European Commission: markt-complaw@ec.europa.

eu

Dsseldorf, 21 July 2011

560

European Commission Green Paper on The EU corporate governance framework, dated 5 April 2011, COM(2011) 164

Dear Sir or Madam, We would like to thank you for the opportunity to comment on the European Commissions Green Paper on the EU corporate governance framework. The IDW generally welcomes the European Commissions initiative to assess the effectiveness of the current corporate governance framework for European companies. Sound corporate governance is important, as it is a key factor in ensuring confidence in listed companies and thus for the functioning of capital markets. The audit of the financial statements of listed companies is an essential element in the corporate governance system. Therefore, any improvements should include due consideration to how audit interacts with the other elements of the governance of the entity. In particular, the relationship between the audit committee and the auditor is of key importance, as noted in the Green Paper Corporate governance in financial institutions and remuneration policies, dated 2 June 2010, and in the Green Paper on Auditing, dated 13 October 2010. We strongly support the opinion of the European Economic and Social Committee that it is imperative that the Commission integrates its proposals on corporate governance with its proposals on audit policy, because both issues are inextricably linked in so far as the veracity of company accounts is concerned (see Opinion

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of the EESC on the Green Paper Audit Policy: Lessons from the Crisis, dated 16 June 2011, sec. 1.9). As already stated in our Comment Letter relating to the Green Paper on corporate governance in financial institutions and remuneration policies, dated 31 August 2010, we view a real change in the behaviour of the relevant actors as the key factor to improve existing corporate governance practices. There needs to be a strengthened corporate governance commitment; a commitment to enhanced corporate governance quality and culture. Nevertheless, one has to keep in mind that getting the culture and behaviour of the relevant players right cannot be achieved solely by setting new rules and requirements at European level. (New) European rules have to be carefully balanced with existing rules and requirements at national level. National regulation, codes, guidance etc. regarding corporate governance matters differ significantly from one EU Member State to another and need to be considered when looking for a common European solution. We therefore support the idea of setting high quality principles and benchmarks for corporate governance at European level in order to create a level playing field. Additionally, the enforcement of corporate governance matters is often not straightforward based on specific laws and regulations. Consequently, a principles-based (comply or explain-) approach to corporate governance is preferable to a rules-based approach (see our answer to questions 24 and 25). Given the fact that various well accepted national corporate governance regimes already exist within the EU, the EU Commissions competence to define detailed rules and regulations regarding this matter can be questioned on the grounds of the principle of subsidiarity provided in Article 5 par. 3 EU Treaty. Finally, our impression of the Green Paper is that it has been overly based on the unitary board system. We would like to suggest that more emphasis be placed on both the different systems (unitary board system as well as two-tier system) that are prevalent in the EU in future. We would like to comment on the questions raised as follows.

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General questions Question 1: Should EU corporate governance measures take into account the size of listed companies? How? Should a differentiated and proportionate regime for small and medium-sized listed companies be established? If so, are there any appropriate definitions or thresholds? If so, please suggest ways of adapting them for SMEs where appropriate when answering the questions below. In principle, a uniform regime should apply to all listed companies. Companies that enter the capital market should generally fulfil the same obligations. Nevertheless, corporate governance measures should be proportionate to the nature, size and complexity of the listed entity and its business. This applies particularly to obligations regarding the composition of boards or the constitution of committees, as such obligations would be inappropriate in cases of boards with, e.g., only three members.

Question 2: Should any corporate governance measures be taken at EU level for unlisted companies? Should the EU focus on promoting development and application of voluntary codes for non-listed companies? We doubt the need for any corporate governance measures at EU level for unlisted companies. The need for specific additional requirements for listed companies is generally based on the principal-agent-conflict. Listed companys shareholders are much more dependent on a reliable management than are owners of a private company who are much closer to their management and thereby have, for instance, information rights or other possibilities to contribute to the companys business. This differentiation is also recognised in the Statutory Audit Directive, which states that public-interest entities shall have an audit committee (Article 41). In addition, as a result of the implementation of the Second EU Directive, unlisted public limited liability companies in all EU-Member States are subject to safeguards for the protection of the interests of members and others. Based on these provisions, Member States had to coordinate their national provisions relating to their formation and to the maintenance, increase or reduction of their capital. In doing so, Member States decided which related corporate governance measures should be adopted for unlisted companies, as was the case in Germany and in most of the other Member States. No further requirements are

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needed, especially as there is no evidence to suggest that national systems failed in this matter.

Boards of directors Question 3: Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided? In our view, the functions and duties of the companys management body should be clearly divided from the functions and duties of its supervisory body, including their respective chair persons. A clear separation of functions and duties contributes to the effectiveness of a corporate governance system. Nevertheless, in exceptional cases, in view of the principle of board competence, it may be appropriate to determine special competences for the boards chair. Division of duties and responsibilities is a constitutional element of the two-tier system, as established in Germany. Nevertheless, a division of functions is not only feasible in two-tier systems, but also in unitary board systems, to the extent that individual board members are allocated duties according to whether they are executive or non-executive board members.

Question 4: Should recruitment policies be more specific about the profile of directors, including the chairman, to ensure that they have the right skills and that the board is suitably diverse? If so, how could that be best achieved and at what level of governance, i.e. at national, EU or international level? It is highly important for the company itself and for the trust that shareholders place in them, that board members have expertise in the specific industry and an understanding of the particular business model as well as sufficient time to fulfil their role. The specific internal know-how of employees also plays an important role in this regard. Experience and skills should be balanced to ensure that each of the companys boards taken as a whole has strong expertise pertaining to the activities of the entity. However, predefining precise profiles for specific board members would give rise to a bureaucratic burden, reduce flexibility and encroach upon an entitys ability to make its own decisions, especially in case of smaller companies.

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These aspects have been taken into consideration, for example, in the German Corporate Governance Code. The Code states, that the supervisory board has to be composed in such a way that its members as a group possess the knowledge, ability and expert experience required to properly complete its tasks. To achieve this, the supervisory board shall specify concrete objectives regarding its composition which, whilst considering the specifics of the enterprise, take into account the international activities of the enterprise, potential conflicts of interest, an age limit to be specified for the members of the supervisory board and diversity. In our view, there is no need for statutory provisions in this area, and certainly not at European level. In this context, we also refer to our answer to question 6 regarding gender balances on boards.

Question 5: Should listed companies be required to disclose whether they have a diversity policy and, if so, describe its objectives and main content and regularly report on progress? In our view, the companys supervisory body should be required to set concrete objectives regarding its composition and the status of their implementation. We also understand the proposal to require the publication of the diversity policy in the annual corporate governance report. However, it should be discussed, whether this could lead to inflexibility or a decrease in quality in relation to the selection of supervisory board members. In our view, such disclosure of the companys diversity policy is a suitable solution for informing the shareholders of listed companies. We suggest it be considered as a European wide recommendation.

Question 6: Should listed companies be required to ensure a better gender balance on boards? If so, how? As already stated in our Comment Letter on the Green Paper on corporate governance in financial institutions and report on remunerations, dated 31 August 2011, we support diversity in supervisory boards and its subcommittees with regard to competences, qualifications, background and, if possible, also to gender, age, nationalities etc. However, it is important to recruit the best person for the job. Therefore, quotas of any kind would be rather counterproductive. Of

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more importance than the composition of the board is ensuring that the board is run effectively, functions properly and works efficiently. In addition, it is important to recruit new members from a sufficiently large and diversified pool of candidates, which is substantially wider that an established network of candidates. Moreover, quotas as a one-size-fits-all-solution would give rise to a bureaucratic burden, reduce flexibility and encroach upon an entitys ability to make its own decisions, especially in case of smaller companies.

Question 7: Do you believe there should be a measure at EU level limiting the number of mandates a non-executive director may hold? If so, how should it be formulated? The key issue is that each board member should be able to devote sufficient time and the necessary attention to his or her respective role. However, we do not think that regulatory measures in the form of detailed rules or particular limits at European level would be appropriate. Member States should decide whether to determine specific rules on this issue, leaving adequate autonomy and flexibility to the companies. It needs to be borne in mind that the time needed by board members to perform their mandate can vary considerably, depending on many circumstances, as, for instance, the complexity of the company or the experience of the board member concerned. A one-limit-fits-allsolution does not seem appropriate. The German Stock Corporation Act specifies requirements for members of the supervisory board including a limitation of the number of mandates: a member of the supervisory board may not hold more than ten mandates in companies that are required by law to set up a supervisory board (sec. 100 par. 2 Nr. 1 AktG). Question 8: Should listed companies be encouraged to conduct an external evaluation regularly (e.g. every three years)? If so, how could this be done? In our opinion, listed companies should be encouraged to conduct evaluations to examine the efficiency of their boards activities. We consider (internal) self-evaluation more beneficial than external evaluation because board member have a more in-depth insight into their activities and may well tend to conduct self-evaluation in a more open and honest manner.

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Nevertheless, companies and boards should be able to decide whether their efficiency should also be evaluated by, or with the help of, qualified external persons from time to time (e.g. every two or three years). We agree with the Commission that the use of an external facilitator could improve board evaluations by bringing an objective perspective and sharing best practices from other companies. A combination of self-evaluation and evaluation by external experts might be a feasible way to combine the benefits of both approaches. In any case, the instrument of (self-)evaluation only works when companies boards can themselves decide upon the evaluation method, the main issues to be evaluated and specific criteria for the evaluation taking due account of the size and complexity of the company and the respective board. Consultations with external evaluators might help finding determining the most suitable evaluation method and criteria for the individual company. A one-size-fits-all-solution might be counterproductive in terms of the benefits of the evaluation and is therefore not suitable. On this basis, we would advise against any statutory provisions in this area. Self-evaluation should be conducted on a regular basis, for example every year. Additional self-evaluation exercises might be appropriate in certain circumstances and thus could be performed if board members decide to do so. In any case, the board as whole should be subject to the (self-)evaluation and not individual board members. The board functions within a cooperative, loyal and trustful relationship, and evaluations of single board members would be counterproductive. We agree with the Commission that disclosure of any evaluation statement should be limited to explaining the review process. It might even be sufficient to explain only whether or not an evaluation has been conducted. It will also be important to ensure confidentiality so as to encourage openness, which, in turn will enhance the efficiency and effectiveness of the evaluation.

Question 9: Should disclosure of remuneration policy, the annual remuneration report (a report on how the remuneration policy was implemented in the past year) and individual remuneration of executive and nonexecutive directors be mandatory? An entitys remuneration policy has a significant impact on managements business activities and behaviour. The disclosure of remuneration policy is an important measure that will enable shareholders to understand and evaluate these

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policies for themselves, and, in some cases, use their influence to have changes made. Shareholders need to be in a position to evaluate the remuneration policy, in particular in terms of whether it has been constructed such as to provide sufficient incentive for management to act in the way shareholders would wish. On the other hand, the benefit of disclosing separately the remuneration of particular individuals is questionable. There might indeed be shareholders interested in such information. Nevertheless, these interests have to be balanced with the risks arising from such disclosure, e.g. the risk of creating false incentives. This would be counterproductive to an entitys general endeavours to strengthen its ability to sustain its commercial operations in the long term.

Question 10: Should it be mandatory to put the remuneration policy and the remuneration report to a vote by shareholders? Because the supervisory board (or the non-executive directors) is generally understood to represent the shareholders, it is right to allow the shareholders opinion on an entitys remuneration policy to be voiced. The remuneration of the supervisory board members in Germany already falls within the responsibility of the shareholders (see sec. 113 AktG). However, shareholder influence does not likewise extend to management boards remuneration. The supervisory board is currently alone responsible for determining the remuneration of the management board and can even be held liable if the remuneration was inappropriate. Given this clear responsibility of the supervisory board, perhaps the remuneration policy and the remuneration report could in future be subject to a non-binding vote by the shareholders, as this would not intervene in the role that the supervisory board currently has.

Question 11: Do you agree that the board should approve and take responsibility for the companys risk appetite and report it meaningfully to shareholders? Should these disclosure arrangements also include relevant key societal risks? Question 12: Do you agree that the board should ensure that the companys risk management arrangements are effective and commensurate with the companys risk profile? As already mentioned in our general comments above, the Green Paper is to a large extent influenced by the unitary board system. That influence becomes

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particularly apparent reading questions 11 and 12 and section 1.5 of the Green Paper. During the further discussion of the Green Paper and in particular when establishing new European rules on corporate governance, it will be necessary to give carefully consideration to the division of roles between the management board and the supervisory board in a two-tier system so that their respective competences which are also laid down in the Statutory Audit Directive 2006 do not become blurred. Our response is based on the two-tier system, as this is applicable in Germany. First of all, we understand the companys risk appetite as the determination of the companys risk profile, which is part of the companys strategic approach, including its assessment of risks and benefits. In a two-tier system, the role of the management board is to define and establish the companys risk profile and risk strategy whereas the role of the supervisory board is to monitor the appropriateness and also the effectiveness of that strategy. This is in line with the Statutory Audit Directive 2006, which describes inter alia the monitoring of the effectiveness of the companys risk management system as one of the duties of the audit committee (Article 41). German law concretises the different roles of the boards by defining specific rights and duties for each board as follows: The German Corporate Governance Code states that the management board coordinates the enterprise's strategic approach with the supervisory board and discusses the current state of strategy implementation with the supervisory board at regular intervals. Furthermore, the management board informs the supervisory board regularly, without delay and comprehensively, of all issues important to the enterprise with regard to planning, business development, risk situation, risk management and compliance (sec. 3.2, 3.4 of the Code). In addition to this, the German Stock Corporation Act accords the supervisory board extensive information rights. Consequently, the management board has to inform the supervisory board regularly, especially with respect to its business policy, material transactions and company issues of interest, as well as at the request of the supervisory board (sec. 90 AktG). Furthermore, the Act states that either the Articles of Association or the supervisory board have to specify which types of business transaction require the approval of the supervisory board, especially as regards decisions or measures which fundamentally change the asset, financial or earnings situation of the company. In those cases

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where the supervisory board refuses to give its approval, the management board can demand approval be sought at the general meeting (sec. 111 par. 4 AktG). It is, however, important to underline that the supervisory board in the German two-tier system has only a veto right, but not the power to give directives to the management board. The management board bears the sole responsibility for the management of the company, and cannot delegate this to the supervisory board. We have concluded that the supervisory board should not take responsibility for the management boards decisions, as the supervisory boards role is primarily a monitoring one.

Shareholders Minority shareholder protection Question 21: Do you think that minority shareholders need additional rights to represent their interests effectively in companies with controlling or dominant shareholders? In our view, the EU-wide harmonisation of some essential parts of the law pertaining to consolidated entities / groups could be useful. In Germany, there are detailed statutory provisions as to (factual) groups which place minority shareholders in a position with well balanced rights. For example, a company which is subject to parent company control must report its relationships with related parties. This enables minority shareholders to receive information about transactions and other measures which have been taken up or rejected by the company. In addition to this and other rights to receive information, the law also provides for dividend guarantees and compensation rights in certain circumstances. In our view this standard as it currently exists in Germany is sufficient. Any additional regulation in this area would be inappropriate as tit would make it difficult for companies to adapt and make structural changes.

Question 22: Do you think that minority shareholders need more protection against related party transactions? If so, what measures could be taken? According to the Fourth and Seventh EU Directive, the notes to the accounts must set out information on material transactions which have been entered into with related parties by the company, including the amount of such transactions, the nature of the related party relationship and other information about the transactions necessary for an understanding of the financial position of the

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company. In Germany, these rules were implemented in 2009 and companies had to comply with these new requirements for the first time in the financial year 2009. The impact of these new disclosure requirements should be determined so that it can be taken into account before addressing further measures regarding related party transactions. Moreover, related party transactions are dealt with in IAS 24. We doubt there is a need for further regulations in this area, particularly in view of the fact that the existing requirements are already quite onerous for companies. There should be no requirement whatsoever for the supervisory board to obtain an opinion from an unbiased external source as to the terms of a transaction with a related party. Such an intervention in the business affairs would be detrimental to the task of managing a company.

Monitoring and implementation of Corporate Governance Codes Question 24: Do you agree that companies departing from the recommendations of corporate governance codes should be required to provide detailed explanations for such departures and describe the alternative solutions adopted? Question 25: Do you agree that monitoring bodies should be authorised to check the informative quality of the explanations in the corporate governance statements and require companies to complete the explanations where necessary? If yes, what exactly should be their role? The IDW is a strong supporter of the comply-or-explain-approach, because it is an appropriate and flexible way in which to influence a companys culture and business behaviour. It is preferable to additional laws and regulations in the area of corporate governance. This approach enables a company to decide upon corporate governance issues to fit its specific strategies and circumstances, such as, for instance, its particular financial situation, size or business model. Listed companies have to explain whether and why they do not comply with recommendations of the Corporate Governance Code. Thus, the capital market receives information about the companys decisions to which it might react. In our opinion, this is an (and the only) appropriate sanction when companies chose to disregard the Code.

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Given the concept behind and operation of Corporate Governance Codes, it seems unnecessary to give regulators the role of verifying such information. We would prefer it be left to the capital market. It would even seem counterproductive, because the companys explanations could tend to become less meaningful (e.g. boilerplate text). If you have any questions relating to our comments, we would be pleased to be of further assistance. Yours faithfully

Klaus-Peter Naumann Chief Executive Officer