Board

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Board

1. Management and control by a one-tier or two-tier board?

Management and control in the corporation is no longer the task of the shareholders themselves; instead, it is the task of the organs of the corporation on behalf of the shareholders. Internationally, two systems have emerged: the system of a one-tier board and the two-tier system with a management board and a supervisory board. In Germany the latter system provides for a mandatory division of labour between the management organ and the control organ. In its more than one century of history, it has never been seriously called into question. But internationally this two-tier system is a path-dependent exception. The one-tier board is the rule, not only in the Anglo-American legal family, but also in Switzerland and many other countries. Yet within the one-tier board, too, it is becoming more and more common to have executive and non-executive directors, sometimes independent directors. A functionally similar separation between management and control is also established in the one-tier board if the chief executive and the chairman of the board cannot be the same person and, going even further, if the independent directors elect a lead director.

There is much controversy regarding the advantages and disadvantages of both systems. The two-tier system has the advantage of a clear, institutionally established separation between the management and control functions. But it must be conceded that the great hopes the German legislature placed in this system have only partially been fulfilled, as shown by the never-ending discussion on board reform in Germany since the end of the 19th century and by many reforms and reform proposals in relation to the board. The German supervisory board has never been a mere control organ; it has always also influenced management by giving more or less extensive advice to the managing board and by forming networks with banks and other companies. Furthermore, the separation—though mandatory—is only formal, since the supervisory board members are not eo ipso independent, even less so in the traditional German system of ‘Rhenan capitalism’ with its many interlocking directorates and participations. The one-tier system, on the other hand, has the disadvantage that all directors—including the independent ones—are ultimately responsible for the management. This makes control more difficult. But the advantage of this system is that even the independent directors are fully integrated into the board information system of the company. According to some observers, this is the decisive advantage of the one-tier system (Paul Davies).

It follows that a clear overall advantage of one of the two systems over the other cannot be found. Instead, these systems are path-dependent, ie dependent on historical developments and other idiosyncratic conditions in their various countries. Even in the two-tier board system, the formation of a supervisory board is not mandatory for smaller companies like the limited liability company, such as the GmbH in Germany. If this is so, it stands to reason that the choice between the two systems should not be mandated by the legislature, but should rather be left to the companies themselves, as they know best what suits their specific needs. In France such a choice between two board systems has existed for many years. Italy even allows a choice between three systems. In addition, the statute of the [[European Company (Societas Europaea) and, most recently, Denmark allow a choice between the one-tier and the two-tier board. In Germany this choice is advocated by a growing segment of the legal and economic literature, though labour co-determination, which in Germany is quasi-parity, creates problems for the one-tier board.

As to the details, the legal rules concerning management and control vary considerably in the various countries. This is because the ideas and the experiences surrounding national company law and corporate governance codes are heterogeneous. This cannot be described here ([[company law). For Germany, these details can be found in the commentaries to the Stock Corporation Act and the German Corporate Governance Code (DCGK); as examples, see the far-reaching management function of the German management board, the election and dismissal of the management board and the supervisory board members, their remuneration, the independent directors, the legal relationship between the two boards, the rules concerning each of the two organs, their committees, their duties of care and of loyalty, [[conflicts of interest, liability and so on. These questions form part of the [[corporate governance of each country’s system.

2. Banks and labour co-determination in the supervisory board

In Germany it is a longstanding and common practice to have representatives of the banks on the supervisory boards of major companies. The influence of banks on enterprises has traditionally been much more important in Germany than in other countries, particularly in contrast to the United States and the United Kingdom. This influence has been criticized since there is a combination of the extension of credits, share participation in the company, representation and even chairmanship in the supervisory board and the mandate given to the banks by many of their clients to exercise their voting rights in the general assemblies (the ‘bank deposit vote’). This influence is even stronger if the bank owns an investment subsidiary that holds and administers shares for investors. Yet due to globalization and the growing role of investment banking in Germany, Rhenan capitalism has slowly lost ground. The banks have started to reduce their participation and boardroom representations in the companies; in particular, they have become reluctant to assume the chair. While in the 1970s and 1980s there had been much criticism of the power of the banks, these voices became silent even before the current financial crisis. Instead, there is now a danger that the state, which saved failing banks by taking participation in them and sending representatives to their boards in order to check their recovery, may continue to keep that representation on the board indefinitely, even after the crisis. Politicians and the public tend to forget that the state does not know as much as the market.

Labour co-determination, however, remains as is in Germany. Labour and the trade unions continue to send their representatives to the boards of major German companies (with 1,000 employees or above they fill one-half of the board, from 500 or above they hold one-third of the seats). This system of co-determination at parity or—if the chairman of the supervisory board is elected by the representatives of the shareholders, a so-called quasi-parity labour co-determination—is a clear exception internationally. Even the Netherlands, which had a parity cooptation board system, never mandated it for multinational holding companies for fear of deterring them from taking their seat in the Netherlands. Most recently, the Netherlands even abolished their old system and introduced a one-third parity system with increased rights for the plant councils. In many other European countries there is also co-determination in the board, but with only one-third of the board reserved to labour. In the Anglo-American countries, labour co-determination has been strictly rejected by legislatures, business practice and economic theory. These arguments have gained ground more recently, even in Germany. The critics of quasi-parity co-determination point to global competition and the handicaps for Germany resulting from the German co-determination system. Indeed, it can hardly be denied that non-German companies are very reluctant to accept such a high degree of labour influence in their (one-tier) boards or in those of their subsidiaries. Nevertheless, German trade unions maintain their power and even threaten a general strike if the legislature dares to reduce their ‘vested right’ to labour co-determination. Rather, under the impression of the financial crisis, they ask that their influence be increased to full parity co-determination. German companies are usually quiet on the issue, either because they have adapted to it or because they shy away from confrontation with labour, realizing that in the short run there is no chance for change.

3. European legal rules for the boards

The [[European Commission has tried for decades to harmonize core [[company law. The proposal of the 5th Directive, called the Structure Directive (of 9 October 1972, modified on 19 August 1983 and 20 November 1991), dealt with the structure of the company and the competences and duties of its organs. Yet the key problem was labour co-determination in the board. The proposal has never been enacted, and the Commission has declared it to be dead. Instead, the European Commission came up with its Action Plan of 21 May 2003 and certain company law harmonization measures concerning [[corporate governance and shareholder rights. A number of these measures have already been enacted.

European legal rules for the board obviously exist for European company law forms. The European regulation of 8 October 2001 on the Statute of the [[European Company (Societas Europaea) (Reg 2157/2001) regulates the structure of the SE. The SE must have a board, but it can choose its bylaws between two separate organs for management and control (dualistic or two-tier system) or a unitary or monistic board (Art 38). The statute contains detailed rules on the dualistic system (Arts 39–42) and the monistic system (Arts 43–45) and common rules for both (Arts 46–51). In addition to and apart from the regulation, a European recommendation of the same day regulates the co-determination of labour in the SE. These European rules have been transposed in the national company laws of all Member States. Accordingly, in Germany there is also now a choice between the one-tier and the two-tier systems for the shareholders of a (German) SE. The co-determination in the SE is based on the principle of negotiation between capital and labour. This negotiation can take as long as six months. If no consensus can be reached, the rule is that the most far-reaching system of one of the members of the SE will be maintained as the system of the SE. In practice this leads to the participation of non-German labour in the board of a German SE and to a number of mitigations of the German co-determination rules, such as a clearly smaller size of an SE board than is mandatory for German stock corporations (this was one of the advantages of the German Allianz insurance company’s legal transformation into an SE).

Four European instruments concerning the board of companies, not only of European companies, must be mentioned in particular. These are two regulations and two recommendations. They concern the audit committee of certain companies according to the regulation of 17 May 2006 (Reg 2006/43), transparency and liability according to the regulation of 14 June 2006 (Reg 2006/46), the remuneration of directors according to the recommendation of 14 December 2004, the duties of board members and board committees according to the recommendation of 15 February 2005 and the recommendation of 30 April 2009 that supplements the remuneration recommendation.

Directive 2006/43 mandates that 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 shall be independent and shall have competence in accounting and/or auditing (Art 41, ‘financial literacy’). The Member States may make further rules. Independence is defined in detail. The audit committee shall monitor the financial reporting process, the effectiveness of the company’s internal control and risk management systems and the statutory audit of the annual and consolidated accounts and review and monitor the independence of the statutory auditors. This is without prejudice to the responsibility of the members of the board.

Directive 2006/46 mandates, inter alia, that 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 stipulates the board members’ duty and liability for drawing up and publishing the annual accounts and the annual report and the consolidated accounts and the consolidated annual report. The corporate governance statement shall be included as a specific section of the annual report and shall contain, inter alia, a reference to the corporate governance code to which the company is subject, the extent to which a company departs from the corporate governance code with an explanation of this departure, and a description of the main features of the company’s internal control and risk management systems in relation to the financial reporting process. The board members of the company have the collective duty to ensure that the annual accounts, the annual report and, when provided separately, the corporate governance statement as well as the consolidated instruments are drawn up and published in accordance with the requirements of the directive. Members of the board are liable, at least towards the company, for breach of their duties.

The recommendation of 14 December 2004 tries to foster an appropriate regime for the remuneration of directors of listed companies. Each listed company should disclose a statement of the remuneration policy of the company (the remuneration statement). This statement and significant changes to it should be an explicit item on the agenda of the annual general meeting of the shareholders and should be submitted to them for a vote. The vote may be either mandatory or advisory. The remuneration of individual directors should be disclosed in detail. This is to be seen against the background that the International Financial Reporting Standards (IFRS) have since 2005 provided that share options must be evaluated according to a general fair value method and that the expenses for directors must be calculated over the waiting period. The recommendation of at least an advisory resolution of the general meeting on the remuneration policy goes back to the UK model but has not been followed by most of the Member States, including Germany.

The Commission recommendation of 30 April 2009 was made under the impression of the international critique of excessive remuneration of managers and complements the former recommendations as regards the regime of the remuneration of directors of listed companies. Where the remuneration policy includes a variable component of remuneration, companies should set limits on the variable component(s). The awarding of variable components of remuneration should be subject to predetermined and measurable performance, and performance criteria should promote the long-term sustainability of the company. A major part of the variable component should be deferred for a minimum period of time. Contractual arrangements with executive directors should include provisions that permit the company to reclaim variable components of remuneration that were awarded on the basis of data which subsequently proved to be manifestly misstated. Termination payments should not exceed a fixed amount or a fixed number of years of annual remuneration which should, in general, not be more than two years of the non-variable component of the remuneration. Shares should not vest for at least three years after their award, and remuneration of non-executive directors should not include share options. At least one member of the remuneration committee should have knowledge of and experience in the field of remuneration policy. As to the relevant rules in German company law and in the German Corporate Governance Code, see [[private rule-making and codes of conduct.

Even more important is the recommendation of 15 February 2005 on the role of non-executive directors of listed companies and on the committees of the board. In order to foster the exercise of objective supervision, the roles of the chairman and chief executive should be separate and the chief executive should not immediately become the chairman of the board. If the company departs from this rule, this should be accompanied with information on any safeguards put in place.

As a general rule, with an exception for small and medium-sized companies, the companies should organize their boards in three board committees: a nomination, remuneration and audit committee. At least a majority of the members of each committee should be independent. ‘A director should be considered to be independent only if he is free of any business, family or other relationship, with the company, its controlling shareholder or the management of either, that creates a conflict of interest such as to impair his judgement’ (no 13.1). Annex II of the recommendation contains a long list with additional information on the profile of independent non-executive directors. Relevant situations constituting threats to independence are, inter alia, when the director: is an executive director of the company or an associated company, or has been in such a position for the previous five years; receives, or has received, significant additional remuneration (in particular share options or other performance-related pay schemes) from the company or an associated company apart from a fee received as non-executive director; represents in any way the controlling shareholder(s); has, or had within the last year, a significant business relationship with the company or an associated company, either directly or indirectly as partner, shareholder, director or senior employee of a body having such a relationship.

Even though in the end the board itself determines whether a particular director should be regarded as independent, these rules have a far-reaching influence. This is particularly so in Germany and other continental European countries where controlling shareholders and/or labour co-determination are prevalent. The situation there is fundamentally different from countries such as the United States or the United Kingdom with public companies without major shareholders and without labour representation in the board. Depending on this, the independence requirements of the directive are bound to lead to grave difficulties since they change the decision-making power in the boards considerably.

4. Requests for further European rules for the board

The agenda of the Action Plan of 21 May 2003 provided for two other important rules regarding the board. The first is the choice between a one-tier and a two-tier board for all listed companies as mentioned above. The second is the increased responsibility of the members of the board, especially as concerns a special investigation right, a wrongful trading rule and a director’s disqualification. The right of special investigation has proved to be very effective in the Netherlands, for example. Regarding the wrongful trading rule, there is a lively discussion in legal literature about whether the British rules are more effective than the German ones. In a number of Member States there are provisions making directors unfit for office if they violate their duties in the area of insolvency.

Literature. Paul Davies, ‘Board Structure in the UK and Germany: Convergence or Continuing Divergence?’ (2000) 2 International and Comparative Corporate Law Journal 423; Markus Roth, Unternehmerisches Ermessen und Haftung des Vorstands (2001); High Level Group of Company Law Experts, ‘A Modern Regulatory Framework for Company Law in Europe, Report of the High Level Group of Company Law Experts’, in Guido Ferrarini, Klaus J Hopt, Jaap Winter and Eddy Wymeersch (eds), Reforming Company and Takeover Law in Europe (2004) Annex 3, 925; Klaus J Hopt and Patrick C Leyens, ‘Board Models in Europe’ [2004] ECFR 135; Klaus J Hopt, Markus Roth and Andrea Peddinghaus, ‘Kommentierung von §§ 95-116 AktG’ in Klaus J Hopt and H Wiedemann (eds), Aktiengesetz, Großkommentar (4th edn, 2005); Carsten Jungmann, ‘The Effectiveness of Corporate Governance in One-Tier and Two-Tier Board Systems’ [2006] ECFR 426; Patrick C Leyens, Information des Aufsichtsrats, Ökonomisch-funktionale Analyse und Rechtsvergleich zum englischen Board (2006); Elmar Gerum, Das deutsche Corporate Governance-System (2007); Marcus Lutter and Gerd Krieger, Rechte und Pflichten des Aufsichtsrats (5th edn, 2008); Henrik-Michael Ringleb, Thomas Kremer, Marcus Lutter and Axel von Werder, Deutscher Corporate Governance Kodex (3rd edn, 2008); Reinier Kraakman and others, Anatomy of Corporate Law (2nd edn, 2009).

Retrieved from Board – Max-EuP 2012 on 28 March 2024.

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