By James Hamilton, J.D., LL.M.
A European Commission report on the role of independent directors indicates movement towards stronger corporate governance in the EU based on earlier Commission recommendations. The Commission found widespread adherence to voluntary corporate governance codes on a comply or explain basis. In most of the EU, companies must comply with the independent director provisions of the code or explain why they did not comply.
A number of EU countries, such as Germany and the Netherlands, mandate a two-tier board structure under which the supervisory board is equivalent to the US board of directors and the executive board is composed of the CEO and the senior management team. The Commission recommended there be a sufficient number of independent directors on the supervisory board and that there be a cooling off period before a former CEO is named to the supervisory board.
The report said that all EU states now require or recommend the presence of independent directors on supervisory boards, but that different definitions of independence make standards uneven. In addition, the requirement of independence from the controlling shareholder has not been fully endorsed across the EU. For example, the absence of close links with the controlling shareholder is not recommended at all in Germany.
The Commission finds this problematic since independent directors have a role to play in companies where a controlling shareholder may exert strong control over management. In such cases, conflicts of interest may arise between the majority and minority shareholders, reasoned the Commission, and independence from the controlling shareholder may be an efficient way of alleviating such conflicts.
The Commission also recommended the creation of independent audit, nomination and remuneration committees. The Eighth Company Law Directive will require the creation of audit committees by June 30, 2008.
While the majority of states presently require the creation of such committees, the report revealed that a number of corporate governance codes no not recommend the strong presence of independent directors on audit and remuneration committees.
The creation of a remuneration committee is generally required on a comply or explain basis. In Germany, the creation of such a committee is recommended only and deviations from this rule need not be explained to the public.
About half of the EU has followed the Commission’s recommendation on the basic functions of board committees. The most important shortcoming is the absence of any provision regarding the responsibility for the audit committee in reviewing the effectiveness of the internal controls of the company.