The competition of international corporate governance systems--a German perspective.

VerfasserWitt, Peter

Abstract

* Corporate governance theory deals with the optimal organization of management and control in companies with many stakeholders. Corporate governance systems are shaped by national laws, capital market requirements, and individual corporate decisions.

* For historical reasons, there are large differences between international corporate governance systems. But due to the globalization of product, labor, and capital markets, a competition of international governance systems has evolved. In the long run, this competition will lead to a convergence of all systems, to a continuation of different systems, or to the dominance of one system.

* An empirical study based on data from annual reports indicates that the US and the Japanese governance system each have different, but distinctive strengths. The German governance system is less well prepared for the systems' competition and might disappear from the market in the long run.

Key Results

* Corporate governance systems complete globally. The empirical evidence reported in this paper suggests that the US and the Japanese governance system will survive in the long run as distinct and equally efficient systems whereas the German system will disappear (and probably converge to the US system).

Introduction

Corporate governance theory deals with the optimal organization of mangement and control in companies with different stakeholders, e.g. minority shareholders, institutional shareholders, employees, debt providing banks etc. (Hart 1995, Shleifer/Vishny 1997, Tirole 2001). An individual firm's governance structure is shaped by the national corporate and trading laws of its home country, by capital market requirements (in case of a stock exchange listing), and by own organizational decisions within the framework of existing laws. The core tasks of a corporate governance system are to ensure corporate efficiency and to find a "fair" distribution of the resulting surplus among the stakeholders (O'Sullivan 2000, Witt 2001). Whereas the organizational governance problem and the interests of stakeholders are more or less the same around the world, the actual corporate governance systems in place are not (Charkham 1994, La Porta et al. 1998). Due to historical developments, path dependencies, and different financing patterns of firms around the world, very different corporate governance systems have evolved (Roe 1996, Bebchuck/Roe 1999, Schmidt/Hackethal/Tyrell 2002).

Scholars and practitioners have developed a number of different frameworks and models for comparative corporate governance analysis. One of the most prominent and influential studies in Europe (Charkham 1994) directly compares the corporate governance systems of five countries, traces their origins, and shows that they all fit national history and political preferences. An equally influential study (Roe 1996) analyses different international corporate governance systems from an American perspective and concludes that governance structures do not matter much for corporate performance. The core hypothesis is that different governance systems yield different advantages and disadvantages, making it difficult for one system to be superior to another. A more recent comparative study from a German perspective (Schmidt/Spindler 2002) juxtaposes two stylized corporate governance models, the "outsider control system" of the US and the German "insider control system". The authors find that both systems display typical advantages and disadvantages and can both be regarded as locally optimal systems. The only important advantage for the US system is the greater degree of flexibility in adapting to changes in the competitive environment. Witt (2003, pp. 175-224) develops two game theoretical models for the competition of corporate governance systems. In the first model, countries compete to attract firms that are free to choose their location by offering corporate governance systems and prices (tax packages) for it. The result is the co-existence of two different governance systems. In the second model, two firms compete on a product market in which the selection of a corporate governance system (the location decision) has a direct competitive effect, i.e. is associated with certain disclosure obligations. Here, one corporate governance system (a stylized version of the US system) dominates the other (a stylized version of the German system).

So far, there have been only few studies that empirically compare the efficiency and the distributive effects of internationally different corporate governance systems. Kaplan (1994a, 1994b) investigates control and incentive structures in German, Japanese, and US firms empirically. He finds them to be irrelevant for corporate success. La Porta et al. (1998) empirically study differences in law systems and the degree of investor protection in 49 countries. They do not draw normative conclusions. Conyon and Schwalbach (2000) compare compensation practices in different European countries and only find statistically insignificant relations between governance structures and performance. This paper will report on an empirical study that uses a somewhat broader approach. In particular, a larger variety of different governance related factors are considered and their effect on the competition of systems investigated.

The Theory of the International Competition of Corporate Governance Systems

The Requirements and the Functioning of Systems Competition

The term "systems competition" depicts the ability of private persons or institutions to choose the legal or political system they like best. Governments, or in broader perspective, countries compete to accommodate individuals and firms. They do so by offering sets of political and legal regulation. If persons and institutions are entitled to leave a political system with which they are dissatisfied, and go to another one, systems competition opens up the "exit" mechanism of relocation (Hirschman 1970). A relocation is the market alternative to "voice", i.e. attempts to influence political decision makers to change the legal system. From a political perspective, the competition of systems helps private participants of political systems to test the expediency of available institutional arrangements (Monopolkommission 1998). It induces political competitors to develop more attractive regulations. Systems competition serves as a mechanism to detect better governance regulations. It also aims at "the taming of the Leviathan" (Streit 1996, p. 236), i.e. reduces the power of governments and politicians.

A competition among different legal systems is impossible without mobile production factors. In the case of corporate governance, systems competition requires that companies are able to freely choose their location and thus the (politically determined part of their) governance system. The core assumption behind the theory of systems competition is that corporate governance has direct and indirect effects on the competitiveness of firms because it influences the prices of production factors and their productivities. (1) To give a few examples: co-determination, which is legally mandatory for large firms in Germany, may raise a company's labor costs, e.g. because salaried employees no longer directly work for the firm but represent employees' interests in works councils and supervisory boards. It may also induce higher labor productivity by stimulating higher investments of employees in finn specific human capital. Investor protection via rigid disclosure rules, typical for the US governance system, may reduce agency costs, increase shareholder returns, and thus lead to lower costs of equity financing for firms that belong to the US system. Institutionalized protection for debt providers, e.g. seats for representatives of banks in the supervisory board of German companies, help to overcome the information asymmetry between borrower and lender und thus reduce the debt financing costs for the respective finns.

The more geographically mobile employees and managers are, and the less restrictions apply to the movement of goods, services, and capital, the more effective systems competition becomes. In the ideal case, firms can choose their legal location independent of their actual physical location. An example is the US, where corporate governance regulation is state law. Firms are free to register where they want. Geographically small states, like Delaware, accommodate the majority of all large American firms, simply because their governance regulations are seen by firms as more attractive than in other states of the US and because those finns are allowed to have their physical presence elsewhere. The so-called "Delaware effect" results from an internal systems competition, a corporate governance mechanism which observers have been calling "the genius of American corporate Law" (Romano 1993, p. 174).

In Europe the free relocation of firms independent of their physical site is not yet possible. And physical relocations are costly. Firms will only undertake the effort to move to another country with a better corporate governance system if the benefits from relocating are larger than the transaction costs involved (which can well be substantial). In addition, despite the common notion of an increasing globalization, many markets like the markets for services or labor are still local rather than global. Thus, factor mobility may be insufficient to stimulate a full-scale competition of international corporate governance systems. Nonetheless, the economic integration of the European Union, the factual globalization of capital markets, and the rapid improvements of international information and communication technologies have made some production factors like equity, debt, and management fairly mobile. This development has fostered the international competition among corporate governance systems.

Possible Results of Governance Systems...

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