For international observers and investors, German corporate governance for a long time has been opaque, if not downright mysterious.
To a large extent, this is due to two peculiarities of the German system. The first one is the country’s two-tier system of corporate management, where a supervisory board of external directors oversees a management board, including the chief executive.
The second uniquely German feature is the country’s mandatory system of co-determination, where up to half of supervisory board members are elected by employees rather than shareholders. Add an enormous volume of codified corporate law, which is constantly modified by court judgment, and the result is a German governance system that lacks the pragmatism and dynamism of English-style case law.
For international observers and investors, German corporate governance has been opaque, if not downright mysterious.
To improve understanding of this system, the German government in 2001 created the German Corporate Governance Commission, which a year later issued the Corporate Governance Code, a voluntary set of best practice guidelines for all publicly quoted German companies.
Besides explaining Germany’s complex system to foreign investors and stakeholders, the commission has spent considerable effort identifying and ultimately codifying best practices in Germany and abroad.
Unlike in the United States and Britain, the notion of self-regulation by a commission of government-appointed managers, investors, academics and unions was novel for Germany, sometimes causing tension between corporations, regulators, courts and lawmakers.
There is general consensus, however, that the governance code has not only succeeded in making the German system more transparent and understandable to international investors, but also demonstrated its logic and effectiveness. One example is the important role played by co-determination involving labor that enabled German companies to successfully navigate the recent financial crisis.
But corporate governance environments, markets and target groups are changing.
Take for example the growing influence of international proxy advisors on annual shareholder voting. While this is a global trend, it has had a special impact on German companies, because many of the rather rigorous rules applied by these advisors are based on a single-tier system and translate poorly to Germany’s two-tier system.
The Commission has intensified its dialogue with international advisors to foster a deeper understanding of the German system.
The Commission has therefore intensified its dialogue with international advisors such as ISS, Glass Lewis and IWOX to foster a deeper understanding of the German system – not to water down international governance standards but to assure adequate implementation in a different system.
The length of a required cooling-off period for managers before joining the same company’s supervisory board, the meaning of “independence” for a director in a co-determined board or a family-controlled company, or the amount of supervisory board positions a single director may accept are all areas that do not lend themselves to the simple yes or no judgments customary in a single-tier system.
This special nature of the German dual-board system is relevant not only to proxy recommendations but also to the evolving system of international corporate governance rules.
The European Union, for instance, is increasingly active in corporate governance and regulatory topics. Here too, a majority of countries in the European Union uses a single-tier system and E.U. legislation gets drafted with that reality in mind and subsequently – but not always – it is left to national legislatures to adapt the rules to their own domestic legal environments.
The most recent changes in E.U. governance requirements for banks are one example of where European rules go beyond the boundaries of German corporate law and leave it up to local courts to sort out the uncertainties. Similar issues, for example, are bound to arise in more general good governance practices such as “say on pay,” where shareholders at an annual meeting are the only ones entitled to vote on the management board’s compensation.
The most recent changes in E.U. governance requirements for banks are one example of where European rules go beyond the boundaries of German corporate law and leave it up to local courts to sort out the uncertainties.
Independent from the fact that the European Commission believes that transparency is a much more effective tool to curb excesses in corporate pay than a vote at an annual meeting, the introduction of a final binding vote at an annual shareholders’ meeting has to take national legal systems into account. Otherwise, the result might even be counterproductive.
In the German context, a vote by shareholders would remove this decision from the supervisory board, a co-determined body elected to represent multiple stakeholders, and give it to shareholders only.
Given the role of co-determination in the delicate fabric of German corporate governance, this is highly problematic. In addition, German corporate law sets very low thresholds for minority shareholder law suits, which may require long litigation before shareholder resolutions can be implemented. In the case of annual executive compensation, this would not be a very practical solution.
Besides managing the realities of having at least two different corporate governance systems globally, it is a further challenge for all professionals involved in corporate governance that the widely used German practice of having a symbiotic relationship between legislators and a self-regulatory body in corporate governance has no equivalent at the European level.
Furthermore, the national governance bodies appear to be only marginally coordinated.
It is against this background that under the new leadership of Manfred Gentz, the former chief financial officer of Daimler, the commission this summer shifted its focus from best practice standard-setting back to explaining the German system in active dialogue with proxy advisors, regulators, European authorities, academics and investors.
Besides explaining the German approach on corporate governance, the commission will continue to work on improving governance practices to avoid unnecessary and counterproductive regulation. After all, a dynamic code of best practices is the best deterrent to excessive regulation. While the emphasis on explaining, educating and standard setting are continually evolving, the tasks of the German Corporate Governance Commission remain as varied and important as ever.
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