International Review of Law and Economics 25 (2005) 513–540
Functional Change and Bank Strategy in German Corporate Governance
Dwight B. Crane a,1, Ulrike Schaede b,∗
a Harvard Business School, United States
b University of California, San Diego, Graduate School of International Relations and Pacific Studies,
La Jolla, CA 92093-0519, United States
Abstract
This paper analyses changes in the German corporate governance system in the 1990s, using afunctional perspective that separates the functions of governance from the institutions that performthese functions. Financial globalization, harmonized legislation within the European Union, anddomestic pressures have triggered a move 留學(xué)生金融學(xué)畢業(yè)dissertationaway from the postwar German system of bank-basedgovernance, and towards more market-oriented processes. The paper shows that these forces haveresulted in heightening transparency, more active capital markets, and a greatly reduced role of banksin the governance process. However, Germany’s 2002 boycott of EU takeover legislation has created avoid in the current governance system: because bank intervention and the market for corporate controlare substitutes, a reduced role of a banks and protective takeover legislation mean that one importantgovernance function is currently underserved..
Keywords: Corporate governance reform; Germany, EU takeover code harmonization; Functional perspective
1. Introduction
The corporate governance system of a country determines the set of institutions that areentrusted with the process of monitoring firms, by either inducing or forcing management
∗ Corresponding author. Tel.: +1 858 534 2357.
E-mail addresses: [email protected] (D.B. Crane), [email protected] (U. Schaede).
1 Tel.: +1 617 495 6679.
0144-8188/$ – see front matter © 2005 Elsevier Inc. All rights reserved.
doi:10.1016/j.irle.2005.12.001516 D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540
2. System change in corporate governance
We propose that the change process is best analyzed based on a functional perspective,in which the specific functions of corporate governance are separated from the institutionsthat perform them. The underlying functions of corporate governance, such as protectingthe providers of capital, are stable over time and across geographic boundaries, but theinstitutional arrangements for performing these functions can vary considerably in differentenvironments or over time. Thus, an analysis of change should focus on assessing variationsin the processes through which the main functions of corporate governance are delivered.In this section, we introduce this model and operationalize it by determining expected areasof change.
2.1. A functional perspective of governance
Effective corporate governance systems perform three key functions.4 The first is toprotect the interests of the providers of financial capital and other resources, and to resolveconflicts among those interests. This protection assures the efficient flow of goods and#p#分頁(yè)標(biāo)題#e#
services to business firms, in particular from creditors. A second function is to provideways to manage problems stemming from inadequate or incomplete information. Givenmanagers’ superior information about the firm’s condition and prospects, well-functioninggovernance systems must ensure information flow and manage problems that result fromasymmetric information, such as adverse selection. The third governance function is tomonitor and influence the performance of firms and their compliance with rules of behavior.When companies are mismanaged and underperform, mechanisms are needed to recognize
the problem and take corrective action.These basic functions are carried out by various institutions, which can be groupedinto four major types: (1) boards of directors, protecting the interests of constituenciesand monitoring the performance of managers; (2) banks and other financial institutions,gathering information as part of their credit management process, structuring financialcontracts that constrain company behavior, and monitoring performance; (3) information
intermediaries, such as accounting firms, securities analysts and rating agencies, improvingthe flow of information to outside providers of resources; and (4) laws and regulatory bodies(including government agencies, legislators, and self-regulatory organizations), establishing
rules and monitoring compliance.
The role of these institutions varies considerably from country to country. Fig. 1 illustratesimportant differences across the three major corporate governance models. The most commonmodel is the business group-based system of corporate governance. In some countries,business groups are organized around families, while elsewhere they might pivot arounda bank or a large industrial enterprise, or a combination thereof (e.g. Granovetter, 2004).
While there is tremendous variation among business groups, the focus in their governance ison protecting the interests of stable, inside shareholders. This is often cemented in extensive
4 This framework has its roots in a functional perspective of the global financial system; see Merton (1995) andCrane, Froot, Mason, et al. (1995). The Global Corporate Governance Project at the Harvard Business School hasextended this functional perspective to systems of corporate governance.518 D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540provides information in the market (it can be bought, because its properties are considered
generic). Accordingly, a transition from a bank-focus toward a market-focus requires thedevelopment of a market for information, and the appropriate supervisory regulation tomonitor this market.
2.2. Analyzing system change in Germany
None of these governance models exists in a pure form, and all systems are constantly
under pressure for change at the margins. In the 1990s, however, pressure accumulated to
touch the core logic of the bank-based model, through globalization of financial markets#p#分頁(yè)標(biāo)題#e#
and advances in financial technology, regulatory changes, and changes in information tools
and the distribution of information.
The basic insight offered by the functional perspective is that a system of corporate
governance will work as long as all three functions are adequately provided, regardless of
the institutional setup. Institutional differences across countries may translate into different
emphasis on one function over another, but not necessarily into “better” or “worse” systems,
so long as all three functions of governance are performed. However, in shifting emphasis
among the specific institutions of a corporate governance system, it is important to differentiate
among complements (mutually enhancing properties) and substitutes (replaceable
properties). For example, in a universal banking system, such as Germany’s, system change
can occur if an evolution in bank strategy leads to a different or reduced role as information
intermediaries, so long as the market for information develops, supported by a shift in the
regulatory environment.
Beginning in the 1990s, Germany has been subjected to three forces for change: EU
rule harmonization, globalization of finance and a subsequent diversification of large firm
refinancing options, and changes in investment attitudes by increasingly affluent domestic
households. The question of this paper is whether these forces are truly pushing Germany
towards a more market-based system. The functional model, as sketched in Fig. 1, suggests
three large directions of change, that combine in a shift away from the focus on direct
management interference through banks, and towards more emphasis on information and
monitoring. The three “change arrows” suggest three areas that can be quantitatively and
qualitatively analyzed:
(1) Disintermediation and growth in the market for corporate control: As large companies
see new options in external financing, they can diversify their sources of funding.
Evidence of this can be found in a decline in bank loans in the external financing of
large firms, and a growing use of market instruments such as bond and stocks. This in
turn should result in a growing number of firms listed on stock exchanges. Concurrent
with the shift toward direct financing by firms, we should observe a shift in investment
strategies by households, away from savings deposits and life insurance contracts, and
towards equity, bonds, and investment funds.
Moreover, as large firms diversify their sources of funding, they become subject to
the forces of the bond and stock markets. This should lead to an increase in mergers and
acquisitions and a decline in stable and block shareholdings, as corporate ownership
becomes more disperse.D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540 519#p#分頁(yè)標(biāo)題#e#
(2) The development and growth of a market for information: For companies to raise funds
directly on the market, they need to disclose more information to potential investors
in a globally accessible form. A shift towards more market-based transactions requires
a shift towards more detailed accounting information, and an increase in the activities
of information intermediaries (e.g. banks’ research departments, credit rating agencies,
etc.). At the same time, the market for information has to be supervised based on
new rules and new institutions that are different from the previous system of banking
supervision. Thus, change in this area would manifest itself in substantial legal reforms
towards a market for information.
(3) Decline in banks’ direct involvement in corporate governance: The previous two propositions
imply a decline in the role of banks in corporate governance; however, it
is possible that banks attempt to maintain their roles, either by adapting their own
processes and strategies, or by attempting to frustrate new entry into the corporate
governance system. Measurable indicators of change in banks’ governance strategies
are: (a) a decline in the number of bankers among members of the supervisory board;
(b) a decline in majority ownership in large companies, as banks diversify risk given
their diminished control over their clients; and (c) a decline in large bank activity in the
system of proxy voting (as explained in Section 3).
These three broad areas of system change and their expected manifestations lay the
ground for our analysis.
3. The German corporate governance system until the 1990s
3.1. The banking system
Between the 1950s and the mid-1990s, the German banking system had three distinctive
features that resulted in a special dynamic. First, all banks were universal banks; i.e. by law
they could offer the full array of commercial and investment banking services. Thus, the
banks’ strategic decisions rather than government restrictions determined how corporate
finance evolved over time. Second, while consisting of several categories, the financial
system was dominated by the “three big banks” (Deutsche Bank, Dresdner Bank, and
Commerzbank) (see Table 1). While these three banks played pivotal roles in Germany’s
political economy, their total share of the domestic deposit market was relatively small.
Initially, this was due to a division of labor with cooperative banks (Volksbanken) and
publicly owned savings banks (Sparkassen). These smaller banks focused on household
savings and loans to local small-sized companies (Mittelstand), which were large in number
and of significant economic relevance.5 Most Mittelstand companies were privately held
and often family-owned.
5 The regional central institutions of the Sparkassen were the Landesbanken (“LB”, state banks). Sparkassen#p#分頁(yè)標(biāo)題#e#
transferred their surplus funds to the LBs, which were originally in charge of running the finances of the state
governments. Over time, the LBs entered all types of banking business, and began to engage in head-on competition
with the large commercial banks. See Beckmann (2000).D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540 521
Table 2
External financing of German corporations, 1950–1990 (amounts in DM billion)
Year Bank loans Total external financing Bank loans as a percent of total
1950 8.5 11.7 72.6
1955 11.3 19.2 58.9
1960 17.6 27.7 63.5
1965 27.3 50.3 54.3
1970 40.7 76.0 53.6
1975 29.1 65.3 44.6
1980 90.2 156.0 57.8
1985 69.7 122.5 56.9
1990 126.7 222.8 56.9
Source: Deutsches Aktieninstitut, DAI Factbook, May 2003, Table 03-9.
3.2. Corporate finance
Household savings and investment patterns were consistent with the dominant role of
bank lending and small capital markets. The major portion of household savings went
into standard savings accounts at banks and similar institutions.7 This conservative investment
philosophy was supported by tax incentives for bank savings plans and life insurance
contracts. Accordingly, banks offered specialized savings products, such as insurance and
mortgage savings, while alternatives for stock market investments remained limited.
Large corporations were typically organized either as privately held limited liability
corporations (GmbH), or as public stock corporations (AG). Except for more strenuous
legal requirements for establishing an AG and the possibility of trading AG shares on an
exchange, there were no significant differences between the two corporate types. Tax rates,
disclosure requirements and board representation rules were all based on company size
rather than legal form. Traditionally, the vast majority of German firms were GmbH: In
1976, there were 2200 AG as compared to 60,000 GmbH, and in 1996, just 4000 AG were
dwarfed by more than 500,000 GmbH. In other words, just 0.15% of German firms were
publicly traded.8 A big reason for this phenomenon was that most firms were parts of large
“Konzerne”, i.e. they belonged to or were subsidiaries of other companies that were stable
owners or dominant partners with little interest in trading the company publicly.
Only the largest AG raised funds through active equity issues. Through the 1980s, the
stock market remained limited with fewer than 500 listed companies (as compared to the
over 5000 in the US). The trading volume of many stocks was very low, because many
AG were owned by other firms in long-term, stable arrangements. Cross-ownership led to
extensive corporate networks. One important example of such a network was that spun
by Allianz Holding, which by 1999 held large portions of the two big banks, and was#p#分頁(yè)標(biāo)題#e#
itself owned to a significant degree by these two banks. In addition, these three financial
institutions also owned large shares of some of Germany’s largest enterprises. Although
companies were not obligated to report their cross-holdings until the late 1990s, according
7 Deutsches Aktieninstitut, DAI Factbook, May 2003, Table 07.1-2. For details, see Table 3 below.
8 Deutsches Aktieninstitut, DAI Factbook 1999, Table 01-4.522 D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540
to one estimate, in the mid-1990s, 97% of all listed companies were part of a Konzern
(Prigge, 1998).
With stock ownership heavily concentrated in large corporate networks, any attempt by a
single shareholder to affect change in a company’s management was certain to be frustrated.
Management was further shielded from the forces of the stock market by the law, which
allowed for various types of shares, each associated with special rights. Although by the
1980s the “one share one vote” system had become more common, the 30 largest firms all
still had shares with differential voting rights. In particular, there were three ways to inhibit
shareholders from exerting control through voting restrictions. First, the company could
limit the maximum voting right of one shareholder to 5% or 10%, regardless of ownership.
As late as 1995, 20 of the largest German corporations still had voting rights restrictions.
Second, companies could issue shares that did not carry votes. For instance, by the early
1990s the Quandt family owned only 3.6% of theBMWAG, but this small portion of shares
accounted for 45.6% of all votes.With every capital increase, the company could issue more
non-voting shares, thus preserving the majority vote for the family. Finally, shares could
be issued with trading limits, so that they could be sold only with the explicit permission
of the issuing company. As a result of these limitations, takeovers were rare and hostile
takeovers were impossible unless one was able to align several banks and other owners
holding tradable shares with voting rights.
3.3. Corporate governance under the bank-led system
Given the limited role of the stock and takeover markets, corporate boards played an
important role in corporate governance. Large German companies had two boards.9 The
management board (Vorstand) consisted of corporate executives, one of whom was the
“speaker of the board”, and for all practical intents and purposes the CEO. The management
board was in charge of all corporate decisions, so much so that some labeled their
situation a “monopoly” (Ulmer, 2001). The supervisory board (Aufsichtsrat) consisted of
representatives of shareholders and employees. The proportion of labor representation was
legally prescribed and differed by industry and company size; firms with more than 2000#p#分頁(yè)標(biāo)題#e#
employees had to have a 50% labor representation. When voting on issues that needed a
simple majority, the chairman had two votes.
Co-determination gave labor a critical voice in board meetings, but over time it also
influenced the working dynamics of supervisory board. In the largest firms, labor representatives
were not firm employees but mostly union representatives. It was also difficult
for shareholder representatives to discuss the pros and cons of management’s plans in the
presence of labor. Controversial issues were often negotiated informally prior to the board
meeting to resolve diversity of opinion within the two groups and represent united fronts at
the meeting. Critical issues were rarely discussed at the board meeting, which afforded the
board chairman a particularly important role through informal input.10
9 For details on the following summary account, see Hopt et al. (1998) and Schaede (1995).
10 Ulmer (2001), and interviews with German executives, summer 2001. A famous German legal scholar was
cited as complaining: “Nowhere in Germany is there as much lying and as much hush-hush as in the evaluation of
the true effects of co-determination over time” (Zoellner, cited in Ulmer (2001, p. 162). An additional problem isD.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540 523
The legally prescribed responsibilities of German supervisory boards were much more
limited than normal practices of US boards of directors, as they did not include discussions
of management strategy. Instead, the law defined the board’s authority narrowly to consist
of: (a) approving the company’s accounting statements for a specified period; (b) approving
major capital expenditures, acquisitions or divestitures; (c) appointing (and dismissing) the
management board; and (d) approving dividend payouts. Unlike in the US, German boards
had no audit or compensation committees that influenced executive management decisions.
German law also prohibited any crossover in board membership; no corporate executive
could be a member of the supervisory board, and vice versa. Combined with strict rules on
information privacy, this meant that the board’s access to corporate information was much
more restricted than in the US. German rules also required less disclosure than international
standards, and German companies were allowed to charge various reserves, such as pension
reserves, against income, which provided some flexibility in the amount of reported profits.
This made financials difficult to follow at times, which opened up a critical role to play for
the house bank.
In addition to their superior access to financial information as major lenders, banks gained
power in the governance system through three routes: (1) their seats on supervisory boards,
often as chairman; (2) direct ownership; and (3) the proxy (depositary) voting system. Board#p#分頁(yè)標(biāo)題#e#
data for the 100 largest firms in 1986 reveal that banks were represented on 75 supervisory
boards, and in total held more than 10% of all seats; i.e. on average these largest companies
had more than one banker on their supervisory boards. In 1992, of the 30 companies included
in the DAX index (i.e. the largest publicly traded firms), 11 supervisory board chairmen
and 25% of all supervisory board members were bankers (Prigge, 1998).
Overall, banks owned about 10% of outstanding equity of the major firms (Baums &
Fraune, 1995). While this may seem low, most of these shares had unrestricted voting rights.
The banks’ influence was further enhanced through proxy voting on behalf of corporate and
individual shareholders. Most investors held their shares in a custodial account with a big
bank. Prior to a company’s annual meeting, the bank mailed a proxy (or “depository”)
form to its clients, with its specified intentions. If an investor disagreed, she could ask the
bank to vote differently. Most investors let banks vote as indicated, since it was the easier
path and banks had better information. One observer has called proxy voting “the core
issue of German corporate governance: unless they have full information, shareholders act
rationally if they delegate their vote to the bank” (Wackerbarth, 2001). As a result, the
three big banks, controlling the majority of custodial accounts, dominated the shareholder
meetings: In 1992, banks represented an average 84% of the votes at the annual shareholder
meetings of the 24 largest widely held companies (Baums & Fraune, 1995).
3.4. Bank strategy in a bank-led corporate governance system
Banks were clearly at the center of the German system, performing the three critical
functions of corporate governance. As major providers of finance, they structured financial
contracts and monitored companies over time. In their role on supervisory boards, bankers
that co-determination was never meant to be about monitoring management; in fact, when the supervisory board
discusses issues of the management board, labor is expected to abstain (Ulmer, 2001, p. 163).D.B. Crane, U. Schaede / International Review of Law and Economics 25 (2005) 513–540 525
pure lender’s perspective was liquidation. On balance the benefits of the German system
outweighed the costs, and banks sought to maintain their power in corporate governance
during the postwar period.
4. Change in the 1990s
In the 1990s Germany’s financial system was subjected to three concurrent forces for
change which in combination challenged banks to reorient their strategies by initiating a
process of legal and institutional change that continues as of 2003.
4.1. Pressures for change
4.1.1. Economic prosperity
In the 1990s, households began to demand more diversified financial options, beyond#p#分頁(yè)標(biāo)題#e#
the traditional bank deposits and insurance contracts. In addition to an affluence effect, this
was due to a generation change: in contrast to the prewar generation – who had lost their
wealth three times, during WWI, in 1929, and during WWII – Germany’s baby-boomers
were interested in investment options with varying degrees of risk and return. The expected
strains on the country’s pension system caused by a rapidly aging population also encouraged
some households to increase their own long-term equity investing. The German government
encouraged this shift by privatizing several public companies, led by Deutsche Telekom,
Deutsche Post and Deutsche Bahn (railroad). The Deutsche Telekom initial public offering
generated significant interest and the stock performed well until the temporary halt of the
worldwide telecommunication boom in 2000 revealed gross overinvestment in spectrum
rights and foreign subsidiaries.
Bankers and other business leaders supported the public’s interest in financial markets
by backing the formation of The Deutsche B¨orse AG (“German Stock Exchange”) as a private
stock exchange in 1996, with an initial focus on futures trading and advanced clearing
mechanisms. Deutsche Bank, a leading clearing institution in Europe, was a major shareholder
and assumed chairmanship of the supervisory board. In 1997, the Deutsche B¨orse
opened the Neuer Markt (NM), a new market segment for start-up IPOs with more stringent
disclosure requirements than the main trading floor. Germany embarked on its own
venture capital boom, and within three years of its creation, the NM noted its 300th listing.
Although the segment was closed down after the burst of the venture boom in 2002, it has
influenced the trading practices at Deutsche B¨orse by way of adoption of some of the NM’s
more stringent rules.
4.1.2. Globalization
The traditional reliance on bank loans changed with the arrival of international bond
http://www.400190.com/dissertation_writing/markets, new technologies allowing long-distance trading and real-time quotes, and financial
instruments such as swaps. As leading German companies listed on the New York
and Tokyo Stock Exchanges to attract international capital, they shifted to US GAAP or to
International Accounting Standards (IAS) accounting, thus creating competitive pressure
within Germany for more disclosure.