Of laymen and lemmings

The flaws of Germany’s corporate board system

germany's supervisory board system, corporate governance
Please, no monkey business. Source: Wieslaw Smetek for Handelsblatt

As Deutsche Bank’s share price sagged to an all-time low last week, investors blamed the bank’s non-executive board chairman, Paul Achleitner, for poor management. During its annual shareholders’ meeting on Thursday, fund managers criticized Mr. Achleitner for slow decision-making and flip-flopping on strategy. “Why did you not act sooner when it became clear that the strategy wasn’t working?” asked a fund manager of Deka Investments.

In Germany’s two-tier board system, Mr. Achleitner and his fellow non-executive directors are responsible for monitoring the bank’s executives. The so-called supervisors approve strategy changes, dividend payouts and have the power to fire executives. But the troubles at Deutsche Bank and other listed companies show that Germany’s peculiar corporate governance system can lead to strategic failures costing millions – or even billions – of euros.

Deutsche Bank’s share price has halved since Mr. Achleitner became chairman. VW’s Dieselgate scandal has cost the carmaker €25 billion since US regulators revealed the emissions fraud in 2015. Deutsche Börse’s attempt to merge with the London Stock Exchange triggered an investigation into insider trading by CEO Carsten Kengeter, who ultimately resigned last year. Bilfinger, once Germany’s largest construction firm, has shrunk down to a mid-sized engineering firm after a series of strategic blunders and corruption cases.

Germany's two-tier board system

Germany’s peculiar two-tier board system, combined with workers’ right to nominate up to half of the non-executive board, are not to blame for the scandals, experts argued. “If Germany’s two-tier system is applied properly, it can outperform the one-tier board system,” said Christian Strenger, former head of fund manager DWS and an ex-member of Germany’s Corporate Governance Committee.

Instead, a lack of expertise and tunnel vision are often the cause for mismanagement and weak oversight by the non-executive panel, formally known as a supervisory board. The directors should possess expert industry knowledge and be as ambitious as the executives. Florian Schilling, a specialist in auditing boards, urges managers to consider supervisory positions as serious professions and not just a side job to pick up during retirement. “It would really make sense if more successful managers make the switch earlier and collect a number of non-executive positions and not wait until the retirement age kicks in,” he said.

Hans-Christoph Hirt, an executive at British asset manager Hermes, also stressed the need for industry expertise and experience as well as diversity on Germany’s supervisory boards. “A problem is the lack of international and ethnic variety because German language skills are often a prerequisite,” Mr. Hirt said. Combined with a high number of working hours and a relatively low pay, it is difficult to attract non-executive directors from the US or Asia, he said.

More female board members would also help to improve checks and balances between management and non-executives, Mr. Hirt added. Promoting diversity was one of the reasons Germany adopted a gender quota for supervisory boards, forcing big, listed companies to have women occupy at least 30 percent of non-executive positions.

Two examples illustrate how a lack of diversity can cause havoc. At Volkswagen, controlled by the Porsche and Piëch families and the state of Lower Saxony, a top-down management structure created a culture where honesty and openness were absent, allowing employees to deceive 11 million car owners for almost a decade. A closely held alliance of non-executive directors and labor representatives was unable to discover the fraud. At Deutsche Börse, the groupthink promoted by non-executive chairman Joachim Faber and CEO Carsten Kengeter led to the strategic failures that ended Mr. Kengeter’s term early and damaged Mr. Faber’s reputation.

Diversity does not always guarantee success, unfortunately. At Deutsche Bank, women have occupied more than 30 percent of non-executive seats for years, but this hasn’t kept the bank from running into trouble repeatedly. An international board with non-executive directors from the US, Britain and Switzerland hasn’t prevented it, either. Perhaps there were simply too many finance experts on the panel, who failed to see what strategy would best fit Germany’s biggest bank.

Dieter Fockenbrock is Handelsblatt’s chief correspondent for the companies and markets desk, focusing on corporate governance, opinion and rail transport. To contact the author: fockenbrock@handelsblatt.com

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