In an official recommendation – now in final draft form – issued in October last year, the European Commission (EC) told member states to review their laws on non-executive or supervisory boards, in light of guidelines outlined in the recommendation. If national laws do not ensure boards are sufficiently independent and free of conflicts of interest, those laws must change by June 2006.
Following financial scandals at Netherlands-based Ahold and Italy’s Parmalat, the EU asked its high-level group of company law experts to recommend ways in which the EU could reform company law to prevent future scandals. The group’s report became the basis for the EU’s action plan on company law, including corporate governance, of which the October recommendation is a part. The main objectives of the action plan are to strengthen shareholder rights and foster efficiency and competitiveness of business.
‘We will be watching,’ Dominique Thienpont, the EC’s administrator for financial markets, told attendees at the annual governance conference hosted by DSW, the German shareholder rights group, in December. ‘If companies don’t comply by June 2006, we might issue a legally binding directive.’
Brave words but – to turn Theodore Roosevelt’s famous dictum on its head – is the EC just speaking loudly while carrying a small stick? There are good reasons to believe the October recommendations will slip unnoticed into the EC’s dusty logbook of well-meant but ultimately unused initiatives. For one thing, the recommendations allow listed companies to decide for themselves what constitutes boardroom independence. For another, they do not require member states to do anything in particular, merely to monitor compliance with general principles.
Moreover, the October document – grandly entitled ‘Commission recommendation on strengthening the role of non-executive or supervisory directors’ – does not specify the proportion of independent directors who should be present on any board. Nor does it define minimum qualifications for board members, leaving that decision up to the companies themselves. What the EC does say, in plain language, is: ‘The ultimate determination of what constitutes independence is fundamentally an issue for the board itself to determine.’
Get real
If the EC means business, why did it leave such big loopholes in its recommendation? The main reason is that the EC is the combined creature of its member states, and can only push the political envelope so far. Some big and powerful listed companies – such as US-listed German multinationals grappling with new German pay-disclosure rules as well as with Sarbanes-Oxley – have told their governments that meddling with time-honored governance structures would be distinctly unwelcome at this time.
In his comments to the DSW conference, Thienpont acknowledged as much. ‘The vast majority of member states do not want a binding instrument,’ he said. ‘Many people believe the non-binding approach will deliver results. We will monitor the situation and we expect results by June 2006. However, if a lot of member states do nothing by then, or put in codes that no-one observes, the EC might decide to come up with binding rules, just as we did with auditing standards a few years ago. It is not our intention to do this, but if it is the only way, then we will.’
Fighting talk
While the wording of the recommendations is general, there is language in the appendices that could start to pinch, if the EC chooses to enforce it. Hidden in appendix II is a requirement that boards should not lose sight of minority shareholders. In particular, Section D of appendix II says board independence means, among other things, ‘not to be, or to represent in any way, the controlling shareholders.’
This provision poses a problem for Germany and, to some extent, Austria, as both countries use a two-tier corporate structure consisting of separate supervisory and managing boards. The supervisory board typically includes representatives of employees – who clearly are not independent of the company – as well as representatives of controlling shareholders, in apparent contravention of the appendix II provision.
Furthermore, appendix II raises a specific objection to the presence of representatives of controlling shareholders, particularly if there are no truly independent board members present to protect other shareholders. The absence of independent board members on many German supervisory boards means Germany has a problem – and needs to find a solution.
The sticking point is that, under the EC recommendation, independence can be defined by the supervisory boards themselves, notes Jella Benner-Heinacher of DSW. ‘I think this will create confusion,’ she says. ‘The [EC] should be more specific, more detailed.’
The wider issue
And what of the other countries in the EU? Most avoid the obvious structural governance problems present in the German and Austrian systems. The UK, for example, has adopted stringent governance reforms over the last few years, while France and the Netherlands have reformed their governance systems more recently.
Under the circumstances, even a generally worded document should help to move Europe toward harmonized governance rules, which in turn should encourage investors, says Andrew Clearfield, director of international corporate governance for New York-based TIAA-Cref. ‘It is certainly better than just having a couple of US and British institutions stand up and scream loudly,’ he told the DSW conference.
According to Christian Strenger, a member of the German government’s Corporate Governance Commission, and former CEO of DWS Investment, Germany’s largest mutual fund manager, the EC recommendation was a victim of its over-rich menu from the outset. ‘In April or May 2004, the commission proposed detailed criteria for defining the independence of board members,’ he explained to the DSW conference. ‘That did not fall on friendly ears during the consultation period.’ As a result, that approach was dropped in favor of general principles.
General guidelines are fine for countries that have a culture of democratic corporate governance, Strenger added. ‘But the new EU member states need clear terms of reference, and even in countries such as France and Germany, lawyers will look for a law that spells it all out,’ he warned.
