Increasing professionalism

Stricter requirements for the supervisory boards of listed companies
By Dr. Martina Schmid

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The recent amendments to the German Corporate Governance Code adopted by the government commission are aimed at increasing the professionalism of the supervisory board and underline the increasingly significant role of the supervisory board. Following a year without any material changes to the German Corporate Governance Code (GCGC), the government commission adopted this year’s amendments to the Code on May 5, 2015. Alongside some clarifications and adaptations to amendments to statutes that have taken effect in the meantime, these include new, supplementary recommendations for the supervisory board of listed companies.

Introduction

The German Corporate Governance Code presents essential statutory regulations for the management and supervision of German listed companies and contains recognized standards for good and responsible governance. As well as a description of the applicable statutory duties of the company and its executive bodies, the Code includes recommendations that the companies may deviate from, but are subsequently obliged to disclose and justify these deviations (“comply or explain”) on an annual basis. Furthermore, the Code contains suggestions for the company and its executive bodies that can be deviated from without disclosure. The new recommendations recently adopted by the government commission are all addressed at the supervisory board of listed companies.

Determination of term limits for supervisory board membership

Pursuant to 5.4.1 (2) GCGC, the supervisory board shall specify concrete objectives regarding its composition, whereby it shall consider the specific situation of the company. To date, these concrete objectives have included an age limit to be specified for members of the supervisory board. Now, a new criterion is being introduced. According to the new version of the recommendation, the supervisory board shall also set a (regular) limit for the term of membership of the supervisory board. The government commission states that the expertise and knowledge of a supervisory board member increases with his or her length of service. However, a continuous renewal of the board could have a positive effect on the supervisory board’s work, giving it a “fresh outlook” and new momentum. According to press reports, another objective being pursued by the commission is to reduce the average age of supervisory board members. This new recommendation is being criticized by some as inappropriate. is re-elected would have to be decided in each individual case and thereby assessed whether another period in office makes sense. This procedure would be impaired if a strict limit was specified. Moreover, doubts have also been expressed regarding whether defining an upper limit for the length of service on a supervisory board is at all suited to lowering the average age of supervisory board members. For setting a time limit for the term of membership does not necessarily mean that younger candidates would fill vacant positions. The high average age of supervisory board members in Germany is rather based among other things on the requirements placed on exercising the mandate that have increased over time. This fact, as well as the recommendation in 5.4.5 of the Code citing that a member of the management board of a listed company shall not hold more than three supervisory board mandates in nongroup listed companies, ultimately leads to a situation where incumbent management board members of listed companies will hardly be able to execute supervisory board mandates in listed companies in addition to their office on the management board. In fact, management board members are only able to serve on a supervisory board after they have retired from the management board, thus usually at an advanced age.

>> Setting a time limit for the term of membership of the supervisory board does not necessarily mean that younger candidates would fill vacant positions <<

Finally, issues of concern may arise from the new recommendation for companies with anchor shareholders who have an understandable interest in members serving long terms on the board. The government commission stresses that the new recommendation should provide the necessary flexibility in individual cases, particularly in companies with anchor or family shareholders. It is however doubtful whether a majority shareholder will submit to such a duty to make new appointments to the board on a regular basis. In light of this, it is to be expected that a considerable number of companies will deviate from the new recommendation.

Practical consequences

Thus in future, the supervisory board must also give thought to setting a maximum term limit on membership of the supervisory board. If, taking into account the specifics of the company, the supervisory board comes to the conclusion that such a regular term limit does not make sense, it will have to declare a deviation from this recommendation.

More transparency regarding the time related with supervisory board activities

In future, the supervisory board shall ascertain that supervisory candidates are able to invest the expected amount of time required to fulfill their supervisory board duties (5.4.1 Abs. 4 GCGC). With this new recommendation, the commission intends to create more transparency for the supervisory board as well as for supervisory board candidates and raise awareness among future supervisory board members of the burden in terms of the time involved in fulfilling supervisory board duties. Rather than a fixed limit on the number of mandates, a flexible, case-by-case regulation is being introduced to enable the situation of the respective candidate and the company to be taken into account, thereby ensuring that supervisory board members have enough time to perform their duties. This case-by-case approach is generally to be welcomed, as in practice the time required to perform these duties varies substantially from company to company. However, the weakness of the new recommendation lies in the fact that the time required to perform supervisory board duties may also greatly vary within a company. Prior to election to the supervisory board, the candidate can only be informed about the expected time required for regular supervisory board meetings and possible committee meetings. This “basic time requirement” may dramatically increase due to a special situation or crisis so that the amount of time required in the past is not a reliable indicator of how much time will be required in the future. Due to these uncertainties, the new recommendation is only suited to a limited extent for ensuring that, in particular, supervisory board members with several mandates actually have the time needed to perform their supervisory board duties. It remains to be seen whether the recommendation can in practice curtail the often seen plurality of offices.

Practical consequences

In practice, the new recommendation means that the supervisory board (for the first time) has to assess the expected amount of time required to fulfill the supervisory board duties and must discuss and clarify this with the supervisory board candidate. If a deviation from the recommendation is not declared from the outset based on the aforementioned grounds, it is recommendable to estimate the expected amount of time generously.

Extended reporting on the participation of supervisory board members in meetings

In future, it shall be noted in the supervisory board report if a member of the supervisory board has participated in only half or less than half of the meetings of the supervisory board or of the committees that he or she belongs to within a fiscal year (5.4.7 GCGC). This constitutes a tightening of requirements compared to the previous version of the Code. Thus far, a note only had to be made in the report if a member took part in less than half of the supervisory board meetings. In future, supervisory board members must therefore participate in more than half of the meetings to avoid an entry in the report (if no deviation from the recommendation is declared). Moreover, a note in the report by the supervisory board shall in future also be made if a supervisory board member has participated in only half or less than half of the committee meetings that he or she is a member of. According to the previous version of the Code, participation in committee meetings was not to be reported at all. This tightening of the regulation is in many cases not likely to lead to an increase in notes in supervisory board reports, however, as the commission defines the term of participation in meetings in sentence 2, stating that this includes participation by telephone or video conferences. This is the same way it was usually handled in the past. Yet the commission clearly states that participation via telephone or videoconference should not be the rule so that (mere) virtual participation in meetings should be limited to a few exceptional cases. Finally, voting by proxy still does not apply as “participation” in a meeting.

Practical consequences

For supervisory board members, the extended recommendation means that a negative entry in the supervisory board report can occur more quickly in the future than was previously the case. Participation via telephone or videoconference should only be used as an exception.

Non-material adaptations: deletions and specifications

Apart from the aforementioned additional recommendations, the new version of the Code includes a variety of linguistic simplifications and specifications. Moreover, adaptations to statutes that have taken effect in the meantime, in particular the law on the “female quota” that recently came into effect, have also been made.

Specification of recommendations

On the one hand, it was specified that important transactions with persons or undertakings closely associated with a member of the management board shall only be carried out with the consent of the supervisory board (4.3.3 GCGC). On the other hand, the list of dates to be published in the financial calendar was extended (6.3 GCGC). In future, the dates of balance-sheet press and analysts’ conferences shall also be published. Moreover, the financial calendar shall be published on the company’s website.

Deletion of recommendations

Finally, two recommendations have been deleted. One concerns the recommendation according to 6.2 GCGC, wherein any information that the company discloses abroad in line with corresponding capital market law provisions shall also be disclosed in Germany without delay. The other deletion concerns the former recommendation in 7.1.4 GCGC regarding the publication of a list of third party companies wherein the company is a shareholder that is not of minor importance for the enterprise.

Martina.Schmid@cms-hs.com