Duality by the back door? European supervisory boards face attack

As the annual meeting season gets underway, a variety of companies across Europe – especially in Germany, Austria and the Netherlands – face a potential wave of shareholder challenges to their board structure – when companies try to retain a retiring CEO by elevating that person to chair of the board. It could lead to lively debates, now that one of the big proxy-voting firms – ISS – has advised its clients to vote against any such candidates, and against reappointment of anyone previously elevated to the chair.

The Financial Times reported it this way:

The progression underlined the consensual approach to management among German companies, prioritising continuity over fresh thinking in corporate culture.

Current examples to go down the path include Norbert Reithofer at BMW, Michael Diekmann at Allianz, Kurt Bock at BASF and Nikolaus von Bomhard at Munich Re. And Volkswagen chair Hans Dieter Pötsch and Karl-Ludwig Kley at Lufthansa also previously were their respective company’s chief financial officer.

These countries operate two-tier board structures, with an all-executive management board reporting to a supervisory board made up entirely of non-executives. This structure is meant to distance the policy decision-making and oversight functions – the monitoring and control activities – from the execution of policy. Such independence of the top level is meant to frustrate the ability of top executives from manipulating the levers of control, from stealing or shirking or using the company’s resource for personal aims. That’s what corporate governance scholars call the “agency problem” (Bebchuk & Fried, 2003) common in countries with “unitary boards”, where executives and outsider share decision-making and scrutiny of performance towards corporate goals.

“… is meant to”. There’s a problem with this way of organising boards. A long time ago when I worked in the Germany, I met several executives reporting to supervisory boards who candidly confided that they gave their supervisory boards as little information as possible. They tried to keep anything controversial from coming up for discussion. They sought, quietly, to modify terms of reference of the management board to raise the threshold of spending that had to be taken to the supervisory board. These days, I suspect people on management boards wouldn’t be so candid – but they are probably playing the same games.

The rationale for this deception wasn’t greed or laziness. The executives put it this way: The outside, non-executives don’t know – can’t know – the business in the sort of detail that executives do. You need expertise, detailed understanding of the inner workings of complex organisations if you want decisions that fit the situation. Manipulation was merely a pragmatic work-around of the structural problem. So too was promoted a retiring CEO to the role of chairing the supervisory board.

These concerns are why the companies in the United States, Britain, and elsewhere want to keep execs and non-execs working together, collegially – inside knowledge, outside perspective. Codes of corporate governance in those countries urge other structure to check the agency problem: avoiding CEO duality, when one person is both CEO and chair of the board; a majority of non-execs; non-execs leading key board committees; and board chairs who are outsiders when they assume the chair.

This problem has several dimensions – independence vs. expertise, control vs. collaboration, continuity vs. fresh thinking. It’s why corporate governance is such a fraught, problematic field, both intellectually and in practice. It needs nuanced implementation, which isn’t easily undertaken in public, even the “public” of a company’s annual meeting.

There are parallels in the governance of states. As I’ve written before in these pages, the separation of powers is meant to check the power of heads of government and heads of state, in ways that corporate governance codes have tried to emulate. When cooperation between the holders of power – compromise and candid discussion – is replaced with infighting and self-aggrandisement, governance and decision-making break down, opening an opportunity for autocratic rule to seize the reins.

There are good reasons to avoid absolutes – and good reasons for investors to pay attention to the guidelines from the likes of ISS, and not to pay too much attention to them as well.

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For reference, these are the ISS guidelines for 2024:, the second of these relate directly to the issue of dual board systems, and first to the more general recommendation for unitary boards:

Combined Chair/CEO Policy Recommendation: Generally, vote against the (re)election of combined chair/CEOs at widely-held European companies. When the company provides assurance that the chair/CEO would only serve in the combined role on an interim basis (no more than two years), the vote recommendation would be made on a case-by-case basis. In the above-mentioned situation, the Global Board-Aligned policy will consider the rationale provided by the company and whether it has set up adequate control mechanisms on the board (such as a lead independent director, a high overall board independence, and a high level of independence on the board's key committees).

Election of Former CEO as Chair of the Board Policy Recommendation: Generally vote against the (re)election of a former CEO to the supervisory board or board of directors in Austria, Germany, and the Netherlands if the former CEO is to be chair of the relevant board. To this end, companies are expected to confirm prior to the general meeting that the former CEO will not be (re)appointed as chair of the relevant board. Given the importance of board leadership, the Global Board-Aligned policy may consider that the chair of the board should be an independent non-executive director according to the Global Board-Aligned policy’s Classification of Directors.

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Bebchuk, L. A., & Fried, J. M. (2003). Executive Compensation as an Agency Problem. Journal of Economic Perspectives, 17(3), 71-92.