Reform of the German Corporate Governance Code - The calm after the storm

On May 9, 2019, the revised version of the German Corporate Governance Code (Deutscher Corporate Governance Kodex, "DCGK") – the "Rules of Conduct" for listed companies - was adopted. After fierce protests from the top management of German companies, there was not much left of some almost revolutionary amendments that were part of the first draft of the new version published at the beginning of November 2018. Nevertheless, there are a number of notable changes for German companies. Although these changes primarily affect listed companies, they may also be relevant for small corporations such as limited liability companies (GmbHs). Reason for this is that, according to its preamble, the DCGK explicitly claims to serve as a guideline for non-capital market-oriented companies, as well.

New structure and clarity

The new version of the DCGK was drafted aiming for a "sharper and shorter" version. Unnecessary repetitions of the wording of the law were to be deleted and instead the focus was meant to be on the essentials. The tangible result of these efforts is that the new Code consist of approximately 1/3 words less than the previous version. The clarity of the Code has also been improved: Whereas the DCGK 2017 increasingly lost clarity due to its structure with up to three different topic levels plus in some cases more than five additional sub-paragraphs, the DCGK 2019 is built up stringently. Seven main chapters present the essences of the most important legal fundamentals in so-called "Principles". These Principles are then supplemented by "Recommendations" (from which a deviation needs to be explained by the company, "Comply-or-Explain" see below) and "Suggestions" (from which deviations are possible without any need for justification).

Still Comply-or-Explain instead of Apply-and-Explain

The first draft of the DCGK 2019 provided for a novelty that eclipsed all other adaptations in its scope: the "comply or explain" principle, which had been customary until then, was to be supplemented by an "apply and explain" principle, similar to foreign codes. According to this principle, companies would not only have been obliged to explain deviations from the Code, but also to provide detailed information about the specific ways of implementation of the respective requirements of the Code – even in the event of full compliance with all Code recommendations. Because of the inevitable administrative work that would have been required to do so, there was massive opposition to this approach from almost all big players in the market, resulting in the idea of the "Apply and Explain" being deleted from the draft.

Executive board compensation

The new DCGK contains far-reaching changes in the area of executive board remuneration. Accordingly, the companies are obliged to define a so-called "total target compensation" (Zielgesamtvergütung) and a "total maximum compensation" (Maximalgesamtvergütung) for members of the executive board (recommendation G.1 ff. DCGK 2019). The total target compensation defines the salary that the respective executive board member receives when fulfilling predetermined commercial targets; the total maximum compensation, on the other hand, defines the "salary cap", which may not be exceeded even if all expectations are surpassed. However, the determination of the specific amounts of the remuneration remains the full responsibility of the supervisory board of the respective company which nevertheless has to take care that the remuneration is at least appropriate for the respective industry, so-called "peer group comparison" (Peer-Group-Vergleich, recommendation G.3 DCGK 2019).

What is also new is that the Code makes statements on the type of remuneration which should consist of fixed and variable (i.e. performance-based) components. With regard to the variable components, an additional distinction is to be made between short- and long-term targets, whereby the remuneration for achieving long-term targets is to be paid in shares of the company.

According to the Code, agreements on change-of-control compensation payments, i.e. fixed payments to members of the executive board who leave the company due to a change of a majority shareholder, should generally not be concluded (no. G.14 DCGK 2019). What seems to be an improvement in terms of comprehensible payments is actually a step backwards: While the DCGK 2019 only suggests to forgo change-of-control compensation payments and hereby enables companies to depart from this suggestion without giving any justification, the DCGK 2017 contained a recommendation which provided for a maximum amount for such payments (no. 4.2.3 (5) DCGK 2017). Such a recommended maximum amount - which could not be ignored without having to explain the reasons for this - is missing in the revised version.

Term of office of executive board members

Another novelty was included regarding the term of office of the members of the executive board. According to the DCGK 2019, the initial term of office shall only be three years (recommendation B.3 DCGK 2019). In the DCGK 2017, five years had been the standard so far (cf. no. 5.1.2 subsection 2, DCGK 2017). The faster possibility to replace new executive board members – which is associated with this "probationary period" – enables companies to quickly react to the professional or personal ineptitude of new board members without making too much “noise”.

Independence of supervisory board members and limitation of memberships

For the first time, the DCGK states pre-defined criteria that contradict the required independence of supervisory board members on the shareholder side (recommendation C.7 DCGK 2019). Indicators against such independence are, for example, being a member of the supervisory board for more than 12 years or a previous (up to two years) activity as a member of the executive board of the same company. If a company wants to elect a person to the supervisory board despite fulfilling one or more of the pre-defined criteria, such company has to explain and justify why this specific person is nevertheless suitable in terms of independence (recommendation C.8 DCGK 2019).

In addition, the DCGK 2019 addresses the phenomenon of "overboarding", i.e. simultaneous membership in a large number of different company committees, which is not uncommon among members of a supervisory board. The maximum number of supervisory board mandates exercised at the same time is now five; acting as a supervisory board chairman counts double in this regard (recommendation C.4 DCGK 2019). Furthermore, a member of the supervisory board, who is also a member of the executive board of another listed company, may not hold more than two supervisory board mandates in total and is not permitted to act as a chairman of a supervisory board (recommendation C.5 DCGK 2019).

Entry into force

However, it will be some time before the DCGK 2019 actually applies. The first step to be taken will be the implementation of the Act Implementing the Second Shareholders' Rights Directive (ARUG II). Since ARUG II itself is already delayed - the corresponding EU Directive would have had to be implemented into national law by June 10, 2019 - the new DCGK 2019 will probably not be officially published by the Federal Ministry of Justice before late autumn 2019.