4.4.2 What is the background of corporate governance in the country under review?

Since World War II Germany has been characterised by a relationship-based insider corporate governance system that, in the beginning, was heralded by many authors since the long-term relations among stakeholders led to long-term investments and a secure financial environment (Solomon 2007, p. 205). The main goal in Germany is not the maximisation of shareholder value, but the long-term objectives of the stakeholders, i.e. ensuring stability and growth. As phrased by Hackethal, Schmidt et al.: "banks want their loans to be secure; employees and unions want job security (...); family block holders want the family name and family involvement to last (Hackethal, Schmidt et al. 2005, p. 398).

The German corporate governance features - among which the two-tier board, co-determination and bank influence - were admired as well. German companies characterised by a two-tier board have a management board (Vorstand)and a large supervisory board (Aufsichtsrat) with employee representatives. The employees are important stakeholders in Germany; besides the employee representation in the supervisory board, significant employee ownership exists (Solomon 2007, p. 205) (the Co-determination Act of 1976). Thus co-determination (Mittbestimmung)1is considered an important feature of Germany's system (Mallin 2007, p. 214). In German listed companies ownership and control are mainly concentrated (Hackethal, Schmidt et al. 2005, p. 398)

and pyramidal ownership structures by means of cross-shareholdings among companies are common practice (Mallin 2007, p. 215) (Solomon 2007, p. 205). Several studies show that most German listed companies have a block owner owning more than 50% of the shares, often by means of these pyramid structures (Goergen, Manjon et al. 2008, p. 176) (Weimer and Pape 1999, p. 158), notwithstanding the fact that minority shareholders are protected and encouraged to use their shareholder rights (Voogsgeerd 2006). Another German characteristic is that banks are influential because of their direct ownership through shares, the proxy votes they can exercise and the long-term lending relationships (Goergen, Manjon et al. 2008, p. 185) (Mallin 2007, 215).

However, more recently the once heralded characteristics, referred to above, have resulted in less capital from the global market compared to othercountries; Germany had to become more market-orientated. Characteristics which had first been praised and which had contributed to the economic success, such as the two-tier board structure, the co-determination and banks' interference, were now increasingly at odds with international best practices and possibly accelerated the economic downturn (Voogsgeerd 2006, p. 73) (EStandards-Forum Financial Standards Foundation Report 2010) (Schilling 2001, p. 148) (Cromme 2005, p. 362). Therefore, achieving harmonisation with international corporate governance standards was the main driver for Germany to improve its corporate governance system (Solomon 2007, p. 205). A second objective was improving the functioning of the traditional insider-controlled corporate governance structure (EStandardsForum Financial Standards Foundation Report 2010). Several initiatives have been taken2 since this realisation to promote the German financial markets, to increase transparency and to create a level playing field in the market for corporate control. After two early and competing draft codes (Voogsgeerd 2006, p. 76) and based on the 150 recommendations of a government panel chaired by Professor Baum (Bericht der Regierungskommission Corporate Governance 10 July 2001), two legislative initiatives were taken; one mandatory (the Transparency and Disclosure Act) and one voluntary (the German Corporate Code). The government commission of the German corporate governance code, under the chairmanship of industrialist Gerhard Cromme, published its Deutscher Corporate Governance Kodex for listed companies on 26 February 2002. The code is revised annually and amended if necessary (Ringleb, Kremer et al. 2008, no. 87). The Transparency and Disclosure Act of 26 July 2002 was drafted simultaneously and dealt with transparency matters including the legal foundation for application of the code (art. 161 AktG).3 After the coming into force of the Transparanz- und Publizitatsgesetz on 25 August 2002 the management and supervisory boards were legally obliged to declare annually whether they comply with the code and, if not, what the reasons for the deviations are (Cromme 2002).

The aim of the German corporate governance code is dual and a direct result of the above developments on the German capital market (Lutter 2002, p. 524): "making the German Corporate Governance system transparent and understandable. Its purpose is to promote the trust ofinternational and national investors, customers, employees and the general public in the management and supervision of listed German stock corporations (German Code 2010, Foreword).

The code has a descriptive and a normative role. The German corporate governance system must become transparent and understandable (descriptive) and the internationally recognised standards for good corporate governance are defined (normative) (Goncharov, Werner et al. 2006, p. 433). The government determined the scope of the code in advance and by emphasising the key features of German company law the code is thus used as a marketing and communication tool (Voogsgeerd 2006, p. 82) (Cromme 2002). According to German legal doctrine, the definition of corporate governance in Germany reasons from the stakeholders' and not the shareholders' value maximisation (Goergen, Manjon et al. 2008, p. 175). The national German code, however, does not provide a definition for corporate governance. The Berliner German Code of Corporate Governance of 2001 states that corporate governance "describes the legal and factual regulatory framework for managing and supervising a company (Von Werder 2000, p. 2). Hence, in Germany corporate governance is seen as a regulatory framework that is intended to promote the quality of company management. The definition focuses on the regulation and not on the relationships and structure within the company as in the highly accepted definition4 of the OECD. At first glance this is surprising, since Germany is highly stakeholder-orientated and one would expect stakeholder elements in the definition, but taking the German desire for legislation into account (see section 4.4.4), the German definition makes sense.