The following article is from our February 2006 issue.

Whose Company Is It, Anyway? Employee representatives in the boardroom: a corporate governance model under fire. By Christine Windbichler

The composition and performance of corporate boards dominate the corporate governance debate in Germany, in Europe, and in many other countries. German companies run on the principle of "co-determination" - with employee representatives on the boards. Will anything change?

Let's take a current case. The insurance and financial services giant Allianz recently announced an upcoming merger of its Italian subsidiary Riunione Adriatica di Sicurtà with the parent company that will result in the conversion of Allianz into a European company (societas europaea, or SE). The Allianz shareholders will most likely approve this extraordinary structural change in a meeting on Feb. 8. In its new form, the supervisory board is expected to shrink from 20 to 12 members; six board members will be employee representatives.

Corporate governance specialists criticize large boards as ineffective. By law, publicly held companies in Germany are governed by a two-tier board structure, a 20-member supervisory board that appoints the managing board. Germany's laws on worker co-management of companies, an idiosyncrasy much praised, despised and discussed, give worker representatives half the seats on the supervisory board.

The EU Commission's Action 
Plan to modernize commercial law and enhance corporate governance, adopted in 2003 under the influence of the Sarbanes-Oxley-Act, seeks to strengthen the role of independent non-executive and supervisory directors. It does not address co-management issues. However, EU legislation establishing the European company (SE) struggled with a wide range of models for worker involvement in the member states. Basically, the new form ensures that prior workers' participation in the original company is preserved on the highest level when no other agreement is reached.

German-type co-determination has not been an export blockbuster. Its advocates say it is a win-win scenario emphasizing better information flow of shop-floor knowledge to the very top of the company, fewer workdays lost due to industrial conflict compared to other countries, smoother implementation of changes legitimized by a more diverse board, and a general contribution to the common good through democratic structures. Be that as it may, a radically changed environment is seriously challenging this peaceful world of compromise between capital and labor, if it ever existed.

The universally adopted form of an internationally active business enterprise is the corporate group consisting of a (publicly held) parent company controlling many domestic and foreign subsidiaries. German laws include the workforce of national subsidiaries in the constituency that elects the employee representatives to the parent company's board. But German law could hardly include foreign subsidiaries without overstepping its jurisdiction. In international groups, this leads to peculiar consequences.

DaimlerChrysler AG, incorporated under German law and listed on the New York Stock Exchange, is subject to both the German co-management regime and U.S. law. In its operational subsidiaries, DaimlerChrysler employs about 388,000 people worldwide, predominantly in Germany (185,000) and the U.S. (99,000). On the supervisory board, employee representatives elected by the German workforce take 10 of the 20 seats. The actual outcome of the elections shows a mature way of handling a delicate problem. The German metal workers' union nominated Nate Gooden, vice president of the (American) United Auto Workers, who the German workers then elected.

Increased competition of legal regimes adds to the challenges to German corporate law. After recent rulings by the European Court of Justice, firms have more opportunities to relocate to another member state where they consider corporate law less burdensome.

The announced conversion of Allianz AG into a European company (SE) is a step forward. The 12-member supervisory board is significantly smaller. It will basically follow the German model, but with one important difference: The entire (European) workforce of the SE and its subsidiaries will be represented. That means that employee representatives from several countries will have to share the six seats on the board.

German-style co-determination raises other corporate governance questions as well, especially regarding independence. Employees do not qualify as "independent directors" under the Sarbanes-Oxley Act. However, the Securities and Exchange Commission has exempted worker representatives in foreign corporations elected according to co-determination laws from the independence requirement.

In Germany, employee involvement comes in various forms. In day-to-day business, shop-floor co-determination of staff councils (also prescribed by law) flourishes. Practically, most worker representatives on the board simultaneously chair staff councils. By law, these councils representing the workers have the authority to exchange information, consult, and negotiate with managers.

Often, these same players face each other again within the company hierarchy, this time with the employee representatives as members of the supervisory board that appoints and oversees the managing board.

Frequent exchanges between management and worker representatives in day-to-day business create an environment prone to coalitions that one could label, depending on one's perspective, as consensual corporate culture, or even back-scratching. Shareholder representatives on the supervisory board may have less information and less frequent contact with management. And even if they are well-informed and want to keep a watchful eye over management, open criticism in the presence of employees (as fellow board members) may be dampened by concerns that such criticism could weaken management's effectiveness toward the workforce.

If the current regime stays unchanged it is, in the long run, likely to lose out in international competition. In its present form, co-determination as an expression of economic democracy exercising constraints over the use of private capital has not adapted to the challenges of globalization. Staunch defenders of the German model usually argue in favor of it from a narrow perspective: from inside a German corporation on German soil subject to national laws and traditional financing.

Surrendering to a single-minded shareholder-value approach, however, would throw out the baby with the bathwater. Team-based production, various forms of cooperative management, and investment in a well-trained and loyal workforce are widespread and eminently important in a sophisticated, knowledge-based economy. Employee involvement, in a very general sense, is by and large accepted as a policy goal in the EU. The predominant enlightened shareholder value orientation demonstrates that competitiveness of corporations is not precluded by sensitivity to social and environmental concerns. Sustainability, long-term goals and corporate citizenship are in line with corporate governance objectives. The problem is to find channels for employee involvement that are compatible with corporate housekeeping rules.

The German government is waiting for a report with recommendations for changes in the law by a commission already set up by the former government. Its chairman, Kurt Biedenkopf, presided over a similar commission more than 30 years ago that led to the current co-determination law. An evolutionary approach to reform requires flexible legislation, not deference to existing models. Allianz, at least, is already taking a small step.

- Christine Windbichler is a professor of law at the Humboldt University, Berlin.