Handelsblatt explains Why German corporate governance is so different

For over a century, corporate governance evolved differently in Germany than in English-speaking countries: with a two-tier board system, where labor representatives often hold sway. To do business with German firms, foreigners need to understand the rules.

When Elon Musk is not busy launching electric cars into space and the like, he still has a business to run: Tesla, Inc. And that occasionally brings him to Germany, the homeland of car technology. Imagine his culture shock when Mr. Musk — born in South Africa, with stops in Canada along the way to Silicon Valley — arrived in the Rhenish town of Prüm. The Anglo-Saxon über-achiever came to buy Grohmann, a German automotive supplier, and expected to whip its workforce into the flexibility he is used to. Instead, he ran right into Grohmann’s works council — and had to dial his speed down a few notches.

Mr. Musk’s experience is shared by nearly all American, British and other English-speaking executives and investors when they first encounter German corporate governance. Whether it is the German Bayer buying the American Monsanto or the German Linde trying to merge with the American Praxair, entire worlds of mentality and law separate those transatlantic negotiators who come unprepared. That is because corporate governance in Germany, like so much else in the country, has developed differently in response to its turbulent history than it did elsewhere.

The main differences concern the structure of corporate boards and the influence of workers on decision making at the top. Companies in English-speaking countries tend to have one board, whose chairman is often also the chief executive officer. Employees, meanwhile, have little to no say in strategy. The company’s fiduciaries must act only in the interests of their main “stakeholders,” which are their shareholders. At German companies, all this is different.

The differences have their origins in the 19th century. As the newly unified Germany was industrializing, Otto von Bismarck, the arch-conservative “iron chancellor,” introduced the world’s first tentative welfare laws, including mandatory health insurance and pensions, to defuse the threat of socialist revolution. Other laws addressed the many new companies and stock listings at the time, introducing a two-tier system for boards, which was originally inspired by publicly-traded companies in the Netherlands during the 17th century.

Thus Germany made it compulsory to have one board of executive officers and another, separate, board of supervisors. This independent non-executive panel had the duty to hold management accountable and to protect the interests of shareholders.

The next step came after Germany lost World War I in 1918. The home of Karl Marx, Germany was in the throes of revolution. Workers and soldiers rebelled, and the Kaiser abdicated. To avoid the fate of Russia, socialist labor unions and capitalist employers compromised on a series of reforms. They introduced works councils at companies, and gave employees the right to nominate one or two members to the supervisory boards.

After Germany’s next defeat in another world war, in 1945, labor unions in the western zones of occupied Germany felt empowered to press for even more control. The American and British overlords welcomed this movement, wishing to defang the old industrial conglomerates. After all, ThyssenKrupp had made cannons and warships, Volkswagen had churned out bombs and tanks, Siemens had supplied munitions. Many companies had forced prisoners of war, Jews and others to work in their factories.

“This effectively was the industry Hitler had used to conquer Europe,” said Theodor Baums, a European corporate-governance expert at Goethe University in Frankfurt. “It had to be made democratic from the inside.” So German employers and unions agreed that half of the seats on supervisory boards of firms in the coal and steel sectors would go to labor representatives. In other industries, workers initially got only a third of the supervisory seats.

Then, in the late 1960s and 70s, Willy Brandt and Helmut Schmidt became West Germany’s first and second Social Democratic chancellors. Labor had the upper side, and now half of the non-executive directors in all public limited companies with more than 2,000 employees came from the works councils and unions. This law is known as the codetermination act.

It forms the core of what is sometimes called “Rhineland capitalism,” says Mr. Baums. More generally, this model obliges directors to consider all stakeholders in corporate decisions. Thus German boards must, in theory, heed the concerns not only of shareholders but also of employees, creditors, suppliers, and local governments, and should take a long-term perspective that stretches over generations.

Nowadays, the chairperson of the supervisory board holds most of the cards. He or she (in practice, it is still mostly a he) can never hold the position of CEO at the same time, but must stay in regular contact with the executive board to discuss strategy, business developments and risks. In theory, the chair can overrule labor representatives, because the chair’s vote is counted twice when there is a tie. In practice, the chairperson rarely exercises this right to prevent an outright clash with unions and employees. Supervisors and managers usually abstain from forced lay-offs for a number of years to win labor’s backing for reorganizations or takeovers.

Such compromises took place last year when Linde, which makes industrial gases, agreed to a €60-billion merger with US rival Praxair, and when carmaker Peugeot bought Opel from GM. VW’s 2016 plan to cut 23,000 German jobs came in the form of attractive, early retirement plans for older employees and the guarantee to keep all domestic plants open. That, after all, is the idea: to take some of the sting out of capitalism for people who work for firms or live near them — even if that means some inconvenience for the people who own them.

Gilbert Kreijger is an editor with Handelsblatt Global. To contact the author: [email protected]