CORPORATE

GOVERNANCE IN
GERMANY

TABLE OF CONTENT

S. NO

TOPIC

PAGE NO.

1.

Introduction

2.

Corporate Governance Reforms

3.

The German Corporate Governance Code

4.

The Effectiveness of Internal Controls

(i) The Two Tier Board

(ii) Influence of Globalization and European integration

10

(iii) Checking Self Dealing

10

5.

The External Controls

11

6.

Financial Reporting Standards

12

7.

Conclusion

13

Bibliography

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INTRODUCTION

When it comes to corporate governance, German companies typically show a number

of distinctive features. These include a two-tier (management and supervisory) board
with co-determination between shareholders and employees on the supervisory board,
creditor monitoring arising from long-term lending relationships, concentrated
ownership structures with substantial cross-holdings and banks among the pivotal
shareholders.

Another important aspect of the German corporate governance system is the

efficiency criterion that companies are to uphold. Whereas in Germany the definition
of corporate governance explicitly mentions stakeholder value maximization, the
Anglo-American system mostly focuses on generating a fair return for the
shareholders.

Before 1995, many large companies were still run by management boards with little
outside control. The German corporate governance system began to change in the late
90s. The ownership structures of German firms also changed significantly. The
change was precipitated by the following reasons:
-

Spurt in broad share distribution in public hands and reduction in block-

holdings
Failure of big companies like Holzmann and Metallgesellschaft indicated

the need of governance improvements

Pursuit of corporate governance was seen to make companies more
competitive and also helped in attracting clients and investors.

Though there was a realization of the importance of corporate governance, the

implementation part was hindered due to lack of knowledge of corporate governance
principles.

In September 1999, a panel of ten experts representing listed companies, auditors,

investors and legal practitioners undertook the task of framing a Code of Best
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Practice for German companies. This was a private initiative. After lengthy
discussions, the code that incorporated ideas and provisions from existing German
laws, international standards and expectations of national and international investors
was presented in January, 2000.

German Society of Financial Analysts developed a Score-card for German Corporate

Governance based on the Code of Best Practices.

By this time the German Government also started looking into the matter and after
months of intensive work published the German Corporate Governance Code in
February, 2002. German companies were now obligated to comply at least annually
with the Code or explain deviations.

CORPORATE GOVERNANCE REFORMS

The corporate governance reform that started in the 90s did not aim at bringing about
a market based system of corporate control. The reforms sought to pursue a system of
effective corporate governance supported by both insiders and outsiders.

Institutions and regulations were established as a starter for reforms. These reforms
included the prohibition of insider trading (1994), the establishment of the Federal
Securities Supervisory Office (1995), mandatory disclosure of stakes that result in
substantial voting rights (1995), the 1998 Antitrust Act, and the usage of International
Accounting Standards or US Generally Accepted Accounting Principles by parent
companies (1998).

Other reforms were introduced that focussed on enhancing the functioning of the
existing corporate governance structure. Legislations like the 1998 Law for
Reinforcement of Control and Transparency (KonTraG), which aimed to enhance
control by the supervisory board (SB) over the management board (MB), were
introduced. The KonTraG also phased out voting caps and shares with multiple voting
rights, typically held by insiders to buttress their corporate control.

Several Capital market reforms were introduced in an effort to secure investor

confidence and as a part of European Union (EU) initiatives.

The GCCG, dealt in some detail in subsequent sections of this report, helped in
creating a better understanding of Germanys governance setup.

THE GERMAN CORPORATE GOVERNANCE CODE

This German Corporate Governance Code (the "Code") incorporates the statutory
regulations for the management and supervision of German listed companies. The
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Code seeks to make Corporate Governance more transparent and understandable. The
objective is to promote the confidence of investors, employees, partners, big and
small shareholders and other stakeholders.

The Code clarifies the obligation of the Management Board and the Supervisory
Board to ensure the continued existence of the enterprise and its sustainable creation
of value in conformity with the principles of the social market economy (interest of
the enterprise).

A dual board system is prescribed by law for German stock corporations:

The Management Board is responsible for managing the enterprise. Its members
headed by a chairman are jointly accountable for the management of the enterprise.

The Supervisory Board headed by a chairman appoints, supervises and advises the
members of the Management Board and is directly involved in decisions of
fundamental importance to the enterprise.

The Supervisory Board is elected by shareholders at the General Meeting. In

enterprises with more than 500 or 2000 employees in Germany, employees are also
represented in the Supervisory Board, which then is composed of employee
representatives to one third or to one half respectively. For enterprises with more than
2000 employees, the Chairman of the Supervisory Board, who, for all practical
purposes, is a representative of the shareholders, has the casting vote in the case of
split resolutions. The representatives elected by the shareholders and the employeerepresentatives are equally obliged to act in the best interests of company.

The European Company (SE) with enterprises in Germany may opt for internationally
widespread system of governance by a single body which is the board of directors.

The dual-board system, common in other European countries, and the globally
common single-board system are converging because of the intensive interaction of
the MBs and the SBs.

THE EFFECTIVENESS OF INTERNAL CONTROLS

(i)

THE TWO TIER BOARD

The two-tier board structure and extensive labour representation are the defining
features of Germanys internal control mechanisms. Most other European countries
have single-tier board structurethat is a board that combines management and
supervisory responsibilities. The effectiveness of the two tier system however is a
topic of debate.

One view about the two tier board is that- two-tier system brings stability and longterm perspective to companies. The labour representation accounting for half of the
seats in SB (Co-determination or Mitbestimmung) gives employees key role in
strategic decision making and often keeps labour disputes away.

Others think that the supervisory boards are an unreformed area. A lack of outsiders
leaves all-German non-executive directors, often sitting on each others boards, to run
most of Germanys top companies. The supervisory boards contain workers
representatives in addition to directors chosen by shareholders and this dilutes
investors influence. German SBs have the fewest number of foreigners when
compared to other European countries and have least number of meetings in a year.

Volkswagen, a leading German car manufacturer, derives 81% of sales from outside
Germany and still has no foreigner on its board (with the exception of Ferdinand
Piech, VW Chairman who was born in Austria but spent most of his time in
Germany). There are also problems of conflict of interest. Porsche, a competitor, is
also its largest shareholder and controls the VW board, holding the chairmanship and
two other seats.

(ii)

INFLUENCE OF GLOBALIZATION AND EUROPEAN INTEGRATION

In 2005, the German government felt the need to review the system of codetermination in light of European and global challenges. A commission consisting of
trade unions, employers, and academic experts was formed to devise reforms;
however, disagreements over proposals to scale back labour representation in the SB
of large companies to one-third led to the failure of the commission.

Since late 2004, public companies operating in at least two EU markets have been
allowed to adopt Societas Europea (SE) legal framework. Conversion to SE status
offers more flexibility in terms of internal controls, including by offering the
possibility of moving to a one-tier board, smaller board sizes, and reduced labour
participation.
(iii)

CHECKING SELF DEALING

The agency problem under concentrated ownership is different from that under
dispersed ownership. Dominant shareholders may use their influence over the
management to seek undue personal benefits at the expense of small shareholders.
Some examples can be- exorbitant compensations for management, asset sales at
below-market prices, or dilution of minority stock holdings through mergers.

German corporate law (Konzernrecht) focuses on regulating conflicts between

minority and large shareholders. Consistent with the two-tier board structure, control
relies on the SB, and the law requires SB approval for specified self dealing
transactions. However, it is to be noted that there are less legal barriers to self-dealing
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in Germany. When ownership is concentrated, large shareholders dominate both MB

and SB. When ownership is more dispersed, management tries to control SB. Many
view this as ineffectiveness of SB (sometimes even involving unscrupulous
understanding between MB, SB and large shareholders) in checking self dealing.

THE EXTERNAL CONTROLS

Germany may be seen as having non liberal corporate governance standards due to
the limited the role of markets as mediating mechanisms for both capital and labour.
Capital market regulations and accounting rules tend to weaken the position of
minority shareholders and market mechanisms. For example, the German accounting
rules are creditor-oriented and are considered to lack the same transparency as found
in International Accounting Standards (IAS) or the US General Accepted Accounting
Standards (GAAP).

The German takeover law aims at protecting the interests of minority shareholders. It
stipulates a strict mandatory bid requirement to provide minority shareholders with an
acceptable exit option. In transactions exceeding 30% of voting rights, the law
requires a mandatory offer by the acquiring party to all shareholders. The mandatory
bid requirement intends to raise the costs of takeovers to benefit the management.

Clearly, the law fails to create a level playing field. Enhancing the effectiveness of the
market for external control, and especially involuntary take-overs, could serve as a
major step toward enhancing corporate governance.

FINANCIAL REPORTING STANDARDS

The EC Regulation 1606/2002 made it mandatory for all EU listed companies to

adopt IFRS in their financial statements. All the listed companies in Germany are
required to file their consolidated financial statements in line with the IFRS. However,
for profit distribution, taxation purposes and financial services supervision, adherence
to national accounting standards (German Commercial Code (HGB)) is required.

The use of IFRS is permitted for statutory filings of consolidated financial statements
only and does not extend to other separate financial statements.

In November 2007, the German Accounting Law Modernization Act, which seeks to
bring national accounting standards closer to the IFRS standards, was passed.
However, in April 2009 Germany allowed use of national laws and standards for
small-medium sized companies and considered IFRS as cost-intensive and highly
complex. Currently, Germany is at Stage II of the adoption process.

CONCLUSION

Germanys corporate governance system has undergone substantial reforms since the
1990s. Some changes include improved functioning of insider-controlled corporate
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governance structures and significant strengthening of outsider control.

Notwithstanding the steady pace of change, consideration should be given to further
enhancing the effectiveness of the corporate governance framework in three central
areas:
-

Internal control mechanisms need more flexibility. The legally mandated two-tier
board structure, large SBs, and high labour representation remain a topic of continued
controversy. Market driven flexible corporate governance norms need to be given a
try. Extending the flexibility accorded under the SE statute to private companies could
be a better option.

Self-dealing remains a challenge to effective internal controlexacerbated by high

ownership concentration. Perhaps a new law specifically targeting self dealing needs
to be introduced. Additionally, more integrative and open communication regarding
all dealings and transactions could be of help. In particular, the practice of providing
an annual report detailing self-dealing transactions exclusively to the SB should be
discontinued and the report should be provided to all shareholders.

External control needs to be further strengthened. The market for corporate control
faces several legal barriers, including measures allowing incumbent management to
take defensive action to stave off involuntary takeover bids. Removing defensive
measures from the German takeover law would be a welcome step in this direction.

BIBLIOGRAPHY

1. https://www.imf.org/external/pubs/ft/wp/2008/wp08179.pdf
2. http://eprints.whiterose.ac.uk/4798/1/4798_goergen.pdf

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3. https://www.sglgroup.com/cms/international/investor-relations/corporategovernance/principles-of-german-corporate-governance/index.html?__locale=en
4. http://www.jura.uni-frankfurt.de/43029805/paper70.pdf
5. http://www.slideshare.net/shiveshr1/corporate-governance-standards-in-germany26468910?qid=8be14be7-f9e9-4d098c3c11e2043798a3&v=default&b=&from_search=1
6. https://www.imf.org/external/pubs/ft/wp/2008/wp08179.pdf

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