Timid Oversight

Fear in the Board Room

board
Traditional supervisory boards are fast becoming a thing of the past.
  • Why it matters

    Why it matters

    Supervisory boards have in recent years been blamed for failings that have led to scandals at several big German companies, such as Deutsche Bank and Bilfinger.

  • Facts

    Facts

    • Supervisory boards in Germany oversee the executive board’s decisions and can appoint managers.
    • They are usually a mix of former company managers and external experts and executives.
    • Investors are increasingly putting pressure on supervisory boards to meet regulatory requirements.
  • Audio

    Audio

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Politicians as well as shareholders have forced through greater regulatory oversight of the ways that German companies are managed in recent years. But despite good intentions, the resulting changes have not always been successful.

In practice, the myriad of new rules and regulatory requirements put in place since 2008 have raised fears about liability and personal prosecution. All of this has encouraged supervisory boards, the powerful overseers also known as non-executive boards, to minimise or avoid taking risks.

The many challenges also mean that fewer people now even want to do the job, and that is beginning to harm the very companies that the regulations were supposed to improve.

Examples of shareholders taking company supervisors to task are evident across the German corporate landscape in the past year. From Deutsche Bank to Volkswagen, investors are increasingly aggressive when it comes to holding the supervisors’ feet to the fire.

Take Stada, for example. Last Friday, the Harmony Hall of the Frankfurt Congress Centre was the inappropriately named venue for the annual general meeting of the pharmaceutical company. Its managers have recently been locked in a power struggle with an activist investor, and tensions have been running high. Talk at the AGM was of nepotism and a slackening of the reins of corporate governance.

In the firing line was the long-time chairman of Stada’s supervisory board Martin Abend, who many shareholders believe is too close to the company’s management board. His members would normally have been expected to nod through a lavish remuneration package for Stada directors. But Winfried Mathes, of the investment house Deka, had had enough.

The evidence shows that the more rules and regulations are created, the less decisive supervisory boards become.

Calling time on Mr. Abend’s tenure, he declared: “Mr. Abend, 13 years is quite enough.” By the end of the meeting, Mr. Abend had been voted out of office and was replaced by the banker Ferdinand Oetker.

Over the summer there were equally ugly scenes at Deutsche Bank, which led to the departure of Georg Thoma, a member of the bank’s supervisory board. Mr. Thoma had been outspoken on how Germany’s largest bank should deal with past scandals and, after very publicly ending his friendship with Supervisory Board Chairman Paul Achleitner over the issue, was unceremoniously pushed out by the rest of the board.

Meanwhile at Volkswagen last week, the so-called Dieselgate scandal took another twist. It emerged that the automobile firm’s former chief Martin Winterkorn had informed former supervisory board chairman Ferdinand Piech about the company’s emissions cheating devices far earlier than previously thought.

Such events have thrust the machinations of supervisory boards – a part of the corporate world that previously received little attention – into the limelight.

It’s not that those in charge of companies have suddenly discovered an appetite for carrying out their supervisory oversight functions in public. Instead, they have been forced into action by the increasing regulatory requirements that have been the political and legislative response to big corporate scandals.

Meanwhile, increasingly confident shareholders and investor groups have taken regulatory compliance requirements seriously and are demanding that supervisory boards do their job and stand up to directors, regardless of personal consequences.

But, as is often the case, good intentions don’t guarantee good results. In fact, all the evidence shows that the more rules and regulations are created, the less decisive supervisory boards become.

In many companies, such as Stada, both the management and supervisory boards have been paralyzed into inaction through fear of falling out of favor with shareholders.

The challenge is to find a way of implementing effective supervisory mechanisms without discouraging good candidates from coming forward, while at the same time keeping legislators and shareholders happy.

In any debate over these issues, it is hard to avoid mentioning Ulrich Lehner. The former chief executive of the household products conglomerate Henkel is, more than anyone else in Germany, the living embodiment of supervisory boards.

“There used to be four meetings a year, at which board members met for a couple of hours before scurrying away to a partially deserved meal.”

Christian Strenger, German corporate governance commission

He heads the supervisory boards at Deutsche Telekom and ThyssenKrupp and is an ordinary member of the supervisory boards of E.ON, Porsche and the private bank HSBC Trinkhaus & Burkhardt.

The 70-year-old former engineer believes that the duties and responsibilities of supervisory boards have become increasingly demanding in recent years. But he also says that despite the raft of new laws and requirements, they still have “much more to do.”

The implementation of new rules on management pay has, according to Mr Lehner, made the entire remuneration system unnecessarily complicated. He also points to increasingly complex and burdensome audit requirements.

While being a member of a company’s supervisory board used to guarantee maximum prestige with minimal effort, the opposite is now the case.

“The pace and the rate of change in companies over what is controlled has become increasingly complex,” Mr Lehner said. The pressure of the regulatory burden means that an appointment to a company’s supervisory board is no longer seen as a nice side job or a cushy position for a long-serving manager.

In the 1980s, the legendary Deutsche Bank boss Alfred Herrhausen sat on the supervisory board of no fewer than 10 companies and was chair of the board of five of them: something that would be impossible for an individual today.

As a long-standing member of the German corporate governance commission and a former chief executive of the asset management firm DWS, Christian Strenger for years fought hard for higher standards and greater responsibilities for supervisory boards.

“There used to be four meetings a year, at which board members met for a couple of hours before scurrying away to a partially deserved meal,” Mr. Strenger recalled.

But things have changed considerably over the past few decades. Although supervisory boards have undoubtedly become more professional, board members are now on the hook when things go wrong and can even be held personally liable.

As early as 1999, Germany’s highest court decided that supervisory boards should take responsibility for mistakes made by the executive board. But it took several years before the importance of the judgement filtered down and affected the economy as a whole.

As the legislative and regulatory requirements increase, so does the uncertainty. That can undermine the economic viability of a company. This affects German firms in particular as their liability is financially unlimited, inducing fear and a consequently unhealthy focus on legal compliance.

The result has been a security culture where legal issues have become at least as important as the good of the company. At worst, the regulatory corset has become so tight that companies are virtually paralyzed into inaction.

A case in point is that of Deutsche Bank’s Mr. Achleitner, whose behaviour is now the subject of a legal investigation.

The bank’s executive board – overseen by Mr. Achleitner – is in an awkward situation. It must decide whether he delayed responding to an investigation into the bank’s LIBOR interest-rate setting practices, which eventually cost the bank $2.5 billion in fines over rate rigging and fraud charges. If confirmed, the executive board would be required to demand compensation from Mr. Achleitner, who could also find himself being prosecuted for embezzlement.

If there is evidence of wrongdoing, management and supervisory boards must investigate each other and are required to seek damages as redress. If they do not fulfil these obligations, the boards themselves become liable.

“In every tenth case of director liability, compensation from the supervisory board is payable,” estimated Michael Hendricks, head of the insurance broker Howden Group.

Of course the reasons vary from firm to firm. In the case of the industrial services company Bilfinger, a decision about the sale of an asset erupted into a public scandal.

The company’s supervisory board chairman, Eckhard Cordes, had wanted to push through the sale of Bilfinger’s real estate services unit to the private equity firm EQT, according to an attendee at a meeting of its board. The decision to sell its most consistently profitable unit prompted the resignation of two members of Bilfinger’s supervisory board.

Most discussions within a company about such responsibilities and failings take place in secret. When such debates enter the public domain, as was the case with Deutsche Bank, the company involved is likely to take a reputational hit.

The case of Deutsche Bank’s Mr. Thoma highlights the pitfalls. When Mr. Achleitner appointed the lawyer to the bank’s supervisory board in 2013, he thought it was a real coup. As head of the newly-created integrity committee, Mr. Thoma would embody the bank’s moral reawakening – or so Mr. Achleitner thought.

Fast forward three years and by the spring of this year Mr. Achleitner had successfully and publicly mobilized the rest of the board against Mr. Thoma, who was eventually forced to resign.

Mr. Thoma had been criticized for being overzealous in pushing for investigations into Deutsche Bank executives. Some also felt that he had acted not only in the interests of truth but to protect himself against any potential liability claims.

The role of the supervisory board in holding companies to account raises a host of interesting philosophical questions, some of which are only just beginning to be debated.

At what point, for example, does due diligence turn into a blockade? How much trust is possible and what levels of control are necessary? How much time and effort should seekers of truth be expected to invest? To what extent can supervisory board members intervene in the running of a company? How deep can or should they go? And where does their liability begin and end?

At the moment, few supervisory boards have the answers.

 

This article originally appeared in the business magazine WirtschaftsWoche, a sister publication of Handelsblatt. Claudia Tödtmann, Angela Hennersdorf, Jürgen Salz, Christian Schlesiger, Harald Schumacher, Cornelius Welp and Lukas Zdrzalek contributed to this story. To contact the authors: online@wiwo.de

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