View from Frankfurt: A supervisory board that could see no evil

There is a persistent rumour coursing the streets of Frankfurt. Senior executives from Deutsche and Dresdner banks have been spotted slipping into chemist shops asking for extra-creamy soap. Speculation as to the grounds for such behaviour has fallen on a statement by the wise old man and former head of Deutsche Bank, Hermann Josef Abs. 'Pinning responsibility on a supervisory board is harder than catching a pig with a soapy tail.'

Right now, there are many who would dearly like to try their hand at catching, like the hundred or so creditor banks of Metallgesellschaft. Germany's 14th biggest industrial concern, encompassing 258 companies covering metals, engineering and environmental technology, was steered on to the reef in full view of an unknowing supervisory board, studded with star representatives from the finest addresses of Germany's corporate establishment, including Deutsche and Dresdner banks.

Indebted to the tune of DM9bn ( pounds 3.48bn), its 57,000-strong labour force fearing for its livelihood, the worth of its entire equity capital wiped out by losses, MG quickly gained an honorary place high in the annals of German corporate catastrophes. Where were the supervisors, boomed Otto Graf Lambsdorff, former Economics Minister and leader of the Free Democratic Party, and president of a national investors' association.

By all accounts, the 20-man body whose duty it is to oversee, control and guide executive management, with the power to hire and fire, was put on the spot. The supervisory board's statement in MG's last annual report opens thus: 'The management board informed us regularly about its conduct of business, the state of the company and all significant transactions. Activities that required the accord of the supervisory board were scrutinised and discussed in detail with the management board.'

Just a month after it had renewed for a further five years Heinz Schimmelbusch's contract as chief executive of MG, the supervisory board in mid-December fired him and most of his fellow managers in a boardroom massacre of unusual brutality. But this was belated retribution by minders caught spectacularly with their trousers down.

MG had run up DM1.8bn of losses in 1992/93, rather than the DM347m declared by Mr Schimmelbusch. On top of this is a potential DM1.5bn of losses as MG extracts itself from disastrous forays into the US energy futures market. Most difficult to explain is the fact that more than half of the DM1.8bn losses was in business operations, which the supervisors had failed to spot. Mr Schimmelbusch was not entirely forthcoming with details, and for this he is being investigated by the Frankfurt state prosecutor's office. But who said supervisory boards had to work with their eyes closed?

Certainly, no one can claim that those charged with minding MG's management are second-rate. The head of the supervisory board is Ronaldo Schmitz, corporate finance chief at Deutsche Bank, which rotates the chairmanship with Dresdner Bank, represented by its board member Bernhard Walter. Then there is Gerhard Liener, chief financial officer of Daimler-Benz, and Henning Schulte-Noelle, chief executive of Germany's insurance colossus, Allianz.

The fact that men of this calibre were embarrassed raises questions about the system of corporate governance. It casts a shadow on the intricate network of cross- shareholdings that shape big business in Germany. And in particular, it highlights the perennial controversy about the ubiquitous role and influence in industry of the banking behemoths.

MG offers a model case study. Together, Deutsche and Dresdner banks, Daimler-Benz and Allianz, own over 40 per cent of MG. The remaining big institutional shareholder is the government of Kuwait, with 20 per cent.

Deutsche Bank is also MG's biggest creditor, to the tune of DM539m. It chairs the supervisory board and steers shareholder meetings.

Deutsche has DM24bn worth of non-bank holdings; it sits on hundreds of supervisory boards. Dresdner has over DM15bn of stakes in non-banking businesses. To apologists, and there are many, this is one of the keys to the success of German capitalism.

The extensive direct involvement of the banks in industry, in particular, and the tradition of big firms taking cross-holdings in one another, in general, encourages a degree of corporate stability, it is argued, that Anglo-Saxon systems can only envy. The presence of the banks fosters the long-termism that German business prides itself on.

In MG's case, Deutsche and Dresdner did their utmost to ensure its survival, precisely because of their stakes and commitment to the business. Would banks in other countries have had the power and will to force such a vast crew of angry creditors into line behind a rescue plan?

The influence of the banks is a vital element in Germany's peculiar form of protectionism. This has nothing to do with external trade barriers; Germany is a very liberal, open economy. Its protectionism is internal, as the mutually supportive network of cross-shareholdings in effect closes corporate Germany to unwanted interference.

It is no surprise that boardroom coups and hostile takeovers are so rare. This sort of closed system offers great stability, the chance to make mistakes and correct them. But it also harbours dangers when security slides into intimacy, creating a cosiness in which criticism gives way to credulity and those who are meant to be scrutinising and controlling become sloppy. There is far too much clubbiness in mutually protected corporate Germany, and MG appears to be a casualty of its worst excesses.

Hilmar Kopper, the chief executive of Deutsche Bank, has misgivings about the extent of his institute's role in industry. He has begun a quiet, slow-burning revolution. Deutsche is reducing its stake in Daimler-Benz to just below the blocking majority of 25 per cent. It is cutting its 25 per cent stake in Karstadt, the retailer, to 10 per cent.

As board member, Deutsche wants to take its industrial holdings 'out of the political firing line regarding the apparent power of the banks'. The MG debacle has enflamed this debate again, much to Mr Kopper's embarrassment and ire. But if it jolts the banks and big business into taking a critical look at the weaknesses in Germany's system of corporate governance, then much good could come from MG's painfully narrow escape.