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.

1. 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. 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. 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. 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. 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. 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. 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. 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/