Fundamentals of German Corporate Governance

German corporate governance fundamentals and practices are generally based on the provisions of the German Stock Corporation Act (Aktiengesetz), the German Codetermination Act (Mitbestimmungsgesetz), and the German Corporate Governance Code. In principle, this also applies to a European Company (SE), which is, however, also governed by the provisions of the SE Regulation, and to which national codetermination laws do not apply. Instead, codetermination in the SE is governed by the provisions of an agreement on employee involvement or the regulations provided by the German Act on Employee Involvement in a European Company (SEBG).

German stock corporations (Aktiengesellschaft) and SE’s typically have three corporate bodies– an annual general meeting of shareholders, a board of management (Vorstand) and a supervisory board (Aufsichtsrat). At the annual general meeting, shareholders exercise the rights granted to them by the German Stock Corporation Act. These include, in particular, the resolution on the appropriation of net retained profits, the election of the auditor, the discharge of the board of management and the supervisory board, amendments to the Articles of Association, the issue of new stock and convertible bonds and bonds with warrants, the authorization to acquire own stock, structural changes like transformations or enterprise contracts and the election of the shareholders’ representatives to the supervisory board.

The German Stock Corporation Act and the SE Regulation, which primarily applies to the SE, call for a clear separation of duties between management and supervisory functions in SE`s with a two-tier board and therefore prohibits simultaneous membership on both boards. Members of the board of management and the supervisory board must exercise the standard of care of a prudent and diligent business person when carrying out their duties. In complying with this standard of care, members must not only take into account the interests of shareholders, as would typically be the case with a U.S. board of directors, but also the interests of other constituents, such as the company’s employees, and, to some extent, the public interest.

The board of management is responsible for managing the company and representing it in its dealings with third parties. The board of management’s responsibilities in the ordinary course of business are comparable to those performed by the senior executives of a U.S. company. However, the members of the board of management of a German stock corporation and of an SE including its chairman or speaker, are regarded as peers and share a collective responsibility for all management decisions.

The supervisory board oversees the company’s board of management and appoints its members. Members of the supervisory board may generally not be involved in the day-to-day management of the company. However, the company’s articles of association must specify those matters of fundamental importance which may only be dealt with upon the prior consent of the supervisory board; the supervisory board may specify further matters which require its consent. Matters requiring such prior consent usually include decisions or actions having a fundamental impact on the assets, financial or profit situation of the company.

The supervisory boards of major German stock corporations and SE’s are subject to employee co-determination and are comprised of representatives of the shareholders and employees. Traditionally, the shareholder representatives on the supervisory board have a good understanding of the business activities of the company. Depending on the company’s total number of employees, up to one-half of the supervisory board members will be elected by the company’s employees. The chairman of the Supervisory Board is a representative of the shareholders, and the deputy chairman or one of the two deputy chairmen common to an SE is a representative of the employees. In the event of a tie vote, the deciding vote is cast by the chairman.

With respect to the supervisory board, attention is paid to ensure that the board`s composition in its entirety covers persons with a wide spectrum of experiences and expertise, it is diverse and has an appropriate number of independent members. In addition, listed and co-determinated German stock corporations and SE`s must have - subject to certain grandfathering rights - at least 30% male and 30% female members in the supervisory board.

German law also has several rules applicable to supervisory board members which are designed to ensure a certain degree of independence of the board members. In addition to prohibiting members of the board of management from serving on the supervisory board, German law requires members of the supervisory board to act in the best interest of the company. They do not have to follow direction or instruction from third parties. Any service, consulting or similar agreements between the company and any of its supervisory board members must be approved by the supervisory board.

In May 2003, a German government commission promulgated a Corporate Governance Code (Code) which has since undergone several amendments. The Code contains additional corporate governance rules applicable to publicly quoted German stock corporations and SEs. Whilst these rules are not legally binding, companies failing to comply with the Code’s recommendations must disclose publicly how and why their practices differ from those recommended by the Code.

The German Stock Corporation Act and the further regulations applying to an SE do not require the creation of specific supervisory board committees. The Code recommends, however, that the supervisory board establish an audit committee to handle the appointment of the company’s independent auditor once he has been approved by the annual general meeting of shareholders. The audit committee also addresses issues of accounting, additional non-auditing related services by the company`s auditor, risk management, compliance and auditor independence. Furthermore, the Code recommends the creation of a nomination committee to be composed exclusively of shareholders’ representatives, which proposes suitable candidates to the supervisory board for its recommendations for election to the General Meeting. In the majority of the German stock corporations, supervisory boards have also formed other committees to make the work of the supervisory board more efficient. For instance, a personnel committee is often installed to deal with the compensation of board members and nomination issues. Members of the supervisory board elected by the employees may serve on any committee established by the supervisory board (with the exception of the nomination committee), but an equal participation of shareholder- and employee representatives is not prescribed. All committee members as well as the chairman of the supervisory board are elected by the supervisory board itself and not by the annual general meeting of shareholders.