An extract from The Corporate Governance Review, 10th Edition

Corporate leadership

i Board structure and practicesMandatory two-tier structure

The two-tiered board structure of German stock corporations requires a management board and a supervisory board.

Composition of the management board

The management board must consist of natural persons who are appointed by the supervisory board. The Corporate Governance Code requires that, when appointing management board members, the supervisory board must pay attention to diversity and shall, in particular, aim for appropriate representation of women on the management board.

Members of the management board may not be appointed for a period exceeding five years. For first-time appointments, the new Corporate Governance Code recommends that members of the management board should not be appointed for more than three years. The appointment may be renewed or the term of office may be extended, provided that the term of each such renewal or extension does not exceed five years.

The supervisory board may only dismiss members of the management board for good cause. Good cause is, in particular, deemed to exist in the event of material breaches of duty; for example, if a management board member is not able to properly fulfil his or her duties (e.g., owing to long-lasting illness or a lack of required skills or knowledge) or where the general meeting has adopted a vote of no-confidence and provided that the vote has not been adopted for apparently inappropriate reasons.

Composition of the supervisory board

The supervisory board must consist of at least three members, who are generally elected by the shareholder's meeting. The maximum number of supervisory board members permitted by law increases depending on the amount of the stock corporation's registered share capital. In any event, the total number of supervisory board members must be divisible by three.

Where a stock corporation generally has more than 500 employees, one-third of the supervisory board members must be employee representatives. In companies with more than 2,000 employees, half of the supervisory board members must be employee representatives. At least 30 per cent of the supervisory board members of listed companies with more than 2,000 employees must be women. In addition, companies with more than 500 employees must adopt certain target ratios regarding the representation of female members on their supervisory and management boards as well as in their senior management.

According to the Corporate Governance Code, the supervisory board should be composed in such a way that its members jointly have the knowledge, ability and experience to properly carry out its tasks and shall include an adequate number of independent members.

Supervisory board members are considered to be independent from the company and its management board if they have no personal or business relationship with the company or its management board that may cause a substantial – and not merely temporary – conflict of interest. More than half of the shareholder representatives shall be independent from the company and the management board. The new Corporate Governance Code defines a supervisory board member as independent from the controlling shareholder, if he, she or a close family member is neither a controlling shareholder nor a member of the executive governing body of the controlling shareholder and does not have a personal or business relationship with the controlling shareholder that may cause a substantial conflict of interest.

In practice, the supervisory board members are appointed for a period of five years; renewed appointments are permissible.

ii Legal responsibilities and representationManagement board

The management board is responsible for managing the business of the stock corporation and legally represents the corporation in relation to third parties. Under the statutory concept, all members of the management board manage and represent the corporation jointly. However, in practice, the rule is that the corporation is represented by each member of the management board acting individually or by two members of the management board acting jointly.

In managing the business of the corporation, the members of the management board must apply the care of a prudent and diligent businessperson. According to the duty of loyalty, each management board member is obligated to give the stock corporation's interest priority over their personal interests. Failure by a management board member to meet these duties may lead to personal civil law liability for damages of the company.

A member of the management board cannot be held personally liable if, in making an entrepreneurial decision, he or she had adequate information and believed they were acting in the best interests of the stock corporation. This 'business judgement rule' applies in the context of decisions that are not predetermined by the law, the articles of association or resolutions of the shareholders' meeting. The management board is considered to have had adequate information for making its decision if it has consulted all sources of factual and legal information reasonably available to it in the specific situation and, on that basis, has weighed the advantages and disadvantages of its decision against each other. However, it is not required that all conceivable information is obtained and every conceivable impact is quantified before making the decision.

The management board is subject to a duty of legality. This means that the management board may not itself commit, and may not order third parties to commit on behalf of the company, any violations of the law. In an unclear legal situation, the board members may also rely on the advice of a third-party expert. The members of the management board may rely on the third party expert's advice if: (1) they have provided the expert with the necessary documents and a comprehensive description of the facts to be examined; (2) the expert is independent and professionally qualified to advise on the issue; and (3) they carry out a careful plausibility check of the advice provided by the expert.

The management board must ensure that all employees of the company, when acting within the scope of their operational activities, act in compliance with the law. This presumes that the management board must establish an appropriate system of organisation and control to prevent violations of law from within the company.

The management board is obligated to manage the stock corporation independently. It is not subject to instructions by the supervisory board or the general meeting. However, the shareholder's prior consent is required for transactions of outstanding importance, for example, selling the most valuable parts of the company, or if by-laws of the management board provide for the shareholder's consent.

Apart from that, material transactions with related parties are subject to prior approval of the supervisory board or, if the supervisory board refuses to grant its approval, by the general meeting. Whether a transaction is deemed to be material is determined by a number of aspects such as the influence that the information about the transaction may have on the economic decisions of shareholders or the risks associated with the transaction. A transaction constitutes a material related-party transaction if its economic value is at least 1.5 per cent of the total of the company's fixed and current assets. No approval is required for transactions that are concluded in the ordinary course of business and on customary market terms or for transactions with directly or indirectly wholly owned subsidiaries. Companies must publicly announce related-party transactions at the latest when the transaction is concluded, which is when the transaction documents are signed.

Supervisory board

The supervisory board is responsible for supervising and controlling the management board. To this end, the supervisory board is entitled to inspect the corporation's books and records and may, at any time, request the management board to report about the corporation's affairs.

Like members of the management board, members of the supervisory board must act in the best interests of the stock corporation and must demonstrate the care of a prudent and diligent businessperson. They are obligated to keep confidential any non-public information that they receive in their capacity as supervisory board members. One of the notable responsibilities of the supervisory board is enforcing damage claims of the stock corporation against members of the management board. In particular in the wake of the global financial and economic crisis of 2008, this has led to a significant increase in the number of lawsuits brought by corporations against former members of the management board.

The supervisory board's responsibility to supervise the management imposes a duty to avert actions by the management that may be detrimental to the company and that do not fall within the ambit of the business judgement rule. A supervisory board member may even be subject to criminal liability if, by consenting to certain transactions, the supervisory board member allows behaviour of the management that is not covered by the business judgement rule.

iii Delegation of board responsibilities

All members of the management board manage the stock corporation collectively and are jointly responsible for their actions.

In practice, responsibility for the management of certain business divisions or certain functions (e.g., finances, accounting, controlling, human resources, tax, legal, compliance) is delegated to individual members of the management board. Insofar, each management board member is primarily responsible for her or his delegated tasks, but the other board members still monitor and control the other members' performances within their divisions. As a general rule, it is deemed to be sufficient to carefully, continuously and appropriately observe developments in the delegated divisions or functions and the performance of other management board members' duties.

iv Roles of the chair of the management board and the chair of the supervisory board

Where the management board consists of more than one person, the supervisory board may appoint one of them as chair. The chair is responsible for administrative tasks relating to the work of the management board, such as preparing and chairing meetings and keeping minutes, as well as for coordinating and supervising the work of the management board. He or she typically is in charge of liaising with the supervisory board and represents the management board in public, and thus has a prominent position among the other members of the management board. The manner in which many chairs of management boards discharge these responsibilities in practice has given rise to the perception that the position is comparable to that of the chief executive officer of a US corporation. However, from a legal perspective, this is not the case. In particular, the chair has no right to give instructions to other management board members and is not entitled to decide matters against a majority of the other members of the management board.

The members of the supervisory board must elect a chair and a deputy chair. The chair of the supervisory board is a largely administrative role that is not endowed with any particular powers. The chair calls, prepares and leads meetings of the supervisory board. Typically, the articles of incorporation provide that the chair of the supervisory board also chairs the general meeting.

v Compensation of members of the management board and the supervisory board

In accordance with the German law implementing the Shareholder Rights Directive (EU) 2017/828 (SRD II) and the new German Corporate Governance Code, the compensation of each member of the management board (e.g., fixed salary, variable salary components and pensions) must be clear, comprehensible and reasonable in light of the responsibilities and individual performance of that management board member as well as the situation of the company. It is required to determine the total remuneration in the event that all agreed goals are achieved as well as to set a 'cap' for the maximum remuneration of the management board. In addition, the share of long-term variable remuneration of members of the management board shall exceed the share of short-term variable remuneration also by taking into account the sustainable corporate development as well as social and ecological aspects.

The compensation of members of the management board is determined by the supervisory board, usually following a recommendation by a committee established for that purpose. Pursuant to the German law implementing SRD II, the general meeting must vote on the company's remuneration policy in the event of a material change but at least every four years. Since the German two-tiered board structure still requires that the supervisory board determines the management board compensation, the vote of the general meeting has an advisory function and is non-binding only. The general meeting cannot change the management board's remuneration policy but it has now the right to vote against the maximum remuneration of the management board ('cap') as set by the supervisory board.

The compensation of the supervisory board is determined in the articles of incorporation or by the general meeting. Pursuant to the German law implementing SRD II, the general meeting is obligated to resolve upon the supervisory board's compensation on a four-year basis. Like the management board members' compensation, it must take into account the duties of the supervisory board member and the condition of the company. The supervisory board members' compensation may also comprise variable components based on the corporation's long-term performance.

Listed stock corporations must disclose the aggregate and individual remuneration granted to members of the management board and the supervisory board, respectively, in their financial statements. In addition, the German law implementing SRD II and the new German Corporate Governance Code require that the management board as well as the supervisory board prepare an annual remuneration report. The information in the remuneration report is extensive and includes a five-year comparison of a member's compensation, the company's earnings performance and employee compensation. The remuneration report must be formally reviewed by the auditor and made publicly available on the company's website.

vi Committees

The supervisory board is not required to, but may form committees, in particular for the purpose of preparing its deliberations and supervising the implementation of its resolutions.

Where the supervisory board is composed of both shareholders and employee representatives, the supervisory board must form a reconciliation committee composed of the chair of the supervisory board, his or her deputy and one member of the supervisory board elected by the shareholder and the employees, respectively.

The supervisory board may establish an audit committee to deal with matters relating to the preparation of the corporation's financial statements, the effectiveness of the internal audit and risk management systems. The audit committee is also responsible for monitoring the accounting process and the efficacy of the internal control system. The Corporate Governance Code recommends that the chairman of the audit committee should have specialist knowledge and expertise in the application of accounting principles and internal control processes.

The Corporate Governance Code further recommends forming a nomination committee that is composed exclusively of shareholder representatives and that is tasked with proposing suitable candidates that the supervisory board may recommend to the general meeting for election to the supervisory board.

vii Board and company practice in takeovers

In the event a company becomes the target of a takeover offer, the management board and the supervisory board must publish a reasoned statement regarding the offer on the internet. The statement is intended to enable the shareholders to make an informed decision on the offer and must, in particular, contain the management board and the supervisory board's assessment of the consideration offered by the bidder, the expected consequences of a successful takeover offer for the company, its employees, the employee representatives (i.e., the works council), the terms and conditions of employment and the company's production and other sites, the goals pursued by the bidder, and information on whether the members of the management board and the supervisory board intend to accept the offer.