4.4.9 Summary question: What are the developments after having the comply or explain principle in place for several years?

The German corporate governance system has long been considered the standard example of an insider-controlled and stakeholder-orientated system (Hackethal, Schmidt et al. 2005, p. 397). Despite many reforms and substantial changes, the main characteristics of the German corporate governance system still apply, among which a two-tier board, co-determination and block ownership (Mallin 2007, p. 214). Because of a capital market that, compared to other countries, had fallen behind and in order to attract international investors, achieving harmonisation with international corporate governance standards was the main driver for Germany to improve its corporate governance system (Solomon 2007, p. 205). On 26 February 2002 the government commission of the German corporate governance code published its first Deutscher Corporate Governance Kodex that has its legal embedding in article 161 AktG. The code is above all used as a marketing and communication tool (Voogsgeerd 2006, p. 82) (Cromme 2002). Hence its twofold aim: (i) making the German Corporate Governance system transparent and understandable and (ii) to promote the trust of the stakeholders in the management and supervision of listed German stock corporations (German Code 2010, Foreword).

In its foreword the code makes a distinction between recommendations (Empfehlungen) and suggestions (Anregungen). Companies may deviate from the recommendations but are obliged to disclose this. The German code discusses the major criticisms usually levelled (by international investors) at Germany (Nowak, Rott et al. 2006, p. 10), i.e. inadequate focus on shareholder interests, the two-tier board system, inadequate board independence, inadequate transparency and limited independence of auditors. The key issue of the German national code is, however, the supervisory board (Voogsgeerd 2006, p. 89) (Du Plessis, Großfeld et al. 2007, p. 28) (Ulmer 2002, p. 155). Many provisions explain the desired relationship with the management board and the functioning of the supervisory board. Although the appointment periods and the maximum number of board members can be regarded as changes in German corporate governance, the German code does not contain any detailed criteria on the independence of supervisory board members. This seems a missed opportunity, but Germany fears that far-reaching detailed material independence criteria will interfere with the legislative system of co-determination (Voogsgeerd 2006, p. 88). Although the extensive provisions on the supervisory board reflect Germany's corporate governance characteristic of a two-tier board, the main cultural dimensions of Germany (i.e. uncertainty avoidance and a low power distance) are not reflected in the actual code provisions. Nevertheless, the code's aims and emphases strongly show these cultural dimensions; most of the code's contents are a repetition of legislation (uncertainty avoidance) and the interests of all stakeholders are taken into account (low power distance). Typical German features such as co-determination and the influence of the banks are not code topics but are laid down in legislation, as can be expected of the uncertainty-avoiding Germany. It is justly wondered whether the German code can be considered an actual new judicial arrangement, since most of it is a repetition of the already existing legislation (Voogsgeerd 2006, p. 84). Nonetheless, judicial corporate governance arrangement D (regulation of self-regulation) applies. The code and comply or explain principle are legally embedded in article 161 of the Transparanz- und Publizitätsgesetz, since the code needed legislation to gain judicial value. And, as stated above, most rules in the German code are a repetition of German legislation, with an explanatory nature (Du Plessis, Großfeld et al. 2007, p. 28) (Ulmer 2002, p. 152). For Germany the judicial arrangement itself is a novelty, due to the limited experience with self-regulation. The code contents - although in line with the international best practices - are, however, hardly innovative. Important corporate governance rules still need to be laid down in legislation (Nowak, Rott et al. 2006, p. 9) and the legal nature of the code and the recommendations remain a matter to be discussed.

The corporate governance statement has to be disclosed annually by the management and supervisory board in the company's annual report and previous statements have to be kept visible on the company's website for five years. The internet is regarded as an important communication instrument between the company and its stakeholders. The German comply or explain principle is orientated to the past and to the future (Du Plessis, Großfeld et al. 2007, p. 25) (Ulmer 2002, p. 171). This future-orientated approach is remarkable, yet quite obvious. Investors' decisions regarding investments or disinvestments are largely based on future facts and therefore a corporate governance statement that is future-orientated is in fact more valuable for and investor (Du Plessis, Großfeld et al. 2007, p. 25).

Germany believes that market forces will result in the adoption of the code (Nowak, Rott et al. 2006, p. 12). Companies not complying or explaining sufficiently risk underpricing of their shares; shareholders should be willing to pay more for shares in companies with good corporate governance. Supervision of material and formal code compliance ought to be performed by shareholders during shareholders' meetings and through the share market itself. Since the corporate governance statement is part of the annual report, the external auditor performs supervision of code compliance as well. Although in literature the debate on the precise role of the auditor is ongoing, the auditor has the legal duty to report on the timeliness of publication and the accessibility of the corporate governance report (supervision of formal compliance). The German court cannot be regarded as a supervisor of code compliance, notwithstanding the fact that in doctrine discussion exists on possible court proceedings concerning code compliance (Wymeersch 2005, p. 122). The position will probably be that, in the future, the code could be used by the German courts as a useful instrument in determining the standards of good corporate governance (Du Plessis, Großfeld et al. 2007, p. 32). And the lingering discussions require further clarification of the liability risks and legal consequences of publishing misleading or incorrect corporate governance statements (Nowak, Rott et al. 2006, p. 11).

Several different studies on German code compliance have been performed and since 2003 the Berlin Center of Corporate Governance annually assesses the code compliance as well. In general a high level of code compliance can be seen, which tends to increase with the size of the companies and has stabilised in more recent years (Talaulicar and Von Werder 2008, p. 257). A fixed set of code recommendations are not or insufficiently complied with, especially the recommendations on the (disclosure of) board compensation and the elections of the supervisory board (Talaulicar and Von Werder 2008, p. 261) (Cromme 2004) (Voogsgeerd 2006, p. 99). The high level of compliance is partly explainable because the contents of the code are, for the greater majority, already laid down in legislation and as a consequence thereof compliance is easy and obligatory.

The optimum framework for Germany (see table 4.4.9 above) is quite diffuse. On some points Germany scores very well and on others points substandard. An updated code, annual compliance studies, discussion and jurisprudence on accountability rules and a statement aimed at future code compliance are positive items. On the other hand, three-level supervision of code compliance is not present. Moreover, the fact that the word "shall" in code provisions indicates that the comply or explain principle is applicable is very unclear. The word is easily overlooked and questions remain as to whether the principle then applies to the entire code provision.

To conclude, after having the comply or explain principle in place for several years Germany lives up to the international standards, scores high on code compliance, with a fixed set of recommendations insufficiently complied with, and still has its cultural features in place as laid down in legislation. The German corporate governance code functions properly as a marketing and communication tool, but lacks innovation, three-level supervision and clarity about which recommendation the comply or explain principle is applicable to.