Germany: Co-determination review concludes

Thirty years after the introduction of equal employee and shareholder membership of large company boards, an official review has given the system a broadly positive bill of health. However, differences between trade unions and employers prevented consensus on proposals for reform.

On this page:
The Co-determination Commission
Co-determination "not a barrier" to corporate success
Economic impact on companies
Hostility to co-determination by managers
Opportunistic behaviour by managers
Recommendations
Scope for flexibility and simplification at enterprise level
Europeanisation and internationalisation
Rationalisation of existing law
Dissenting perspectives
Box 1: Enterprise co-determination in Germany.

Co-determination and corporate governance have been of interest in recent years in Germany, in the wake of the European Company Statute (European Company Statute adopted), the 2005 EU Directive on cross-border mergers, rulings of the European Court of Justice on issues such as freedom of establishment, and a debate on the relationship between investors and company managements. At the same time, there has been discussion of the impact of employee co-determination (see box 1) on German company strategies, with arguments that it creates greater legitimacy for difficult decisions countered by accusations that it favours "insiders" and shores up unviable corporate - and corporatist - structures.

The desire by German companies to become "global players" has intensified pressures on firms to adhere to international "best practice" on governance. This led to legal reforms in the 1990s that tightened the obligations of non-executive directors. In 2001, a Commission on Corporate Governance was set up, which produced a voluntary code for quoted companies, mostly requiring a "comply or explain" response on many issues, including disclosure of individual directors' remuneration. In 2005, legislation was passed because around one-third of the companies in the DAX German stock exchange index failed to do this. The code has continued to be developed, with further amendments in 2006.

Parallel to this, the prospect of hostile takeovers and the growing role of private equity have nourished trade union fears that co-determination could be undermined by investors unsympathetic to, and uninvolved with, the German system. The new scope for companies with administrative headquarters in one EU country to incorporate in another, with governance arrangements set locally, has added to these concerns - although, as yet, only a small number of firms of the relevant size has taken advantage of this. Employers' organisations have argued that the German system deters inward investment and leads to a "mark-down" by investors of the value of German firms.

Corporate internationalisation also means that many German firms now employ a substantial proportion of their workforce abroad: these employees have no scope to participate in board-level decisions.

More recently, governance issues have attracted negative headlines, with allegations that the personnel director of Volkswagen, Peter Hartz, sought to win agreement over restructuring at the company by providing works council members with inducements such as illegal payments and holidays. At Siemens, a bribery scandal has highlighted the problems of chief executives assuming the role of supervisory board chair; Heinrich von Pierer, the current chair, must now scrutinise alleged dubious transactions made by managers during his tenure as chief executive. At ThyssenKrupp, Gerhard Cromme, chair of the company's supervisory board and of the Commission on Corporate Governance, has irritated some - mainly UK - institutional shareholders after raising the number of board members to which the Alfried Krupp Foundation, which holds just over a quarter of the shares in the company, is automatically entitled, instead of election of members by all shareholders. These nominees are likely to vote with employee members to thwart hostile takeovers.

The Co-determination Commission

A Co-determination Commission was set up in 2005 by Chancellor Gerhard Schröder during the social democrat-green coalition (EER 382 p.8) and confirmed by the social democrat-conservative "grand coalition" formed after the September 2005 elections. Its brief was to examine board-level co-determination and suggest proposals for a modern system of enterprise co-determination that is "fit for Europe". It was chaired by Professor Kurt Biedenkopf - a Christian democrat politician and member of a commission that sat from 1968 to 1970 and whose recommendations paved the way for the 1976 Co-determination Law - and was made up of employer and trade union representatives, with two academic experts. The employer side consisted of the presidents of the three main central employers' bodies (BDA, BDI and the International Chamber of Commerce), with unions represented by the general secretaries of the IG Metall metalworkers' union and the German Trade Union Confederation (DGB), and the chair of the group works council of RWE Power AG.

The academic experts, Professor Wolfgang Streeck (of the Max Planck Institute for the Study of Societies) and Dr Helmut Wissmann (former president of the Federal Labour Court), were invited to investigate the "tasks, efficacy, perceptions and economic impact of enterprise co-determination" against the background of "changing capital markets, the changed environment for corporate financing and the shift to a knowledge economy". Each convened two groups of experts of union and employer specialists and academics.

The government pledged to legislate on any mutually agreed proposals. However, it became evident during 2006 that no agreed recommendations would be possible as employer and union positions became irreconcilable. An announcement to this effect in November 2006 led to a public spat involving national employers' organisations, which took issue with Professor Biedenkopf's interpretation of the differences within the commission, and argued that confirmation of the status quo, as broadly suggested by the experts and supported by the unions, would leave "Germany isolated in Europe". The final report¹ consists of the experts' review, with employer and union positions as appendices (EER 395 p.6).

The focus of the commission's work was the "parity" system established by the 1976 Co-determination Law (see box above). Passage of this law was controversial and challenged by employer bodies on the grounds of constitutionality. This left the commission with some "unfinished business" - that is, a 1979 judgment of the Constitutional Court that found that the law was consistent with the German constitution. The court noted, however, that the future impact of the law could not be accurately foreseen and, should a future assessment prove negative, "correction" might be necessary.

Co-determination "not a barrier" to corporate success

The commission revisited the 1979 judgment by reviewing research on the relationship between co-determination and company performance. However, it emphasises that the law was not framed to boost corporate performance but rather to ensure that "employees in large enterprises had an effective means of participating in decisions that affected them". On balance, the experts consider there is no need to reopen the question of the balance between companies' freedom of action and employee participation rights, and that the 1979 court ruling therefore remains valid.

The group then looked at a range of specific concerns about co-determination.

Economic impact on companies

Prior research on the effects of co-determination on indicators such as share price, productivity, innovation and return on equity was not found to have "demonstrated any negative economic impact". In the face of the methodological problems associated with the research, the group draws the pragmatic conclusion that "inasmuch as co-determined German companies are internationally successful, it can at least be confirmed that co-determination has not proved a barrier" and that the net balance of the additional cost of employee participation set against the benefits of a "stable and integrated workforce" is a matter that "seems to be open and could well depend on the skill of the individuals concerned both in the interaction with each other and with the statutory institutions".

The experts also note that the German economy was generally flourishing in the 1980s at a time when the "German Model" was arguably at its strongest and most admired. Whatever difficulties German businesses have since experienced, the experts state that it would be difficult to claim that these are mainly or even identifiably due to co-determination - especially in view of the continuing global strength of many German firms and German export successes. In particular, there is no evidence that the share price or value of co-determined companies is "marked down" by institutional investors. However, in view of rapid changes in this area, the experts advise that this issue be kept under review.

Hostility to co-determination by managers

Based on an analysis of recent surveys, no evidence was found that managers fundamentally reject co-determination or want it abolished. Most executives feel that both "good" and "bad" practice can be found and seek specific reforms on issues such as board size and internationalisation.

This review proved controversial. Employer members of the commission complained that the experts group failed to differentiate managers' perceptions of the works council system and of board-level co-determination. The employer side conducted research into board-level co-determination in a study carried out in summer 2006 by the Institut der deutschen Wirtschaft (IW) and the Frankfurt Institute of Law and Finance. This involved a questionnaire sent to 2,500 firms. Of these, 200 replied - 8% of the overall sample and, it is claimed, 15% of companies covered by the 1976 legislation. The experts group comments that the response rate was "surprisingly low", given the importance that was attached to the survey by business leaders, in the form of an accompanying letter. Of the responses, 34% viewed board-level representation positively or very positively, and 38% negatively or very negatively. In all, 49% of the responses judged employee representatives to be either "competent" or "very competent", with 36% stating that board-level co-determination improved the quality of decisions. Some 41% of the respondents stated that employee representatives were "less" competent or not competent, and 20% felt that the arrangements led to poorer decisions.

The commission's report concludes that, on balance, given the likelihood that critics of co-determination were more likely to have responded, the IW survey does not prove an "overwhelming rejection of enterprise co-determination". The employers, in their separate commentary, continue to argue that the survey shows that parity co-determination "is overwhelmingly viewed as an obstacle" by managers, and they reject the report's interpretation of the survey.

Opportunistic behaviour by managers

Some commentators have argued that co-determination is detrimental to shareholder interests because it encourages executives to behave "opportunistically" by concluding "soft" deals with employee representatives in return for support on their own contracts and appointments. The experts group rejects this on the ground that "the profound restructuring of leading German companies, which has included tough and contentious measures", would have been impossible had managers been concerned only with currying favour with employee representatives.

Recommendations

The recommendations of the final report, the prospects for which are uncertain given the lack of consensus on the findings, are mainly aimed at improving, but not fundamentally revising, parity co-determination.

Scope for flexibility and simplification at enterprise level

Collective agreements should allow for deviation from the law on a range of issues, "raising" or "lowering" the degree of practised co-determination, the report states. For example, the powers of the supervisory board of a "closely managed" subsidiary could be transferred to the parent company, or the supervisory board could be made larger or smaller. This would entail the creation of a new form of enterprise-based negotiation in which employees would be represented by a forum consisting of the works council, the trade union represented on the supervisory board, and members of the executives' representative committee. The company would need a mandate from a two-thirds majority at a shareholders meeting. There would be no right to take industrial action in support of negotiations.

On the issue of transactions needing supervisory board consent, the experts recommend that boards should agree a "catalogue" of measures, for clarification and in the interests of good governance, but that this should not be required by law. The report also proposes simplifying the procedures for electing employee members and it advocates indirect election via the works council and executive representation committee. Trade union representatives would continue to be nominated directly by unions.

Europeanisation and internationalisation

In view of the changing European context noted above, the report makes a number of proposals.

While it does not suggest legislation to apply co-determination to firms incorporated abroad, the report claims that this would be compatible with European law if the bulk of their operations and staff are located in Germany.

On involving the non-German workforce, the report recommends that this should be allowed via the special negotiating machinery outlined above, which would also include the foreign subsidiary as a contractual party. Options might include the inclusion of employees in foreign subsidiaries in elections or through reserved seats. By agreement, the foreign workforce could be included in the total workforce numbers to determine whether a company is above the parity co-determination threshold.

Rationalisation of existing law

The report addresses a number of "inconsistencies" in existing law, although the employers have challenged this characterisation in some areas. One issue of note is that of subcommittees that are set up by a supervisory board for particular tasks; at present there is no requirement for these to have equal shareholder and employee representation. Indeed, the 2002 Corporate Governance Code states that this should be avoided if it would slow decision-making or entail appointing individuals without specialist competences. The German courts have ruled that non-equal representation is permitted only if there is "objective justification" and scope for a casting vote by a shareholder member. The expert group recommends that this issue should now be regulated by statute and that any subcommittee assigned a decision-making power should mirror the distribution of seats on the main board.

Dissenting perspectives

The trade unions broadly endorse the report and consider that co-determination must be extended, in particular to ensure that restructuring is dealt with in a "socially responsible way". They accept the principle of negotiation on divergence from statute on issues such as the size of the supervisory board, and they accept that co-determination could, in some cases, be adapted to the circumstances of individual firms. However, they are sceptical of deviation to a "lower" standard, and argue that collective bargaining should only be used to improve on the law in parent companies. A lower standard might be conceivable for subsidiaries, but then only with the agreement of all parties. They also argue that executive representation bodies should not be an independent party to negotiations.

German employers' organisations have rejected the final report for failing to meet the terms of its brief, and contest several of the report's findings. They insist that co-determination does deter individually owned companies from becoming stock corporations (Kapitalgesellschaften) and promotes their move abroad, and that the German system of corporate governance is problematic in an international context. While agreeing with the report's findings on the desirability of more negotiated options, the employers' organisations contend that negotiations on board size and the "intensity" of co-determination should be primary, with a fallback position in the event of a failure to agree - and that this should be a one-third employee representation on boards "as an incentive to bargain". Employers' organisations reject the proposal for election of board members from among works councillors, and argue for a simpler form of direct vote by the whole workforce.

One area, at least, of potential agreement is the inclusion of foreign employees in supervisory boards through voluntary negotiation. However, the employers argue that this should not lead to an "extension of co-determination" - for example, by counting such employees when calculating whether a company in Germany becomes subject to parity co-determination.

1. Kommission zur Modernisierung der deutschen Unternehmensmitbestimmung [Commission on the Modernisation of German Enterprise Co-determination] (2006) (external website), Bericht der wissenschaftlichen Mitglieder der Kommission.

This article is based on material submitted by Pete Burgess, European Employment Review correspondent for Germany.

European Employment Review 397 (EER 397): contents