Prof. Dr. Peter Doralt, Vienna1 „Action Plan Com (2003)284 final of the Commission - The Plan to Move Forward“ (Communication of the Commission to the Council and the EP) Target Modernising Company Law and Enhancing Corporate Governance in the EU Background Global and European Internal Capital Market global emergence of Corporate Governance Codes repercussions of various scandals: („recent events“ Enron, World Com, Parmalat) U.S. Sarbanes Oxley Act enlargement

Prof. Dr. Peter Doralt, Vienna2 7 Headings 1.What ist Corporate Governance? 2.Sources of Corporate Governance 3.Why did Corporate Governance emerge? 4.Categories of Corporations 5.Separation of Ownership/Management Two-tier – one-tier-system 6.Ownership structures and their respective risks for inverstors 7.Remedies

Prof. Dr. Peter Doralt, Vienna3 1. Corporate Governance = system by which companies are directed, controlled and their performance monitored (precise) rules and (general) standards of organisation and behaviour for corporate players: - managing (executive) directors - supervising (non executive) directors (NED) - auditors - shareholders

Prof. Dr. Peter Doralt, Vienna4 2. Sources: Corparate Law, Corporate Governance Rules and Standards Black Letter Law (European Directives, Regulations, National Acts) European and National Court Decisions: (e.g. Centros, Inspire Art) Soft Law - (European) Recommendations - (national) Corporate Governance Codes (some 40 National Codes in Europe) * ) - OECD Principles 1999, 2004** ) * ) (see Comp. Study prepared by Weil, Gotshal & Manges LLP, 2002, ** ) (see:

Prof. Dr. Peter Doralt, Vienna5 3. Why did Corporate Governance Codes emerge? first, where (uniform) legislation evolves slowly (UK, US): Cadbury Code (U.K. 1992), Principles of Corp. Governance (Am. Law Inst ) investor relations tool* ) : UK and US investors expected CGC abroad (export of an idea by „demand“) universal benchmark, easily accessible focus on typical expectations of investors flexible adaptation over time – competition of codes (possibility of „race to the top“ rather than „race to the bottom“?) flexible adaptation to different types of corporations: „Comply or explain“. * )

Prof. Dr. Peter Doralt, Vienna6 4. Categories of Companies Listed Companies: (publicly raised capital, U.K.: public limited company, plc) Unlisted Companies: (private: UK: Limited or Ltd) Public Companies – Private Companies large companies – SME Companies (countries with special flexible second type: GmbH) Company with core shareholder (controlled company: typical on the European continent) Company without core shareholder (only dispersed shareholders = Berle & Means Corp.): typ. in U.K. and US

Prof. Dr. Peter Doralt, Vienna7 5. Separation of Ownership/Management 5.1 Two tier system – one tier system large public listed comp.: typically have separation of - shareholders (absenter ownership) - managers need for „Accountability of Managers“ vis a vis Owners This results in further separation of: - monitoring (supervising) on behalf of shareholders by: Non Exec. Directors (NED) or Supervisory Board - day to day management: Exec. Directors or Management Board

Prof. Dr. Peter Doralt, Vienna8 5.2 One tier system one board as a whole responsible for + strategic decisions + day to day managing ~ by executive director + monitoring ~ by non executive dir. (internal separation)

Prof. Dr. Peter Doralt, Vienna9 5.3 Two tier system two boards: - managing board responsible for day to day management - supervisory board responsible for supervision (monitoring)

Prof. Dr. Peter Doralt, Vienna Evaluation and Convergence no clear advantage of one system over the other good corp. governance does not depend on one or two tier model but on sound principles convergence in strategic decision: - even in one-tier system usually prepared by exec. dir. and only approved by whole board - even in two-tier system usually monitored by approval of supervis. board full participation (co-determination) of workers representatives easier in two-tier model SE implementation requires introduction of option between both models trend: „pro choice“

Prof. Dr. Peter Doralt, Vienna11 6. Ownership structure and risks for investors 6.1 Totally dispersed ownership*: US, UK shareholders have little factual influence, power lies with management (inspite of blackletter law in U.K.) agency problem arises mainly between management and all shareholders related party transaction risks because breach of loyality by managers in their own interest * first analysed by Berle & Means, 1932

Prof. Dr. Peter Doralt, Vienna12 managers have influence on appointment of - non executive (outside) directors, or - members of supervisory board and - of auditors „reverse appointment flow“ therefore: Sarbanes Oxley Act (US) and new U.K. Combined Code are concerned with independence of non executive directors and auditors (i.e. from management), and with empowerment of independent directors (in various crucial matters), General Meeting and shareholders

Prof. Dr. Peter Doralt, Vienna Core shareholder structure (Europ. Continent) – risks for small shareholders Core Shareholder has factually strong influence on management (even if denied in black letter law e.g. in Germany) Core Shareholder can protect himself against management special „agency“ problem: core shareholder + management incl. NED (supervisory board) become agents with potentially harmful power; their principals: dispersed (minority) shareholders (and auditors)

Prof. Dr. Peter Doralt, Vienna14 related party transactions: main risk from breach of loyalty in the interest of core shareholder (e.g. unfair transfer pricing in favour of group of core shareholder); particular danger if core shareholder has strategic interest „normal“ downward flow of appointment, increases risk of dependency of management and/or coalition between core shareholder + management against small shareholders NED and auditors, independent of managers (SOX and Combined Code remedies) do not help; true independence of core shareholder required empowerment of Gen. Meeting does not empower small shareholders

Prof. Dr. Peter Doralt, Vienna Summary: ownership-structure Dispersed ownership: STRONG managers – Weak owners Risks: - management dominates General Meeting - auditors/NED depend on managers - strong managers tempted to harm all shareholders = accountability to shareholders as a whole is at risk (classic principal-agent-problem)

Prof. Dr. Peter Doralt, Vienna16 Core shareholder: STRONG core-owner: weak small owners, dependent managers Risks: –core owner: dominates GM appoints supervisors and auditors - supervisors and auditors dependent on him appoints managers - managers selected for their loyalty to core shareholder –managers tempted to act against interest of small (minority) shareholders = accountability to minority shareholders at risk, danger of unequal treatment of small shareholders

Prof. Dr. Peter Doralt, Vienna17 7. Remedies appointment of NEDs and auditors independent (of Management and of core shareholders) Chairman of one tier board ≠ CEO - advantage of two-tier-system 3 strong committes - auditing, nomination, remuneration – with majority of independent NEDs Recommendation on Independent Directors* *

Prof. Dr. Peter Doralt, Vienna18 Strengthening of: –independence of auditors and auditing process*- proposal to amend the 8th Directive** - strong auditing committe with „financially literate“ (knowledgeable) members –corporate governance by disclosure requirements as to adherence***) –transparency in particular in pyramid (group) structure of related parties transactions to prevent tunnelling (syphoning) = violation of at arms length principle***) –board members responsibility for drawing up financial statements - proposal for directive on collective board responsibility*** * ** ***

Prof. Dr. Peter Doralt, Vienna19 strengthening shareholder rights - initiative for simplification of cross border voting - Recommendation on remuneration of directors* ° transparency to the public ° independent remuneration committee ° vote of the GM (binding or not?) in particular on share option programmes *