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The collapse of major corporations like Enron, WorldCom, and Adelphia exposed the weaknesses and ineffectiveness of corporate governance rules throughout the United States. These corporations were bankrupted by fraudulent managerial conduct and corporate governance failures. These scandals hurt both individual investors and capital market as a whole. To prevent similar crisis occurs in the future, it is important for the United States to examine other foreign countries’ corporate governance model such as Japan, France, and Germany to determine which aspect of foreign companies’ corporate governance is best to import to improve the weaknesses of American companies’ corporate governance. This paper describes the corporate governance structure of Germany and analyzes the strengths and weaknesses of its corporate governance system. This will provide a better understanding of the nature and limitations of American companies’ corporate governance system and their capacity for adopting foreign improvements.
The word codetermination or Mitbestimmungsgesetz in Germany refers to a system of corporate governance under which workers of an organization have the right to vote for representatives (usually trade union representatives) on its board of directors. Codetermination is meant to flourish the cooperation between management and workers in decision-making. It is meant to introduce a democratic decision making process and the equality of capital and work (Berger and Vaccarino, 2016).
Codetermination was introduced in 1951. Codetermination in Germany consists of two separate levels of corporate governance: Establishment Level and Company and Group Level. These levels are governed by different laws. Establishment Level is codetermination through the works councils (Betriebsrat) which is governed by Works Constitution Act of 1972. Company and Group Level is codetermination through the Supervisory board (Aufsichtsrat) which is governed by Codetermination Act in the Coal, Iron & Steel industry of 1951, Supplementary Codetermination Act of 1956, Third Part Act of 2004, Codetermination Act of 1976, and Codetermination in European Legal Entities such as SE or SCE (Rebecca, 2011).
The works council has the rights to access information, to inspect documents, right of supervision, right to make recommendation, to be consulted, to advice, right of opposition, right of veto, right to negotiate and initiate measure, and obligation to agree. Employers must consult and negotiate with the works council if changes affecting the workplace take place. On the other hand, codetermination at the company level composes the employees’ participation or their representatives in the supervisory board. The Supervisory board involves in the appointment of the management board members, monitoring of business operations, overseeing the activities of the management board, and deciding the compensation of its members (Berger and Vaccarino, 2016 and Rebecca, 2011).
The number of employee representatives depends on the size and legal type of the company. For companies with over 500 employees, one-third of the supervisory board must be elected. In companies consisting of over 2000 employees, the Mitbestimmungsgesetz requires half of the supervisory board must represent employees members (Berger and Vaccarino, 2016 and Wikipedia, 2018)
In 1976 the German government extended codetermination to other industries, but it was not fully parity. According to Kommission Mitbestimmung (1998), the main purposes of codetermination are to make investments in human capital profitable and regard employees with participation rights of their loyalty towards the company (Berger and Vaccarino, 2016). The objectives of codetermination compose of equality of capital and work, democracy in the economy, social development, and control of economic power (Rebecca, 2011). The German two-tier board is categorized in three major areas: management-labor relations, management-shareholder relations, and relations between management and the market for corporate control (Loewenstein, 2002).
One of the major differences between German and American business models is the structure of a corporation’s board of governance. The one-tier American board includes both executive directors and non-executive directors. For instance, Ken Lay was both CEO and chairman of the board of directors of Enron. This system does not provide adequate oversight and gives opportunities for self-dealing. In contrast, the two-tier German board structure excludes all executives from its supervisory board and hence the supervisory board cannot get involved in managing the company directly. In other words, the CEO is not a member of the supervisory board and is not responsible for the member’s positions on the board. This gives German board an advantage over American board in promoting efficiencies and allowing for more independent supervision of the management.
The German model allows the supervisory board to hold private meetings to discuss about the matters such as management compliance and compensation. This two-tier structure offers more procedural efficiency than one-tier board. The supervisory board structure has a clearer scope of duties and a better application of any measures of a director’s independence (Tien, 2009). Consequently, supervisory board members are obligated to scrutinize all information and strongly object to reckless or wrong-headed corporate policy (Adams, 2003).
Also, Enron’s scandal demonstrated that American liabilities laws were not enforceable. They did not prevent arrogant, greedy, selfish executives like Ken Lay from violating their fiduciary duties. This one-tier board system is ineffective and causes the public to distrust corporate managers (Tien, 2009). Therefore, America should reform its corporate governance and adopt German two-tier board structure to promote a truly independent supervisory board and help to prevail over problems with conflicts of interest.
The principal advantage of the German’s model is management accountability. The German model permits banks to hold dominant positions in the supervisory board and hence bank representatives are able to exert great influence on corporate decision-making to ensure the executives do not pursue whatever course of business they want in an inappropriate manner. Moreover, the banks would help to empower German corporations in decision-making process to effectively react to technology-driven and rapidly changing markets by infusing their expertise and abundance of additional information (Adams, 2003).
Another significant advantage of the German two-tier structure is its auditing system. It allows the supervisory board to perform the audits independently and exclusively. Auditors’ reports submit directly to the supervisory board. The German audit system helps to ensure a truly independent audit process and to eliminate potential conflicts of interest. In contrast, in the United States, the case of Enron revealed the conflicts of interest involved in corporate auditing (Tien, 2009). Therefore, the United States can import the aspect of the German audit system to prevent fraudulent managerial conduct.
Nevertheless, the German two-tier structure has some disadvantages. The first one is that the supervisory board is excluded from management and hence, it has limited right of access to company information regarding company performance. Without sufficient information, the supervisory board may unable to take a stand against the management. The supervisory board can overcome this by actively oversight and involved. The American board can adopt the German auditing system and the two-tier structure. However, the American board should improve the German auditing system’s weakness by increasing the authority of its supervisory board and eliminate employee participation in corporate governance. To the contrary, the next concern is that the supervisory board will wield too much power that may negatively interrupt with management’s business judgment. Indeed, government could develop a separate system of checks and balances to detect any threat of too much power (Tien, 2009).
In Germany, employees are allowed to participate in corporate governance. However, the United States should eliminate this. Although codetermination in German has a chilling effect on hostile takeovers as a result of labor representation on the board, there are costs associated with this system of governance. On the other hand, the American companies are able to adjust to market downturns and seize market opportunities than German companies because they are freed from the constraints imposed by an entrenched labor pool and conservative bank directors (Loewenstein, 2002). Additionally the United States have different business culture and labor policies such as employment at will and collective bargaining. American companies embrace a national free market economy and a flexible labor law system; hence this employee participation aspect of German structure would not work well in America (Tien, 2009).
In addition, it is questionable about employee interests when the German firms provide strong protection for employees of the firms. Large firms often have other stakeholders besides their employees and shareholders and hence it is concerned whether the German model is responsive to the interest of those other stakeholders (Loewenstein, 2002). Furthermore, German firms invest in human capital to take the advantages of a stable, well-trained, and loyal workforce. At the same time, this same stability means that German firms forego new talent employees in favor of retaining permanent employees. As a result, German firms sacrifice future leaders disrupt normal promotion and career progress, and possibly affect the firms’ long-term competitiveness.
In conclusion, the corporate governance structure of each country has its own strengths and weaknesses. The choice of selecting particular corporate governance is often influenced by the country’s history, social practices, and cultural mores. Thus, it may not be possible to import all aspects of German model in the United States. However, the German model has certain characteristics that the American system does not have: employees’ involvement in corporate decision making; cross-shareholding with suppliers and customers; banks influence; and low hostile takeovers. The United States should adopt some certain good features of German corporate governance structure such as its two-tier boar structure, management accountability and audit system to properly balance the many competing interests necessary to help securing a corporation’s success and improving American economy.