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A financial system can only perform its function of channelling funds from savers to investors if it offers sufficient assurance to the providers of the funds that they will reap the rewards which have been promised to them. To the extent that this assurance is not provided by contracts alone, potential financiers will want to monitor and influence managerial decisions. This is why corporate governance is an essential part of any financial system. It is almost obvious that providers of equity have a genuine interest in the functioning of corporate governance. However, corporate governance encompasses more than investor protection. Similar considerations also apply to other stakeholders who invest their resources in a firm and whose expectations of later receiving an appropriate return on their investment also depend on decisions at the level of the individual firm which would be extremely difficult to anticipate and prescribe in a set of complete contingent contracts. Lenders, especially long-term lenders, are one such group of stakeholders who may also want to play a role in corporate governance; employees, especially those with high skill levels and firm-specific knowledge, are another. The German corporate governance system is different from that of the Anglo-Saxon countries because it foresees the possibility, and even the necessity, to integrate lenders and employees in the governance of large corporations. The German corporate governance system is generally regarded as the standard example of an insider-controlled and stakeholder-oriented system. Moreover, only a few years ago it was a consistent system in the sense of being composed of complementary elements which fit together well. The first objective of this paper is to show why and in which respect these characterisations were once appropriate. However, the past decade has seen a wave of developments in the German corporate governance system, which make it worthwhile and indeed necessary to investigate whether German corporate governance has recently changed in a fundamental way. More specifically one can ask which elements and features of German corporate governance have in fact changed, why they have changed and whether those changes which did occur constitute a structural change which would have converted the old insider-controlled system into an outsider-controlled and shareholder-oriented system and/or would have deprived it of its former consistency. It is the second purpose of this paper to answer these questions.
Some of the most widely expressed myths about the German financial system are concerned with the close ties and intensive interaction between banks and firms, often described as Hausbank relationships. Links between banks and firms include direct shareholdings, board representation, and proxy voting and are particularly significant for corporate governance. Allegedly, these relationships promote investment and improve the performance of firms. Furthermore, German universal banks are believed to play a special role as large and informed monitoring investors (shareholders). However, for the very same reasons, German universal banks are frequently accused of abusing their influence on firms by exploiting rents and sustaining the entrenchment of firms against efficient transfers of firm control. In this paper, we review recent empirical evidence regarding the special role of banks for the corporate governance of German firms. We differentiate between large exchangelisted firms and small and medium sized companies throughout. With respect to the role of banks as monitoring investors, the evidence does not unanimously support a special role of banks for large firms. Only one study finds that banks´ control of management goes beyond what nonbank shareholders achieve. Proxyvoting rights apparently do not provide a significant means for banks to exert management control. Most of the recent evidence regarding small firms suggests that a Hausbank relationship can indeed be beneficial. Hausbanks are more willing to sustain financing when borrower quality deteriorates, and they invest more often than arm´s length banks in workouts if borrowers face financial distress.
Taking shareholder protection seriously? : Corporate governance in the United States and Germany
(2003)
The paper undertakes a comparative study of the set of laws affecting corporate governance in the United States and Germany, and an evaluation of their design if one assumes that their objective were the protection of the interests of minority outside shareholders. The rationale for such an objective is reviewed, in terms of agency cost theory, and then the institutions that serve to bound agency costs are examined and critiqued. In particular, there is discussion of the applicable legal rules in each country, the role of the board of directors, the functioning of the market for corporate control, and (briefly) the use of incentive compensation. The paper concludes with the authors views on what taking shareholder protection seriously, in each country s legal system, would require.
Recent empirical work shows that a better legal environment leads to lower expected rates of return in an international cross-section of countries. This paper investigates whether differences in firm-specific corporate governance also help to explain expected returns in a cross-section of firms within a single jurisdiction. Constructing a corporate governance rating (CGR) for German firms, we document a positive relationship between the CGR and firm value. In addition, there is strong evidence that expected returns are negatively correlated with the CGR, if dividend yields and price-earnings ratios are used as proxies for the cost of capital. Most results are robust for endogeneity, with causation running from corporate governance practices to firm fundamentals. Finally, an investment strategy that bought high-CGR firms and shorted low-CGR firms would have earned abnormal returns of around 12 percent on an annual basis during the sample period. We rationalize the empirical evidence with lower agency costs and/or the removal of certain governance malfunctions for the high-CGR firms.