Corporate leadershipi Board structure and practicesMandatory two-tier structure
The two-tiered board structure of German stock corporations must have a management board and a supervisory board.Composition of the management board
The management board must have one or more members that must be natural persons. If the registered share capital of the stock corporation amounts to more than €3 million, or where the Co-Determination Act requires that the management board must include a labour director, the management board must consist of at least two members.
Members of the management board 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 an 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 Corporate Governance Code recommends that an appointment for a full period of five years should not be the rule. 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. In the draft amended Corporate Governance Code, the recommendation is made that the initial appointment of members of the management board should be for a maximum of three years. A management board member's term of office may be renewed or extended, at the earliest, one year before the expiration of the term.
However, it is feasible and common practice to dismiss and immediately reappoint a management board member for a new term of office. The Federal Court of Justice held that this practice does not constitute a violation of the statutory prohibition.
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, a management board member's inability to properly discharge 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. The maximum number of supervisory board members permitted by law increases depending on the amount of the stock corporation's registered share capital to a maximum of nine members for stock corporations with a registered share capital of up to €1.5 million, to a maximum of 21 members for stock corporations with a registered share capital of more than €10 million. In any event, the total number of supervisory board members must be divisible by three.
Members of the supervisory board are generally elected by the shareholders' meeting. The articles of incorporation may provide that certain shareholders or the respective holders of certain shares shall have a right to designate members of the supervisory board. Such designation rights may only be granted in respect of up to one-third of the number of members of the supervisory board to be elected by the shareholders.
On 9 October 2018, the Federal Court of Justice ruled that a resolution of the supervisory board on the nomination of a candidate for the board and its announcement in advance of a general meeting does not become void if the candidate nominated by the supervisory board does not comply with the recommendations of the Corporate Governance Code regarding membership in multiple boards. Since the Corporate Governance Code is not a binding statute, a deviation from its recommendations has no effect on the validity of the candidate's nomination or eventual election in the general meeting. The Court also held that there is no legal obligation to inform shareholders about the fact that a nominee does not comply with the recommendations of the Corporate Governance Code.
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. The new Corporate Governance Code recommends that, except in cases where the supervisory board only consists of three members, at least two representatives of the shareholders shall be independent from the controlling shareholder.
The Corporate Governance Code defines an independent member as a person who has no business or personal relations with the stock corporation, its executive bodies (which include the management board and the supervisory board), or any controlling shareholder or enterprise associated with the latter that could cause a substantial and material conflict of interests. The draft amended Corporate Governance Code foresees a catalogue of criteria for assessing independence. In particular, it ought to be taken into account whether the supervisory board member (or a person having a close family relationship with him or her):
- was a member of the company's management board in the two years prior to his or her appointment;
- currently is maintaining (or has maintained) a material business relationship with the company or one of the entities controlled by the company (e.g., as a customer, supplier, lender or adviser) in the year prior to the appointment, directly or as a shareholder, or in a leading position of a third-party entity;
- along with the remuneration as a member of the supervisory board, receives other material variable remuneration from the company, or one of the entities controlled by the company;
- is in a close relationship with a member of the management board;
- is a controlling shareholder or a member of the executive governing body of the controlling shareholder, or maintains a personal or business relationship with a controlling shareholder; and
- has been a member of the supervisory board for more than 12 years.
The Corporate Governance Code recommends that the supervisory board should inform the general meeting about conflicts of interest and how they have been dealt with. Such report to the general meeting must mention the relevant supervisory board members, the topics of the supervisory board's agenda to which the respective conflict is related and how the conflict was dealt with.
Supervisory board members should not hold directorships or similar positions or advisory roles for important competitors of the stock corporation, and should not have any personal relationship with a significant competitor. Moreover, not more than two former members of the stock corporation's management board should be members of the supervisory board at any time.
Former members of the management board of a listed company may not be elected to the company's supervisory board for two years following their resignation or dismissal as members of the management board. In addition, it is not permitted for anyone to be a member of the supervisory boards of more than 10 companies at the same time.
In practice, the term of office of supervisory board members is about 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. Failure by a member of the management board to meet this standard of care will render him or her personally liable for damages incurred by the corporation as a result.
The fiduciary duties that they owe to the stock corporation require members of the management board to give the stock corporation's interests priority over their own when concluding transactions with the corporation. Failure to do so may lead to a management board member's personal liability for any damages suffered by the corporation in connection with the transaction.
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 he or she was 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 a 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 a decision. The necessary depth of information is determined by parameters such as the potential risk to the company, the cost of obtaining information and the period of time available for decision-making.
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 obtain the advice of a third-party expert. The members of the management board may rely on the third-party expert's advice if they have provided the expert with the necessary documents and a comprehensive description of the facts to be examined; the expert is independent and professionally qualified to advise on the issue; and 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.
While compliance with the law itself is not subject to the management board's discretion, the management board is entitled to wide discretion when designing and implementing the organisation and control measures intended to ensure compliance. On 23 April 2018, the European Commission published its proposal for a directive on the protection of persons who report violations of EU law. According to this proposal, legal entities will be obliged to set up suitable reporting systems.
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 shareholders may determine in the stock corporation's articles of incorporation that certain transactions require the prior consent of the supervisory board. Where the articles of incorporation do not contain a catalogue of transactions requiring supervisory board consent, the supervisory board may set forth such catalogue in the by-laws of the management board. In addition, the management board is obligated to obtain the general meeting's approval where the proposed transaction is of outstanding importance and could substantially affect the shareholders' rights: for example, a spin-off of the most valuable part of a company's business.
Further, one of the principles set out in the draft amended Corporate Governance Code stipulates that material transactions with related parties are subject to the prior approval of the supervisory board.Supervisory board
The supervisory board is responsible for supervising and controlling the management of the stock corporation's business by 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 to it about the corporation's affairs. The right to request reports from the management board extends to the corporation's legal and business relationships with affiliated companies as well as to the affairs of the corporation's affiliates if they could have a significant impact on the corporation.
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. One of the notable responsibilities of the supervisory board is enforcing damage claims of the stock corporation against members of the management board. As a general rule, the supervisory board is obligated to assess the existence and enforceability of possible claims against members of the management board and, if its assessment reaches the conclusion that they exist and are enforceable, to pursue the claims. The supervisory board may only refrain from doing so in exceptional cases where pursuing the claims would entail significant disadvantages for the corporation that outweigh the possibility of recovering the corporation's damages from the management board members. 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 management boards.
Members of the supervisory board are obligated to keep confidential any non-public information that they receive in their capacity as supervisory board members. This obligation prohibits the disclosure of information to any person who is not a member of the supervisory board or management board. For example, the knowledge that a person acquires in his or her capacity as a supervisory board member of a bank must not be disclosed to the supervisory board member's employer. Moreover, the obligation may not be waived by the general meeting or the supervisory board in advance. As a consequence, knowledge acquired by a person in his or her capacity as a supervisory board member may not be attributed to that person's employer.
The supervisory board's responsibility to supervise the management imposes a duty on the members of the supervisory board 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 collectively 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. The effect of this delegation is that the respective member of the management board is excluded from the management of the other divisions or functions and becomes primarily responsible for the delegated tasks.
However, delegation does not fully relieve the other members of the management board from all responsibilities with respect to the delegated tasks. They remain responsible for monitoring and controlling the performance of the delegated tasks by the delegate. The extent of specific monitoring measures is at the discretion of the individual management board member. In general, it is deemed to be sufficient to carefully, continuously and appropriately observe developments in the delegated divisions or functions and the performance by the other management board members of their duties. A general mistrust of other members of the management board is neither appropriate nor necessary.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.
In a German stock corporation, it is not possible for the chair of the management board to also be chair of the supervisory board. With few exceptions, membership of both the supervisory board and the management board of the same corporation is incompatible.v Compensation of members of the management board and the supervisory board
The total compensation of each member of the management board (e.g., fixed salary, variable salary components and pensions) as well as each of its individual components must be reasonable in light of the duties and responsibilities and the individual performance of that management board member, as well as the situation of the company. In listed companies, the compensation must be geared towards a sustainable development of the company. This means, in particular, that the basis of assessment for variable components must be a period of several years. In this context, short-term elements of variable remuneration must be distinguished from long-term elements. The short-term variable remuneration shall be disbursed in cash, whereas the draft amended Corporate Governance Code recommends for long-term variable remuneration to be granted in the form of shares in the company that may not be sold for a period of at least four years. The proposed amendments to the Stock Corporation Act and the Corporate Governance Code will likely require changes to currently employed remuneration systems for the management board and the supervisory board. The compensation of members of the management board is determined by the full body of the supervisory board, usually following a recommendation by a committee established for that purpose. In the absence of any particular circumstances, the compensation may not exceed usual compensation levels. When determining the compensation of a member of the management board, the supervisory board must therefore compare the proposed compensation both with the compensation structure of peer companies (horizontal comparison) and with the company's own compensation structure (vertical comparison). Under the Corporate Governance Code, the supervisory board should also consider the relationship between the compensation of the management board and that of senior managers with the total staff, including the development of the compensation over time. The supervisory board should also place caps on compensation in terms of the aggregate amount and in terms of individual components.
If, after the compensation has been determined, the situation of the company changes for the worse because of circumstances that can be attributed to the management board, and continuing to pay the compensation as originally determined would be unreasonable, the supervisory board is not only entitled but, absent any particular circumstances, also obligated, to reduce the compensation (including pensions) to an appropriate level.
The Corporate Governance Code recommends that severance payments to members of the management board should not exceed an amount of two times the annual compensation, and that severance payments in the event of a change of control of the company should not exceed 150 per cent of that amount.
Supervisory board members' compensation is determined in the articles of incorporation or by the general meeting. Like the management board members' compensation, it must bear a reasonable relationship to the duties of the supervisory board members and to the condition of the company. Supervisory board members' compensation may also comprise variable components. The Corporate Governance Code recommends that variable components should be based on the corporation's long-term performance.
Contracts between a member of the supervisory board and the stock corporation relating to services outside the scope of the supervisory board member's statutory duties require the consent of the supervisory board. The management board will act in breach of its duties if payments are made to a supervisory board member without the supervisory board's prior consent to the contract. Although the supervisory board may approve the contract and the payments owed to the supervisory board member thereunder after the services have been performed, the management board will breach its duties if payments are made in mere anticipation of the approval. Absent such prior consent by the supervisory board, the contract gives rise to a conflict of interest of the supervisory board member.
Stock corporations must disclose the aggregate remuneration granted to members of the management board and the supervisory board, respectively, in their financial statements. Listed companies must also disclose the remuneration of each individual member of the management board. According to the Corporate Governance Code, the information to be disclosed with respect to each member of the management board should, among other things, set out the benefits (including fringe benefits) actually achieved by the management board member in the relevant financial year, as well as the maximum and minimum amounts of the variable compensation that would have been achievable in that year. The general meeting may opt out of these disclosure requirements for a period of not more than five years by passing a resolution with a majority of 75 per cent of the capital represented. To improve the ease of comparison over time and with other companies, the Corporate Governance Code recommends that important facts and figures regarding the management board's compensation should be prepared and presented using a standardised table format, the template for which is set out in an annex to the Corporate Governance Code.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 execution of its resolutions.
Where the supervisory board is composed of both shareholder 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 as well as the conduct of audits and ensuring the auditor's independence. The audit committee is responsible for monitoring the accounting process and the efficacy of the internal control system, the risk management system and the internal audit system as well as additional services provided by the stock corporation's auditor. Where the supervisory board of a corporation whose securities are traded or that has applied for its securities to be admitted to trading in an organised market has elected to form an audit committee, at least one member of the committee must have expertise in the areas of accounting and auditing. However, the Corporate Governance Code recommends that the chair of the audit committee should have specialist knowledge and expertise in the application of accounting principles and internal control processes. Additionally, the chair shall be independent and may not have been a member of the company's management board in the past two years. The chair of the supervisory board should not at the same time be the chair of the audit committee.
Moreover, the draft amended Corporate Governance Code recommends that the supervisory board reports on how many meetings of the supervisory board, and of the committees, individual members attended.
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.