Commentary: Cut Labor's Clout On German Boards

The co-determination system is hobbling the nation's economy

DaimlerChrysler (DCX ) Chief Executive Jürgen E. Schrempp is the most powerful man at the Stuttgart auto maker. Guess who is No. 2? Hands down, it's Erich Klemm, the chairman of the workers council at DaimlerChrysler and a member of the powerful metalworkers union IG Metall. Klemm's in the driver's seat next to Schrempp, thanks to a 28-year-old German law that gives labor 50% of the seats on the supervisory boards of large companies, a system called co-determination. It also gives workers the right to nominate the deputy chairman of the supervisory board. At DaimlerChrysler, that's Klemm again. "Schrempp is totally dependent on Klemm," says Horst-Udo Niedenhoff, an expert on co-determination at the Institute for German Economics in Cologne.

Supporters of co-determination note that it has brought Germany unparalleled labor peace over the past three decades. But an increasing number of employers say the price paid in soaring labor costs and postponed restructuring has been too high. A joint commission of the German Employers' Assn. and the German Industry Assn. will publish a report this month advocating a cut in labor representation on supervisory boards to one-third as a way to diminish their clout in board votes. Industry Assn. head Michael Rogowski triggered a public debate on the issue when he branded co-determination "a historic mistake" in a magazine interview.

The critics are right. Reform of co-determination is urgent. While board insiders concede the system's advantages, they agree its flaws have become glaring in a 21st century global economy. Worker representatives often know more about a company's problems than outside directors, but union leaders who also sit on the boards of German companies systematically delay restructuring. "The key to staying competitive is making decisions early, not after the boat is almost sunk," says one senior consultant who sits on several boards, pointing to cost crises at Volkswagen, Adam Opel, and Karstadt Quelle.

Equally worrying, the board structure dictated by co-determination saps good governance. It automatically rules out a board composed of a majority of independent outsiders, a key tool for improving oversight. Second, since the appointment of top management every five years, and the ousting of underperformers, requires a two-thirds vote on the supervisory board, CEOs and their teams depend on labor reps for their jobs. That makes them loath to carry out tough restructurings or even criticize the system in public. Outspoken Infineon CEO Ulrich Schumacher learned the hard way when workers, angered by his threats to move headquarters to Switzerland, contributed to his ouster. Conversely, weak CEOs who ally themselves with labor can shield themselves from shareholder wrath, as did Udo Stark at MG Technologies. "You can't remove a CEO from the board against the will of labor," says Theodor Baums, professor of finance at the Johann Wolfgang Goethe University in Frankfurt. The solution, says Baums, would be to bar labor reps from votes to approve or fire management.

Chancellor Gerhard Schröder, who claims to be designing a modern German economy, has failed to acknowledge that co-determination is undercutting competitiveness. But a recent decision by the European Court of Justice raises the pressure on Germany. It allows foreign companies that set up an administrative headquarters there to ignore the co-determination law. "That will spur competition between systems," says Michael Blatz, partner and head of corporate restructuring at Roland Berger Strategy Consultants in Munich. A new, more flexible version of co-determination could be a secret bullet against outsourcing and high unemployment. But first German politicians have to realize how damaging the old structures are.

By Gail Edmondson

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