2. Basics of Corporate Governance
3. The German Corporate Governance Code
3.1 Background and Development
3.2 Tasks and Objectives
3.3 Structure and Content
4. Implementation of the Code
In the early days, the academic research in the field of corporate governance (hereafter: CG) developed largely in silos, depending on the areas of interest of the respective researchers. Since the last decade however, researchers pay more attention to the formation of a holistic approach that focusses on the effectiveness and efficiency of CG as a whole (Ulrich, 2011).
From a practitioner’s view, CG methods are essential in order to improve sustainable economic growth, economic efficiency and the trust of national and international investors (OECD, 2004). Due to the takeover wave during the 1980s, the advancing deregulation and globalisation of the capital markets as well as the Asian financial crisis in the end of the 1990s, CG has gained a greater profile (Strebel, 2008). This was reinforced by several corporate scandals in the U.S. (e.g. Enron) but also in Europe in the early 2000s. Because of this, voices for a higher necessity of responsible management and CG have arisen.
For Germany in particular, the Holzmann-scandal during the turn of the millennium compelled the German legislator to step up its monitoring on CG of listed companies. As a consequence, the German Corporate Governance Code was established by its eponymous government commission in 2002. The objective of the establishment was not only to strengthen the confidence in the German CG and corporate control system, but also to provide suggestions for a modernisation of the legislation with respect to the ongoing globalisation and internationalisation of the capital markets and the accompanying transformation of corporate and market structures (Baums, 2001).
After building a theoretical background on the basics of CG, the paper focusses on the German Corporate Governance Code: First, its development history will be mentioned and a brief definition will be given, followed by its tasks and objectives as well as its structure and content. Afterwards, the implementation of the Code in German corporations - with focus on the largest German corporations (DAX and MDAX-members)- will be analysed. In the end, there will be a short summary.
2. Basics of Corporate Governance
In the last decades, the research in the field of CG has heavily increased. While the term has been rarely applied in the early 1980s, it is very common today and not only used by academics but also practitioners around the world, for both, developed as well as emerging markets (Denis, 2001; Denis & McConnell, 2003).
This tremendous amount in research entails that there is no consistent definition of CG. The definition of the term is rather ‘biased’ (Huse, 2007; p. 14) by the subject-matter lens, it is examined through which are, for example, the general subject of CG, boards of directors, executive compensation, blockholders, merger activity or shareholder activism (Denis & McConnell 2003; p. 6).
According to Denis (2001), the very early roots of research on CG can be traced back to Adam Smith who stated that“being the managers rather of other people's money than oftheir own, it cannot well be expected that they should watch over it with the same anxiousvigilance […]”(Smith, 1776). This idea was taken up by Berle & Means (1932) who described the issue of separation of ownership and control in corporations and“went so far as to suggest that this problem made the corporation an untenable form of organization”(Denis, 2001; p. 192). However, the cornerstone for the ‘modern’ CG theory was laid by Jensen & Meckling (1976) who applied agency theory to the modern corporation and stated that the separation of ownership and control goes along with several conflict of interests:“Thestockholders are principals, who certainly cannot observe in detail whether the management,their agent, is making appropriate decisions. The principal agent theory provides aninstrument to discuss the rationale of the‘separation of ownership and control’problem […]” (ibid., p. 327).
As mentioned above, today there exist several definitions for the term CG. A very broad introductory one can be given by Maier (2005) who states that,“corporate governancedescribes the framework by which companies are directed and controlled i.e. the setting ofcorporate objectives and the monitoring of performance against these objectives. […] [It]defines a set of relationships between a company’s management, its board, its shareholdersand other stakeholders.”(p. 2). Furthermore, CG comprises“the combination of laws,regulations, listing rules and voluntary private sector practices that enable the company toattract capital, perform efficiently, generate profit and meet other legal obligations andgeneral societal expectations.”(ibid.).
In general, CG can be seen in its narrow as well as its wider sense. In itsnarrowest sense, it is mostly described as the institutionalised system of accountability of the company’s management to the shareholders or, in other words, the assurance of the shareholders’ residual claims in corporations (Ulrich, 2011; Maher & Andersson, 1999). This perspective is based on the shareholder approach, only focussing on the increase in value of companies. Writing in this perspective, Shleifer & Vishny (1997) who argue that it“deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.” (p. 737). This is in line with Denis & McConnell (2003) mention that CG represents“the setof mechanisms- both institutional and market-based- that induce the self-interestedcontrollers of a company […] to make decisions that maximize the value of the company to its owners (the suppliers of capital).”(p. 1).
Contrary to that, CG in itsbroader senseis shaped by the stakeholder approach and takes - besides the shareholder interests - also the interests of other stakeholders into account (according to Fauver & Fuerst, 2006 e.g. the interests of creditors, employees, customers, suppliers, and government). By analogy with the shareholder value, here, the generation of stakeholder value is at the focus (Ulrich, 2011). This means that it examines the network of formal and informal relations of the corporation and takes also business-political structures and processes (which are important for the firm’s performance) into consideration. Due to that, the Cadbury Committee suggests that“corporate governance is the system by whichcompanies are directed and controlled”(Cadbury Committee 1992, p. 15). In addition, the OECD (2004) states that CG“involves a set of relationships between a company’smanagement, its board, its shareholders and other stakeholders […] [and] provides thestructure through which the objectives of the company are set, and the means of attainingthose objectives and monitoring performance are determined”(p. 11).
Beyond that, mechanisms of CG can be distinguished into an internal and an external perspective. The internal perspective of CG deals with the inner organisation of companies and its relationships as well as mechanisms like the board of directors or the equity ownership structure of the corporation (Denis & McConnell, 2003). In terms of the German CG system, also issues related to employee codetermination have to be taken into consideration (Fauver & Fuerst, 2006). On the other hand, the external perspective deals with the external relations of the corporation (Lentfer, 2005) with mechanisms like the external market for corporate control or the legal system (Denis & McConnell, 2003).
Analogously, it can be differentiated between the insider- and the outsider-model. The outsider model on the one hand predominates in the Anglo-American markets that are shaped by the shareholder approach; it is characterised by a dispersed ownership and, given the separation of ownership and control, it primary focuses on the control of the management through the capital market (Lentfer, 2005; Fauver & Fuerst, 2006). The insider model on the other hand is mostly applied in Continental European and Japanese markets (e.g. Germany, France and Japan). These countries are shaped by the stakeholder approach and characterised by a concentrated ownership structure as well as the usage of long term corporate strategies.
The management control is mostly carried out through internal mechanisms like the board of directors or a direct verbal exchange with the management (Lentfer, 2005; Fauver & Fuerst, 2006).
As Ulrich (2011) states, CG frameworks are determined by the CG system of the respective country. Taking this, the German CG system is - compared in an international context - unique: Due to its corporations, intertwined among themselves, the term ‘Deutschland AG’ (Cromme, 2005; p. 362) developed over time for the German CG system. In Germany, a two- tiered structure as well as the above mentioned representation of employees on the supervisory board are mandatory (Denis & McConnell, 2003; Fauver & Fuerst, 2006). Furthermore, equity ownership has historically been more concentrated in Germany than in the U.S. and banks usually have a strong voting power and thus a significant control over firms. Nevertheless, the most prevalent blockholders in Germany are other companies and (founding) families (Denis & McConnell, 2003, referring to Franks & Mayer, 2001).
The approach, to use compliance - the observance of pre-defined regulations and guidelines - as a measure for the quality of CG is mostly applied in European countries (Ulrich, 2011). As a basis for that, in Europe, several indigenous codes exist, e.g. the German Corporate Governance Code (hereafter ‘the Code’) in Germany, the Swiss Code of Best Practice in Switzerland or the Combined Code in the U.K.
3. The German Corporate Governance Code
3.1 Background and Development
The insolvency of the German construction company Philipp Holzmann AG in 2002 was one of the largest in the history of the Federal Republic of Germany (Statista, 2013) and happened very unexpected for both, the public as well as the politics. While in 1988, the liabilities were at 88 million German marks (GM), they rapidly increased to 3,2 billion GM in 1997 when Lothar Mayer retired four months before the expiration of his contract from his position as a CEO. In late 1999, his successor Heinrich Binder announced further 2,4 billion GM losses (including an operating loss of 1,1 billion GM) that remain undetected so far. (Reuter, 2001). Attempts to rescue the Holzmann AG - also with governmental support - failed in the end and the company filed for insolvency in March 2002.
The review of the incidents showed that several managerial decisions have not led to the desired success and that the top managers subsequently concealed the real losses through several critical accounting policy measures (Reuter, 2001; Henrich et al., 1999). As a consequence, the German government under chancellor Schröder implemented the governmental commission ‘Corporate Governance - Unternehmensführung - Unternehmenskontrolle - Modernisierung des Aktienrechts’ (also called ‘Baums- Commission’) in the end of May 2000. Its objectives were to analyse possible deficits in the German CG and corporate control system, but also to provide suggestions for a modernisation of the legislation with respect to the ongoing globalisation and internationalisation of the capital markets and the accompanying transformation of corporate and market structures. The final report in 2001 resulted in the recommendation to establish a ‘Code of Best Practice’ for German corporations (Baums, 2001).
As a consequence, the ‘Regierungskommission Deutscher Corporate Governance Kodex’ (Governmental Commission German Corporate Governance Code) with its chairman Dr. Gerhard Cromme was established by the Federal Minister of Justice, Prof. Dr. Herta DäublerGmelin in September 2001. The thirteen-member commission consisted of representatives of CEOs and chairmen of the board of large German corporation as well as its stakeholders (e.g. lawyers, auditors, scientists, unionists) (DCGK, 2002) and presented its first draft of the Code already in December 2001 (Cromme, 2001). This draft of the later Code was mostly based on the recommendations and suggestions of the Baums-Commission as well as the Berlin-based ‘German Code of Corporate Governance Initiative’ (Steller, 2011).
After also the interested public had the opportunity to deliver opinions, the first final version was handed over to the Federal Minister of Justice on February 26th, 2002 and published in the Federal Gazette1on August 30th, 2002.
3.2 Tasks and Objectives
The Code sets new standards for a responsible CG and specifies the tasks and responsibilities of both, the Management Board as well as the Supervisory Board (Fauver & Fuerst, 2006) to ensure the continuous existence of the company and the sustainable creation of value, both in line with the principles of the social market economy (DCGK, 2015). It is primarily aimed at listed corporations; however, its application is explicitly recommended to other not publicly listed companies (ibid., 2015).
The Code consists of three elements: First, it presents essential legal regulations for the management and supervision (governance) of listed companies in Germany which are mostly referring to the German Stock Corporation Act (‘Aktiengesetz’, abbreviated AktG). The corporations should achieve their corporate goals in a manner that it serves not only the interests of the corporation itself but also the interests of its stakeholders like owners, creditors, customers, suppliers or the society in the long term.
Second, it contains nationally and internationally accepted standards for a good and responsible CG in form of recommendations and suggestions. As von Werder (2010) mentions, this regulatory function is aimed at (further) improving the CG of German corporations by establishing national and international ‘best practices’. In the Code, recommendations are always labelled with the expression ‘shall’, while suggestions are labelled with ‘should’. These recommendations and suggestions are not mandatory; however, the Code has a legal basis due to the anchoring through the declaration of conformity (pursuant to § 161 AktG). This paragraph obliges the Management Board and the Supervisory Board to annually disclose to what extent they follow the Code.
According to the paragraph and the ‘comply or explain’-principle, companies can deviate from the recommendations, but are - as a consequence - obliged to disclose this as well as to justify the deviations annually. This regulation enables corporations to take also sector- and enterprise-specific requirements into account. A well justified deviation from a recommendation of the Code may also be in the interest of a good CG. Through that, the Code contributes to a higher flexibility and self-regulation of the German corporate constitution.
Third, the Code has the aim to improve the transparency and comprehensibility of the German CG system, in order to promote the confidence of international and national investors as well as clients, employees and the general public in the management and supervision of German listed corporations (DCGK, 2016). This communicational function is necessary due to the characteristics of the German governance system, based on the two-tier-model with the institutional separation of management (Management Board) and their overseers (Supervisory Board), the principle of collegiality for the Management Board as well as the codetermination (von Werder, 2010). By this, the Code should also address the criticism on the German corporate constitution like an inadequate alignment of shareholder interests, a lacking
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