Germany still has much to do to fix corporate governance shortcomings

A US company is spurring a profound change in the way Deutschland AG works. For decades, a common path for German top managers was to move from chief executive to chair at the same company.

The progression underlined the consensual approach to management among German companies, prioritising continuity over fresh thinking in corporate culture.

Current examples to go down the path include Norbert Reithofer at BMW, Michael Diekmann at Allianz, Kurt Bock at BASF and Nikolaus von Bomhard at Munich Re. And Volkswagen chair Hans Dieter Pötsch and Karl-Ludwig Kley at Lufthansa also previously were their respective company’s chief financial officer.

But things are changing. Since 2009, German law has stipulated there must a two-year cooling-off period between such jobs. Then in December 2021, Institutional Shareholder Services — one of the leading global firms that advise investors how to vote on corporate governance issues — announced that it would not back any former chief executive who aspired to become or remain chair of the same company.

While in effect since early 2022, the new ISS policy started to cause a stir this year as the proxy adviser recommended voting against the re-election of BASF’s Bock and Munich Re’s von Bomhard. Both won re-election despite protest votes at annual meetings, as voting out a sitting chair seemed too much for most shareholders who feared that the lack of any obvious successor could do more harm than good.

But the re-elections signalled it is becoming harder to make the step from chief executive to chair. Few managers will be willing to see through the two-year cooling-off period to then face significant uncertainty over winning enough shareholder votes.

This has the potential to change German boardrooms. Critics have long argued that moving chief executives to the chair role contributed to groupthink and a general dislike of corporate change that has undermined German companies’ ability to adjust to new trends. Chairs often need to sort out managements’ past strategic mistakes. If they have personally been responsible for the decisions as chief executive, they may be keen to defend their personal legacy.

The new ISS policy aims to make German supervisory boards more independent and effective. To achieve that, more than market pressure might be needed, though, to fix long-standing flaws in German corporate governance. Some shortcomings require the intervention of lawmakers and changes to German corporate and securities laws.

Take the fundamental competencies of supervisory boards. Under the country’s two-tier boardroom structure, their role is to oversee the executive board which is solely in charge of the day-to-day business. But apart from hiring and firing top management, and setting their pay, the power of supervisory boards is limited. They cannot give orders to executives, and usually do not directly liaise with employees who are working below the management board.

Just as important as independent and powerful boards are effective checks and balances by external shareholders. And here, some shareholders complain German law falls well short of international best practice. It is very difficult for outside investors to sue over potential violations of fiduciary duties by executives and supervisory boards.

“Shareholders in Germany have no reasonable way to stop decisions that blatantly violate their interests,” says Thomas Schweppe, who runs Frankfurt-based boutique shareholder advisory firm 7 Square.

The built-in flaws and gaps in governance can easily be exploited by managements with bad intentions, as the Wirecard scandal shows. But for now, there seems little political interest in beefing up the rights of supervisory boards or shareholders. Quite on the contrary, the German parliament is actually discussing making it harder for shareholders to challenge potentially flawed decisions taken at annual meetings in court — a move some shareholders believe could undermine their rights even more.

Given much of Deutschland AG — particularly in the industrial sector — is facing deep challenges ranging from competition from China to navigating the green transition, it is not hard to make a case that boosting shareholder confidence in companies through better corporate governance should be higher on Berlin’s agenda.

olaf.storbeck@ft.com