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Corporate governance standards in germany
 

Corporate governance standards in germany

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This document deals with the Corporate Governance standards in Germany. The evolution of corporate governance norms, development of the German Code of Corporate Governance, Effectiveness of internal ...

This document deals with the Corporate Governance standards in Germany. The evolution of corporate governance norms, development of the German Code of Corporate Governance, Effectiveness of internal controls, issues like Self Dealing, external controls and financial reporting standards are the topics discussed here.

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    Corporate governance standards in germany Corporate governance standards in germany Document Transcript

    • ShiveshRanjan 2012 CorporateGovernanceinGermany This document deals with the Corporate Governance standards in Germany. The evolution of corporate governance norms, development of the German Code of Corporate Governance, Effectiveness of internal controls, issues like Self Dealing, external controls and financial reporting standards are the topics discussed here.
    • 2 Table of Contents 1. Introduction:....................................................................................................................................3 2. Corporate Governance Reforms: ....................................................................................................3 3. The German Corporate Governance Code......................................................................................4 4. The Effectiveness of Internal Controls ............................................................................................5 4.1 The Two Tier Board .......................................................................................................................5 4.2 Influence of Globalization and European integration...................................................................5 4.3 Checking Self Dealing ....................................................................................................................6 5. The External Controls......................................................................................................................6 6. Financial Reporting Standards.........................................................................................................7 7. Conclusion.......................................................................................................................................7 8. References.......................................................................................................................................8
    • 3 1. Introduction: 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. [1] 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 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. 2. 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. [2] 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).
    • 4 - 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 Germany’s governance setup. 3. The German Corporate Governance Code [3] This German Corporate Governance Code (the "Code") incorporates the statutory regulations for the management and supervision of German listed companies. The 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 employee- representatives are equally obliged to act in the best interests of company.
    • 5 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. 4. The Effectiveness of Internal Controls 4.1 The Two Tier Board The two-tier board structure and extensive labour representation are the defining features of Germany’s internal control mechanisms. Most other European countries have single-tier board structure—that 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 long-term 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 other’s boards, to run most of Germany’s 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. 4.2 Influence of Globalization and European integration In 2005, the German government felt the need to review the system of co- determination in light of European and global challenges. A commission consisting of trade unions, employers, and academic experts was formed to
    • 6 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. 4.3 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 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. 5. 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).
    • 7 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. 6. 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. 7. Conclusion Germany’s corporate governance system has undergone substantial reforms since the 1990s. Some changes include improved functioning of insider-controlled corporate 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.
    • 8 - Self-dealing remains a challenge to effective internal control—exacerbated 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. 8. References [1]- World Bank / OECDThe Global Corporate Governance Forum5th Meeting of the Eurasian Corporate Governance Roundtable http://www.oecd.org/daf/corporateaffairs/corporategovernanceprinciples/3187513 0.pdf [2]- IMF- WP/08/179: Jürgen Odenius http://www.imf.org/external/pubs/ft/wp/2008/wp08179.pdf [3]- German Corporate Governance Code- amended on May26, 2010 http://www.corporate-governance-code.de/eng/archiv/index.html Other Readings: 1. Article: Germany’s two-tier governance system comes under fire http://www.ft.com/intl/cms/s/0/e222e59a-fd90-11db-8d62- 000b5df10621.html#axzz2F6sj563h 2. http://www.adoptifrs.org/uploads/Germany/E__Germany_Deloitte%20IAS%20PLUS.pdf 3. Current Corporate Governance Laws in Germany http://blogs.law.harvard.edu/corpgov/2010/05/14/current-corporate-governance- trends-in-germany/