Why German companies should embrace the role of lead independent director

Stewardship Principles Why German companies allianzgi.com should embrace the role of lead independent director July 2022 Recent examples of German supervisory boards adding the role of lead independent director (LID) are useful role models for their peers. A LID can help strengthen trust and improve communication between boards and investors. Additionally, it should foster independent, transparent and well-communicated succession planning, which can be lacking among German companies. Antje Stobbe From a governance perspective, we favour Head of Stewardship a clear division of responsibility at the top Key takeaways of companies and a system of checks and – A LID provides an independent point balances on the board. Furthermore, we see of contact for other board members, value in having more than one channel of company executives, investors and communication and engagement between other stakeholders who may be boards and investors. unable or unwilling to raise issues The 2021 voting season saw the start in directly with the chairperson the German market of what could prove a – Within Germany’s existing two-tier new development across the country: two system of corporate governance there listed companies installed lead independent is a place for a LID, which does not directors (LIDs) on their supervisory boards2. conflict with the deputy chairperson As is typical in Germany, both have a two-tier position typically nominated by board structure and in both cases the existing employees chairperson was considered non-independent. – The LID should ideally chair the 1 One case was Siemens Energy whose new nominating committee and lead chairperson was a former CEO of its parent the process of appointing the company. In the other firm – Fresenius Medical chairperson’s successor, which Care – the chairperson had been a member of includes consultations with investors the board for more than 20 years3. 1 Nominating and governance committees are a group of board members who are responsible for the selection of board members as well as ensuring good governance practices. 2 The supervisory board and management board are the two-tiers of board structure predominantly observed with German companies. 3 Disclaimer: issuer companies are named for illustrative purposes only, this shall not be deemed an offer to sell or a solicitation of an offer to buy any security, strategy, investment product or services nor shall this constitute investment advice or recommendation. Value. Shared.

Why German companies should embrace the role of lead independent director This year, SAP announced a LID role reacting to investor The role of the LID in the German context concerns related to the non-independent chairperson.4 While we acknowledge that introducing the concept of a Here, the purpose was also to facilitate investor dialogue. LID in Germany may not always be straightforward, there We welcome the introduction of this role in each of these are several scenarios where the role could add value for cases and encourage other German companies to consider companies and investors alike: following suit. 1. During succession planning and the transition to a LIDs, also known as senior independent directors, are a new chairperson, it is not always clear who investors key component of governance in a number of established should approach to discuss the future composition of markets. In France and the United States, the position is the board. The outgoing chairperson is no longer the frequently used to counterbalance the combined role of appropriate point of contact, and the deputy chairperson chairperson and CEO. Additionally in the UK and Ireland, (usually an employee representative) is neither responsible the role of LID is also well established on public company for such decisions nor an objective representative of boards, irrespective of their leadership structure. shareholder interests. In this situation, a LID – who However, installing a LID might appear less appropriate should ideally chair the nominating committee – could lead the selection process for the new chairperson, for the two-tier board system widely adopted in representing an independent point of view and thus Germany, where the roles of chairperson and CEO avoiding the involvement of the previous chair in the are already separate. Some might also point out that selection process. As such, the individual would provide Germany’s co-determined boards5 already include a an alternative channel of communication for investors deputy chair elected by the employee representatives. and be a continuous point of contact in times of transition. Therefore, a LID might be viewed as not fitting naturally Combining the role of LID with chairing the nominating into the existing governance system. However, this fails committee should foster independent, transparent and to understand and appreciate the added value that role well-communicated succession planning, which can be can bring. There are situations in Germany where the lacking among German companies. addition of a LID would help address areas of the current 2. Investors may have legitimate concerns over the governance framework which may not be effectively chairperson’s independence, qualifications or addressed currently. performance which can result in dialogue between What does a lead independent director do? them becoming confrontational. Acting as a valuable intermediary between the board, the chairperson and As a fully independent member of the board, the LID shareholders, the LID can enable investors to express provides counsel to the chairperson in “normal” times their concerns and expectations openly, ensuring that and contributes to the effective functioning of the board. the entire board is made aware of their views. Having The LID is also an independent point of contact for other an independent, objective channel to the board in board members, company executives, investors and other these circumstances can allow honest and constructive stakeholders who may be unable or unwilling to raise conversations to take place. This ultimately builds trust issues directly with the chairperson. between boards and investors. In times of stress or when the company is facing a crisis, 3. Periods of difficulty for companies and their boards can the LID could be expected to help resolve the situation. arise from the deteriorating global economy, litigation This might involve liaising with external stakeholders, undermining public trust in company leadership, cases of including investors, where this cannot be done effectively large transactions that have attracted negative publicity or, by the chairperson or company management. We also as in the last couple of years, the Covid pandemic. In these see the LID as instrumental in assessing the chairperson’s situations, the chairperson may have adopted a position performance and leading the process of nominating and that is seen as too closely aligned with the management’s installing a successor. strategic decision-making and is therefore perceived as lacking independence. In such instances, the LID can Experience from other countries shows that a LID can be provide a means of communication between the board, a valued intermediary between the chair or the board as management and investors, strengthening trust among a whole and investors. This is especially true when there investors and the wider public alike. Experience from other are differing views on the best strategy ahead, where countries shows that, in difficult situations, a LID serving as investors are dissatisfied with their interactions with the chair of a combined nominating and governance committee chairperson, or where the chair of the supervisory board is can help to resolve litigation or other governance issues that not considered independent. could affect the company’s valuation. 4 Corporate Governance | SAP Investor Relations, February 2022 5 Deloitte, The German Supervisory Board: A Practical Introduction for US Public Company Directors, 2021: In most companies with more than 2000 employees, half of supervisory board members are to be elected by employees, while for companies with 500-2000 employees, this applies to one-third of the board. 2

Why German companies should embrace the role of lead independent director An important addition to the governance framework Most importantly, the role should not be a substitute for the We believe the role of LID can add significant value in chairperson. Rather, it exercises a complementary set of the German system of two-tier, co-determined boards. powers and responsibilities in the interests of the company It should be an independent role that complements the and its investors. Once nominated, investors would chair of the supervisory board. The LID should always expect the two roles of chairperson and LID to establish chair the nominating committee but could also chair a constructive and practical division of responsibility that a combined nominating and governance committee supports the distribution of tasks required of the two with responsibility not only for succession planning and positions and helps them to exercise their roles effectively. shareholder concerns, but also for broader governance Clear disclosure is required on the role and responsibilities and litigation issues. of LIDs to assure investors about the scope of these tasks. The two-tier board structure typical in Germany – Supervisory body Reports to – Review and approve financial statements Supervisory – Shareholder and employee representatives – if subject Board to co-determination Annual – Typically includes audit committee, nominating committee, Elects shareholder shareholder and remuneration/compensation committee representatives meeting and ratifies Reports Appoints, to and oversees The two boards ecisions ta­en on areas informs and work together such as the advises closely to benefit supervisory the company – appropriation of net board income – ratification of the acts of the members of the managing and supervisory boards – the appointment of – Top management body Reports to independent auditors Managing – ecisions on basic issues of business policy, Board corporate strategy and annual and multi-year plans – reparation of financial statements Ratifies Source llian lobal nvestors To read more in our Stewardship Principles series, visit our corporate home page: https://www.allianzgi.com/en/ 3

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