Universal Banking, Control Rights, and Corporate Finance in Germany

By Emmons, William R.; Schmid, Frank A. | Federal Reserve Bank of St. Louis Review, July-August 1998 | Go to article overview

Universal Banking, Control Rights, and Corporate Finance in Germany


Emmons, William R., Schmid, Frank A., Federal Reserve Bank of St. Louis Review


Corporate governance mechanisms assure investors in corporations that they will receive adequate returns on their investments (Shleifer and Vishny, 1997, p. 737). If these mechanisms did not exist or did not function properly, outside investors would not lend to firms or buy equity in them. Businesses would be forced to rely entirely on their own internally generated cash flows and accumulated financial resources to finance ongoing operations as well as profitable investment opportunities. Overall economic performance would suffer because many good business opportunities would be missed and temporary financial problems at individual firms would spread quickly to employees, consumers, and other firms.

Despite their universal importance and a considerable international exchange of ideas and institutions, corporate governance systems differ, even among advanced market economies. Useful generalizations can be drawn, however, and researchers commonly differentiate between two leading corporate governance systems (Shleifer and Vishny, 1997, p. 737): (1) the "Anglo-Saxon" model found in the United States, the United Kingdom, and other English-speaking countries, and (2) the "German-Japanese" model found in the two countries named and, to varying degrees, in other countries that share historical or economic traditions with them. Two important dimensions along which these leading corporate governance systems differ are the role of financial markets and the influence of workers on corporate decision making.

Financial markets are important sources of corporate finance and corporate governance in countries operating under the Anglo-Saxon model. Public and private markets for debt and equity securities issued by corporations outstrip the amount of financing provided directly by financial intermediaries by a wide margin. Many firms change hands each year on the stock market, some without the consent of incumbent management (i.e., via hostile takeovers). Meanwhile, employees' influence on matters of corporate governance is very diffused, exercised primarily through union representation and a limited amount of equity ownership in pension or personal savings plans. Firms in which non-executive workers play a meaningful role in corporate decision making are the exception rather than the rule in these economies.(1)

Capital allocation and corporate governance practices in countries operating under the German-Japanese model differ substantially from practices in the Anglo-Saxon model. This article focuses on the German system in particular, in which universal banks are the primary source of corporate finance to firms of all sizes.(2) These banks lend directly to firms, take equity stakes under certain circumstances, and provide underwriting services to firms issuing debt or equity securities to the public market. Corporate debt and equity markets remain very small in relation to the size of the German economy. Corporate governance is dominated by universal banks and by nonbank block shareholders. Control changes (i.e., changes of management teams) tend to be arranged behind closed doors, often by the banks or other blockholders, rather than being carried out through a stock-market takeover. In stark contrast to the United States and other countries operating under the Anglo-Saxon model, there have been only a handful of hostile takeovers in Germany since World War II.

The other notable feature of the German system highlighted in this article is employees' significant direct influence on strategic corporate decision making. This role in corporate governance extends far beyond that conferred by union representation and employee stock ownership, the main channels of employee influence in the Anglo-Saxon model.

Theoretical analyses of the relative merits of the U.S. and German financial and corporate governance systems have begun to appear only recently; for example, see Hellwig (1991), Allen and Gale (1995), or Dietl (1998). …

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