by Klaus J Hopt
1. The concept and the international development of corporate governance
Corporate governance, its concept and its problems was first discussed and developed extensively in the United States and in Europe, primarily in the United Kingdom. From there, corporate governance has made its way victoriously through all modern industrialized countries. Contributions to and research projects on this topic can be found all over the world. A European Corporate Governance Network was founded in 1995 with its seat in Brussels (the name was later changed to the European Corporate Governance Institute, ECGI). Since 2009 it has had its seat in Luxembourg and counts numerous researchers among its global members, primarily from law and economics, as well as many practitioners and companies. In the meantime, corporate governance has also become a topic of paramount importance in the practice of stock exchanges, banks, industrial associations and even parliaments in various countries. In many countries, far-reaching reforms of the company, auditing, stock exchange and capital market laws have been enacted in the last decade or are about to be enacted. All are meant to improve national corporate governance either directly or indirectly.
The problem has already been aptly described in 1776 by Adam Smith in his famous book entitled ‘An Inquiry into the Nature and Causes of the Wealth of Nations’ as follows: “The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.” In modern terminology, this is the principal-agent conflict between the shareholders and management.
2. Internal and external corporate governance
At first glance, it might seem that corporate governance is just a problem of the legal organization of the public company, and indeed, the original thrust of the corporate governance movement in the United States was directed towards the role, duties and liability of the directors of the corporation. The code of conduct movement, too, which essentially originated in the United Kingdom, had its focus on recommendations for the board of directors, its committees and its control by the auditors. This is also true in Germany for the German Corporate Governance Code (DCGK). Apart from some recommendations on the rights of the shareholders and the general meeting, it deals mainly with the management board and the supervisory board. Yet in the modern international corporate governance discussion, it is accepted that apart from internal corporate governance, there is also an important role to be played by external corporate governance, ie corporate governance forces exercised by pressures of the market, in particular, but not only, by the market for corporate control.
Internal corporate governance is mainly concerned with the rules for management and the control organ(s) of the company. In the modern Berle Means Corporation, ownership and control are separated. In the German stock corporation, the shareholders have placed the management into the hands of the management board and the control into the hands of the supervisory board. Yet on the international scene this is rather a path-dependent exception. In the countries of the Anglo-American legal family, but also in Switzerland and many other countries, there is only one board (monistic or one-tier board system), though there is a distinction in it between executive and non-executive, often independent, directors. This implies that a choice given to the shareholders between the two systems may be better than the legislature mandating one system or the other ([[board).
On the other hand, the different shareholder structures in the various countries play an important role. In the United States and the United Kingdom, public companies are without major shareholders (the outsider model) as a rule, while in continental European countries the norm is rather companies with blockholders, family companies or companies with a controlling shareholder either within or outside of a group of companies (the insider model). In the latter cases, the principal-agent conflict between the shareholders and the management is much less important than the conflict between the minority shareholders (in the group they are also called outside shareholders) and the controlling shareholder. In such cases, the corporate governance problems are fundamentally different, as reflected in the subject matter of the economic and international discussion today. Of course, there are also transition phenomena, and the question then is whether a transition from one system to the other is possible without destabilizing the system as a whole.
In the United Kingdom, in Germany and internationally, disclosure and auditing are indispensible parts or building blocks of all corporate governance systems. Disclosure in its various legal forms is important, particularly if it is audited, for it provides the market participants with important information for their investment and disinvestment decisions. Disclosure, even mandatory, is a less far-reaching regulatory intervention than a substantive, mandatory legal rule. It conforms more to the play of the market and to a market economy. Disclosure and auditing belong closely to the modern company, but since auditors must be independent they cannot be considered organs of the company. Both disclosure and auditing stand somewhere in between internal and external corporate governance. The auditors belong to the category of ‘gatekeepers’ with a particularly important role.
The most important external corporate governance—apart from banks, stock exchanges, the capital market and labour co-determination in the board—is the market for corporate control. As a rule, takeovers are useful because they are a means of furthering the use of synergies as well as an instrument of control of the management of the (target) companies with dispersed ownership, particularly if they are listed. This is not to say that takeover bids are always advantageous for all (or even only one) of the parties involved. The stock price of the bidder goes down in most cases, and the shareholders of the target may face the insertion of their company into a group or sometimes even the danger of looting. The development of a level playing field for takeover bids is an aim for the internal market (European internal market) within the European Union. But this must not lead to a reduction of competition, as many economists fear occurs when the quest for a level playing field is made. On the contrary, the conditions and framework rules for a well-functioning market for corporate control within the internal market should be furthered. In order to reach this aim, the obstacles to takeovers—even hostile takeovers—should be reduced within all Member States. Corporate governance rules to this effect are part of the takeover law.
3. European law and convergence of the national corporate governance laws
There is much controversy whether and, if so, to what degree corporate governance rules should be harmonized on the European level or whether they should be left to national legislation and regulation. This is not just a question of subsidiarity, as laid down in European Union law, but also a question as to the right level of law- and rule-making, both economically and politically. The latter question goes to the very root of regulation theory and European legal policy and ranks among its most controversial issues. Economists usually tend to prefer competition between legislatures and rulemakers (competition between legal systems), while lawyers and law professors usually prefer harmonization. The European Union has followed different attitudes regarding this over the years (including maximum harmonization, full recognition, minimum harmonization, core regulation, deregulation, best regulation). We cannot go deeper into this here. Yet in any case, the burden of proof should be with those who plead for European harmonization, since harmonization is only justified if two conditions can be convincingly demonstrated as fulfilled: first, that regulatory intervention by the legislature into the corporate governance is legitimate—eg because of market failure or external effects or the necessity to implement the political decision in favour of creating and maintaining an internal market—and secondly, that, in order to be successful, the intervention must be on the European level since intervention on the Member State level is not sufficient. Even in the latter case, this usually does not lead to an either/or situation, but to a mutual complementation of European and national corporate governance rules in which the former constrains itself to framework rules, core problems or building blocks of regulation. Whether the scale leans towards one or the other side in the long run depends on many economic and political conditions and is hard to predict.
Even apart from European rules, there is a clear development towards more convergence of company law and corporate governance that is driven by market forces. In the United States some authors have even proclaimed the ‘end of the history of corporate law’. From a European perspective this appears to be utopian, but it is true that despite all the peculiarities and path-dependencies of the national corporate governance systems, there is a clear movement towards convergence, also as far as corporate governance is concerned.
4. European rules for internal corporate governance
European rules for internal corporate governance can be found in European company law. It is true that this law does not reach as far as the European stock exchange law (exchanges) and capital markets law, as illustrated by the dire fate of the 5th Structure Directive and the plans for a 9th Directive on group law, both of which have been abandoned by the European Commission. Yet it must be recorded that European company law is important, for its extent as well as its content. The assertion that European company law is trivial is a misperception. As to the details and legal sources of the European company law directives, company law, stock corporation and mandatory disclosure (securities markets).
In its Action Plan of 21 May 2003, the European Commission rightly placed corporate governance in the middle of its agenda. This is already shown by the title of the Action Plan, ‘Modernizing Company Law and Enhancing Corporate Governance in the European Union—a Plan to Move Forward’. The short-term measures envisaged therein have already been implemented by various directives and recommendations. For example, this is true for the enhanced corporate governance disclosure requirements and confirmation of collective responsibility of board members for financial and key non-financial statements in the annual report, as mandated by Dir 2006/46 of 14 June 2006. According to this directive, a company whose securities are admitted to trading on a regulated market shall include a corporate governance statement in its annual report (corporate governance report), and board members are liable if they do not draw up and publish this report. In Germany this has been transposed by the balance sheet reform of 2009 and has led to a marked strengthening of Art 161 of the Stock Corporation Act concerning the company’s declaration as to whether and how far it follows the German Corporate Governance Code (as to the latter, private rule-making and codes of conduct).
Directive 2007/36 of 11 July 2007 on the exercise of voting rights by shareholders of companies having their registered office in a Member State and whose shares are admitted to trading on a regulated market provides for better communication of the company with the shareholders and makes the taking of shareholder resolutions easier (including participation in the shareholder meeting by electronic means and the asking of questions). It facilitates the exercise of voting rights by proxy voting and other means of voting, including the exercise of voting rights across the borders.
Recommendation 2004/913 of 14 December 2004 concerning the remuneration of directors of listed companies deals with a topic that has lately become of particular concern to the public. According to this recommendation, the remuneration policy of the company must be disclosed and the general meeting of the shareholders should have a say, either mandatory or advisory, on the pay policy. To the great disappointment of the European Commission, Germany and most other Member States did not follow the pay recommendation. Therefore, and under the impression of the international critique of excessive manager remuneration, the Commission published a complementary recommendation on 30 April 2009 (board).
The role of independent non-executive directors is dealt with in Recommendation 2005/162 of 15 February 2005 on the role of non-executive directors of listed companies and on the committees of the board. According to this recommendation, the roles of the chairman and chief executive should be separate and the chief executive should not immediately become chairman of the board. This is particularly relevant for Germany where this is quite common and was even practised by the late chairman of the German Corporate Governance Code Commission himself in his company. If the company does not follow the recommendation, it must at least publish information on any safeguards put in place. Furthermore, the companies (with the exception of small and medium companies) must establish a nomination, remuneration and audit committee in which the majority of the members must be independent. The recommendation—and in particular its Annex II—contains far-reaching details on what independence means. While in the end it is up to the board to determine whether a particular board member should be considered independent, the full transposition of the recommendation would have grave consequences for Germany and other countries having a majority of companies in which there are controlling shareholders or which are subject to quasi-parity labour co-determination. For more information, board.
The formation of an audit committee is mandated for certain companies by Dir 2006/43 of 17 May 2006. Each public interest entity must have an audit committee. Public interest entities are entities governed by the law of a Member State whose transferable securities are admitted to trading on a regulated market of a Member State as well as credit institutions and insurance undertakings. At least one member of the audit committee must be independent and shall have competence in accounting and/or auditing.
The further measures envisaged in the Action Plan were halted by the European Commission under Commissioner McCreevy. They concern, inter alia, enhanced disclosure by institutional investors of their investment and voting policies; choice for all listed companies between two types (monistic/dualistic) of board structures; and enhancing the responsibilities of board members (special investigation rights, wrongful trading rule, director’s disqualification). Against the advice of experts, Commissioner McCreevy also pushed an approach of full shareholder democracy (one share/one vote), at least for listed companies. Yet he foundered miserably with this ill-prepared plan and fell to the other extreme by not taking any further corporate governance measures as envisaged in the Action Plan. This has been rightly criticized by European experts and the European Parliament.
5. European rules for external corporate governance
The 13th Directive of 21 April 2004 on takeovers (Dir 2004/25) belongs to the most important measures for external corporate governance. The adventurous story of this directive’s genesis, its content and its relevance are described in takeover law.
Further elements may have a positive effect on corporate governance from the outside of the company. This is particularly true for disclosure requirements that lead to more transparency regarding the company and its actual corporate governance and that give more information relevant for investors and possible bidders. In European company law and capital markets law there are many disclosure rules, quite apart from the periodic disclosure contained in the annual accounts and group accounts. For example, they concern the mandatory corporate governance statement, the obligations relating to the information to be published when a major holding in a listed company is acquired or disposed of, and the obligation of issuers of financial instruments to inform the public as soon as possible of inside information that directly concerns these issuers.
American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (1994); Klaus J Hopt and others (eds), Comparative Corporate Governance: The State of the Art and Emerging Research (1998); Susanne Kalss, Anlegerinteressen: Der Anleger im Handlungsdreieck von Vertrag, Verband und Markt (2001); Paul Frentrop, History of Corporate Governance 1602–2002 (2002); High Level Group of Company Law Experts, Report on Issues Related to Takeover Bids (Report I) and A Modern Regulatory Framework for Company Law in Europe (Report II), Reports of the High Level Group of Company Law Experts, European Commission, Brussels, 10 January 2002 and 4 November 2002, also available in Guido Ferrarini, Klaus J Hopt, Jaap Winter and Eddy Wymeersch (eds), Reforming Company and Takeover Law in Europe (2004) Annex 2, 825 and Annex 3, 925; Klaus J Hopt, Eddy Wymeersch, Hideki Kanda and Harald Baum (eds), Corporate Governance in Context: Corporations, States, and Markets in Europe, Japan, and the US (2005); Klaus J Hopt and Eddy Wymeersch (eds), European Company and Financial Law, Texts and Leading Cases (4th edn, 2007); Patrick C Leyens, ‘Corporate Governance: Grundsatzfragen und Forschungsperspektiven’ (2007) JZ 1061; Henrik-Michael Ringleb, Thomas Kremer, Marcus Lutter and Axel von Werder, Deutscher Corporate Governance Kodex (3rd edn, 2008); Klaus J Hopt, ‘Gemeinsame Grundsätze der Corporate Governance in Europa?’  ZGR 779.