CG in Continental Europe and Corporate Governance Code
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A corporate governance brief report on Germany, Central Europe and the Nordic-Countries.

Development of Corporate Governance in Germany
German finance was bank-driven and universal banking was the norm (Gerschenkron 1962). Banks extended loans and credits, provided bridging finance, facilitated the transfer of ownership and participated in corporate governance through both the exercise of shareholders’ proxy votes and direct equity holdings. Despite the existence of these broad capacities, strong bank participation in corporate governance was a dominant feature of the German landscape only during the first few decades after World War II and began to weaken in the 1990s.

Germany’s traditionally insider-dominated corporate governance system has undergone substantial reforms since the early 1990s. These resulted in a “hybrid system,” Complementing the traditional stakeholder-oriented system with important elements of the shareholder-oriented system. As a result, the control of outsiders, especially minority
Shareholders, has increased and insider control has been reined in. Moreover, these reforms fostered flexibility and promoted competition between corporate governance structures, especially for public companies operating under the SE statute.

German law mandates a two-tier board structure, made up of a “supervisory board” and a “managerial board.” In companies with more than 2,000 employees, the supervisory board must be composed of equal numbers of shareholder-elected and employee-chosen members.

Banks have traditionally played a central role in listed companies’ supervisory boards, as a result of their shareholdings and of their acting as their clients’ proxies in shareholder meetings (Fohlin, 2005). Unsurprisingly, supervisory boards, packed with employees and bank representatives, have been quite ineffective in monitoring management (and dominant shareholders) on behalf of outside investors (Theisen, 1998) Concentrated ownership and “insider” control remain prominent characteristics of Germany’s corporate governance notwithstanding far-reaching reforms. Besides management, insiders include large shareholders, lenders, and labor. The importance of large shareholders is derived from the high degree of ownership concentration, despite the substantial unwinding of cross-holdings catalyzed by changes in capital gains taxation in 2002. Ownership structures remain complex and work against transparency in corporate control. Pyramidal ownership remains prevalent, allowing a dominant shareholder to exercise control of one company through the ownership of another.

It was and is an insider control system with a clear stakeholder orientation. Governance was, and possibly still is, exercised by a coalition of active stakeholder groups

Germany in the 1990s, toward greater dispersal of holdings, less relationally in banking, more liquidity in markets, greater attention to shareholder value, and more emphasis on market solutions to public problems. The full implications of current changes, however, remain ambiguous and uncertain (Streeck & Höpner 2003, Höpner 2001)

Development of Corporate Governance in Central Europe
(Czech Republic, Slovakia, southern Poland, Hungary and Slovenia)
In Central Europe the initial conditions for development of corporate governance were much more favorable than those in Russia, and are mainly determined by openness to the influence of Western Europe. The Czech Republic, Slovakia, southern Poland, Hungary and Slovenia used to form a part of the Austro- Hungarian Empire and share German civil law tradition, which they obtained from Austria or borrowed from Germany during the inter-war period. The development of capitalism was interrupted in these countries after the World War II when they were turned into Socialist states. When the Communist Block ceased to exist, Central European countries began a transition to market economy and return to capitalism. The first step in this path was the transfer of ownership from the state to private sector by means of privatization.

In the 1990s different approaches were used by different countries in Central Europe to implement privatization. According to the 2002 World Bank Report, the voucher program was the primary method of privatization only in the Czech Republic; while Slovakia used it as the secondary method and direct sales the primary one. Hungary and Poland preferred direct sales to strategic investors as their primary privatization method and management-employee buyouts as secondary. The latter was used as the primary method in Slovenia, where voucher program was the secondary method. Hungary, Poland and Slovenia chose a gradual and cautious approach to privatization, employing more traditional case by-case privatization technique, in which companies are sold to large strategic investors. However, the Czech and Slovak republics embarked on rapid mass privatization. The Czech Republic was a pioneer of mass privatization: it started the program in1991 and by 1994 had privatized more than 1,600 firms. In 1996 the Czech Republic was performing very well: new companies were emerging, economy was rapidly developing, and stock markets were functioning well. The Czech experience with privatization was called ‘a success story’. But in 1997 the situation on the Czech market deteriorated and the country went into recession. The cause of the problem was widespread tunneling: many privatized companies had been looted by insiders and voucher investment funds. The privatization in the Czech Republic was conducted through investment funds which initial number was over 500; in 1991-1992 they received over 60 percent of the total available assets. Reformers hoped that investment funds would provide necessary monitoring of enterprise restructuring; but it turned out that the funds preferred tunneling to restructuring. Many investment funds were controlled by unreformed state-dominated commercial banks which combined the functions of lenders to companies and owners to the funds. The banks did not evolve into effective monitors, and a bank-based corporate governance model similar to the German one, to the disappointment of some reformers, failed to emerge. In the absence of sound bankruptcy procedures, bank and fund relationships resulted in disregard of shareholders’ interest. Commenting on the results of mass privatization in the Czech Republic, the World Bank report states: ‘the lack of appropriate accompanying institutional polices and lagging banking sector reform made mass privatization unnecessarily costly in equity, transparency, and microeconomic efficiency’. Comparing to the Czech approach to privatization, which bore rather a spontaneous character, Polish privatization experience was a result of careful and planned calculations. Poland did not follow ‘the Washington consensus of shocktherapy’, which pressed for rapid privatization, but concentrated first on building legal and institutional framework, necessary to ensure healthy functioning of market economy. The voucher privatization program, that was planned to be launched as early as 1990, was postponed until 1995, took five years to implement and was accompanied by the government control over the ownership structure. In addition to voucher program, Poland also employed other forms of privatization, such as “privatization through liquidation”, in which assets and selected liabilities of over 1000 enterprises were sold through installment sales, as well as share floatation and direct sales. Such cautious implementation of privatization helped Poland to avoid ‘the risks of market failure and political Corruption that may result when control seekers are tempted to bribe and seduce the judicial and regulatory systems to achieve the private benefit of control’. Polish and Czech experiences with privatization exemplify two opposing views of reform planners on how privatization should be conducted. Proponents of rapid mass privatization program argue that it allows establishing ‘new owners who would support further market reforms.’ Their opponents, however, stress that ‘the quality of privatization should not be sacrificed for the speed of privatization.’ John Coffee, for instance, speaks in favor of ‘a prudent course of phased privatization’ and asserts that Poland’s success in privatization relates.

Development of Corporate Governance in Nordic countries
(Denmark, Sweden, Norway, Finland, Iceland)

The Nordic corporate governance structure lies between the Anglo-Saxon one-tier and the continental European two-tier model. The Board is responsible for the overall, In line with generally accepted international standards, the codes or the listing rules of all Nordic countries stipulate that at least half, or a majority of the Board members to be elected by the shareholders have to be independent of the company.

Conclusion

Corporate governance in continental Europe traditionally differs from that in the US and the Uk, most European companies have controlling shareholders, while most American corporations are widely held; second, the regulations on self-dealing have traditionally been stricter in the US.

The bank oriented model prevalent in Continental Europe is characterized by a certain degree of ownership concentration, and more importantly a great degree of control concentration, in the hands of one or a handful of shareholders the “blockholders”. It is bank oriented, instead of financial markets oriented, because of the central role played by financial institutions (banks and insurance companies). It is insider dominated instead of outsider dominated because these institutions are closely involved in the affairs of the companies, and are generally represented on the board.

Due to such concentrated ownership that prevails in most of the European countries that works against transparency in corporate control and allows a dominant shareholder to exercise control of one company , European countries have enacted significant corporate law reforms to strengthen the mechanisms of internal governance, empower shareholders, enhance disclosure requirements and toughen public enforcement.