Current Trends in Good Governance

Dr. Margarete HaaseMember of the Board

DEUTZ AG

Public perception of governance

Since the financial crisis and a number of slips in managerial behavior, a tremendous amount of con-fidence has been destroyed.

Good management starts at the top of the company, in the supervisory board, in top management and is cen-tered on the social value system and on regulatory parameters.

Not only the clients as direct recipients of products and services, but also the expectations which the public at large has of corporate governance are exerting increas-ingly more influence on the governance of companies.

These expectations shape the influence of owners and shareholders via the supervisory boards on good gover-nance. That which in owner-operated companies is transferred directly by the shareholders to the culture and the control system of the company, is effected in the public trade company via financial market communica-

tion and investor relations activities into the company indirectly.

Current developments indicate that companies today – more so than in the past – need the acceptance of the public in order to be successful. This ultimately entails that companies make a fair contribution to financing public services, also by paying taxes.

If every tax loophole is utilized by carving it out to its fullest extent, it should come as no surprise if a company comes under fire, and if there is a race with legislators to close loopholes.

Good governance means not just barely abiding by the laws, but also managing company funds with sound judgement, striking a balance among stakeholders, and voluntarily committing to and practicing a code of con-duct. The German Corporate Governance Code (DCGK) is a good starting point. Even without following the recommendations to a T, it helps to give some thought to good governance and to reflect on one’s own situation.

The management of large companies is currently being viewed very critically by the public at large.

Is there a lack of management? More likely is that there is a lack of confidence in management.

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Dr. Margarete Haase Current Trends in Good Governance

The DCGK Commission is a step in this direction. It prepares recommendations; non-compliance with them is not sanctioned directly, but nevertheless has to be pub-lished in keeping with the motto ‘comply or explain’.

Our entire economic system is currently the subject of considerable criticism and is being put to the test. We can all contribute a lot to strengthening the acceptance of the social market economy because the market economy is social, it makes people wealthy, provides them with goods, services, jobs, and ensures social integration.

The understanding that the conduct of an honorable businessman is worthwhile in the long run could help contain the urge to further regulate. And conversely, we have to expect that the regulation of business activity will further increase if numerous and significant slips and violations to the law continue to be the order of the day (see VW, Deutsche Bank, Schlecker, ADAC etc.).

The supervisory board in the spotlight

In the company the perception of practiced governance starts in the role model effect of the supervisory board. The requirements made of supervisory boards have in-creased dramatically. Not only has the risk of liability in-creased immensely, but so has the public pressure on responsible work in the supervisory board.

This is why the professionalization of the work of the supervisory board is taking shape. The supervisory board is not an honorary position anymore. Since the super-visory board has to challenge and advise the board on issues of strategy, business development, departures from the original target etc., it will not manage without indus-try knowledge and management skills to say nothing of the required independence.

Some supervisory boards like to participate in opera-tive topics. As a result, however, this does not create added value in our dual system. Instead, added value is created through so-called checks and balances. This in-cludes the ability to operate at a high level of abstraction and to participate nonetheless in a very specific way in the main topics of corporate governance and, above all, in strategy.

Moreover, the advisory board has to deal in depth with issues of compliance and reputation. Part of hitting the right “tone from the top” involves the supervisory board conveying just how important it takes issues of good gov-ernance, especially complying with laws and internal codes of conduct.

For years, waves of regulation have been rolling through German supervisory boards in short intervals, stipulating more intense oversight without any increase in pay for the supervisory boards.

In particular, while the reform of the final audit strengthens the audit committee in the supervisory board, it also adds to the responsibility and comes with a risk of new personal sanctions in the case of repeated violations of the provisions. Notably, the audit committee is going to have more duties stemming from various reg-ulations. Currently, the EU final audit reform is making considerable demands of the audit committee.

One observed tendency is that the handling of finan-cial and compliance issues is delegated completely to the audit committee. Even if the expertise is usually more bundled there than in the supervisory body as a whole, the entire supervisory board has to deal with these issues and, above all, set a good example. And that, too, is a result of growing regulation and the risk-averse nature of those supervisory board members not represented in the committees.

GOOD GOVERNANCE MEANS NOT JUST BARELY ABIDING BY

THE LAWS, BUT ALSO MANAGING COMPANY FUNDS

WITH SOUND JUDGEMENT, STRIKING A BALANCE AMONG

STAKEHOLDERS, AND VOLUNTARILY COMMITTING

TO AND PRACTICING A CODE OF CON DUCT.

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Dr. Margarete Haase Current Trends in Good Governance

In light of this, the whole supervisory board has grow-ing expectations of the audit committee, and deci-sion-making preparations are generally happily trans-ferred to the committees.

The financial expert in the audit committee is increas-ingly assuming the role of the hinge among the chairmen of supervisory boards, the CFOs, and auditors on matters concerning the audit, compliance, and risk management. Playing this role well at this interface can contribute a lot to a well-practiced governance culture in the company. Ultimately, the whole supervisory board and the board have to be convinced of taking suitable measures for de-veloping a compliance culture.

One of the most important tasks of the supervisory board is succession planning, the selection of the board members, their evaluation, and the introduction of a re-muneration system which satisfies the requirements of company governance and the long-term character in ac-cordance with law. When it comes to the criteria for in-centivization, there are more and more discussions about including compliance targets.

Following the financial crisis, I observed that supervi-sory boards were increasingly committing themselves to risk protection and not enough to opportunity manage-ment.

But this trend appears to be in the process of reversing itself. In future, the activities of supervisory boards will shift more to strategy, HR, and further developing the company.

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Dr. Margarete Haase Current Trends in Good Governance

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Governance and investors

With ownership comes responsibility. This responsibility is being perceived more clearly in light of the current de-velopment. Even investment companies are asking more about contacts to the supervisory bodies because for their part they are held more responsible by the shareholders.

Governance is undergoing a major change. Institu-tional investors are asking more questions about the qual-ity of governance and compliance. They are devoting par-ticular scrutiny to the management compensation system in terms of incentive criteria.

And so via investor relations a very constructive dialog is taking place with investors which requires little addi-tional regulation.

More specifically, investors and analysts gather the in-formation they need right from roadshows or confer-ences.

The general meeting, by contrast, has become a boring, pseudo-democratic, and mandatory event that is in des-perate need of reform.

Usually analysts are organized in such a way that they have an overview of the entire branch. This helps the an-alyzed companies to better assess their own competitive-ness.

This dialog also indirectly helps corporate governance and, in doing so, has a direct effect on corporate value. What is often overlooked and sometimes not taken ad-vantage of is the fact that analysts are the cheapest consul-tants.

There is a clear shift in the focus of analyst issues that seems to be moving away from quarterly results to infor-mation on the long-term development, the strategy, and the sustainability of business models with a strong em-phasis being placed on corporate governance.

The intention behind creating the DCGK was to make the German dual management system more familiar and understandable in the international world of finance. Since its introduction, numerous improvements have been incorporated, accompanied by umpteen suggestions from practitioners as part of the so-called consultation process. This has helped to make the system manageable.

The code and the German transparency regime have earned themselves a good reputation in the financial world, and over the long term this fact will increase the willingness of international investors to invest in Germany. Moreover, this helps promote the shareholder culture in Germany which is still embarrassingly backward.

Governance and corporate culture

A corporate culture based on values and trust is the foun-dation for governance. Many companies have drawn up a code of conduct, some even have employees and manag-ers confirm that they have received it.

If this entirely voluntary model had had a lasting pos-itive effect, we would not need any excessive rules. The notion of the medieval honorable businessman might appear antiquated to some. But, in fact, the conduct of the honorable businessman was embedded in the legal provi-sions adopted later on and taken as a basic concept.

Ethics is often just a part of the public image of compa-nies. Just how much of it is implemented and practiced internally is a whole different matter. It is impossible to write an ethics handbook that contains the right instruc-tion for every situation. Personal integrity guides every action.

In a successful corporate culture, people trust that the enacted codes of conduct will be followed; the culture re-lies on its managers and employees.

Well-thought-out compliance systems right up to whistleblower hotlines do not replace a managerial cul-ture based on trust. Showing trust in employees has a positive effect on the willingness to perform, cooperate, and be innovative, thereby reducing the effort involved in safeguarding and controlling.

The indispensable compliance tools are sometimes even an obstacle for the culture of trust. An increasing tendency to mistrust is the result of blatant cases of mis-conduct in business. Corporate management has to cred-ibly convey to employees that it will not use the system against them as long as they comply with the code of con-duct. Ultimately, the positive role model effect of man-agement is key for a corporate culture based on trust.

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Dr. Margarete Haase Current Trends in Good Governance

Governance+C o n t r o l l i n g

IN A SUCCESSFUL CORPORATE CULTURE, PEOPLE TRUST

THAT THE ENACTED CODES OF CONDUCT WILL

BE FOLLOWED.

Governance and controlling

Good corporate governance does not function without hard facts, transparency, and suitable control systems. The right mix of hard factors (control systems) and soft factors (corporate culture) is key for corporate gover-nance.

The role and acceptance of controlling is relevant for the credibility of management. Controlling only creates the prerequisites for corporate governance and control by making the results, planning and deviations visible. The main task of controlling is to provide information that allows the supervisory board and the board to push through realistic plans and targets.

The stipulations contained in the German Act on the Appropriateness of Management Board Remuneration (VorstAG) for long-term aspects of remuneration can only be fulfilled by a forward-looking system. Moreover, qualitative aspects and strategic targets, such as an in-crease in market share, customer satisfaction, employee satisfaction, fluctuation, etc. should play a role. Yet often the target is overshot. For security reasons, remuneration systems in large companies are designed in a much too complicated way. For lack of transparency and calculabil-ity these systems cannot develop any incentive effect for board members.

Since the work of the supervisory board is moving away from retrospective oversight to evaluating future development and strategy implementation, controlling is taking on an important role in supporting the work of the supervisory board.

Conclusion

The following points can be concluded: ❱ Good governance strengthens the acceptance of our

economic system. ❱ Supervisory boards are challenged not only when it

comes to oversight, but also when it comes to strategy, succession, and governance.

❱ Investors are more actively involved in the discussion on governance.

❱ Corporate culture holds the major aspect to imple-menting good governance and has to be lived out.

❱ Without assertive controlling governance does not work.

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