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1.2 Corporate Governance Elsewhere in the World
In Germany, labor unions traditionally have had seats on corporate boards. At Japanese firms, loyal managers often finish their careers with a stint in the boardroom. Founding families hold sway on Indian corporate boards. And in China, boards are populated by Communist Party officials.Bradley, Schipani, Sundaram, and Walsh (1999).
The German and Japanese corporate governance systems are very different from that in the United States. Knowing how they function is important. The German and Japanese economies play host to many of the world’s largest corporations. Moreover, their governance systems have had substantial spillover effects beyond their respective borders. Many countries in Europe, such as Austria, Belgium, Hungary, and, to a lesser extent, France and Switzerland, and much of northern Europe, evolved their governance systems along Germanic, rather than Anglo-American, lines. Moreover, the newly liberalizing economies of Eastern Europe appear to be patterning their governance systems along Germanic lines as well. The spillover effects of the Japanese governance system are increasingly evident in Asia where Japanese firms have been the largest direct foreign investors during the past decade. In contrast, variants of the Anglo-American system of governance are only found in a few countries, such as the United Kingdom, Canada, Australia, and New Zealand.
The German Corporate Governance System
The goals of German corporations are clearly defined in German corporation law. Originally enacted in 1937, and subsequently modified in 1965, German corporate law defines the role of the board to govern the corporation for the “good of the enterprise, its multiple stakeholders, and society at large.” Until the 1965 revision, the German corporate law said nothing specific about shareholders. The law also provides that if a company endangers public welfare and does not take corrective action, it can be dissolved by an act of state. Despite the relatively recent recognition that shareholders represent an important constituency, corporate law in Germany makes it abundantly clear that shareholders are only one of many stakeholder groups on whose behalf managers must run the firm.
Large public German companies—those with more than 500 employees—are required to have a two-tier board structure: a supervisory board (Aufsichtsrat) that performs the strategic oversight role and a management board (Vorstand) that performs an operational and day-to-day management oversight role. There are no overlaps in membership between the two boards. The supervisory board appoints and oversees the management board. In companies with more than 2,000 employees, half of the supervisory board must consist of employees, the other half of shareholder representatives. The chairperson of the supervisory board is, however, typically a shareholder representative and has the tie-breaking vote. The management board consists almost entirely of the senior executives of the company. Thus, management board members have considerable firm- and industry-specific knowledge. The essence of this two-tiered board structure is the explicit representation of stakeholder interests other than of shareholders: No major strategic decisions can be made without the cooperation of employees and their representatives.
The ownership structure of German firms also differs quite substantially from that observed in Anglo-American firms. Intercorporate and bank shareholdings are common, and only a relatively small proportion of the equity is owned by private citizens. Ownership typically is more concentrated: Almost one quarter of the publicly held German firms has a single majority shareholder. Also, a substantial portion of equity is “bearer” rather than “registered” stock. Such equity is typically on deposit with the company’s hausbank, which handles matters such as dividend payments and record keeping. German law allows banks to vote such equity on deposit by proxy, unless depositors explicitly instruct banks to do otherwise. Because of inertia on the part of many investors, banks, in reality, control a substantial portion of the equity in German companies. The ownership structure, the voting restrictions, and the control of the banks also imply that takeovers are less common in Germany compared to the United States as evidenced by the relatively small number of mergers and acquisitions. When corporate combinations do take place, they usually are friendly, arranged deals. Until the recent rise of private equity, hostile takeovers and leveraged buyouts were virtually nonexistent; even today antitakeover provisions, poison pills, and golden parachutes are rare.
The Japanese Corporate Governance System
The Japanese economy consists of multiple networks of firms with stable, reciprocal, minority equity interests in each other, known as keiretsus. Although the firms in a keiretsu are typically independent companies, they trade with each other and cooperate on matters, such as governance. Keiretsus can be vertical or horizontal. Vertical keiretsus are networks of firms along the supply chain; horizontal keiretsus are networks of businesses in similar product markets. Horizontal keiretsus typically include a large main bank that does business with all of the member firms and holds minority equity positions in each.
Like Anglo-American companies, Japanese firms have single-tier boards. However, in Japan a substantial majority of board members are company insiders, usually current or former senior executives. Thus, unlike the United States, outside directorships are still rare, although they are becoming more prevalent. The one exception to outside directorships is the main banks. Their representatives usually sit on the boards of the keiretsu firms with whom they do business. In contrast to the German governance system where employees and sometimes suppliers tend to have explicit board representation, the interests of stakeholders other than management or the banks are not directly represented on Japanese boards.
Share ownership in Japan is concentrated and stable. Although Japanese banks are not allowed to hold more than 5% of a single firm’s stock, a small group of four or five banks typically controls about 20% to 25% of a firm’s equity. As in Germany, the market for corporate control in Japan is relatively inactive compared to that in the United States. Bradley, Schipani, Sundaram, and Walsh (1999) found that disclosure quality, although considered superior to that of German companies, is poor in comparison to that of U.S. firms. Although there are rules against insider trading and monopolistic practices, the application of these laws is, at best, uneven and inconsistent.Bradley, Schipani, Sundaram, and Walsh (1999).
As Bradley et al. (1999) observe, although there are significant differences, there also is a surprising degree of similarity between the German and Japanese governance systems. Similarities include the relatively small reliance on external capital markets; the minor role of individual share ownership; significant institutional and intercorporate ownership, which is often concentrated; relatively stable and permanent capital providers; boards comprising functional specialists and insiders with knowledge of the firm and the industry; the relatively important role of banks as financiers, advisers, managers, and monitors of top management; the increased role of leverage with emphasis on bank financing; informal as opposed to formal workouts in financial distress; the emphasis on salary and bonuses rather than equity-based executive compensation; the relatively poor disclosure from the standpoint of outside investors; and conservatism in accounting policies. Moreover, both the German and Japanese governance systems emphasize the protection of employee and creditor interests, at least as much as the interests of shareholders. The market for corporate control as a credible disciplining device is largely absent in both countries, as is the need for takeover defenses because the governance system itself, in reality, is a poison pill.Bradley, Schipani, Sundaram, and Walsh (1999).
As recent history has shown, however, the stakeholder orientation of German and Japanese corporate governance is not without costs. The central role played by both employees (Germany) and suppliers (Japan) in corporate governance can lead to inflexibility in sourcing strategies, labor markets, and corporate restructurings. It is often harder, therefore, for firms in Germany and Japan to move quickly to meet competitive challenges from the global product-market arena. The employees’ role in governance also affects labor costs, while a suppliers’ role in governance, as in the case of the vertical keiretsu in Japan, can lead to potential problems of implicit or explicit vertical restraints to competition, or what we would refer to as antitrust problems. Finally, the equity ownership structures in both systems make takeovers far more difficult, which arguably is an important source of managerial discipline in the Anglo-American system.