Improving Corporate Governance in Companies with a Dual Board Structure

Lessons from Germany and China

Scientific Essay 2012 11 Pages

Law - Comparative Legal Systems, Comparative Law


Table of content


I. Introduction.

II. Internal governance structure of companies.
1. Germany.
2. China.

III. Supervisory concerns and reforms.
1. Germany.
2. China.

IV. Comparison and assessment
1. The notion of independent director
2. The role of the supervisory board.
3. The role of the management board.
4. The role of the shareholders.
5. The role of the state.
6. Cultural obstacles.

V. Conclusion.


Effective monitoring structure within a company is one major concern of corporate governance. Both China and Germany adopt a two-tier board structure and have experienced similar considerable difficulties regarding the efficacy of the supervisory boards. This paper focuses on the different ways in which both countries addressed this problem. It is argued that there has been no need for China to adopt a parallel system of independent directors. Rather China should have followed the German way and professionalized its supervisory boards.

I. Introduction

According to the noted Cadbury Report corporate governance is ‘the system by which companies are directed and controlled’[1] . This paper centres on the realization of the control aspect in China and Germany. Both countries adopt the so-called two-tier board system which is believed to de-liver a strong monitoring function over managerial performance. However, both countries faced significant problems with insufficient performance by the supervisors.

Noteworthy, the countermeasures were different. Since laws that suite one legal environment, may fail in another, corporate governance structures and recent reforms in Germany and China must be viewed in the context of each country’s tradition, history and culture [2] . Considering China it is also necessary to observe how the law is exercised in practice.

This paper seeks to understand reasons for China to complement its dual board system by the institution of independent director known from the Anglo-American corporate model, and to assess whether this way worked. Therefore, it is necessary to picture the statutory internal governance structure of companies in both countries (II.) and to carve out the major concerns with the former situation (III.). Based on this the reforms will be assessed in detail (IV.).

II. Internal governance structure of companies

1. Germany

German corporate landscape consists largely of limited liability companies (GmbH) and a small number of stock companies (AG). Although each type is governed by its own law ( Limited Liability Company Act ( GmbHG) and Stock Company Act ( AktG) respectively) they feature structural similarities. Regarding the internal governance structure and the relations between the respective bodies of the company there is, however, a major difference. The division of powers in German companies mirrors the general idea of each company: The GmbH is suitable for small and medium businesses, where both capital and people co-operate (akin to a private company). Hence, the power is in the hands of the members’ meeting. The AG is the business structure for capital co-operation (akin to a public company). Since the reforms primarily addressed the role of the supervisory board of an AG which is different from the one of a GmbH, further analysis will focus on the former.

There are no directors in the sense of the Anglo-American one-tier board structure in the AG. Rather, it has managers, who form the management board and are (jointly) legal representatives of the company. The second tier is formed by the supervisory board assuming the watchdog function vis-à-vis the management board. In the German understanding the supervisory board is the forum where the concerns of various interest groups are represented[3] , most prominent being the employees (so-called principle of co-determination). The shareholders’ meeting forms the third compulsory organ. Although the shareholders’ meeting retains important duties of constitutive kind, it is the management board that is not only responsible for the day-to-day management of the company but also directs all aspects of entrepreneurial planning, internal co-ordination and control and general business policy[4] . In this regard the shareholders’ meeting has no competence except if the management board asks for a decision (sec. 119 (2) AktG). This power shift towards the management board is balanced by a continuing chain of accountability: The members of the management board are appointed and discharged by the supervisory board whose members in turn are elected and dropped by the shareholders’ meeting.

2. China

Similarly to the German law the Zhonghua Renmin Gongheguo Gongsi Fa [ Company Law of the People’s Republic of China ] ( Chinese Company Law - CCL) provides for two types of companies which can be established in China since 1 July 1994 (discounting the special regimes additionally applicable to foreign investments, Art. 218 CCL): the limited liability company (LLC) and the company limited by shares (CLS) (former joint stock company) (Art. 2 CCL).

Despite the fact that the two types of companies in China serve different purposes in terms of the scope of business, most features of the internal governance regime are, unlike in Germany, widely congruent. The law requires both companies to have three organs: the shareholders’ meeting, the board of directors (hereinafter management board) and the board of supervisors (hereinafter supervisory board) with some relief for small LLCs (Art. 51, 52 CCL). Additionally managers may be appointed by the management board.

By virtue of the wide powers conferred upon the shareholders’ meeting by Art. 38 and 100 CCL it serves as the organ of power in the company (Art. 37 and 99 CCL). Particularly it decides the company’s business policy (Art. 38 (1) CCL). 2005 amendments even widened its powers by giving the right to reserve any other power in the articles of association (Art. 38 (11) CCL). Thus, the law gives the shareholders’ meeting a position that is – particularly for the CLS – much more powerful compared to its counterparts in other jurisdictions.

Correspondingly, the range of powers left to the management board is smaller[5] . The main tasks of the management board as stated in Art 47, 109 (4) CCL are of preparatory and executing character[6] . Unlike under the German law the managerial organ of a company in China is constituted by the management board with the authority to make decisions regarding the day-to-day business and the manager(s) of the company whose task is to carry out the daily business (Art. 50, 114 (2) CCL)[7] . Finally, the supervisory board – consisting of shareholder and employee representatives (not less than one third) – is primarily assigned a monitoring and supervisory role over the management (Art. 54, 119 (1) CCL). A major difference to the German law is, however, that in China members of both boards are elected and dismissed by the shareholders’ meeting and the boards are thus coequal and subordinate to the shareholders’ meeting.

III. Supervisory concerns and reforms

1. Germany

In the middle 1990s the German two-tier board system faced several critics regarding the role of the supervisory board. Commentators found fault with its ineffectiveness in general, the defects in its composition and the difficulties associated with its relationship with the management board[8] . Some commentators additionally stressed that the law contained no guidelines on how the duties of the supervisory board were to perform[9] . Subsequently the supervisory board became the focus of attention for the German legislation.

First major amendments to the AktG were made in 1998 by the Law on Control and Transparency in Enterprises ( KonTraG). Inter alias it obliged the management board to periodically report to the supervisory board on important matters regarding planning, business development and risks (sec. 90 (1) AktG); introduced the individual right of each supervisory board’s member to ask additional reports from the management board (sec. 90 (3) sent. 2 AktG); stipulated the establishment of a risk management system supervised by the supervisory board (sec. 91 (2) AktG) and shifted the duties regarding the audit to the supervisory board (sec. 111 (2) sent. 3, 171 AktG). In 2002 the Law on Publicity and Transparency ( TransPuG) gave the supervisory board the power to determine transactions that require its approval prior to the execution by the management board (sec. 111 (4) sent. 2 AktG) and made the supervisory board jointly responsible for the corporate governance statement (sec. 161 AktG).

Altogether the reforms broadened the duties and the rights of the supervisory board considerably and, hence, enabled it to fulfil its function as the central supervisory body on behalf of the shareholders, creditors and employees[10] . Commentators refer to these developments as the “professionalization” of the supervisory board[11] .

2. China

The initial Chinese Company Law had its focus on the creation of rational institutional structures for state asset management. However, China’s fast economic development soon uncovered several statutory and practical shortcomings. The reform process was accelerated by the growing number of private companies that suffered from the malfunction of the internal structures[12] . As all Chinese companies feature similar internal structure the problems are not unique to listed companies.

China features a highly concentrated ownership structure not only in state controlled companies[13] . This fact creates two potential problems which are to be carefully distinguished: the majority/minority conflict and the so-called ‘insider control’ issue.

The main corporate governance concern in China is to achieve a balance between majority and minority shareholders[14] . Under the former law small shareholders were extremely disadvantaged as they had rights ‘on paper’ but no power to enforce[15] . Hence, even if the company was properly managed, there was a substantial risk of expropriation by majority shareholder[16] .


[1] See Jean Jacques du Plessis, Anil Hargovan and Mirko Bagaric, Principles of contemporary corporate governance (New York, Cambridge University Press, 2nd ed, 2011) 3.

[2] Jean Jacques du Plessis, ‘ Reflections on Some Recent Corporate Governance Reforms in Germany: A Transformation of the German Aktienrecht? ’ (2003) 8 DLR 381, 382.

[3] Jean Jacques du Plessis, ‘ The German Two-Tier Board and the German Corporate Governance Code ’ [2004] EBLR 1139, 1148.

[4] Jean Jacques du Plessis, above No 3, 1146.

[5] James V. Feinermann, ‘ New Hope for Corporate Governance in China? ’ (2007) 191 The China Quarterly 590, 598; Yuwa Wei, Comparative Corporate Governance: A Chinese Perspective (The Hague, Kluwer Law International, 2003) 113 and 116.

[6] Yuwa Wei, above No 5, 116.

[7] Yuwa Wei, above No 5, 117.

[8] du Plessis et al, above No 1, 343-4.

[9] J. Shearman, ‘ Controlling directors the German way ’ (1997) 18(4) Company Lawyer 123, 123.

[10] du Plessis, above No 2, 393.

[11] Marcus Lutter, ‘ Professionalisierung des Aufsichtsrats ’ [ The professionalization of the supervisory board ] [2009] Der Betrieb [The Enterprise] 775.

[12] Yuwa Wei, above No 5, 200.

[13] Yuan Zhao, ‘ Independent directors in China: the path in which direction? ’ (2011) 22(11) ICCLR 352, 353.

[14] du Plessis et al, above No 1, 396.

[15] Simon S. M. Ho and Xu Hai-Gen, ‘ Corporate Governance in the People’s Republic of China ‘ in Low Chee Keong (ed), Corporate Governance: An Asia-Pacific Critique (Hong Kong, Sweet & Maxwell Asia, 2002) 269, 285.

[16] Donald C Clarke, ‘ The Independent Director in Chinese Corporate Governance ’ (2006) 31 DJCL 125, 142.


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University of New South Wales, Sydney
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Independent Director Corporate Law China Germany Corporate Governance



Title: Improving Corporate Governance in Companies with a Dual Board Structure