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Analysis: Does Germany’s two-tier system promote good corporate governance?

Recent history would suggest perhaps not, but experts don’t fault the system

In theory, Germany’s two-tier system of corporate governance, which consists of a board of company supervisors separate from the company’s managers, would seem ideal in preventing abuse and safeguarding the interests of shareholders. Elected by and responsible to shareholders, the German supervisory board appoints the company’s managers and oversees their stewardship. It is supposed to keep those managers, who can wield considerable power, honest and grounded.

Unfortunately however, recent history shows that Germany’s two-tier system has not necessarily meant better governance. On the contrary, some of Germany’s best-known companies, among them Siemens, ThyssenKrupp, Deutsche Bank and Volkswagen, have been embarrassed by terrible scandals and gross incompetence. In each case, the shareholders suffered the most, as billions and billions of euros in company funds and market capitalisation were squandered.

To recall several egregious examples: Siemens was fined $1.6bn by regulators for providing bribes to win business in emerging countries; ThyssenKrupp wasted €12bn on ill-fated steel mills in Brazil and the US; Deutsche Bank was fined $2.5bn by regulators for helping to rig Libor interest rates; and finally, Volkswagen admitted in mid-September to cheating on diesel engine emissions (costs: at least €7bn). Why didn’t the much-vaunted German supervisory board prevent these things from happening?

The answer lies in a pattern evident in all four cases. And that is that the wrongdoing happened during the tenure of a powerful Chairman who was either a former CEO or CFO of the company. At Siemens, it was Heinrich von Pierer; at ThyssenKrupp Gerhard Cromme; at Deutsche Bank Clemens Börsig (the only former CFO); and at Volkswagen Ferdinand Piëch, whose extended family is also majority owner of the auto giant. These powerful figures made sure that the other supervisors either backed management in their folly or turned a blind eye to it.

Experts on German corporate governance agree that in those cases, the supervisory boards simply did not fulfil their duty to act as a check on management. “It’s clear that the controllers of these companies failed and that part of the reason was the sheer influence exerted by the chairmen,” said Ingo Speich, Head of Proxy Operations at Union Investment, the Frankfurt-based asset manager that is a major investor in Dax-30 companies. “But it would be wrong to say that Germany’s two-tier system does not promote good governance. It does, but the condition is that supervisors live up to their obligations.”Christian Strenger, the former CEO of Deutsche’s fund arm DWS and a leading corporate governance advocate, has a similar view. “These few failures should not distract from the fact that the German model of management running the business and the supervisory board overseeing and setting strategy is a proven one,” he says. Strenger admits though that two things have to improve: the sense of independence among supervisors and the number of directors taken from outside the company. Regarding the latter point, Strenger says big shareholders can play an important role.

The example of Deutsche Bank also proves Strenger’s latter point. Only after a coalition of institutional shareholders, among them Union Investment, Hermes EOS and PGGM, voted to deny Deutsche’s management discharge at the annual general meeting (AGM) last May (the result was an unprecedented 40% against discharge), did Paul Achleitner, the bank’s Chairman, truly act.

The result: Co-CEO Anshu Jain, who was the investment bank chief at the time of the Libor scandal, as well as several other managers allied to Jain, were asked to leave. Now Deutsche is led by CEO John Cryan, an outsider who is trying to get beyond the scandals and restore the bank’s reputation.

At Volkswagen, however, outside shareholders, including many of the world’s biggest institutional investors, have had no influence. That is due to its ownership structure, in which Piëch’s extended family owns 52%, the state of Lower Saxony another 20% and Qatar 12%. Its supervisory board members really only answer to these main shareholders, though to the automaker’s credit it has brought in a new CEO and Chairman to fully investigate the emissions rigging scandal, pay for the consequences and repair the damage to its brand. Says Manuel René Theisen, Professor of Corporate Governance at Ludwig-Maximilian-University in Munich: “Outside shareholders in VW have always known that the company is ultimately Piëch’s family business. While things will be different now that the patriarch is gone, VW’s corporate governance was a bit of a joke for the many years he was CEO and then Chairman (between 1993 and 2015).”

Professor Theisen says that while Germany’s two-tier model can be effective, there is still work to be done to ensure that it is. He therefore favours forbidding the former CEO from becoming the supervisory board’s chairman, noting that otherwise, the board’s independence might continue to be undermined as it was at the four firms mentioned. “Having the ex-CEO serve as a normal director should suffice in my view,” he says.

In 2009, a law was passed requiring a “cooling off” period of two years for former CEOs who wanted to become Board Chair. Theisen also supports term limits of ten years for supervisors to further strengthen the independence and vitality of the board.

Speich agrees strongly with Theisen on the subject of term limits. He says: “I realise that supervisors who have served a long time are an asset because of their knowledge and experience. But they are often not aware of or even resist changes in the business world, like for example sustainability or digitalisation. That’s why I favour bringing in new blood on a regular basis.”Speich, who regularly speaks on behalf of Union Investment at the AGMs of Dax companies, says, however, that former CEOs should still be able to chair the supervisory board simply because of their vast knowledge of the company. He therefore supports the cooling-off compromise set in 2009.

Apart from requiring that 30% of supervisory boards of big German firms be women, the ruling Conservatives and Social Democrats have no plans for further corporate governance reform. For now, that seems acceptable. The scandals and other misfortunes which rocked Siemens, ThyssenKrupp, Volkswagen and Deutsche Bank have changed all four for the better. New management has been brought in and both Siemens and ThyssenKrupp are making money for shareholders again.