THE RECONSTRUCTION OF GERMAN
CORPORATE GOVERNANCE:
REASSESSING THE ROLE OF CAPITAL MARKET PRESSURES
Sigurt Vitols
Wissenschaftszentrum Berlin für Sozialforschung
Reichpietschufer 50
D-10785 Berlin, Germany
[email protected]
Background paper for the debate "Höpner vs. Vitols vs. Zugehör: Do Financial Markets Matter? Capital Market
Orientation of Large German Companies", First Annual Meeting of the Research Network on Corporate Governance,
Berlin Germany 23-24 June 2000
In the 1980s one of the key preoccupations of comparative political economy was the mapping of broad institutional
differences in national models of capitalism and the linking of these differences with outcomes such as economic
performance (Lange and Garrett 1985; Soskice 1990; Zysman 1983). In the 1990s, however, the focus has shifted to
the problem of convergence between national models: what are the pressures for convergence and how strong are
they (Boyer and Drache 1996; Crouch and Streeck 1998)? With the risk of some oversimplification, the majority
view in this debate sees international capital markets as the primary driver in this process and posits quite substantial
pressures for convergence toward a market-oriented "Anglo-American" model. In the area of corporate governance
the mechanism driving convergence is the (increasingly) global search by portfolio investors for higher returns;
companies are (increasingly) being faced with the following basic choice: adopt the shareholder value (i.e.
"shareholder interests first") model of corporate organization or be starved of the external capital needed to survive.
Some even speculate that shareholder value may have become the central organizing principle of the latest phase of
capitalism (Boyer 2000).
This paper denies neither the significant changes that are taking place in asset management nor the fundamental
challenges non-liberal varieties of capitalism such as the postwar German "social market economy" are facing. Its
fundamental claim however is that the majority view grossly overestimates the role of capital markets and the degree
of pressure for convergence they impose. This critique of the majority view is based on three claims.1 Firstly, the
type of value-oriented investors needed to consistently reward shareholder value – the Warren Buffetts and Peter
Lynches of the money management community – no longer define the dominant investing style. Instead, the
"marginal dollar" is controlled (and thus share price is determined) by investment managers for which traditional
valuation methods play a minor role. These include in particular macro hedge funds at the wholesale level and
growth and momentum equity funds at the retail level. As a result, corporate efforts to implement shareholder value
are not consistently rewarded and capital markets should therefore be conceptualized as a weak constraint for
convergence. Secondly, product markets are generally a more significant driver of corporate change, and capital
market pressures often indirectly reflect these product market pressures.
Thirdly and finally, external pressures for change are often diffuse and the future implications of different
alternatives are unclear. Therefore strategic corporate choices cannot be read off of institutions but rather are
determined by the political struggles of concrete actors within the firm and variables such as "management ideology"
and "labor solidarity" play a role. As a result, corporate change in Germany is characterized by considerable
heterogeneity, covering the whole spectrum from radical acceptance of shareholder value to stubborn resistance to
change. The path of least resistance however appears not to be any generalized convergence to the Anglo-American
model, but rather the adoption of "hybrid" models of corporate organization combining a partial upgrading of the
status of minority shareholders (mainly through increased financial transparency and a nominal commitment to
increasing share price) with traditional stakeholder practices such as consensus bargaining among management and
between management and labor.
The first section of this paper outlines the concept of capital markets as a weak constraint for shareholder value in
Germany and provides some statistical evidence for this view. The second section analyzes the politics of change in
a select sample of large German companies. The third section argues that the most typical response among large
German companies will likely be the adoption of a "weak shareholder value" model.
1. Capital Markets as a Weak Constraint for Shareholder Value
The seminal academic expression of a fundamental problem of industrial capitalism -- the separation of ownership
and management in large companies -- was provided by Berle and Means (1932). The increasing size and capital
needs of companies outstrip the capacity of owner/entrepreneur to provide finance and thus increase the need for
"outside" shareholders. Furthermore, as companies matured, owner-entrepreneurs were increasingly replaced with
professional management. These developments result in the following problems: 1) conflicting interests between
owners, who are interested in increasing the value of the firm (as reflected in share price in the case of listed
companies), and top management, which is interested in consumption and "empire building". 2) difficulties in
monitoring management performance by owners due to asymmetric and costly information. 3) collective action
problems among owners, since the benefits of monitoring and corrective actions are small relative to costs in the
context of the free riding endemic to dispersed ownership.
1
For another account of the German case sceptical of the convergence view see Jürgens, Naumann and Rupp (2000).
1
One of the key findings of comparative research was that different corporate governance systems have different ways
of dealing with this fundamental structural problem (Berglöf 1991; Franks and Mayer 1990; Mayer and Alexander
1990). In market systems such as the US and UK the primary mechanism controlling management is "exit", i.e.
shareholders will sell shares in under-performing companies. Ultimately companies will be starved of the capital
they need to make new investments (and also presumably to fund the kind of empire-building that top management is
interested in). In the 1980s, a second mechanism aligning shareholder and management interests was developed with
the rise of junk-bond financed hostile takeovers in the US (Auerbach 1988). When management did a blatantly bad
job of running the firm and share prices were depressed far enough, an external party could convince shareholders
that management should be removed and a new management team appointed to make changes that would boost share
price. In part because of disappointment with the efficacy of these mechanisms, stock options have been receiving
more emphasis in recent times as a third mechanism for aligning interests (Keasy and Wright 1997). Management is
granted stock options which can be exercised only with the achievement of certain performance targets, typically
share price performance relative to some index.
The traditional German "stakeholder" model of corporate governance lacks all three of these mechanisms (Kelly,
Kelly, and Gamble 1997; Vitols et al. 1997). First, most listed German companies are owned by large shareholders
that, due to their size and the thinness of the stock market, cannot sell without destroying share price and can thus
exit only through private negotiation over the package sale of shares to some other large party (Deutsche
Bundesbank 1997). Furthermore, for most of these large shareholders – the large banks, family/founders, or other
companies – share price has only been one of a number of interests (and frequently a minor interest at that. Second,
the German model of corporate organization contained considerable barriers to hostile takeovers, including different
classes of voting shares, restrictions on voting rights by outsiders, and codetermination. Finally, German securities
law did not permit large-scale granting of stock options to management and employees.2
In recent years, however, a number of changes have led to a discussion about whether the traditional German
stakeholder model is viable. Firstly, a number of large shareholders have announced that they wish to reduce their
shareholdings. The most prominent of these are the largest banks (Deutsche Bank and Dresdner Bank) and various
levels of government seeking revenue from privatization to cover deficits. It also appears that a number of family
shareholders are also interested in reducing or entirely selling their equity stakes.3 Decreasing holdings by large
shareholders allows for an increase in the importance of minority shareholders and liquidity, thus in principle the
feasibility of the "exit" option has been improved for many companies. Secondly, a number of hostile takeover bids
have been made, most prominently Krupp-Hoesch's bid for Thyssen and Vodafone's bid for Mannesmann. Though
in fact in both cases "friendly" merger agreements were reached, it is clear that a new weapon is now available in the
arsenal for corporate battles on German territory. The threat that this weapon could be used is clearly recognized by
both management and works councils in large companies. Finally, reform legislation affecting German company and
securities law (Kontrag, or the Law on Transparency and Control of Large Companies) allows companies to grant
stock options much more easily, introduces the "one share-one vote" principle, and does a number of other things
such as authorize share buyback programs (Ziegler 2000).
These changes (which are similarly occurring in many non-liberal countries other than Germany) – in conjunction
with the increased willingness of institutional investors (particularly those based in the US and UK) to invest across
national borders – have given rise to the thesis that companies in these countries will be forced to converge to the
"shareholder value" model of organization. In this model of corporate organization minority shareholder interests are
given top (by some accounts even sole) priority when it comes to company strategy and the allocation of resources.
The basic assumption of this model is that there are in fact some set of characteristics (or "shareholder value
principles") which companies can adopt which would result in a greater (long term) appreciation in share price than
other alternative models of corporate organization. The leading investment fund family in Germany, DWS, defines
these characteristics as follows:
2
Linking management remuneration to share price was not in fact totally banned but involved a very cumbersome
procedure using convertible bonds as the incentive vehicle.
3
For example, the sale of of a large equity stake by one of the Thyssen family, who was reportedly more interested
in cattle-raising in South America, put the Thyssen concern "in play" in the mid-1990s. The Quandt family, which
owns 48% of BMW through a foundation and a large share of one of the mid-cap (MDAX) pharma companies, is
also reportedly interested in decreasing their stakes.
2
•
•
•
•
•
"A "core" set of markets offering above-average growth potential should be defined. Subsidiaries not in this
core area should be sold, and acquisitions made to strengthen the company in these core areas.
Capital should be allocated within the firm according to an “investment matrix” identifying the growth potential,
cash flow, and investment needs of different business units.
Clear minimum profit goals should be set for all business units and progress in meeting them should be
monitored. Under-performing business units should be sanctioned. If there is no improvement in meeting goals,
these units should be sold or shut down.
A major part of managers' and employees' compensation should be tied to performance.
The strategy, performance and financial situation of the company should be transparent and clearly
communicated to investors. This includes quarterly reports according to US-GAAP or IAS standards, frequent
meetings with investment analysts, and the timely reporting of events with significance for share price (ad-hoc
publicity)" (Strenger 1997).
The mechanism driving convergence is the fact that institutional investors now "scan the globe" for investment
opportunities offering the highest potential increase in value. Increasing choice for retail investors and the resulting
competition drive money mangers to seek above-average rates of return and thereby attract more assets under
management (money manager remuneration is usually based in part on the size of assets under management). If a
critical mass of money managers come to believe that shareholder value principles lead to higher long-term share
prices, their investment decisions will be made conditional upon the adoption of these principles by companies. If
this in fact becomes the dominant investment philosophy among money managers German companies will be forced
to adopt shareholder value or be starved of new capital. This view has become dominant in academic circles
(particularly among economists) and also finds many supporters among political parties, particularly the (neo)-liberal
parties.
A key problem with this model, however, is the fact that since the mid-1990s this "value-oriented" style of investing
typified by investors like Warren Buffett and Peter Lynch (Lowenstein 1995; Lynch 1990s) is no longer the
dominant investment philosophy in the US and UK. 4 At the retail level the lion's share of new money has gone into
the class of equity funds broadly labeled "growth funds" (including growth, aggressive growth, momentum and to
some extent growth and income funds). Comprehensive data on US equity funds show that total assets under
management by value-oriented funds grew at a rate ten percentage points less than assets under management for
equity funds as a whole in 1999 (see table 1). Assets accounted for by growth funds as a whole in contrast increased
at a rate of 105 percent, i.e. more than double the overall rate. Since the value investing principle consistently led to
severe under-performance relative to growth funds in the latter half of the 1990s (on the order of 6-7 percent versus
40+ percent), value funds have been forced to either become "closet" growth funds or to close up as investor money
is taken away from them.
A key characteristic of growth funds is that investments are concentrated on companies in sectors offering
significantly higher-than-average growth rates -- in practice these turn out to be almost exclusively high tech sectors
such as information technology, multimedia, and telecommunications ("TMT"), and biotechnology. As the cleft
between "high growth" and "non-high growth" sectors has become progressively larger traditional valuation
measures such as price-to-earnings (p/e) ratios and book-to-market-value ratios have become increasingly
meaningless (Merrill Lynch 2000). The most difficult cases for traditional valuation methodologies are the biotech
and internet sectors, where most companies have little or no revenues, make huge losses, and provide a glimmer of
hope of breaking even only in the distant future. Growth fund managers have therefore discarded these valuation
methods in favor of more dynamic measures emphasizing future sales and downplaying current profitability. The
extreme case in investment philosophy is provided by the so-called momentum funds, which ignore so-called
company fundamentals entirely and invest purely on the basis of technical factors (such as chart analysis) which for
the most part counterintuitive for value investors.5
4
Excellent coverage and analysis of this seismic shift in investment philosophy is provided on theStreet.com
(www.theStreet.com), particularly by James Cramer, managing partner of a $300 million hedge fund.
5
Fundamental rules for value investors are "buy cheap and sell dear" and "buy when others are selling." In contrast,
one common trading rule for momentum investors is buy stocks when they make a new 52-week high, i.e. buy dear
not cheap and sell even dearer. The pathbreaking classic of technical analysis is Edwards and Magee (1948). A
newer text covering modern technical tools such as oscillators and applying them to commodity futures is Schwager
(1996).
3
A second characteristic of growth funds is that they focus for the most part on so-called large cap companies, i.e.
companies whose market value ("capitalization") is very large, whose resulting high levels of liquidity allow for
quick entry and exit.6 A significant segment of these funds are either foreign or international funds, i.e. they invest
either solely outside of their home country or mix their investments between the home country and foreign countries,
respectively. Most of these funds enjoy great flexibility in allocating their investments between different countries
and will change their country and regional weightings quite rapidly according to their assessment of future
macroeconomic and political developments, i.e. buy and sell rapidly.
At the wholesale investor level (e.g. endowments and pension funds) the trend has been to contracting out asset
management to external (independent) money managers. An increasingly prominent role is being played by hedge
funds. For example, Calpers (the pension system for California state public workers), which is one of the largest
pension funds in the US, has allocated $11 billion to "hybrid investments", which includes hedge funds and corporate
governance funds (Peltz 2000). Hedge funds are essentially non-regulated funds, generally registered offshore, who
typically take on a greater degree of risk than a normal equity fund in an effort to achieve higher returns
(Bundesbank 1999; Eichengreen and Mathieson 1998; Eichengreen and Mathieson 1999). In order to do so many
hedge funds invest in a wider variety of investment vehicles (e.g. options and futures not only on equities and equity
indexes but also currencies, bonds and commodities) and are not subject to the prudential restrictions that apply to
retail investment funds.7
Industry observers estimate that at the end of 1999 about 3,000 hedge funds were in existence accounting for about
$205 billion in assets (Peltz 1999). The size of assets under management continues to climb rapidly despite financial
turbulence and some spectacular failures caused by the Asian crisis (e.g. Long Term Capital Management). Though
accounting for only about three percent of hedge funds by number, the lion's share of assets are accounted for by the
so-called macro hedge funds, i.e. funds that invest in and divest out of countries mainly for macroeconomic reasons
(e.g. looser monetary policy, anticipated recession or political reasons). The most prominent among these are the
Soros group of funds (with about $20 billion under management) and funds under management at both Tudor
Investment (Paul Tudor Jones) and Tiger Management (Julian Robertson). These hedge funds have a bias toward
large companies both through their direct equity investments (due to preference for liquidity for quick entry and exit)
and through their indirect investments since most derivatives are concentrated on large companies (futures on large
cap indexes, index options, and single equity options on the most frequently traded companies).
Insofar as Germany is concerned, the "marginal dollar" invested or divested by foreign investors does not appear to
be controlled by the kind of value investor that is needed to drive the shareholder value model. The degree of
foreign activity has in fact dramatically increased in the latter part of the 1990s (see table 2). Foreign purchases of
German equities increased tenfold in nominal terms between 1987 and 1998 (from 65 to 652 billion DM). This
increased activity, however, appears to be accompanied by increased volatility in equity flows. Whereas purchases
and sales of German equities were roughly equal in the first half of the 1990s, net inflows into Germany increased
dramatically starting in 1996 and reached 97 billion DM in 1998. (Other statistics show a major net outflow of
foreign investment in the first quarter of 1999). The first quar A breakdown by the home country of investors shows
widely varying investment behavior. The net balance for the UK, which accounts for almost half of foreign equity
purchases in Germany, never exceeds ten percent of purchases (either minus or plus). Activity by US-based
investors, however, is much more volatile. Net purchases of German equities in 1998 reached 52 billion DM, or
almost half of total purchases of 116 billion DM. Although comprising only eighteen percent of foreign equity
purchases in 1999, US-based investors therefor accounted for almost half of the net balance of foreign purchases in
6
The bane of institutional investors is that the purchase or sale of a relatively small number of shares can
significantly move share price up or down. This affect varies quite substantially both according to the nature of the
market for a specific company's shares (typical daily turnover and level of outstanding "buy" and "sell" orders) and
to general market conditions. The preference for large capitalization companies comes from the fact that the
purchase of $1 million of stock in Microsoft would have much less impact on share price than the purchase of $1
million of stock in the Wissenschaftszentrum Berlin, were it listed on the Berlin stock exchange. One rough rule of
thumb is that institutional investors will avoid companies with market capitalizations of less than $500 million,
unless they are restricted to do so by their charters (e.g. small cap technology funds).
7
For fascinating insider accounts and collections of interviews with hedge fund managers see Niederhoffer (1997)
Schwager (1993) and Soros (1987). The all-time speculator's bible is the biographical account of Jesse Livermore,
considered the greatest trader of the first half of the twentieth century (Lefevre 1923).
4
1998. Anecdotal evidence appears to show that the US marginal impact through the futures markets may be even
greater (Hill and Dunn 1999).
Altogether this seems to lead to two important trends in investing behavior. The first trend is the increasing
importance of liquidity and thus a bias toward companies with large capitalizations. This can be seen for example in
the great differences between the relative valuations and share price developments of companies in the DAX (largest
thirty companies) and the MDAX (70 next largest or midcap companies) indexes. Whereas the DAX index
increased 38.9% in 1999, the MDAX index only increased 5.1%. By one common valuation measure, the price-toearnings ratio, the average valuation of DAX companies was twice as high as MDAX companies (52.3 versus 26.6).8
A second trend is short-term flows between "hot" and "cold" sectors, or so-called "branch rotation" or "group
rotation". Hot sectors in 1999 were the TMT stocks, in 1998 pharma, in 1997 automobiles, etc.
The dominance of these investment philosophies can be seen in the weak correlation between the adoption of
shareholder value principles at the company level and actual share performance.9 In the following analysis I use a
measure of "good corporate governance" or shareholder value principles developed by DWS, Germany's largest
investment fund group (and a subsidiary of the Deutsche Bank holding). This index is significant because it reflects
the views of a sizable institutional investor that is trying to model itself on "best practice" in corporate activism in the
US, particularly Calpers. This index (as reported in Manager Magazin, February 2000) provides a ranking of the
DAX 30 companies according to transparency in company accounts and investor relations, quality of the supervisory
board, incentive pay for top managers, and minority shareholder rights. A summary index is developed based on
weighting these factors and adding a fixed number of points if the company recognizes the voluntary Takeover Code.
A correlation analysis of the DWS shareholder value index and the 1999 share performance of the DAX 30
companies shows an extremely low correlation (Pearson correlation coefficient of .207) which fails the test for
significance at the .05 level (two tailed) (see table 3). A scatterplot of the DAX 30 companies against these two
variables provides visual confirmation of the analysis. With the exception of the outlyer Volkswagen, which has the
lowest score for shareholder value and also had one of the poorest share performances in 1999, the scatterplot shows
no clear relationship between the two factors. The two companies scoring highest on the shareholder value index
(DaimlerChrysler and Adidas-Salomon) also had among the worst share price performances of the group in 1999.
A table displaying P/E ratios for the DAX 30 companies on the other hand shows the extreme differences in the
relative valuations of different groups of companies and the tendency to "branch rotation" (see table 4). At the top of
the list are Mannesmann, Deutsche Telekom, and SAP, all stocks in the TMT group. The p/e valuation for
Mannesmann (based on a share price defined in the midst of the Vodafone takeover) is almost 40 times higher than
the valuation for DaimlerChrysler, considered the best shareholder value company according to the DWS index.
In order to determine which factors drive share price performance a number of alternative models were tested (see
table 5). A model using market capitalization and branch dummy variables yielded an R-square of .741 (i.e.
accounts 74% of the variation in the dependent variable) and shows that the market capitalization measure and a
number of the industry dummies are significant at the .05 level (two tailed). The addition of the DWS shareholder
value index fails significance tests both on the individual variable level and the additional explanatory power of the
model level.
There is also anecdotal evidence from key participants that capital market pressures for shareholder value in
Germany are weak. To quote the current speaker of the board of managing directors of the DWS investment group:
"For the big [German] companies, the Blue Chips…institutional investors have today more than 60% [of
shares]. And their influence is strengthened especially by foreign institutional investors.
The question is: Do these institutional investors exert their influence in favor of Corporate Governance?
8
Calculated on the basis of end-of-December share price and 12 month trailing earnings. The difference in the
median p/e ratio was less extreme but still significant (26.6 for DAX companies versus 19.0 for MDAX companies).
9
It should be noted that defining "shareholder value" itself is not unproblematic. The correlation of different
shareholder value indexes with each other (e.g. DWS index, SGZ index, Höpner index) is strong but not stunning.
For example the correlation between the DWS and Höpner indexes is 0.55.
5
I fear that the changing balance of power in corporate ownership has left a vacuum of Corporate
Governance. The retreat of traditional structures has left deficiencies which are, still, not filled by the new
owners. In other words, we need a new governance culture" (Behrenwaldt 2000: 3).
To summarize, there is at best a weak link between shareholder value principles and share price performance, i.e. the
market does not actually appear to reward shareholder value. As a result the market can at best be conceptualized as
exerting weak pressures on company strategies and thus only as a weak constraint for the adoption of shareholder
value principles.
2. The Politics of Corporate Change in Germany
The weakness of this capital market constraint provides considerable "room for manuever" at the corporate level for
organizational and strategic change. When interviewed, management and works councils consistently cite product
market changes as the most important challenges facing companies. This picture is confirmed by management
discussions in company annual reports. The actual solutions chosen to respond to these problems are a result of
management ideologies, intra-management politics and labor solidarity.
Two features of German corporate decision-making are crucial for understanding the politics of corporate change
(Vitols et al. 1997). The first is the relatively weak position of the "CEO" (Vorstandsvorsitzender) vis-à-vis other top
managers in comparative context. In the Ango-American context the CEO is typically the clear power center of the
company. The CEO often also holds the post of board chairperson and heads one or more board committees as well.
Other board members (both executive and non-executive) are typically more or less handpicked by the CEO. As a
result, in the absence of clear resolute opposition, once reaching a decision the CEO can get board approval for
radical changes relatively easily.
In Germany in contrast a "federalistic" form of organization within the management board predominates. The head
of the management board is generally considered "first among equals" and is often referred to as the board "speaker"
rather than chairperson. Individual board members enjoy great autonomy in decision-making and have their own
constituency they can draw upon for political support. The strongest of these are typically the CFO, with a
constituency in the financial community, and the labor and social affairs director, with a constituency in the works
council structure and union(s).10 As a result decisions are typically made on a consensus basis, which makes it quite
difficult to get agreement on radical changes at the board level. One can of course find some cases in which CEOs
receive a mandate from the supervisory board for implementing radical change against the opposition of the rest of
the management board (e.g. Lufthansa in the early 1990s). However, these appear to occur rarely and only in the
context of crises. After the crisis is over the more typical pattern of consensus decision-making tends to returns
(Lehrer 1997).
In terms of the management board, capital market pressures appear mainly through the CFO as relayed by their
financial community "constituency".11 Due to consensus decision making principles the CFO thus finds it difficult to
push through alone the kind of radical changes that shareholder value requires. Interviews indicate that the minimum
requirements for the implementation of shareholder value principles are a strong commitment by both the CEO and
the CFO to these principles plus a generalized feeling that current corporate strategy is inadequate (most clearly in
the case of a financial crisis).
10
The reasons for this high level of autonomy are worthy of further investigation. At a formal level company law in
fact creates the same generalized obligations and "equal responsibility" of board members in both Germany, the US
and UK. The fact that individual management board members must be approved by the supervisory board in
Germany would certainly play a role in reducing dependency on the CEO.
11
Interviews indicate that Anglo-American investor relations practices are a great shock for many German CFOs.
These include "road shows", investor conferences and quarterly conference calls where the CFO has a relatively
short period of time (e.g. half an hour) to make a presentation before and be subject to questioning by stock analysts.
In addition US and UK fund managers demand regular "one-on-ones" or meetings with the CFO. CFOs in the US
can spend up to half of their working time on investor relations activities. Stock analysts are typically in their
twenties or thirties and CFOs often do not adapt easily to a critical style of questioning by people thirty or even
fourty years their junior.
6
A second key feature of German corporate decision-making is the importance of consensus with the works council
on key changes in policy. Under the Works Constitution Acts works councils enjoy very strong legal rights to
negotiate a number of key changes with management. Shareholder value principles violate a number of key
traditional German labor practices. A number of conflicts with the works council over implementation of
shareholder value is thus preprogrammed (see table 6). A resourceful works council can effectively block a number
of changes considered crucial to implementation.
"Labor solidarity" thus is a crucial variable influencing the ability of works councils to resist management demands
for shareholder value. This solidarity is influenced by at least three factors:
1) the degree of corporate diversification, and the tendency of highly diversified companies to have holding
company structures. In the case of high diversification the works council structure typically has multiple power
centers located in the main subsidiaries and coordination can be difficult. Representation by a number of unions
reduce the ability of unions to play a coordinating role.
2) the power of opposition groups within the works council structure. Works councils may have two or more large
"fractions" which makes it more difficult to pose an effective counterweight to management
3) the strength of employee groups less susceptable to "collective representation". The most prominent of these are
highly skilled white collar workers such as researchers in the pharma and IT branches.
Conditions "favorable" to the implementation of shareholder value principles have in fact appeared in a number of
cases in Germany. The most prominent examples here include VEBA (a diversified energy company), Hoechst
(diversified chemicals and pharmaceuticals) and Daimler Benz -- now DaimlerChrysler (auto and truck manufacturer
also involved in aerospace and IT activities). In all three cases there was a widespread feeling among management
that corporate strategy was inadequate. In the case of VEBA a reformulation of strategy was driven by the looming
liberalization of its core energy markets (particularly electricity generation) and dissapointment with the results of
the "wild diversification" of the 1980s. Once the world's largest pharmaceutical company, Hoechst had seen market
share shrink since the 1970s to the point where it was on the verge of dissapearing from the list of top ten
international pharma companies by sales. Daimler Benz's core auto and truck operations were simultaneously hit by
the triple problems of a strong Deutschemark, assault of Japanese lean producers of the upmarket segment of the
automotive market, and a Bundesbank-induced European recession. In conjunction with the failure of its 1980s
diversification strategy it suffered huge losses in the mid-1990s.
Labor solidarity was also weak in the first two cases and possibly in the third as well. VEBA has a holding company
structure and a strong employee representation structure at the holding company level was never developed.
Different unions represented included unions for the chemical workers, public sector workers union, and
metalworking. At Hoechst the works council power center was located in the industrial chemicals division and
representation in the pharma area and agricultural chemicals was weak. At Daimler Benz the diversification into
aerospace (Dasa), electronics (AEG) and information technology (Debis) may have also provided a major challenge
for a solidaristic labor policy.
In all three companies company boards approved plans for implementing a "radical" form of shareholder value.
VEBA was the first major German company to explicitly adopt shareholder value as a top corporate goal. Its actions
included listing on the New York Stock Exchange (NYSE) (which required bookkeeping according to US-GAAP),
the adoption of ambitious profitability goals, and the announcement of the intention to sell off "non-core" and
underperforming business units. Hoechst announced that it would exit its low-margin, low-growth industrial
chemicals businesses and use the proceeds to fund research and make the acquisitions necessary to be a world-class
life sciences (pharma and agrochemicals) company. This strategy culminated in the merger with Rhone-Poulenc and
the "giving up" of German identity in favor of the new French-based company Aventis. Daimler-Benz also
announced a "return" to its core business of auto and truck manufacturing, adopted profitability goals and introduced
business centers, and switched to US-GAAP and obtained a NYSE listing. It also took the radical step of an
international merger with Chrysler (though unlike Hoechst the identity of the merged company remained clearly
German).
Although initially gaining great attention and awaking a variety of hopes and fears, to date the most "radical"
shareholder value companies in Germany have not clearly shown that they consistently and substantially outperform
"peer group" companies adopting more gradualist responses to product market change. "Real" indicators such as
profitability levels and market share have not consistently improved relative to these peer companies. Perhaps most
7
disappointing for shareholder value advocates, the stock market has not rewarded these shareholder value pioneers
for their efforts (see table 7). This failure to outperform has undermined the political position of those arguing for
radical shareholder value solutions in Germany.
3. The Future of German Corporate Governance: "Weak" Shareholder Value as a Hybrid Model?
Given the significant barriers to radical corporate change and the lack of clear superiority of radical shareholder
value approaches, the most likely outcome to pressures for change in large German companies is to follow the "path
of least resistance". This involves the CFO pusing for measures that can be implemented without too much
opposition from other managers and the works council. In areas where it is difficult to get consensus from other
managers and the works council, however, traditional "stakeholder" practices would continue.
The kind of measures minority shareholders want on which it is easiest to get such approval deal with increased
transparency and a nominal commitment to improving share price. Measures which go much more to the heart of
consensus bargaining and many traditional practices however are much more difficult to implement and often
become quite watered down in the final version.
One can see this tendency in the fact that the adoption rate of US-GAAP or IAS is much higher than "deeper"
measures. The stock option plans introduced after the passage of Kontrag are quite small and poorly link
management remuneration with share price performance. "Cost of capital" approaches are for the most part
restricted to retrospective evaluation of performance at the management board level and have not been implemented
on a widewpread scale for forward investment planning at a decentralized operative level (KPMG 2000).
In the future there will certainly will be a certain degree of heterogeneity among large German companies (in fact
there always has been). However, a "hybrid" model combining more attention to minority shareholders with many
traditional practices of the stakeholder model of organization – which could perhaps be labelled a "weak"
shareholder value model -- will likely be the dominant response among large German companies to pressures for
change.12
12
For a sophisticated exposition of the concept of hybridization and its application to the spread of the "american"
mass production model to Europe see the recent work of Zeitlin.
8
TABLE 1:
US Equity Fund Performance in 1999
Type of Fund
1999 Fund
Performance
Growth Rate
251.2
653.2
393.1
128.3
56.6
67.9
50.4
27.7
38.6
647.7
798.2
570.6
142.5
43.6
62.4
88.9
33.3
45.3
396.5
145.0
177.5
14.2
-13.0
-5.5
38.5
5.6
6.7
157.8%
22.2%
45.2%
11.1%
-23.0%
-8.1%
76.4%
20.2%
17.4%
TOTAL
1667.0
2432.5
765.5
45.9%
memo:
All Growth
All Blend
All Value
All Large
All Mid-Cap
All Small
429.9
737.5
477.4
1297.5
252.8
116.7
879.1
875.1
647.5
2016.5
248.5
167.5
449.2
137.6
170.1
719.0
-4.3
50.8
104.5%
18.7%
35.6%
55.4%
-1.7%
43.5%
Large Growth
Large Blend
Large Value
Mid-Cap Growth
Mid-Cap Blend
Mid-Cap Value
Small Growth
Small Blend
Small Value
38.6%
19.5%
6.6%
60.1%
17.1%
6.7%
65.8%
22.2%
4.9%
Total Assets under Management ($ Billion)
31-Dec-98
31-Dec-99 Growth in $
Source: www.Morningstar.com Q'4 98 and Q4'99 Fund Performance Close-ups
9
Table 2:
Total Foreign, UK and US Investments in German Equities, 1987-1998
(In billion DM)
Year
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
Total foreign investments
Purchases
Sales
Balance
64.6
53.9
105.9
125.0
86.0
102.0
171.3
167.0
160.9
237.6
385.5
652.1
65.6
48.3
83.1
128.0
82.9
106.3
162.7
165.7
162.6
215.5
358.0
554.9
-1.0
5.6
22.8
-3.0
3.1
-4.3
8.6
1.3
-1.7
22.1
27.5
97.2
Purchases
87.4
133.1
187.7
309.9
UK Investments
Sales
Balance
87.5
120.4
182.4
292.4
-0.2
12.7
5.3
17.5
Purchases
15.2
27.8
39.9
116.4
US Investments
Sales
Balance
14.6
19.4
40.7
63.8
0.6
8.4
-0.8
52.6
Source: Deutsche Bundesbank, Special Publication, Balance of Payments by Region, August 1999
10
Table 3:
Correlation Analysis of Shareholder Value Indexes and 1999 Share Performance
For the DAX 30 Companies
Correlations
SP98_99
PE99TRAI
DWS SV Index
Höpner SV Index
Pearson Correlation
Sig. (2-tailed)
N
Pearson Correlation
Sig. (2-tailed)
N
Pearson Correlation
Sig. (2-tailed)
N
Pearson Correlation
Sig. (2-tailed)
N
Höpner
SP98_99 PE99TRAI DWS SV Index SV Index
1.000
.566**
.207
.127
.
.001
.272
.563
30
30
30
23
.566**
1.000
-.066
.121
.001
.
.731
.583
30
30
30
23
.207
-.066
1.000
.547**
.272
.731
.
.007
30
30
30
23
.127
.121
.547**
1.000
.563
.583
.007
.
23
23
23
23
**. Correlation is significant at the 0.01 level (2-tailed).
Variable Definitions: SP98_99 is 1999 share performance (percentage difference between share prices on
31 December 1999 plus 1999 dividends and share price on 31 December 1998). PE99TRAI is the end-of1999 trailing price to earnings ratio (share price on 31 December 1999 divided by earnings in the previous
12 months). DWS SV Index is the good corporate governance or shareholder value principles developed
by the DWS investment fund group. Höpner SV Index is developed by Martin Höpner (see his contribution
to the debate).
11
Graph 1:
1999 Share Performance vs. DWS Shareholder Value Index
DAX 30 Companies
2.0
Dt. Telekom
Mannesmann
1.5
Siemens
Thyssen Krupp
1.0
Deutsche Bank
BASF
MAN Dresdner Bank
Preussag
SAP
Commerzbank
Bayer
Lufthansa
Münchner Rück
BMW
Schering
Linde
Allianz
Hypo-Vereinsbank
Viag Veba
DaimlerChrysler
Karstadt
Degussa-Hüls
Hoechst
Henkel
RWE
adidas-salomon
Metro
SP98_99
.5
0.0
VW
-.5
10
20
30
40
50
60
70
80
DWS SV Index
12
Table 4:
DAX 30 Company Valuations:
31/12/1999 Share Price to 12-month Trailing Earnings
Company
Mannesmann
Dt. Telekom
SAP
Hypo-Vereinsbank
Münchner Rück
Metro
Thyssen Krupp
Siemens
Allianz
Preussag
Schering
Viag
Linde
Dresdner Bank
Degussa-Hüls
Henkel
Karstadt
BASF
RWE
Commerzbank
Deutsche Bank
VW
Hoechst
Bayer
Veba
MAN
adidas-salomon
Lufthansa
DaimlerChrysler
BMW
1999 Share Price to
Company Earnings Ratio
509.6
144.3
104.4
78.8
78.7
61.4
55.0
48.0
36.6
31.1
29.6
26.8
26.6
26.5
26.2
26.2
25.0
23.8
21.6
19.9
19.7
19.0
18.9
17.2
16.9
14.9
14.8
14.0
12.4
-8.2
Sources: Deutsche Börse (www.exchange.de) and Company Annual Reports
13
Table 5:
Linear Regression Analysis of Alternative Models for Explaining DAX 30 Company Share Price
Performance in 1999
Coefficientsa
Model
1
2
3
(Constant)
MARKTCAP
(Constant)
MARKTCAP
Automobile &
Transportation
Banks & Financial
Services
Chemicals & Pharma
Insurance
Machinery & Industrial
Software, Technology
& Telecoms
(Constant)
MARKTCAP
Automobile &
Transportation
Banks & Financial
Services
Chemicals & Pharma
Insurance
Machinery & Industrial
Software, Technology
& Telecoms
DWS SV Index
Unstandardized
Coefficients
B
Std. Error
3.316E-03
.090
8.664E-06
.000
-.180
.122
4.790E-06
.000
Standardi
zed
Coefficien
ts
Beta
.379
.037
4.977
-1.479
1.946
Sig.
.971
.000
.153
.065
.685
t
.189
.177
.146
1.069
.297
.447
.190
.315
2.353
.028
.221
2.234E-02
.672
.166
.264
.203
.184
.012
.419
1.335
.085
3.318
.195
.933
.003
.862
.298
.608
2.895
.008
-.259
4.623E-06
.265
.000
.366
-.980
1.806
.338
.085
.196
.182
.152
1.080
.292
.432
.199
.305
2.170
.042
.206
1.823E-02
.669
.175
.270
.207
.171
.009
.417
1.182
.068
3.231
.251
.947
.004
.864
.304
.610
2.844
.010
1.672E-03
.005
.042
.340
.738
a. Dependent Variable: SP98_99
14
Table 6:
Shareholder Value Principles and Typical Management-Works
Council Conflicts over Implementation
SHAREHOLDER VALUE PRINCIPLES
TYPICAL CONFLICTS OVER IMPLEMENTATION
Focus on Core Competencies
Definition of Core Business Units
Search for a "Good Buyer" for Non-Core Units
Integration of Acquired Units
Profitability Goals
Definition of Business Units
Definition of (possibly differentiated) Profitability Goals
How Much Time Does the Business Unit Have to Reach the
Goal?
What Happens when the Goal is Not Reached?
Is This Goal Appropriate for Strategic Units?
Performance Oriented Remuneration
Performance of the Company, Business Unit, or Individual
Performance Criteria
Size of Performance Pay
Stock Options
International Accounting Standards (IAS
oder GAAP)
More Transparency for Employees of Conflict with
"Vorsorgeprinzip"?
Investment Decisions According to
Discounted Cash Flow Principles
Location Decision Paramaters
Conflict with Strategic Goals?
15
Table 7:
1999 Share Performance of Selected DAX Companies
Sector
Radical SV Company
Moderate Companies
Autos
DaimlerChrysler
-8.2%
BMW
+19.2%
VW
-17.7%
Chemicals/
Pharma
Hoechst
-14.2%
Bayer
+32.2%
BASF
+56.8%
Energy
VEBA
-5.4%
RWE
-16.6%
Viag
-5.3%
16
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