Corporate Governance

Germany, Japan & US Corporations

Contents
Alternative Governance System (Germany
and Japan)
The German System and Japanese Keiretsu
Governance Structures of American
Corporations
Owners, Voting Rights, Board of Directors,
Corporate Executives and Senior
Managers, Creditors etc
Corporate Governance In
Germany
Introduction
The German Corporate Governance Code
(the "Code") presents essential statutory
regulations for the management and
supervision (governance) of German listed
companies and contains internationally
and nationally recognized standards for
good and responsible governance.
The Code aims to make the German
Corporate Governance system transparent
and understandable.
Its purpose is to promote the trust of
international and national investors,
Dual Board

A dual board system is prescribed by law for

German stock corporations.ie. The Management
Board (Aufsichtsrat) and The Supervisory Board
(Vorstand).
The Management Board is responsible for
managing the enterprise. Its members are jointly
accountable for the management of the
enterprise.
The Chairman of the Management Board
coordinates the work of the Management Board.
The Supervisory Board appoints, supervises and
advises the members of the Management Board
and is directly involved in decisions of
Cont..
The members of the Supervisory Board are elected
by the shareholders at the General Meeting.
The representatives elected by the shareholders
and the representatives of the employees are
equally obliged to act in the enterprise's best
interests.
The accounting standards of German enterprises
are oriented on the true and fair view "principle
and must present a fair picture of the actual
conditions of the asset, financial and earnings
situations of the enterprise.
Management Board (Vorstand)

Composition
The management board is made up of five
to fifteen full-time employees of the
company and is responsible for the
operations of the company.
The management board is appointed by
the supervisory board and reports to it
It shall govern the work of the
Management Board
Involves in the allocation of duties among
individual Management Board members,
Tasks and Responsibilities of
management board
The Management Board is responsible for
independently managing the enterprise by taking
into account the interests of the shareholders, its
employees and other stakeholders
It develops the enterprise's strategy, coordinates
it with the Supervisory Board and ensures its
implementation.
It ensures that all provisions of law and the
enterprises internal policies are abided by and
works to achieve their compliance by group
companies (compliance).
It ensures appropriate risk management and risk
controlling in the enterprise.
Supervisory Board (Aufsichtsrat)

Composition
The supervisory board consists of from nine to
twenty two members
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
In its election recommendations to the General
Meeting, the Supervisory Board shall disclose the
personal and business relations of each individual
candidate with the enterprise, the executive
bodies of the company and with a shareholder
holding a material interest in the company.
Tasks and Responsibilities of
supervisory board
The task of the Supervisory Board is to advise
regularly and supervise the Management Board in the
management of the enterprise. It must be involved in
decisions of fundamental importance to the
enterprise.
It appoints and dismisses the members of the
Management Board.
For first time appointments the maximum possible
appointment period of five years should not be the
rule and an age limit for members of the Management
Board shall be specified.
The Supervisory Board shall issue Terms of Reference.
Shareholders
To the extent provided for in the Articles of Association
the shareholders exercise their rights before or during
at the General Meeting and, in this respect, vote.
In principle, each share carries one vote. There are no
shares with multiple voting rights, preferential voting
rights (golden shares) or maximum voting rights.
Rights of shareholders
Participation in Annual General meeting
Dcisions regarding supervisory board members,
selection of the auditors and use of the annual profit
Stockholders > 5% can set up topics during the general
meeting
General meeting and shareholders

The Management Board submits to the

General Meeting the Annual Financial
Statements, the Management Report, the
Consolidated Financial Statements and the
Group Management Report.
When new shares are issued,
shareholders, in principle, have pre-
emptive rights corresponding to their
share of the equity capital.
Each shareholder is entitled to participate
in the General Meeting to submit
materially relevant questions and
Cont..
At least once a year the shareholders'
General Meeting is to be convened by the
Management Board giving details of the
agenda.
The company shall facilitate the personal
exercising of shareholders' voting rights
and the use of proxies and company
should make it possible for shareholders to
follow the General Meeting using modern
communication media (e.g. Internet).
Cooperation between
Management Board and
Supervisory
The ManagementBoard
Board and Supervisory
Board cooperate closely to the benefit of
the enterprise.
The Management Board coordinates with
the Supervisory Board and discusses the
current state of strategy implementation
at regular intervals.
Providing sufficient information to the
Supervisory Board is the joint
responsibility of the Management Board
and Supervisory Board.
The Management Board informs the
Transparency
The company's treatment of all shareholders in respect of
information shall be equal. All new facts should be disclosed to
financial analysts and shareholders
Any information which the company discloses abroad in line
with corresponding capital market law provisions shall also be
disclosed domestically without delay.
If the entire holdings of all members of the Management Board
and Supervisory Board exceed 1 % of the shares issued by the
company, these shall be reported separately for the
Management Board and Supervisory Board in the Corporate
Governance Report.
As part of regular information policy, the dates of essential
regular publications (including the Annual Report, interim
financial reports) and the date of the General Meeting shall be
published sufficiently in advance in a "financial calendar".
Audit Committee
The Audit Committee shall obtain a statement from the
proposed auditor stating whether, and where applicable,
which business, financial, personal and other relationships
exist between the auditor and its executive bodies
The Audit Committee will be informed immediately of any
grounds for disqualification or partiality occurring during the
audit, unless such grounds are eliminated immediately.
The Supervisory Board shall report without delay on all facts
and events of importance for the tasks which arise during
the performance of the audit.
The auditor takes part in the Supervisory Board's
deliberations on the Annual Financial Statements and
Consolidated Financial Statements and reports on the
essential results of its audit.
UNIVERSAL BANKING: A
GERMAN GOVERNANCE
SOLUTION
The essence of the German universal banking
system is that German banks can own equity in the
companies to which they lend money.
Reduction of conflicts of interest between creditors
and shareholders as they are the same people.
Advantages of Universal Banking
The bank is a committed investor.
Creditors protect themselves from the games of
borrowers by writing positive and negative
covenants into loan agreements and by simply
refusing to lend more money.
Lenders can force the firm to restructure itself
through the bankruptcy courts, or ask the courts to
Cont..

When banks also own equity in the

borrower, the risks associated with the
borrowers playing games that transfer
wealth from the creditor to the borrower
are ameliorated;
Lower cost of capital for firms to increase
their financial leverage and substitute
cheap debt financing for expensive debt
financing.
Access to the companys financial
situation, making it more difficult for the
borrower to mislead the bank.
Disadvantages Of Universal
Banking
Banks may be more interested in the
survival of the firm as a borrower than in
maximizing the wealth of public
shareholders,
Banks will discourage firms from
distributing cash dividends because this
cash would leave the company, thus
weakening the banks creditor position.
Weak Investor Protection Laws
Absence of an efficient equity market
discourage Formation of New Firms
Corporate Governance System
of Japan
Introduction
Japan's corporate governance system
known as akeiretsudates back to the
1600s,
The keiretsu is a network of affiliated
companies (industrial grouping or
"lineage") formed around a central
company or bank and connected through
cross-ownership and relational contracting.
and structured as either a horizontal or
vertical integration model.
These early corporate formations were
termed "zaibatsu," translated to English as
Collapse of the Zaibatsu
Under a zaibatsu, the largest industrial
groups allowed banks and trading
companies to be the most powerful and sit
at the top of an organizational chart.
Banks and trading companies controlled
all financial operations and the distribution
of goods.
When the U.S. rewrote the Japanese
constitution after World War II, the United
States eliminated zaibatsu holding
companies because of their undemocratic
nature as monopolies
Japanese Corporate Model in the
1980s
Cross-holding of shares among businesses
Strong government-business ties: convoy
capitalism
No distinction between execution and supervision
Debt finance preferred to equity finance
Seniority and life time employment system
Cross-shareholding among industrial
groupings called keiretsu
made equity markets illiquid
provided a business with a good defense against
hostile takeovers
rendered shareholders passive owners
Modern Horizontal Keiretsu
Today's keiretsu horizontal model sees banks and trading
companies at the top of the chart with significant control over each
company's part of the keiretsu. Shareholders replaced the families
controlling the cartel as Japanese law allowed for
holding companiesto become stockholding companies.
Typical of a Japanese horizontal keiretsu is Mitsubishi where the
Bank of Tokyo-Mitsubishi sits at the top of the keiretsu. Also part of
the core group is Mitsubishi Motors and Mitsubishi Trust and
Banking followed by Meiji Mutual Life Insurance Company which
provides insurance to all members of the keiretsu. Mitsubishi Shoji
is the trading company for the Mitsubishi keiretsu.
Their purpose is strictly distribution of goods around the world.
They may seek new markets for keiretsu companies; help
incorporate keiretsu companies in other nations and sign contracts
with other companies around the world to supply commodities
used for Japanese industry. Many companies within this keiretsu
have "Mitsubishi" as part of their name
Modern Vertical Keiretsu
Vertical Keiretsu are the group of
companies within the horizontal keiretsu.
The success of these companies is
dependent on suppliers and manufacturers
, employees for production, real estate for
dealerships, suppliers as well as
wholesalers.
The Japanese focus on societal relations,
as well as cross shareholdings, allowed
Keiretsu to perpetuate themselves since
World War II.
All ancillary companies operate within the
Cont..
Banks regularly owned a small percentage
of their keiretsu members' stock and
members owned a portion of the bank's
stock forming an interlocking relationship
The interlocking relationships allowed the
bank to monitor borrowings, strengthen
relationships, monitor customers and help
with problems such as supplier networks
This arrangement limited competition
within the keiretsu and prevented
company takeovers by outsiders of the
keiretsu
Toyota

Toyota's success is dependent on suppliers and

manufacturers for parts, employees for
production, real estate for dealerships, steel,
plastics and electronics suppliers for cars as well
as wholesalers.
All ancillary companies operate within the
vertical keiretsu of Toyota
Without Toyota as the anchor company, these
companies may not have a purpose for existence.
Toyota exists as a major keiretsu member
because of its history and relationship to major
horizontal members that dates back to its early
Under the Committee system

A large company is to
- do away with corporate auditors
- instead establish the three committees for
nomination, compensation and audit, each
consisting of three directors and more with the
majority being outside persons
- introduce the new office of executing
officers separate from the board,
responsible for the execution of business
operations, distinguishing control and
management.
But in practice
Only a limited number of companies have
shifted to the new system: 1.2 %
Under the conventional auditor system
more companies introducing a new non-
statutory corporate officers post,
- delegating some execution power to
such officers,
- slashing the number of directors
A third, mixed type with no statutory base
seems gaining force
Duo Core System
Insider Type Corporate Governance
System
Characteristics
Based on a long-term relation and mutual reliance.
Not taking opportunity principle mutually.
The bearer of corporate governance is limited.
Monitoring is taken on by a main bank.
Insufficient disclosure.
Strengths
Stable management and stable employment.
Retrenchment of monitoring cost.
Internalize adjustment cost
Limitations
Uncertain management system.
The system becomes invalid when the management is
unstable.
Open Type Corporate
Governance System
Based on law, contracts, and self-responsibility.
A lot of bearers of corporate governance.
Various kinds of monitors.
Assuming the existence of the market, with free entry
and free withdrawal.
Sufficient disclosure.
Price mechanism works
Strengths
Incentive mechanism works for managers.
Easy to promote business restructuring.
Limitations
Burgeoning monitoring cost.
Generate free riders of monitoring.
Promote rent-seeking activities.
Insider type governance
does not work well in
current
With the recent Japan?
1) Indirect finance to direct finance by financial deregulation
deregulation of Japanese financial markets,
. Many large firms have replaced bank loans with direct borrowing
from capital markets, such as bonds and commercial paper.
Diversifying the means of financing weaken the function of main
banks. In this case, it is thought that not an insider type, but open
type governance comes to function.
2) Dynamics have changed between main bank and firm
High net worth Japanese firms appear to have freed themselves
from the corporate governance of banks.
Banks are becoming less powerful in corporate governance
matters in many firms, and at the same time are growing more
interested in high share values.
The ability of the Japanese CGS to use bank monitoring to reduce
the agency costs of debt have fallen and can be expected to
continue falling.
The Downsides of Keiretsu
The limited competition within the keiretsu may lead to an
inefficient company because a keiretsu company knows they
can easily access capital.
This could potentially allow a company to take on too much
debt and lead it into taking on overly risky strategies.
Information is shared among customers, suppliers and
employees leading to quicker investment decisions and
suppliers, employees and customers know the purposes and
goals of investments.
Keiretsu can't adjust to market changes quick enough.
The economic crisis in Japan forced companies to compete
for price and quality by using market-based systems instead
of keiretsu relational arrangements
Major horizontal banks' reported losses. Japanese companies
were forced to seek financing outside the keiretsu by
borrowing from thebondandcommercial papermarkets.
Comparison of governance
system in Germany & Japan
Similarities among CGS of
Germany and Japan
Corporate ownership is typically concentrated among
strategically oriented banks and other industrial firms,
rather than fragmented among individuals and
financially oriented institutional investors.
The market for corporate control is largely non-existent
Banks play the central external governance role in time
of financial distress
Employees exercise voice within corporate governance
through legal rights to codetermination in Germany or
extensive use of joint labor-management consultation in
Japan resulting in long employment tenures, infrequent
use of lay-offs and high investment
Internal promotions of top managers
Managerial compensation is much closer to that of
average employees schemes and lack strong
 Differences

Germany Japan
Role of law
The two-tier board system The informal arrangements of
reflects strong legal intervention employee
to promote effective checks and Participation as well as the lack
balances between management of separation between
and shareholder monitoring and management
Constitutional model functions
Strong governance role Community model
Collective bargaining takes Ineffective governance role
place at a sectoral level between Unions are organized around
industrial union and employers enterprise,
associations. Rather than industry or
More focused on development occupational lines
of social skills than business coordination across
related knowledge Firms takes place on the basis
Cont..
Germany
German universal banks are
linked to business through
credit, equity stakes, the
exercise of proxy votes and
supervisory board
representation
Japanese boards are more
hierarchically structured, with
decision making focused on a
group of senior representative
directors under the CEO.
Mandatory to have at least
two outsiders among the
Japan
Concentrated ownership
Japanese main banks act as
delegated monitors through
direct equity stakes, credit and
dispatched directors
Whole managing board has
equal responsibilities, in
principle, and more influence
and more leeway
to participate.
statutory auditors have
largely been ex directors or
ex-employees who fell just
Corporate Governance in
the USA
Introduction

The U.S. is often seen as being the paradigmatic case of the

shareholder-oriented or market-based approach
Ownership of corporations is dispersed, involving high
engagement from institutional investors i.e. pension funds
Corporate boards are small, having high proportion of outside
or independent members
The internal and external aspects of corporate governance
are linked through the monitoring of gatekeepers i.e. auditors
the market for corporate control exerts a final discipline on
poorly performing firms, facing risk of takeover
These stylized characteristics of the U.S. model are widely
cited as best practices or even a global standard for good
corporate governance.
Old Millennium
Managers did not hold share holders interest as
their primary focus
Corporate managements represents the
corporations rather than
The goal of the firm not to maximize share
holder wealth, but to ensure the growth of the
enterprise by balancing the claims of all
important corporate stakeholder
Hostile takeovers were relatively uncommon
Internal incentives from management ownership
of stock were also modest
 A Historical Overview of
Corporate Governance in the
USA
1960s-1970s
Managerial
1980s
Investor
1990s
Shareholder
2000s
Crisis of
Capitalism Capitalism Value shareholder
value
paradigm

Ownership Dispersed, Institutional investors Institutional

individual investors Investors

Market for Weak Strong Medium Medium

Corporate
Control
Boards Insider - Insider - Outsider- Outsider-
advising advising monitoring monitoring
board board board board

Executive Fixed Stock options Stock options Stock options

Remuneratio
n
Gatekeepers Weakly Weakly Weakly Strongly
Corporate Governance

Includes relationships among many

stakeholders involved and the goals for
which corporation is governed.
Stakeholders types
External
Shareholders, debt holders, trade
creditors, suppliers, customers and
communities effected by the corporations
activities
Internal
Board of directors, executives, employs
A SCHEMATIC
CONTRACTUAL
Common
Shareholders
Public
GOVERNANCE STRUCTURE
Shareholders
Institutional
Investors
Large Block
Holders
Other
Board of
Corporations
Directors Creditors
Financial
Institution
CEO s
Bondholde
Managers rs
Governme
and
Supplie nts
Employees
rs Local
Custome State
r National
Foreign
Ownership

The owners are not a

homogeneous group; they
include:
Fragmented public shareholders
Large private block holders
Private and public institutional
Investors
Employees and managers of the firm
Other firms
Voting Rights

United States, corporations may issue

different classes of common stock, with
one class having more voting rights than
other classes.
Examples
Ford Motor Company has two classes of
common stock:
Class A, with 60 percent of the voting
rights, and Class B, with 40 percent of the
voting rights. Class A shares are owned by
the public, and Class B shares are owned
The Board Of Directors
The board of directors is elected by the
owners to represent the owners interests.
The board is made up of both inside and
outside members. Inside members hold
management positions in the company,
whereas outside members do not.
The outside members are often referred
to as independent directors, although this
characterization is misleading because
some outside members may have direct
connections to the company as creditors,
suppliers, customers, or professional
Responsibilities of the Board
Recruitment of future board members
Evaluation of management
Ensures company operates lawfully
Directors vacate their position on the
board if their term of appointment expires,
they resign or are removed by
shareholders on a cause
Vacancy is filled by vote of the board of
directors, and the new director stands for
reelection at the next annual meeting or
when the term expires and a successor is
elected, whichever is later
Cont..
Directors usually receive an annual fee or
a per meeting fee plus expenses for their
service on the board Hire, fire and
compensate CEO
Most actions by the board are taken by
majority vote at formally noticed meetings
Each director has one vote and is not
allowed to vote by proxy
Under state law, directors of a
corporation are deemed to owe their
corporations a fiduciary duty of care
If any statement contains materially false
Creditors
Creditors are likely to approve of
managers keeping cash in the company
because it improves the creditors financial
position
The duties and obligations of
management, and therefore of the owners,
to the creditors are typically spelled out in
the loan agreement.
Potential conflicts of interest between
creditors (bondholders) and owners
(shareholders) have long been recognized
and have been dealt with through positive
Relationship of suppliers and
customers
Suppliers and customers are
corporate stakeholders
The connections between suppliers
and customers, shareholder wealth
maximization, and the survival of the
firm are not always clear
The basic Governance problem with
respect to these stakeholders
(especially suppliers) is how to get
them to make investments or other
Legal aspects of corporate
governance
The US Securities and Exchange
Commission (SEC)
Created in 1934
Responsible for regulating publicly trade
firms
The Sarbanes-Oxley Act, 2002
Law for publicly traded companies
Increased transparency and compliance
CEO and CFO certify financial reports
The Dodd-Frank Act, 2010
Reaction to financial crisis
Promotes financial stability, consumer
Anglo-American Model
Known as "the unitary system
Emphasizes a single-tiered Board of
Directors to- Composed of a mixture of
executives from the company and non-
executive directors, all elected by
shareholders
Non-executive directors outnumber
executive directors and hold key posts in
audit and compensation committees
The United States and the United Kingdom
differ in one critical respect with regard to
Cont..
In US, corporations are directly governed
by state laws
Exchange of securities is governed by
federal legislation.
Individual rules for corporations are based
upon the corporate charter and the
corporate bylaws
Shareholders cannot initiate changes in
the corporate charter although they can
initiate changes to the corporate bylaws.
Anglo American Model

Ownership Dispersed
structure
Ownership Individual
Identity Pension and
mutual funds
Changes in Frequent
ownership
Goals of Share holder
Ownership value
Short term profits
Board Executives