Giving Employees a Seat on the Board is the Ultimate Form of Recognition

What was the German secret that made them economic powerhouse and a country to repeatedly recover the fastest from global economic downturns?

It is called Mitbestimmung and it’s all about empowering employees to have a voice and an active role in the management of companies.

Unlike North American companies, German public and large private companies have a two-tier board system with subtle but very important differences between the two. They have a supervisory board and they have a management board. The supervisory board would only supervise and oversee matters of the company, while the management board deals with the day to day operations of the company.

Mitbestimmung only affects the supervisory board.

Typically on the supervisory board, one third to one half of the board would be made of employees and the rest of advisors and investors. That means that the employees sitting on the board would assist in determining the future of the company and have a real impact on who runs the company.

In the German model, the supervisory board is responsible for appointing the management board, and in that sense the supervisory board has a real impact on the composition of the management board. A model that gives employees so much power over what goes on in a company is a unique one and it probably made you go “whoah! hold on there!”

Yes, it definitely sounds counter-intuitive but the fact and the date shows that employees, working in a very intimate way with the advisors and investors of the company results in the best interests of the corporation as a whole.

Once an employee is appointed to the supervisory board, their mindset changes considerably. They don’t think only in terms of the best interest of employees, but they start to think of the best interest of the corporation as a whole. If they do act only in the best interests of the employees and not in the best interests of the corporation, they would be in breach of their duties.

And the fact that on the same supervisory board you also have the advisors and investors that also must act and think in terms of the best interests of the corporation as a whole, results in a very constructive and a very positive way of governance.

The German model (Which ironically was imposed on the Germans by the British after the second World War, to make sure that there never is a Third Reich) stipulates that 50% of the seats on the supervisory board go to the Employees, so that employees have direct say in appointment of managers.

In a Startup, we can tweak this to be more in line with expectations of a environment and the investors used to the traditional shareholder primacy model by not having 50% of the supervisory board seats going to employees, but 30% instead. We would still have a very interesting input in order to make sure that you don’t appoint individuals that would not act in the best interests of the company and in the best interests of the corporation as a whole.

Shareholder primacy model primarily recognizes the interests of the shareholder. So the group of people who would also oppose any move to allow employees seats on supervisory boards would be the shareholders because they have always been absolutely dominant. They were the only ones that could go to a general meeting and take decisions by way of ordinary decisions or special resolutions, and they don’t like that power just to disappear. So the resistance would normally come from managers, executive directors and from shareholders. But if we look at the bigger picture, if we think about all stakeholders and we recognize how important employees are as stakeholders, then it is clear that this is a very interesting and a very constructive model to look at.

Gary Gorton and Frank Schmid did a comprehensive examination in 2000, which demonstrated co-determination succeeds at empowering workers at a small expense of capital (“firm resources are directed differently, decreasing the return on assets and the market-to-book ratio”) but compensates for the capital losses by making company a lot more responsive to market shifts and employees more loyal during rough patches in the company history.

How would we apply this in a startup?

  1. Amend your articles of association or constitution to make this an experimental arrangement for three years at firs to see how it goes;
  2. Determine how will you elect the employee director. Some obvious mechanisms are democratic vote amongst employees; by seniority (time with the company); random draw etc. The important thing is that the mechanism is clear to everyone.
  3. The employees elected should be made aware of the fact that they then have the same fiduciary duties and duty of care and diligence as all the other directors — they must put the best interests of the company first and cannot act in the best interests of the other employees only;
  4. They also need to be made aware of the strict rule of confidentiality that apply to all directors.
  5. Make sure that the elected employee director is additionally compensated by shares from the ESOP pool (Many jurisdictions have provisions for versions of “Employee Share Schemes”) to ensure they have a further interest in the company which ensure loyalty and working towards the well-being of the company.

It goes without saying that you should get a legal opinion and get lawyers
to assist in getting your model implemented.

There you go, capitalist diversity and diversity within capitalism..

Special thanks to Professor Jean J. du Plessis, of Deakin University School of Law.

Milan Vrekic

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