governance system by recommending a comprehensive set of norms on the role and composition of the board of directors, relationships with shareholders and top management, auditing and information disclosure, and the selection, remuneration, and dismissal of directors and top managers' [31, pp. 417–418]. Cromme [30, p. 364] claims that the governance codes' key function is transparency as 'there can be no better form of control than transparency, for open explanation of management decisions is a major plus point for company credibility'. High-quality disclosure on companies' corporate governance arrangements and increased transparency to the market provides information to investors, facilitates their investment decisions and brings 'reputational benefits for companies, and more legitimacy in the eyes of stakeholders and society as a whole' [32, Article 4]. Research studies show that the introduction of a code positively influences the evolution of companies' governance practices [10]. Even though there are several reasons behind companies' decision to comply with the codes' recommendations, especially two reasons are in front, and that are to increase companies' legitimation among investors and to improve the effectiveness of companies' governance practices.

Corporate governance codes 'do encourage companies to implement stronger corporate governance structures and release more information in a timelier manner to market participants' [8, p. 475]. According to Nowland [8, p. 477], the success of codes 'relies on market mechanisms enticing or pressuring companies to improve their governance and disclosure practices'.

Corporate governance codes can be developed *at the national level, the level of an individual company and at the international level* [10]. Individually or jointly, governments, stock exchanges, employer associations and director associations can issue governance codes in order to address corporate governance specifics in a particular country and to improve the national corporate governance system, especially in the case when other governance mechanisms fail to do that [31]. In authors' opinion, the issuer's ability to enforce changes in governance of companies importantly affects the codes' role in improving governance practice. Governance codes that are issued by governments and stock exchanges have stronger enforceability since they present a norm of operation and therefore might have a stronger impact on improving governance practice. Codes that are developed by professional associations, directors or management associations have lower enforceability due to their voluntary nature and therefore have lower impact on the promotion of good governance practice.

When a firm introduces its own code, the main objective of such a code is 'to establish, and to communicate to investors and other stakeholders, the governance principles adopted by the firm' [10, p. 223]. In this case, a code applies only to that company. Transnational institutions

such as the World Bank, the Organization for Economic Cooperation and Development (OECD) and the International Corporate Governance Network (ICGN) have also created governance codes. The introduction of such codes highlights their importance for prosperity of national economies and specific geographic regions. They are usually more general than a governance code established at the national or firm level [7, 10]. The issue of this type of codes started at the end of the 1990s (first such code was issued in 1996), and there were 14 transnational institutions that issued 21 corporate governance codes by the end of 2014 [10]. A majority of codes issued by transnational institutions are developed for listed companies. However, an increasing number of codes have been issued for non-listed companies, for special types of companies (e.g. state-owned and family ones) or for different types of financial institutions [10, 33]. Governance codes issued by transnational organizations are important for two reasons according to Aguilera and Cuervo-Cazurra [7]. Firstly, they emphasize the importance of good corporate governance and provide best governance practices across several countries. Secondly, they can provide basis for the creation of national governance codes. There is evidence that the creation of national governance codes usually accelerates after the issue of influential transnational codes and the occurrence of corporate scandals and frauds [10].

National governance codes 'tend to be adapted to the country's economic environment and address the country's most salient governance problems' [31, p. 436]. The so-called domestic forces influencing the development of governance codes refer to demands from investors who prefer better protection of their interests. Codes are then introduced to improve governance practice and to close the perceived gap in the domestic national governance system and improve its efficiency. That is often in the cases when other governance mechanisms (e.g. takeover markets and legal environment) fail to protect adequately shareholders' rights [31]. In some countries, corporate collapses and scandals triggered the issues or revisions of corporate governance codes. For example, in Cyprus, the Cyprus Stock Exchanges introduced the Cypriot Corporate Governance Code in 2002 as a response to the major stock exchange collapse [34].

#### *2.2.2. The role of codes in convergence of governance practices*

along many legal and ethical dimensions [2, 7, 30]. Regarding corporate governance legislation, Larcker and Tayan [2] identify an important issue on how such legislation is prepared whether it has its origins in rigorous corporate governance theory and empirical research or it is more the product of political adequacy. Berglöf and Pajuste [26, p. 182] also address this issue by claiming that large controlling owners 'tend to get involved in politics influencing the legislative and regulatory processes as well as the enforcement of adopted laws and regulation'. *Corporate governance codes* are a form of soft regulations or the so-called soft law. They comprise a set of voluntary best governance practices and do not have the force of law [7, 9, 10]. Governance codes are established to 'address deficiencies in the corporate governance system by recommending a comprehensive set of norms on the role and composition of the board of directors, relationships with shareholders and top management, auditing and information disclosure, and the selection, remuneration, and dismissal of directors and top managers' [31, pp. 417–418]. Cromme [30, p. 364] claims that the governance codes' key function is transparency as 'there can be no better form of control than transparency, for open explanation of management decisions is a major plus point for company credibility'. High-quality disclosure on companies' corporate governance arrangements and increased transparency to the market provides information to investors, facilitates their investment decisions and brings 'reputational benefits for companies, and more legitimacy in the eyes of stakeholders and society as a whole' [32, Article 4]. Research studies show that the introduction of a code positively influences the evolution of companies' governance practices [10]. Even though there are several reasons behind companies' decision to comply with the codes' recommendations, especially two reasons are in front, and that are to increase companies' legitimation among investors

58 Corporate Governance and Strategic Decision Making

and to improve the effectiveness of companies' governance practices.

have lower impact on the promotion of good governance practice.

Corporate governance codes 'do encourage companies to implement stronger corporate governance structures and release more information in a timelier manner to market participants' [8, p. 475]. According to Nowland [8, p. 477], the success of codes 'relies on market mechanisms enticing or pressuring companies to improve their governance and disclosure practices'.

Corporate governance codes can be developed *at the national level, the level of an individual company and at the international level* [10]. Individually or jointly, governments, stock exchanges, employer associations and director associations can issue governance codes in order to address corporate governance specifics in a particular country and to improve the national corporate governance system, especially in the case when other governance mechanisms fail to do that [31]. In authors' opinion, the issuer's ability to enforce changes in governance of companies importantly affects the codes' role in improving governance practice. Governance codes that are issued by governments and stock exchanges have stronger enforceability since they present a norm of operation and therefore might have a stronger impact on improving governance practice. Codes that are developed by professional associations, directors or management associations have lower enforceability due to their voluntary nature and therefore

When a firm introduces its own code, the main objective of such a code is 'to establish, and to communicate to investors and other stakeholders, the governance principles adopted by the firm' [10, p. 223]. In this case, a code applies only to that company. Transnational institutions Some evidence [7, 30, 35] demonstrate that governance codes can be viewed as mechanisms facilitating governance convergence across countries. Such convergence is the result of several external forces among which the most powerful are globalization, market liberalization and influential foreign investors [7, 30]. Namely, globalization, the internalization of markets and deregulation have led to rapid changes in traditionally grounded models of corporate governance [19]. These external forces 'lead to pressure on national governments, institutions and companies, to conform to internationally accepted best practices of corporate governance at the international level' [12, p. 54], thereby influencing the attractiveness of countries and companies for foreign investors. Countries that are more exposed to other national economic systems experience greater pressure to change governance practice not only to improve efficiency of domestic companies but also 'to harmonize the national corporate governance system with international best practices' [9, p. 4].

Several research findings on corporate governance codes revealed the governance convergence towards the Anglo-Saxon model (i.e. shareholder model) [30, 34, 35]. Governance codes, which are more in line with the Anglo-Saxon model, can be found not only in the established European economies [30] but also in emerging economies [34]. The explanation for this convergence may lay in the efforts of transnational organizations (e.g. the World Bank and the OECD) to promote those global standards of corporate governance that are more in line with Anglo-Saxon model [7]. The European Commission (EC) also encourages the convergence of governance practice in European countries by issuing recommendations in the area of corporate governance [7, 30, 32]. According to Cromme [30], the governance guidelines at the European level are highly aligned with the country codes. This can be due to the fact that certain governance issues (e.g. stakeholders rights and responsibilities) have been taken more seriously in countries of Continental Europe since 'their former weak capital markets are strengthened and institutional investors become more assertive in promoting more effective governance measures such as higher accountability and better disclosure' [7, p. 381]. Berglöf and Pajuste [26] claim that the introduction and the contents of governance codes of the Eastern European countries were the result of external pressure in terms of the EC corporate governance recommendations. The codes in these countries were largely determined by the demands that resulted from the EU accession process; many contents of the codes were also more or less copied from the UK and the USA codes. However, based on the research results on the comparison of the codes contents of the Eastern European countries, which are the EU member states, Hermes et al. [12] claim that domestic forces (e.g. the extent of enterprise restructuring, large-scale privatization and stock market development) in some of the analysed countries played an important role in shaping the codes' content.

Several scholars [1, 2, 20, 25, 36] raised doubt about 'one size fits all' corporate governance regulations. It is highly unlikely that a single set of best practices exist for all companies since corporate governance is a very complex and dynamic system and not all mechanisms may work well in all governance contexts [2]. The corporate governance practices and regulations should reflect particularities of companies' ownership and control structures that differ across countries and industries and determine the type and severity of agency costs [36].

#### **2.3. 'Comply or explain' approach**

The codes' voluntary nature is realized by the 'comply or explain' approach [7, 10] that is 'an enforcement mechanism that allows companies to deviate from the code norms, but at the same time requires them to disclose these deviations' [37, p. 255]. The basic idea of this approach is that a company has to disclose the compliance with recommendations of a particular code adopted by a company, or in the case of non-compliance, a company must explain the reasons for it [8]. The 'comply or explain' approach enables a company to adapt its governance practices to its particular circumstances [36], its size and shareholding structure [32, Article 7], to consider sectoral specifics [37], thereby allowing flexibility in choosing 'which corporate governance structure to adopt to better pursue their objectives' [10, p. 223]. Departing from the codes recommendations enables companies to govern themselves more effectively by adapting their corporate governance practice to their particularities [32, Article 7].

Differences exist among countries regarding the implementation of this approach. There are two ways of implementing the 'comply or explain' approach and that are mandatory and voluntary one [10]. The mandatory disclosure on the adaptation of code's recommendation or explanation of deviations is required by listing authorities (e.g. in Australia, Canada, Estonia, Luxemburg, Malta, Malaysia, Russia, Singapore and the UK) or by law (e.g. in several EU countries). The voluntary disclosure is present in some emerging economies (e.g. Algeria, Lebanon, Tunisia and Yemen). However, such lack of disclosure may decrease the effectiveness of governance codes since investors cannot understand 'if the company does not adapt the best practices or adopts the best practices, but does not disclose their adoption' [10, p. 224]. In the recent World Bank analysis [33] of corporate governance codes, 112 codes were found. Of the 112 codes, some 27 were purely voluntary with no link to regulatory frameworks, eight were mandatory and seven countries appeared to have some level of mandatory provisions. All other codes were variations of the 'comply or explain' approach.

codes, which are more in line with the Anglo-Saxon model, can be found not only in the established European economies [30] but also in emerging economies [34]. The explanation for this convergence may lay in the efforts of transnational organizations (e.g. the World Bank and the OECD) to promote those global standards of corporate governance that are more in line with Anglo-Saxon model [7]. The European Commission (EC) also encourages the convergence of governance practice in European countries by issuing recommendations in the area of corporate governance [7, 30, 32]. According to Cromme [30], the governance guidelines at the European level are highly aligned with the country codes. This can be due to the fact that certain governance issues (e.g. stakeholders rights and responsibilities) have been taken more seriously in countries of Continental Europe since 'their former weak capital markets are strengthened and institutional investors become more assertive in promoting more effective governance measures such as higher accountability and better disclosure' [7, p. 381]. Berglöf and Pajuste [26] claim that the introduction and the contents of governance codes of the Eastern European countries were the result of external pressure in terms of the EC corporate governance recommendations. The codes in these countries were largely determined by the demands that resulted from the EU accession process; many contents of the codes were also more or less copied from the UK and the USA codes. However, based on the research results on the comparison of the codes contents of the Eastern European countries, which are the EU member states, Hermes et al. [12] claim that domestic forces (e.g. the extent of enterprise restructuring, large-scale privatization and stock market development) in some of the

analysed countries played an important role in shaping the codes' content.

countries and industries and determine the type and severity of agency costs [36].

ing their corporate governance practice to their particularities [32, Article 7].

**2.3. 'Comply or explain' approach**

60 Corporate Governance and Strategic Decision Making

Several scholars [1, 2, 20, 25, 36] raised doubt about 'one size fits all' corporate governance regulations. It is highly unlikely that a single set of best practices exist for all companies since corporate governance is a very complex and dynamic system and not all mechanisms may work well in all governance contexts [2]. The corporate governance practices and regulations should reflect particularities of companies' ownership and control structures that differ across

The codes' voluntary nature is realized by the 'comply or explain' approach [7, 10] that is 'an enforcement mechanism that allows companies to deviate from the code norms, but at the same time requires them to disclose these deviations' [37, p. 255]. The basic idea of this approach is that a company has to disclose the compliance with recommendations of a particular code adopted by a company, or in the case of non-compliance, a company must explain the reasons for it [8]. The 'comply or explain' approach enables a company to adapt its governance practices to its particular circumstances [36], its size and shareholding structure [32, Article 7], to consider sectoral specifics [37], thereby allowing flexibility in choosing 'which corporate governance structure to adopt to better pursue their objectives' [10, p. 223]. Departing from the codes recommendations enables companies to govern themselves more effectively by adapt-

Differences exist among countries regarding the implementation of this approach. There are two ways of implementing the 'comply or explain' approach and that are mandatory and The 'comply or explain' mandatory disclosure requirement is implemented by most stock exchanges. Companies listed on the stock exchange must explain the reasons for non-compliance with the (country) governance code in their annual report [30, 31, 36]. By realizing mandatory 'comply or explain' approach, the code 'helps companies exercise greater selfresponsibility in their dealings with the capital market' [30, p. 364] and 'promotes culture of accountability, encouraging companies to reflect more on corporate governance arrangements' [32, Article 7]. Luo and Salterio [36, p. 460] claim that the disciplining power of this approach 'is the required public disclosure of governance practices that allows market participants to evaluate the effectiveness of the firm's governance system and to make informed assessments of whether noncompliance is justified in particular circumstances'. Appropriate disclosure of non-compliance with the code recommendations and of the reasons for these is very important for ensuring that stakeholders can make informed decisions about companies and for reducing information asymmetry between companies' management and shareholders, thus decreasing the monitoring costs [32, Article 17].

Several research findings demonstrate that listed companies tend to comply with codes recommendations [25, 36] which might be due 'to the market forces and pressures to comply with legitimating practices or "doing the right thing"' [31, p. 419]. Since the best governance practices are generally recognized as value enhancing, listed companies try to make clear explanation on why they do not comply with particular codes' recommendations [25]. Empirical evidences revealed some other factors that influence the rate of compliance with the codes' recommendations—see Ref. [10]. One of them is the firm size—larger companies require more sophisticated governance practices, their ownership structure is more dispersed and they are more under the control from the external environment (i.e. their greater visibility) [37]. Important factors are also the overall institutional environment, especially the legal norms and cultural values, and the development of national economy—the level of compliance with codes' recommendations is higher in developed than in developing countries that lack a tradition of sound corporate governance—see Ref. [10].

Even though analysis indicate gradual improvement in the way companies in the EU member states apply corporate governance codes, shortcomings were identified in the application of the 'comply or explain' approach. There are critiques of this approach as being ineffective due to 'the poor quality of explanations and because it provides a rather soft option, which proved in the financial crisis that it could not be trusted' [33, p. 70]. There are also interesting observations and empirical evidences regarding the explanations for deviations from codes' recommendations. In some European countries (e.g. UK, Netherlands and Germany), companies often use standard explanations for deviations, and often firms complying with the same recommendations use similar explanations for non-compliance. As the level of compliance increases over time, the quality of explanations for non-compliance remains very low showing only marginal improvements—see Ref. [10].

#### **2.4. The diffusion of codes of good governance around the world**

The first code came into being in the late 1970s in the USA. That was a period of 'transition from the conglomerate merger movement of the 1960s … to the empire-building behaviour by management through hostile takeovers … and to the shareholder rights movement of the late 1980s and early 1990s' [31, p. 418]. The year 1992 presents an important landmark in the development of governance codes around the world. That year, the Cadbury Report and the Code of Best Practices were issued in the UK, and since then the number of countries issuing governance codes has been increasing [7]. The Cadbury Report was a result of several financial scandals in the UK in the 1980s and early 1990s. This was the first corporate governance code adopted by the London Stock Exchange. The Cadbury Report is recognized in the literature and in the governance practice as one of the most influential codes, and several dimensions of that code were introduced into corporate governance systems not only in the UK but also around the world, including the USA and Germany [11]. After the issue of the Cadbury Report, the diffusion of codes has been rather slow and accelerated after the issue of both the OECD Principles of Corporate Governance and the ICGN Statement on Global Corporate Governance Principles in 1999. There were only nine countries that issued a code by 1997, while a further 34 countries issued their first code by 2002 [10].

Another important landmark in the diffusion of codes around the world presents the recent financial crisis (with beginnings in 2007–2008) and accompanying scandals that brought attention to the importance of introducing adequate governance mechanisms. The number of corporate governance codes has increased especially between 2009 and 2010 [10]. The recent analysis revealed that since the financial crisis codes have been and are being revised more often than before crisis. For example, the website of the European Corporate Governance Institute (ECGI) reported on 14 code revisions since 1 January 2015 [33].

The research findings show that first countries that issue governance codes, that is, the USA as first, followed by Hong Kong, Ireland, the UK and Canada, were countries with a common law, or English-based, legal system [7]. This is a more flexible legal system in contrast to civillaw system since judicial precedent shapes the interpretation of laws and their application. In the civil-law system, judiciary must base its decisions on strict interpretation of the laws that are issued by legislative bodies [2, 28]. Three types of the civil-law system exist and that are French, Scandinavian and Germanic. Research findings of Aguilera and Cuervo-Cazurra [31] indicate that codes are more likely to be issued in countries with a common-law system. In authors' opinion, there are two explanations for their research findings. Firstly, commonlaw countries, where strong shareholder rights are embedded in their legal system, are more likely to emphasize continuously good governance practice introduced by codes. Secondly, the common-law legal system's characteristics facilitate the enforceability of the codes. Even though in the common-law countries the good governance practice 'tend to reach the level of enforceability in courts, in civil-law system such practices do not have enforceability through the courts unless they become codified into law' [31, p. 434]. This cognition is confirmed by the research results of Zattoni and Cuomo [9] which show that countries with civil-law system issue codes later than common-law countries, and create fewer codes that often comprise ambiguous recommendations. Their research results suggest that 'the issuance of codes in civil-law countries is prompted more by legitimation reasons than by determination to dramatically improve the governance practices of national companies' [9, p. 12].

proved in the financial crisis that it could not be trusted' [33, p. 70]. There are also interesting observations and empirical evidences regarding the explanations for deviations from codes' recommendations. In some European countries (e.g. UK, Netherlands and Germany), companies often use standard explanations for deviations, and often firms complying with the same recommendations use similar explanations for non-compliance. As the level of compliance increases over time, the quality of explanations for non-compliance remains very low show-

The first code came into being in the late 1970s in the USA. That was a period of 'transition from the conglomerate merger movement of the 1960s … to the empire-building behaviour by management through hostile takeovers … and to the shareholder rights movement of the late 1980s and early 1990s' [31, p. 418]. The year 1992 presents an important landmark in the development of governance codes around the world. That year, the Cadbury Report and the Code of Best Practices were issued in the UK, and since then the number of countries issuing governance codes has been increasing [7]. The Cadbury Report was a result of several financial scandals in the UK in the 1980s and early 1990s. This was the first corporate governance code adopted by the London Stock Exchange. The Cadbury Report is recognized in the literature and in the governance practice as one of the most influential codes, and several dimensions of that code were introduced into corporate governance systems not only in the UK but also around the world, including the USA and Germany [11]. After the issue of the Cadbury Report, the diffusion of codes has been rather slow and accelerated after the issue of both the OECD Principles of Corporate Governance and the ICGN Statement on Global Corporate Governance Principles in 1999. There were only nine countries that issued a code by 1997, while a further 34 countries

Another important landmark in the diffusion of codes around the world presents the recent financial crisis (with beginnings in 2007–2008) and accompanying scandals that brought attention to the importance of introducing adequate governance mechanisms. The number of corporate governance codes has increased especially between 2009 and 2010 [10]. The recent analysis revealed that since the financial crisis codes have been and are being revised more often than before crisis. For example, the website of the European Corporate Governance

The research findings show that first countries that issue governance codes, that is, the USA as first, followed by Hong Kong, Ireland, the UK and Canada, were countries with a common law, or English-based, legal system [7]. This is a more flexible legal system in contrast to civillaw system since judicial precedent shapes the interpretation of laws and their application. In the civil-law system, judiciary must base its decisions on strict interpretation of the laws that are issued by legislative bodies [2, 28]. Three types of the civil-law system exist and that are French, Scandinavian and Germanic. Research findings of Aguilera and Cuervo-Cazurra [31] indicate that codes are more likely to be issued in countries with a common-law system. In authors' opinion, there are two explanations for their research findings. Firstly, commonlaw countries, where strong shareholder rights are embedded in their legal system, are more

Institute (ECGI) reported on 14 code revisions since 1 January 2015 [33].

ing only marginal improvements—see Ref. [10].

62 Corporate Governance and Strategic Decision Making

issued their first code by 2002 [10].

**2.4. The diffusion of codes of good governance around the world**

Aguilera and Cuervo-Cazurra [31] identified three exogenous pressures on the development of codes. The first pressure can be explained by the economic integration of a country in the world economy that positively influences the adoption of governance codes. The second pressure that is positively related to the code's adoption is the processes of government liberalization in a particular country. The withdrawal of government presence in the economy creates a need to establish new governance system in the newly privatized companies. The third pressure refers to the presence of foreign institutional investors that positively influence the code's adoption. Institutional investors search for companies with good governance practice since they need assurance for their investment to be protected.

Important research findings on codes' diffusion refer to the relationship between the development of capital markets and the number of governance codes. Countries with larger and deeper capital markets have more governance codes since 'the need for good governance increases as the number of public firms grows because agency problems between disperse owners and managers, or between majority and minority shareholders emerge' [7, p. 379]. Research findings show that developed countries issued more codes than developing countries that are more reluctant to revise their first code. Recent data show that 91 countries issued 345 codes by the end of 2014, of which 91 were first codes and 254 codes were revisions of previous codes. Developed European countries issued more than half of codes issued by all countries (174 out of 345), thereby playing a significant role in the diffusion of codes [10].

A majority of national codes are designed for listed companies. Recently, an increasing number of codes have been issued for specific types of companies (e.g. state-owned or familyowned), for different types of financial institutions (e.g. commercial banks, institutional investors and mutual funds) and for voluntary and charitable organizations [10].

The total number of codes issued in European countries increased after the publication of two important reports and that are The European Union Action Plan on 'Modernizing Company Law and Enhancing Corporate Governance in the EU' published in 2003 and the report by the High-Level Group on Financial Supervision in the EU published in 2009. The aims of both reports were encouraging the convergence of company law and corporate governance practices within the EU [10].

In the EU countries, governance codes are recognized to have a significant role in establishing principles of good corporate governance. Especially listed companies are required to include a corporate governance statement (CG Statement in their management report. In this statement, a company should disclose its corporate governance arrangement [Article 4(1) (14) of Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004]. Since the 'comply or explain' approach is the key principle in the EU governance system, a company is required to explain in its corporate governance statement the deviations from the code's recommendations and the reasons for doing so [32, Article 4, 6]. A company is required to describe the alternative measure taken 'to ensure that the company action remains consistent with the objectives of the recommendation, and of the code' [32, Article 17]. In this respect, the EC emphasizes the required high quality of explanations on non-compliance reported by companies [32, Article 8, 11]. The EC recommendation on the quality of corporate governance reporting predominantly addresses listed companies. However, it suggests that other companies might also benefit by following the EC recommendation [32, Article 14].

In Germany, a corporate governance code was found as being unnecessary until 2002 when the German Corporate Governance Code (GCGC) was adopted [30]. This code contains standards of good governance that represent internationally and nationally recognized best practice. German companies are not required to follow these standards with the exception of listed companies. Listed companies have to disclose the (non)-compliance with the GCGC recommendations [37]. The research study by Talaulicar and Werder [37] showed high degrees of compliance with the GCGC, especially among German-listed companies. The authors were also able to identify some recommendations (i.e. 24 recommendations) that many companies do not comply with. However, in authors' opinion low rates of acceptance of these recommendations do not necessary imply that they need to be changed. On the contrary, such a situation may reflect 'that firms take advantage of the flexibility the code grants and disregard certain code norms in order to address company-specific peculiarities' [37, p. 268].

Hermes et al. [12] conducted a research on codes adoption in seven Eastern European countries or the so-called transition economies (i.e. Czech Republic, Hungary, Lithuania, Poland, Romania, Slovak Republic and Slovenia) that were at the time of the research already the EU member states. Romania was one of the first countries that issued a code in 2000. Other countries such as Slovenia and Hungary followed a few years later and issued a code in 2004. Twelve Eastern European countries issued their own code by the early 2006: Czech Republic (2001, 2004), Poland (2002, 2004), Russia (2002), Slovak Republic (2002), Macedonia, Ukraine (2003), Lithuania (2004), Slovenia (2004, 2005), Hungary (2004), Latvia (2005) and Estonia (2006); some of these countries published the new version of the code in the following years [12]. Hermes et al. [12] conducted analysis of the contents of the governance codes that are based on the analysed seven transition countries on the 'comply or explain' principle. They focused their research on three areas and that were disclosure rules, strengthening shareholder rights and modernizing boards.

Since in many cases these codes were adopted as listing requirement for stock exchanges, this gave codes a formal and compulsory character. The research results show that the codes of the Eastern European countries on average cover only around half of the EC recommendations. For some of the countries included in the research (especially Romania, Hungary and Poland), domestic forces related to country-specific characteristics of corporate governance system influenced considerably the contents of corporate governance codes. Codes in other countries covered a majority or almost all the EC recommendations of the governance principles [12].

Several research findings show that the adoption of corporate governance codes considerably affects the level of disclosures. Sheridan et al. [11] found this in the case of the UK where the introduction of governance standards in terms of reports concerning best practice and codes of good corporate was accompanied by a significant increase in the number of news announcements. The research in eight East Asian (i.e. Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand) countries indicates that voluntary national codes had both direct and indirect effects on companies' disclosure improvements. That is especially the case in those countries where codes have special sections designated to disclosure [8].
