Corporate Cronyism

When watchdogs become lapdogs

Team play at Deutsche Börse got CEO Carsten Kengeter, left, and non-executive chairman Joachim Faber in trouble. Source: Miriam Migliazzi & Mart Klein

A stock incentive program that led to an insider trading investigation has put Deutsche Börse in a bad light. A €35 million ($42 million) pension for the chief executive of pharma firm Stada, whose net earnings were only €85.9 million last year, should have raised eyebrows on Stada’s non-executive board. And Volkswagen’s chairman is responsible for investigating the carmaker’s diesel emissions scandal, which took place when he was its finance chief on the executive board.

Each of these cases are examples of a corporate governance culture where checks and balances seem less than perfect. Instead, the people hired as board watchdogs in German companies, tasked with looking out for investor and employee interests, seemed either too close to the management they’re supposed to supervise or were ignorant of problems.

German governance rules are completely different than in the UK or the United States. Germany’s corporation law mandates a dual-board system: an executive board, composed of the company’s management, and a supervisory board that often includes a large contingent of the company’s workers as well as shareholders. By law, many companies with more than 2,000 employees have to fill half of the non-executive seats with labor representatives. The supervisory board has the power to hire and fire executives, needs to approve changes of strategy and determines executive pay, making it a powerful decision-making body.

“There’s too much chumminess, too many dependencies [between supervisory and executive boards].”

Manuel Theisen, professor emeritus of economics

In practice, this power is not always exercised adequately. All-too-cosy relationships and a lack of transparency have come under fire, not only from German shareholders but activist investors as far away as Britain and the US.

Why do boards – often executives with substantial experience in the industry, or legal or financial experts – fail to do their jobs? Sometimes they’re simply too close to management. At drugmaker Stada, CEO Hartmut Retzlaff’s pension scheme grew disproportionately to the mid-sized company’s sales of €2.1 billion and net earnings. But Mr. Retzlaff used to boast that he knew “how to handle” his supervisory board, which signed off on all manager pay.

It was angry investors, not the supervisory board, that pressured Mr. Retzlaff to forego about half of his €35 million pension before he quit his job for health reasons. The same investors, mainly German fund Active Ownership Capital and US investor Guy Wyser-Pratte, forced the head of the board, lawyer Martin Abend, to step down last year. The actions led to a jump of Stada’s share price and this summer two private equity firms bought up Stada, planning to take it private.

A close relationship between Deutsche Börse’s non-executive chairman Joachim Faber and CEO Carsten Kengeter also created problems at the operator of the Frankfurt stock exchange. Mr. Faber, a former Citicorp banker and board member at insurer Allianz, pushed through a share incentive program, entitling Mr. Kengeter to up to €40 million in rewards, an extremely high amount by German standards.

The so-called co-performance share program also led to an insider trading investigation by German prosecutors, because Mr. Kengeter, a former UBS banker, had to buy Deutsche Börse shares to receive the bonus stock. The purchase, however, took place before the company publicly announced plans to merge with the London Stock Exchange early 2016, although board members had already been considering a deal. In the end, the tie-up, strongly favored by Mr. Kengeter and his boss Mr. Faber, fell apart on antitrust concerns, hurting the company’s reputation.

“In a worst-case scenario, board members nominate each other and monitor, investigate and exonerate themselves.”

Christian Strenger, former fund manager and member of Germany’s Corporate Governance Committee

Deutsche Börse might well win the title of “Worst Corporate Governance Act of the Year,” Manuel Theisen, an emeritus business professor and one of Germany’s leading corporate governance experts, mocked recently in a newspaper opinion piece. Although German corporations have stopped owning cross-holdings in each other’s businesses and halted nominating board members, an informal, personal network remains well alive. “There’s too much chumminess, too many dependencies [between supervisory and executive boards],” Mr. Theisen said.

Deutsche Bank’s board chief, Paul Achleitner, has been criticized for being too close to former co-CEO Anshu Jain. Mr. Jain oversaw Deutsche Bank’s London-based investment bank, which became the source of many of the legal and financial troubles the bank confronted. Yet Mr. Achleitner deflected accusations Mr. Jain was responsible for the bank’s troubles, even before an official investigation could take place. The board chief only distanced himself from his CEO when investors started questioning Mr. Achleitner’s own future with Deutsche Bank.

At Commerzbank, Germany’s second-largest bank, non-executive chairman Klaus-Peter Müller created what sources called a “biotope” of tight-knit, loyal insiders. When longtime boss Martin Blessing left, Mr. Müller ensured that homegrown Martin Zielke won out over external candidates. And when Mr. Müller himself retires next year, former Commerzbank board member Stefan Schmittmann will succeed him.

At Volkswagen, the carmaker caught in the industry’s worst scandal yet, some of the same managers and supervisors that did not detect the almost decade-long Dieselgate fraud are now in charge of clearing it up. Hans Dieter Pötsch, watchdog-in-chief at the troubled automaker, has been with VW for 14 years and switched from the executive board to the supervisory board weeks after the scandal became public in 2015. Four members of the Porsche-Piëch family, descendants of Beetle inventor Ferdinand Porsche who now control a majority of the company’s voting shares, are also on the supervisory board. Even Bernd Osterloh, head of the VW works council and most powerful employee representative on the supervisory board, has held his position for more than 12 years.

Some might also see Air Berlin’s recent insolvency as an example of German mismanagement, but the carrier was actually incorporated as a British firm with a one-tier board.

Christian Strenger, former head of fund manager DWS and an ex-member of Germany’s Corporate Governance Committee, said German efforts to improve management and supervision had paid off, for instance by regularly updating national guidelines. At the same time, no matter how many rules existed, the system of checks and balances sometimes failed. “In a worst-case scenario, board members nominate each other and monitor, investigate and exonerate themselves,” Mr. Strenger said.

A version of this article first appeared in WirtschaftsWoche. Charles Wallace and Gilbert Kreijger adapted this article for Handelsblatt Global. To contact the authors:;;;;;, and

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