Commentary: Germany Inc.: Come Clean Or Else

If companies don't improve governance, new laws will force change

What century do Germany's corporate boards think this is? Certainly not the 21st. A voluntary corporate-governance code has been in effect for more than two years, but many companies continue to ignore key recommendations. Germany Inc., experts say, has a habit of paying lip service to good governance while violating it in spirit and practice. Two-thirds of the country's top 30 companies still keep executive pay a secret; supervisory boards often fail to control or sanction management even for disastrous results; conflicts of interest abound; and boards disregard voluntary guidelines on everything from age limits for their own members to procedures for renewing management contracts.

But German companies' staunch resistance to voluntary guidelines that are standard practice in other leading industrial countries is about to backfire. Angry politicians, shareholder activists, and corporate-governance experts are mounting an offensive, drafting laws that will mandate better behavior. On Oct. 6, EU officials recommended all listed companies publish full details on executive pay and give shareholders a say in companies' remuneration policies. That comes on the heels of a recent warning by German Justice Minister Brigitte Zypries that unless listed companies publish details on executive pay packages in the coming round of annual reports, the government will pass a law in 2005 enforcing transparency. For shareholder-rights champions, the heated national debate this year about executive pay -- as workers face pay freezes and job cuts -- has helped thrust governance into the public spotlight as never before. "The reasons why companies didn't comply with the code in the past were superficial and hollow. They now are starting to acknowledge that better adherence is in their own interest," says Christian Strenger, a member of the German Government Commission on Corporate Governance and a member of the board of the German Association of Private Shareholders (DSW).

Members of Parliament are busy drafting new legislation. One proposal would bar a CEO from jumping directly to supervisory board chairman at the same company. Another would shrink the number of total supervisory-board seats to five, down from 10. Two draft laws now headed for a vote in Parliament would make it easier for shareholders to sue managers and directors for negligence or for disseminating false information. "We want to make corporate governance more effective," says Fritz Kuhn, a member of Parliament from the Green Party. "We need a clear legal framework so trust returns to financial markets."

The most controversial issue is whether or not to force companies to reveal executive pay. Porsche (PSEPF ) CEO Wendelin Wiedeking, a member of the German corporate-governance commission, insists this is a "phony debate driven by populist motives." But governance experts argue that German boards such as DaimlerChrysler's (DCX ) have abused the system by granting huge pay increases to a chief executive even as results plummeted. Change is needed, they say, to ensure accountability to shareholders. "The extent to which self-serving German managers have increased their pay in the last five to seven years is scandalous," says Reinhard H. Schmidt, economics and business professor at the Johann Wolfgang Goethe University in Frankfurt. Studies show some managers' salaries have increased as much as 500% since the late 1990s.

The other tradition that angers activists is the near-automatic promotion of many former CEOs to the post of supervisory-board chairman. Opponents of the practice cite the ascension last year of Albrecht Schmidt at Hypo-und Vereinsbank despite his poor record as chief executive. At 16 of Germany's 30 largest listed companies, the current supervisory-board chairman is the former CEO, including Gerhard Cromme at steelmaker Thyssen Krupp, who also chairs the government's commission on corporate governance. "We want to make it [legally] impossible to move from CEO to supervisory-board chairman," says Kuhn.

At the core, the debate over these changes reveals a collision between the German version of capitalism and that of Anglo-Saxon countries. Traditionally, Germans view a company's primary goal as not only maximizing shareholder value but also doing what's best for the business, workers, clients, shareholders, and even the country as a whole. The trouble with this so-called stakeholder approach is that it allows bosses to gloss over disappointing results in the name of those other interests.

Easier Lawsuits

Although Germany has embraced the notion of a shareholder culture, and some companies, such as Siemens (SI ), have made real progress, many CEOs and board members still chafe at the changes required. "We are moving toward an Anglo-Saxon system, and we have made 75% to 80% of the change necessary. But there are still big gaps," says Theodor Baums, a finance professor at Goethe University and a corporate-governance expert.

One way to close those gaps is to make shareholder lawsuits easier. Two draft laws headed for parliamentary approval in late 2004 or early 2005 will increase executives' and board members' liability for negligence and for disseminating false information. To win a case under current law, German investors have to prove the manager "intended to deceive" and that a shareholder's investment decision was influenced by the false information. Under the proposed law, plaintiffs would no longer have to prove intent -- only that false information was passed on to the market.

The legislative rush in Germany to bring the corporate Establishment to heel reinforces a stepped-up governance drive by the European Union. In early October, EU Internal Market Commissioner Frits Bolkestein called on EU governments to ensure boards actually protect shareholders against conflicts of interest and control management decisions. "Boards should have a sufficient number of independent nonexecutive or supervisory directors who can nip potential conflicts of interest in the bud," said Bolkestein, who at the same time hinted that inaction could result in review and additional measures.

Activists also want German legislators to mandate change in the way annual shareholder meetings are run. German law requires all shareholders who wish to vote at annual meetings to register all their shares up to two weeks before the meeting, a practice that impedes funds from actively trading shares during that period. Big foreign funds won't submit to the restriction. As a result, they remain an absent force at these meetings. But the situation could change by next year thanks to a draft law that would eliminate the requirement. German funds, long passive in their relation to Germany Inc., are also beginning to challenge management more actively. "What German institutional investors do not do well enough is to team up for particular causes," says Strenger, who as a director of DWS Investments has begun to build informal alliances with foreign shareholders.

Germany Inc. might have one last chance to thwart the legal onslaught: by racing to implement best corporate-governance practices before the country's legislators do it for them. Insurer Allianz and engineering heavyweight MAN, for example, have already announced they will reveal CEO pay. But don't count on a mass conversion experience in German boardrooms. Change will come -- but only from the pressure of irate shareholders and legislators.

By Gail Edmondson in Frankfurt

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