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Ideas & Debate

How decisions are made in German-style boards

board
German companies have a very interesting corporate governance system. FILE PHOTO | NMG 

The Germans produce excellent cars. They have also produced a very interesting corporate governance system that was the subject of great scrutiny during the Volkswagen emissions scandal of 2015.

In case you mysteriously missed the “Dieselgate Scandal”, Volkswagen was accused of installing software on its US-based cars to produce fake results, during environmental regulator tests, on the illegal amount of nitrous oxide being emitted by its diesel cars which could lead to premature death due to respiratory diseases occasioned by smog.

So corporate governance experts weighed in on the scandal, saying that it was a matter of when, and not if, it could happen. German company law provides for a two -tier board system. First is a supervisory board whose composition is fairly regimented under a system of co-determination or “Mitbestimmung.”

The co-determination system requires at least a third of the board of directors consist of employee representatives if there are less than 2,000 employees and, where employees are more than 2,000, then half of the board is required to be made up of employee representatives. If the company has less than 500 employees, then there is no requirement for employee representation on the board. The second tier of oversight is a management board which is made up of executives.

For companies that have over 2,000 employees, one of the management board members must be a staff director or “Arbeitsdirektor” who represents the employees.

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In the case of VW by the time the 2015 scandal was rolling by, the unions and labour representatives occupied half of the supervisory board seats, and took up three out of five of the executive committee seats.

Of the remaining seats, according to a September 24, 2015 New York Times article by James Stewart, two seats are appointed by the German State Lower Saxony where VW is headquartered, three of the seats are held by the founding Piech and Porsche families, two other seats are held by the Qatar Sovereign Fund which owns 17 per cent of the shaeholding and one seat is held by a management representative.

How does this affect corporate governance you might ask? A board is only as good as its directors, and if its directors are singularly there to push an agenda, then that agenda is what will prevail at the expense of everything else. Hence the need to balance out a board by having a good number of independent directors who provide the voice of “other stakeholders” including minority shareholders.

In the VW case, between the union and labour representatives as well as the two state government representatives, there was always a need to ensure that employees stayed employed. Period.

The company was also driven by its chairman’s need to become the number one automobile producer in the world, which it achieved in 2014. According to the New York Times article, Ferdinand Porsche, the chairman, directed a successful turnaround at Audi before taking over the leadership at the overall VW group in 1993.

The article continues to state that VW employed nearly 600,000 people in 2014 to produce 10 million vehicles compared to the second largest automobile producer Toyota who employed 340,000 to produce just under nine million vehicles.

So if you think about it, from a basic efficiency ratio perspective, one VW employee produces 16.7 cars compared to a Toyota employee who produces 26.5 cars, almost 10 more cars than his German counterpart. Do you think any push for efficiency and wide ranging automation will garner support at a union and labour representative populated board?

Another curious construct of the VW board at the time, was the election of Piech’s wife Ursula to the board in 2012. Ursula, a former kindergarten teacher, had been his children’s governess before ascending to the new wife job description. But the Porsche and Piech family members who owned over half the voting shares and vote them as a bloc under a family agreement, were not going to be overruled by small voices at an AGM. So an employee dominated board, with a strong and powerful family dynasty representation on the same board, were never going to listen to any concerns that may have filtered up about the risks that the highly touted new diesel engines were carrying.

Nor was this board the one to ask “what is the legal fix?” at the board meeting where it was announced that the cars were never going to pass the American Environmental Protection Agency emission rules. Sell cars, remain number global one and keep everyone happy and employed was the mantra.

Needless to say Piech was forced to step down as chairman, as was the chief executive officer Martin Winterkorn following Dieselgate and VW has been forced to pay almost $25 billion in penalties.

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