Corporate governance comprises all aspects of the management and supervision of a company. In contrast to the internal regulations (Binnenordung) of the company, i.e. as laid down in the articles of association, corporate governance also encompasses questions of the company’s legal and factual integration into the environment, such as the capital market. In this respect, the initial interest concerned the (large) listed companies. Increasingly, however, other legal forms and medium-sized companies are being analyzed regarding their specific requirements for good corporate governance. This applies in particular to companies in the hands of financial investors and family-run businesses.
Corporate governance is not new. The debate about the efficiency of management bodies such as the supervisory board, but also the debate about co-determination in Germany has a long history. In recent years, however, the discussion about appropriate aspects of company management and supervision has gained unprecedented importance nationally and internationally. The drivers are numerous cases of maladministration and corporate distress. Globalization of the economy and the liberalization of the capital markets provided additional impetus for efficient forms of corporate management. Finally, in the recent past, national and international investors have questioned the governance modalities of stock market securities, with sometimes unpleasant consequences for companies.
The starting point of the problem is the company as a bundling of (legal) relationships of different nature, contributions of different stakeholders (e.g. shareholders, creditors, employees and suppliers) and their different interests. This offers the various stakeholders opportunities and motives for opportunistic behavior, to act in their own interest and, if necessary, to the detriment of other stakeholders. The German legislator and provider of the regulatory framework for corporate governance requirements is therefore well advised to continuously address corporate governance issues in order not only to provide companies in Germany with a framework for safe actions, but also to keep them competitive in the international investment world, even if a positive correlation between good corporate governance and corporate success cannot be empirically proven. What this means for the corporate governance of listed, but also in particular of non-listed companies, will be outlined below on the basis of individual aspects.
Principles of corporate governance,in particular forthcoming new developments
The interests of stakeholders are the essential basis of corporate governance and, at the same time, the limit to the actions of companies, insofar as they are contractually and legally fixed. The fundamentals of corporate governance also consist of various elements of a legal and factual nature.
The most important legal system elements include the company’s superordinate key objectives (shareholder or stakeholder orientation), structural features such as a dualistic constitution (two-tier system) with a management board and a supervisory board or a monistic constitution (board system) with an administrative board and a directorial (CEO) or collegial (management board) management organization, the anchoring of employees (participation through operational and entrepreneurial co-determination) and the primary orientation of publicity and auditing according to the market value or prudence principle (US-GAAP or IFRS/IAS vs. HGB). The factual system elements include in particular indicators of the ownership structure (share concentration or majority ratios in case of non-listed companies and/or such ratios in relation to the free float in case of listed companies), the ratio of equity and debt financing of the companies, the role of the banks and the existence of personal ties within a company as well as between companies operating together. Also of importance is the “governance atmosphere” in a company (tone from the top), which contains the corresponding values of the respective company, and e.g. determines which management remuneration is still regarded as appropriate and to what extent opportunistic behavior is reprehensible.
The legal system elements of corporate governance are based on the various legal regulations, depending on the legal form, the structural features selected by the company for top management and any mandatory or voluntary supervisory bodies as well as the transparency requirements specified and selected by the company. Primary legal bases are the Limited Liability Companies Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung, GmbHG), the Stock Corporation Act (Aktiengesetz, AktG), the European and national requirements for the SE, the German Commercial Code (Handelsgesetzbuch, HGB), the Act on Co-determination of Employees (Gesetz über die Mitbestimmung der Arbeitnehmer, MitbestG), the Act on One-Third Participation of Employees on Supervisory Boards (Gesetz über die Drittelbeteiligung der Arbeitnehmer im Aufsichtsrat, DrittelbG) and the Securities Trading Act (Gesetz über den Wertpapierhandel, WpHG).
Innovations by ARUG II
The Act Implementing the Second Shareholders’ Rights Directive (ARUG II) implements the Second Shareholders’ Rights Directive ((EU) 2017/828) in Germany.
With regard to good corporate governance, ARUG II aims, among other things, to strengthen transparency in transactions of listed companies with related companies or persons. Major transactions are to be conducted independently of irrelevant interests and free outflows of assets in favor of related companies or persons are to be prevented. A major transaction exists if its economic value comprises at least 2.5% of the company’s assets in the current fiscal year, unless it is carried out in the ordinary course of business and on customary market terms. In future, major transactions will be subject to the approval of the supervisory board or a supervisory board committee. Furthermore, in order to monitor the aforementioned requirements, the company must, on the one hand, establish an internal control procedure and, on the other hand, publically notify the conclusion of significant transactions. The notification must take place immediately upon conclusion of the contract and aims to provide shareholders with rapid and reliable information.
German Corporate Governance Codex
In addition to the statutory regulations, the so-called soft law is also of considerable importance in the field of corporate governance. Following the insolvency of Philipp Holzmann AG, the Federal Ministry of Justice formed the Government Commission on the German Corporate Governance Code in September 2001. This is an independent self-regulatory body financed by German business. It does not include representatives from government or politics, nor can the Federal Government issue instructions to it. The first version of the German Corporate Governance Code (GCGC) was developed in 2002 under the direction of Gerhard Cromme and published in the electronic Federal Gazette on 30 August 2002. Since then, the Government Commission has annually reviewed whether the GCGC continues to comply with best practice in good corporate governance or whether it needs to be adjusted. The current version of the GCGC has been in force since 24 April 2017.
The GCGC addresses listed companies and companies with access to the capital market. In its current version, the GCGC reflects the key statutory provisions governing the management and supervision of German listed companies and provides recommendations and suggestions for internationally and nationally recognized standards of good and responsible corporate governance. Recommendations of the code are identified in the text by the use of the word “shall”. The companies may deviate from this, but are then obliged pursuant to Section 161 AktG to disclose this annually in their so-called Declaration of Conformity (Entsprechenserklärung) and to give reasons for the deviations (comply or explain). This enables the companies to take into account sector-specific or company-specific needs. Furthermore, the code contains suggestions that can be deviated from without disclosure; for this purpose, the Code uses the term “should”.
In terms of content, the GCGC clarifies the duties of the management board and the supervisory board, the cooperation between the two bodies and specifies their areas of responsibility. In addition, it makes statements on the remuneration structure of the management board and provides guidelines for dealing with any potential conflicts of interest, in particular for supervisory board members. Finally, the GCGC takes up transparency vis-à-vis shareholders and defines requirements with regard to accounting and auditing.
Innovations in the GCGC 2019
The named objectives of the current GCGC reform 2019 are the improvement of transparency and the comprehensibility of the system of good corporate governance in Germany. The reform aims in particular to strengthen the confidence of investors and other stakeholders as well as the confidence of the public in the management of the company. Under this heading, the GCGC 2019 also wants to be clearer and more accessible. In addition to the known categories of recommendations and suggestions, the GCGC 2019 now also contains so-called principles for this purpose. Instead of the previously extensive legal repetitions, the principles provide Information on the essential legal requirements for responsible corporate management. Last but not least, the reform aims to improve the quality of corporate governance in German companies.
In particular, new regulations that are in line with ARUG II include recommendations on management board remuneration. Accordingly,
a remuneration system is to be defined that determines
- the target and maximum total remuneration;
- the relative proportion of the fixed remuneration as well as the short-term and long-term variable remuneration in the targeted total remuneration;
- which (non-)financial performance criteria are to be used to grant variable remuneration;
- the variable remuneration on the basis of the achievement of previously agreed performance criteria; and
- when and in what form the management board member can dispose of the variable remuneration amounts granted.
for each member of the management board
- a specific target and maximum total compensation shall be determined individually;
- the performance criteria for all variable compensation components shall be bindingly fixed for the forthcoming fiscal year;
the proportion of long-term variable compensation shall exceed the proportion of short-term variable compensation and shall predominantly consist of shares of the company or be granted on a share basis.
The reform of the GCGC 2019 came to a standstill due to the reasonable intention of harmonizing the GCGC 2019 with the amendment to the AktG by ARUG II. The competence of the (annual) general meeting to reach a Resolution on the remuneration of the management board (so-called say-on-pay) proposed by the Second Shareholders’ Rights Directive considerably delayed the legislative procedure on ARUG II until today. In particular, the opposition parties were divided after the submission of the government draft as to whether the vote of the (annual) general meeting should be binding or non-binding – in this respect, the directive leaves the implementation to the EU member states.
Apart from this, the GCGC 2019 will specify the requirements for the independence of shareholder representatives on the supervisory board. Potential conflicts of interest may arise from the proximity of shareholder representatives to the company or its management board, from self-interest (e.g. as customer, supplier, lender or due to personal proximity), from the length of membership on the supervisory board and last but not least from the position as controlling shareholder. Internationally, it is common to combine the definition of independence with a catalogue of specific facts. The GCGC 2019 chooses to list a catalogue of indicators for the lack of independence of shareholder representatives on the supervisory board. To answer the question of independence, two points of view need to be considered: On the one hand, the supervisory board member must be independent of the management board or company and, on the other hand, of the controlling shareholder. The distinction between the two relations of independence is therefore important because in future more than half of the shareholder representatives shall be independent of the company and the management board. If the company has a controlling shareholder, it is recommended that a supervisory board with more than six members shall have at least two shareholder representatives who are independent of the controlling shareholder; in the case of a smaller supervisory board, at least one.
The GCGC 2019 addresses the problem of so-called overboarding by restricting the number of supervisory board mandates to five in non-group listed companies or comparable functions; one supervisory board chair counts twice. In the GCGC 2019, the initial appointment term of three years is no longer structured as a suggestion but as a recommendation. However, this is rather an adjustment to the already established practice of a three years’ appointment term compared to the statutory maximum duration of five years, at least at the time of the first appointment.
It is to be welcomed that the previous recommendation to publish a separate Corporate Governance Report (in addition to the Declaration of Conformity (Entsprechenserklärung), the Supervisory Board Report (Aufsichtsratsbericht), the Management Report (Lagebericht) and the Corporate Governance Declaration (Erklärung zur Unternehmensführung) has been dropped due to the fact that the Corporate Governance Declaration will be the central instrument for reporting on corporate governance.
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Financial Year Book Germany EU 2020_Private Equity and Corporate Finance (english version)
This article was first published in: FYB Financial Yearbook, Germany/EU 2020, Private Equity und Corporate Finance, pp. 99-117
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Corporate Governance 2019 – Law and practice in Germany