An analysis of the differences between Corporate Governance Structure in Germany and UK. Claudiu Ghiuzan. Claudiu Ghiuzan

Transcription

1 An analysis of the differences between Corporate Governance Structure in Germany and UK 1

2 German Corporate Governance Structure German Corporate Governance principles and procedures are mainly established on the provisions of the Aktiengesetz (German Stock Corporation), Mitbestimmungsgesetz (Codetermination Act) and the German Corporate Governance Code. The Aktiengesellschaft (German Stock Corporation) typical has a yearly general meeting of shareholders, a board of management (Vorstand) and a supervisory board (Aufsichtsrat). Fundamentally the German company law is based on civil code and it has relied on two-tier board model which describes the principles of separation of powers within the organization. The average management board size includes mainly 15 members and the CEO is separated than Chairman. The main tasks of the board are related to decision making, strategy, manufacturing, product development, finance, marketing or supply chain (Tricker, 2012), (Larcker, 2013). The supervisory board members in Germany are elected in order to appoint or dismiss the members of the management and additionally to monitor them during their candidature. Being part simultaneously of management board and supervisory board is against the law. At the corporate level the supervisory board represents either the shareholders or labour force. Further tasks of the supervisory board are represented by their intervention in the situations when company s interests are seriously affected or when networking with the stakeholders is necessary in order to maintain a stable relationship. During the annual meeting the shareholders are allowed to exercise their vote in accordance with the Stock Corporation Act. This particularly includes the allocation of retained earnings, the election of the auditor, the clearance of the board and supervisory board, modifications to the Articles of Incorporation, stocks, bonds, warrants, the authorization of different resolutions, the election of the representatives to the supervisory board, etc., (Tricker, 2012). British Corporate Governance Structure British Corporate Governance principles and procedures are established on the fundamental of the UK Corporate Governance Code (The Code) aimed for the Premium Listed companies listed on the London Stock Exchange. The companies comply with the Financial Reporting Council which is accordingly derived from the Financial Conduct Authority s Listing Rules. The Listing Rules are under legal authority of Financial Service and Markets Act 2000 which 2

3 requires that public companies acknowledge how they have followed The Code. The procedure follows the principles of comply or explain which is a regulatory approach that avoids binding laws and promote rather the decision of the companies to choose if they comply with the Code. If the company does not comply, it is mandatory to explain publicly why they did not do so. (Legislation.gov.uk, 2000). Fundamentally, the UK company law is based on common law code and it relies on one-tier board system also called unitary board structure or Anglo-Saxon model. In particular, there is a single board of directors but with four feasible structures: board with only executive directors, board with a majority of executive directors, board with only non-executive directors (NED) and board with a majority of non-executive directors. The average management board size include mainly 12 members and the CEO position is not mandatory separated from Chairman (Tricker, 2012). The company law system follows the guidelines that all board members are elected by the shareholders without relying on the executive or non-executive positions. Moreover the investors have authority of removing the directors from their position (Jungmann, 2006). The main role of the non-executive directors (NED) is to constructively stimulate and advice the management by developing proposals on strategies. The members are not considered employees but rather members of the board and therefore are concerned with managerial issues. Moreover they audit the performance of management in meeting the agreed targets and they control the stated achievements. In the last years it has become more apparent that their general task is to keep under control the entire business without involving themselves in the day-to-day activities. Given that, it is understandable that the company is managed by senior managers which are required to run the business and are responsible for the strategic and operational planning. Overall, compared to the two-tier board, the British system has no black or white characteristics between the board functions, neither between the different members nor within a membership itself (Jungmann, 2006). Leadership Structure Theoretically, the UK and Germany provide a different format of administration that may assist the independence of the board through the separation of decision management from decision control. In practice, both systems differ in the way they organize their leadership s structure, the way they make use of committees and how they are centrally composed (Maassen, 2002). 3

4 Now, if we take the example of CEO and Chairman Office we can see that the British companies have the right of determining this particular position within the organization. In other words, the companies must comply with the code which states that the roles of chairman and chief executive should not be exercised by the same individual (Council, 2014) or explain why they did not do so. According to the Financial Reporting Council, in 2014 the majority of companies have complied with the code, however there were still firms in FTSE 350 which had one individual as both Chairman and CEO (Council, 2014). In Germany, on the other side, the separation of those positions is mandatory (Mäntysaari, 2006). Fundamentally, if the positions are combined then the top managerial officer in the organization will also be the chairperson that is responsible for monitoring and evaluating the top managerial officer. This can represents a potential threat to the independence of the board (Maassen, 2002). Indeed, studies have shown that in terms of return of equity, ROI and profit margin, the firms with independent leadership clearly outperformed the once with CEO-duality (Maassen, 2002). Another study published by Dahya et al. in 1996 found support for the hypothesis that corporate boards are more competent when both positions are not used by the same people. The analysis pointed out that the separation of authority of CEO and chairman in a sample of 124 organizations was resulting in significant and positive market response in the UK. This reaction was followed by performance improvement of the firms according to accounting measures in the year following the change (Dahya, 1996). In essence, with respect to the CEO duality there is a clear evidence that once the concept is implemented, it makes the company to function different. The Role of Shareholders Historically, the companies represented by German two-tier board model have relied heavily on banks rather than capital markets for their operating expenses. For example, Deutsche Bank owned shares in 2001 at Daimler AG (12, 1%) and Münchener Rückversicherungs AG (7, 5%) but also at Allianz (4, 2%) and similarly Allianz owned shares at Münchener Rückversicherungs (29, 8 %), at Deutsche Bank (4, 6% ) and at Daimler (1, 6% ) (Larcker, 4

5 2013). Since banks benefit from a position in the supervisory boards it makes unclear whether the institutions in Germany act in the shareholder s interest or they use the voting power for their own benefits (Starks, 2003). In a study conducted by Franks and Mayer in 1998, they found evidence that the role of banks in certain takeovers was egocentric, which means that the institutions were acting basically on their own interest rather than protecting the shareholder s rights (Mayer, 1998). Nevertheless, the development of liberalization of capital markets in the last years and the shift of investment from bank financing to stock market started to open some new features in the German Corporate Governance System. In this way we can probably see in the future more major changes in corporate ownership (Larcker, 2013). In the UK system, it is estimated that the institutional investors own between 65% and 80% in the equity market (Starks, 2003) and despite their legal rights to vote the firms are not exercise it. A study conducted by Mallin in 1995 on 250 UK companies, suggested that the institutions were reporting voting levels of less than 52% (Mallin, 1995). In other words, in UK the institutions tend not to vote their shares systematically and they get involved in companies management just in crisis circumstances. Looking to the form of corporate ownership and voting rights between both systems and with respect to the evidence reviewed in the studies above, the companies in Germany can be exposed more to agency problems in comparison with those in the UK. The agency problems usually refer to the conflict of interest between shareholders and senior managers. Considering also this particular aspect of lending institution being part of the board, it is possible that the banks would have a comparative advantage in monitoring the organizations because of their access to inside information (Starks, 2003). This is also a reason to believe that Germanys model might influence the performance of the companies together with its general functions. General Types of Board Committees In order to better understand the different functionalities of both Corporate Governance Systems it is essential to analyse the general types of board committees. As we can see in the table 1, Harrison (1987) has characterized the various forms of committees and he composed two general categories. The first type called operating committee or management 5

6 support has the function of integrating decision management with decision control in boards of directors. In the British system, most often the composition of these committees are controlled by executive directors. The second category of committee involves the control roles of boards. This committees are made with the purpose of protecting the shareholders interests and supporting the separation of decision management from decision control (Maassen, 2002). The table below, was taking out from the paper of Francesco Maassen called An International Comparison of Corporate Governance Models and it illustrates better those differences. Table 1 Attributes Operating Committees Monitoring Committees Composition Insider dominated Outsider dominated Purpose Advice to management Function Integration of decision management with decision control Examples - Executive committee - Finance committee - Strategy committee Accountability and legitimacy Separation of decision management from decision control - Audit committee - Compensation committee - Nominating committee Source 1: Maasseen (2002) Original Source: Harrison (1987) If we look to the board committees, the differences can be illustrated by displaying the distinctive procedures of committee s structures within the corporation. In the UK, board committees have a substantial administrative function due to the lack of legal two-tier board. For instance, the audit committee of a British public companies consist of independent non-executive members who oversees the executive directors. On the contrary, in Germany the aim of supervisory committees and management committees is to 6

7 make board work more effective. Legally, in a two-tier board structure, a board committees is not monitoring the job of the rest of the board and the members do not have to be independent (Mäntysaari, 2006). Usually, within a British company the audit committee creates a two-tier board structure inside the legal one-tier board, whereas in Germany is not the case. The German audit committee or Prüfungsausschuss cannot be accordingly directly compared with the UK audit committee because the both structures do not have identical powers (Mäntysaari, 2006) and furthermore do not function the same. However, if we look at the recent tremendous scandals such as Enron, Parmalat, Worldcom or Philipp Holzmann we can see that the two-tier boards systems started to consider the introduction of identical roles such as Non-Executive Directors and other methods like the three committees defined in the Cadbury report. The Cadbury report is a British set of recommendations in regards to the organization boards and accounting structures aim to reduce the corporate governance risks and failures. The implementation of this procedures happens with the purpose of overcoming future wrongdoing which can affect the integrity of the company. Namely, in Germany, the majority of public companies have already adopt this committees (Hopt, 2004). It can be noticed for example at Infineon Technologies and Schering Konzern that both have approved a structure with four committees such as: Strategy and Technology, Executive Committee, Meditation Committee, but also Investment, Finance and Audit-Committee. This aspect may shows us that despite their great differences between board structures, the common scandals might bring the systems together. Compensation Committees Another key point in regards to monitoring functions and which emphasize the difference in functionality between the both systems, are the compensation committees. In Germany for instance, the companies are dealing with the issues of raising the level of executive compensation as the organizations have become larger and they needed to compete for their talented work force. For this purpose the compensation levels have begun to increase (Larcker, 2013). It is important to realize that both institutional and cultural differences between Germany and UK results in different managerial compensation structures. The distinct characteristics 7

8 are reflected in the governance of German Code Law which is stakeholder oriented and UK Common Law which is shareholder oriented. This differences have led to remuneration structures that differ in their framework as well as in their levels (Tuschke, 2003). Markedly, the structure of compensation are differentiated by the stock ownership and stock option pay (Conyon, 2000) (Tuschke, 2003). Historically, the UK CEOs received more stock options in comparison with their German counterparts and especially because of the cultural factors such as egalitarianism which in Germany it focuses on supporting the interest of various categories of stakeholders (e.g., labour, customers, institutions and society in general) (Conyon, 2000). In 2007 for example, Wendelin Wiedeking, the CEO of Porche, was criticized by media and politicians for accepting 68 million in compensation after the company s net earnings almost tripled compared to previous year. In Germany a payment of this size is considered unacceptable by the cultural standards (Larcker, 2013). Although this may be valuable, in the last years an important shift in payment has been signalized due to internationalization of the markets and development of liberalization. A study conducted by Vlerick Business School in 2014, shows that the German multinationals are catching up with those in United Kingdom in regards to executive compensation levels. The report has surveyed 512 organizations in Germany, UK, The Netherlands, France and Belgium and identified that the best-paid CEOs are Germans. Moreover the study shows that the executives receive an average total payment of 3.4 million, which is slightly higher than in the UK (Calnan, 2015). Empirically, the different compensation committees and the distinct forms of remuneration can certainly influence the way the organization functions and therefore it has an impact on the company s performance and managerial behaviour (Tuschke, 2003). Looking from this perspective we can recognize that both systems have different compensations committees but in the end they come the same closure. Conclusion I have emphasized that theoretically the Corporate Governance system in Germany function differently from the system in the UK and the fundamental philosophies, of how to address the importance of corporate governance are made different in both countries. In the same 8

9 time, I indicated that both systems practically are using the same procedures in staying globally effective. If we highlight this differences we can see that in the UK, the corporate governance is viewed as something done by individuals while in Germany is recognized as something done by a group of individuals. In Germany is the legislator s job to monitor the management format of the companies while in the UK the focus is on the members who cooperate in the governance of the organizations (Mäntysaari, 2006). The legal procedures and tools applied by these two systems tend to reflect the general administrative approach towards companies. Mainly, the guidelines applicable in the German companies are more standardised and certain if compared to the British rules (Mäntysaari, 2006). We can say that the UK and Germany represent the best examples of two competing structures which makes the matter difficult to admit that one system is more effective that the other. Effective corporate governance control means that an institution is well administrated and all actions of the executives are well reviewed. In fact, both structures include weaknesses and strengths where further improvements are necessary. In the end, the society in which an organization performs will strongly influence their behaviour and the elements that might be acceptable in some societies are considered wrong in others. This influence the sort of activities that managers are willing to participate in and the tendency of self-serving behaviours (Larcker, 2013). The cultural factors have an effect also on the relationship between the organization and its shareholders and stakeholders, as I stated above, and is important to mention that they play an essential role in shaping the governance systems (Larcker, 2013). References Boehmer, E., Corporate Governance in Germany: Institutional Background and Empirical Results, s.l.: University of Georgia. Calnan, M., Germany catches up with the UK on executive pay, Ipswich MA.: Employee Benefits. 9

10 Conyon, J. S., Executive compensation: evidence from the UK and Germany. Long Range Planning, 33(4), pp Council, F. R., [Online] Available at: Governance/Developments-in-Corporate-Governance-and-Stewardsh.pdf [Accessed ]. Dahya, L. A. A. P. D. M., The case for separating the roles of chairman and CEO: an analysis of stockmarket and accounting data. Corporate Governance: An International Review, Volume 4, pp Dalton, M. C. J. L. J. A. E. E., Number of directors and financial performance: a metaanalysis. Academy of Management Journal, 42(6), pp Hopt, L. P., Board Models in Europe - Recent Developments of Internal Corporate Governance Structures in Germany, the United Knigdom, France, and Italy. European Company & Financial Law Review, 1(2), pp Jungmann, The Effectiveness of Corporate Governance in One-Tier and Two-Tier Board Systems - Evidence from UK and Germany. European Company & Financial Law Review, 3(4), pp Larcker, T. B., Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences. 1 edition ed. s.l.:ft Press. Legislation.gov.uk, Legislation.gov.uk. [Online] Available at: [Accessed ]. Maassen, G. F., An International Comparison of Corporate Governance Models. s.l.:spencerstuart. Mallin, Voting and Institutional Investors. Accountancy 116, Volume 1225, p. 76. Mäntysaari, P., Comparative Corporate Governance: Shareholders as a Rule-maker. Berlin: Springer. 10

11 Mayer, F. J. a. C., Bank Control, Takeovers and Corporate Governance in Germany. Journal of Banking and Finance, 10/11(22), pp Starks, S. L. G. a. L. T., Corporate Governance, Corporate Ownership, and the Role of Insitutional Investors: A Global Perspective. Journal of Applied Finance, 13(2), pp Tricker, Corporate Governance - Principles, Policies, and Practices. Second Edition ed. Oxford: Oxford University Press. Tuschke, A., The impact of executive compensation on the post-merger integration of U.S. and German firms. Schmalenbach Business Review (SBR), 55(1), pp