Corporate Governance in the International Discussion
Prof. Dr. Dr. Dr. h.c. mult. Klaus J. Hopt
According to the internationally best-known definition of the British Cadbury Commission of 1992, which has since been adopted by the European Commission, corporate governance is “the system by which companies are directed and controlled”. Companies can survive in cross-border competition for capital only if their management and control system is robust and reliable. Corporate governance is first and foremost about the shareholders as providers of capital. They expect the management agent to safeguard their interests as ultimate risk bearers (principal agent conflict). This does not necessarily mean that shareholder value must be paramount, a view that prevails traditionally in the USA, where free float among shareholders predominates. In Germany and other continental European countries, on the other hand, the focus is on conflicts between majority and minority shareholders (minority protection and law of corporate groups). The shareholder structure there is traditionally characterized by founding families, major shareholders and corporate groups. The current international discussion is about shareholder approach v. stakeholder system. In the European Union, there are plans to commit member states to a moderate form of stakeholder system as in the UK and particularly in Germany. In the USA, too, the Business Roundtable has spoken out in favor of an increased focus on stakeholder interests in 2019, but it remains to be seen whether this leads to a more permanent change.
In corporate governance, a distinction is made between internal and external corporate governance. Internal corporate governance is concerned with how management and control are ensured in the corporation. This is primarily the task of corporate law, for example in Germany the Stock Corporation Act of 1965 which has been reformed many times. But in most countries there are also non-binding corporate governance codes, in Germany the German Corporate Governance Code of 2020. There is a vivid discussion on hard law versus soft law. In German stock corporation law, management is the responsibility of the Management Board, while the Supervisory Board has the task of advising and monitoring (two-tier system). In most other countries, the board is responsible for the overall management and at the same time supervises the management (one-tier system). In this board system there are executive as well as non-executive board members (NEDs) who work together. Neither system is the better one; in practice, the two systems evolve toward each other (convergence). Individual path-dependent differences in the various countries remain, for example in Germany labor co-determination at parity and codified corporate law (Konzernrecht). There is much to be said for giving shareholders the right to choose between the two board systems, as provided for in the European Company Statute (Societas Europaea) and in many member states of the European Union, such as France and Italy. This has also been proposed for Germany, but without success so far. The board(s) need the professional assistance of independent, expert auditors for monitoring purposes. The auditors work together with the board or, in the two-tier system, the supervisory board and its audit committee. They can therefore be considered to be part of internal corporate governance, although in view of their independence they are not organs of the corporation.
One of the many contentious issues in today’s internal corporate governance is the question of the extent to which the supervisory board or the one-tier board must be independent, how many independent members it must have, and in particular who can be considered to be “independent.” This is regulated very differently in various countries, even within the European Union. The financial crisis has shown that in financial institutions, but also in other companies, expertise in supervision is at least as important as independence. In the end it all comes down to the right mix. In the case of labor co-determination on the supervisory board, there is some dispute as to whether employees can be considered to be independent. The better view is that they are not independent. In the case of labor co-determination, there are advantages and disadvantages (costs). There is a number of empirical studies on this, but they have not yet produced a clear picture. For decades, codetermination at parity is mandatory in Germany. This was a decisive obstacle to further harmonization of stock corporation law in the European Union. The convincing solution found there for the European Company is the model of negotiation between representatives of the shareholders and the employees. A system of codetermination that has more or less proved its worth in one country (for example, in Germany) may not be recommendable for another country (for example, in the U.S., despite recent proposals to this effect by Elizabeth Warren) in view of different political, social and cultural circumstances.
For external corporate governance, the market for corporate control has been called “the most effective corporate governance mechanism,” especially in the USA. Management is “disciplined” by the market for corporate control. As a general rule, business managers can best protect themselves from losing their position as a result of a hostile takeover by maintaining a high stock price. A functioning takeover market is in the interest of shareholders and more generally enhances the economy. There are different views on how best to legally ensure this effect. In U.S. law, defensive measures are permitted (just-say-no rule, exceptions under the Revlon doctrine). The role of the board of directors of the target corporation corresponds to that of an auctioneer, who may make the success of the bid more difficult in favor of a higher control premium for the shareholders. In contrast, the British Takeover Code requires the bidder to make a mandatory offer if the control threshold of 30 percent is exceeded and, correspondingly, requires the management of the target corporation to remain neutral, i.e. to refrain from defensive measures (no-frustration rule). After some 30 years of tough wrangling, the European Union followed the British approach with the Takeover Directive adopted in 2004. However, Germany has made use of the directive’s options and has not adopted the strict no-frustration rule. According to this, German management boards are permitted to take defensive measures against takeover bids, provided the supervisory board gives its approval. This is rightly criticized in the literature. For some time now, the market for corporate control has also been restricted by protectionist measures taken by various countries that seal off their “national champions” against takeovers by foreign bidders, including those from the European Union. This is not only contrary to the interests of the shareholders and the market, but is also detrimental to the national interest in the medium term. However, it is important that other countries also allow foreign companies unhindered market access (reciprocity).
Corporate transparency and disclosure stand between internal and external corporate governance. Despite some theoretical and practical uncertainties about the information efficiency of markets, transparency and disclosure are most important instruments of corporate and capital market law. The reduction of information asymmetries between management, shareholders and other stakeholders strengthens private autonomy and supports market mechanisms. Corporate transparency is a more flexible and less intrusive means of regulation. Internationally, disclosure stands for the prevention of abusive use of the capital market: “Sunlight is said to be the best of disinfectants; electric light the most efficient policeman” (Louis D. Brandeis). The disclosure model of European company law also serves the purpose of harmonizing laws where binding rules would be too big a step forward from the point of view of the member states. For corporate governance, disclosure rules are particularly effective when the intended behavioral control is linked to the company’s self-interest in communication (with shareholders and the market). Corporate disclosure concerns not only financial but also non-financial circumstances and is more and more focused on sustainability. This is also increasingly demanded by institutional investors. In the European Union, the conventional system of corporate disclosure is currently undergoing a process of change toward greater consideration of non-financial circumstances (environmental, social, and governance, ESG) with a view to sustainable corporate governance in the interest of shareholders as well as stakeholders. Most recently this is true for example with regard to the climate problem (Shell ruling in the Netherlands). This has also been seen in supply chain legislation such as in Germany in June 2021 and will be a major point of contention in the European Supply Chain Directive that is likely to be proposed by the European Union in the fall of 2021. The extent to which the instrument of civil and criminal liability of the company and the individual board members will be used in this context, and whether individual shareholders and even stakeholders from abroad will be able to sue in Germany and in other member states, is highly controversial.
For more information, see:
Hopt, Comparative Corporate Governance: The State of the Art and International Regulation in: The American Journal of Comparative Law 59 (2011) 1-73.
Hopt/Davies, Corporate Boards in Europe – Accountability and Convergence in: The American Journal of Comparative Law 61 (2013) 301-375.
Hopt, Takeover Defenses in Europe: A Comparative, Theoretical and Policy Analysis in: Columbia Journal of European Law (CJEL) 20 (2014) 249-282.
Hopt, Law and Corporate Governance: Germany within Europe in: Journal of Applied Corporate Finance (JACF), Vol. 27 Number 4, Fall 2015, 8-15.