Corporate Governance, Regulation and Financial Markets. Germany's Pathway to a Market-Based System?

Term Paper (Advanced seminar), 2015

40 Pages, Grade: 1,3



1 Introduction

2 Why Corporate Governance Matters
-2.1 Definition and Intended Purpose
-2.2 Theoretical Foundations

3 Corporate Governance as a System: Historical and Political Context
-3.1 Origins of US Shareholder Capitalism
-3.2 Origins of German Stakeholder Capitalism

4 Globalization: A Potential for Convergence
-4.1 Why Convergence?
-4.2 The German Financial System in Flux

5 Conclusion

List of Figures

List of Tables

List of Abbreviations


1 Introduction

Few areas of business economics are discussed in such a controversial manner as different corporate governance system’s.[1] In a globalized age in which the capital markets of industrialized countries have a large operating range and a growing degree of internationalization, the design and regulation activities in this field have become increasingly important. This has been triggered a "competition of institutions".[2]

In the current academic discussion, different corporate governance paradigms are being examined, to figure out, which could be the most successful in a market economy in order to attract investors.[3] It considers, what system of management of a capital-led company is the most appropriate - in order to provide a location or rather a country - a competitive advantage in competition for global players. It is assumed that the type of the corporate governance system influences the company’s success or even more on the entire national economy.[4]

As reference points, the German and the US model are often being used.[5] Since they are opposed to one another in their paradigmatic and thus embody the exemplary corporate governance system. In addition, since the Cold War and beyond, the US has been a hegemon and has always had a great influence on the economic and financial system worldwide. Germany is regarded as the political and economic core of the most important partner of the USA, the European Union. Both are regarded as a highly developed economic system; their further development will attract attention beyond their national borders.[6]

Although, the aim of corporate governance is identical, the institutional design and the underlying philosophies differ.[7] As of a 1980´s it appears that the German bank-based system cannot meet the needs of the swift progress of financial markets.[8] From the 1990s onwards, especially in the case of some serious legal measures in Germany, a move towards capital market orientation has been taking place.[9] Since the prediction of a system convergence has been considered critical[10] - because they are embedded in a corresponding cultural and socioeconomic system, which makes the transferability of the respective economic paradigms doubtful[11] - this paper tries to examine if these legal regulations triggered a change in the German financial system.

In a first step, we going to give an overview to the standard definitions and the theoretical foundations of corporate governance. In the following chapter, we attempt to classify the different corporate governance paradigms by their characteristics and thus to enable a categorization. These characteristics have grown historically or have their origins in divergent legal systems.[12] Cultural and socioeconomic aspects play a key role, in which environment a company policy is embedded. This also results in the shape of corporate finance, in which different channels of capital procurement have arisen.[13] Afterwards, in chapter 4 we discuss the motives for convergence and which measures Germany has got off the ground to gird oneself for global competition. In the end this paper summarize the outcomings

2 Why Corporate Governance Matters

2.1 Definition and Intended Purpose

The definition of corporate governance remains rather inconsistent in the literature. A direct translation of the English term into the German language is missing so far. The term "corporate constitution" is often used synonymously in German literature.[14] In the German view, however, the concept is used more broadly and represent an equivalent of the model of the state constitution.[15] It is a legally binding Organizational Statute, which - in accordance with the respective economic, legal and social system of a country - defines basic business purposes, regulates existing power relations, governs entrepreneurial decision making, and establishes the rights and obligations of company members.[16] According to the Anglo-American concept of "corporate governance", this is a purely capitalist system of company monitoring, which ensures the participation of the capital providers in the success of the company.[17]

This paper will characterize Corporate Governance as the legal framework for the management and supervision of a company. In contrast to the “company-constitution”, which primarily concerns the internal organization, corporate governance also addresses issues of legal and factual integration into its environment (such as capital markets). All in all, the large listed company is the focus of attention.[18]

The central task, therefore, is to ensure efficiency in CG to generate the largest possible surplus from the used resources. The second central task is to determine the distribution of property rights among the various stakeholders, to ensure an appropriate distribution of factor incomes and of the surpluses, generated to the capital providers, outside creditors, employees and managers of a company.[19]

2.2 Theoretical Foundations

The theoretical foundation of the corporate governance debate is first to be found in the agency theory.[20] Due to the separation between ownership and control - as is common in stock corporations - there may be conflicts of interests between managers and owners.[21] It is assumed that the employed managers tend to opportunistic behaviour and try to maximize their own benefit and do not lead the company in favour to the owners.[22] Trough information asymmetries they might conceal this.[23] This is further encouraged by low control incentives for minority shareholders. In order to avoid a complete stand still of the market, protection mechanisms must be created to monitor and mitigate the harmful behaviour of managers.[24] Control mechanisms ensure ex ante and ex post contractual efficiency.[25] This results in declining transaction and agency costs. Strengthened trust in management is accompanied by lower risk premiums at capital markets and, thus, contributes to company success.[26]

This one-dimensional view to conflicts among shareholders and management, excludes other concerns.[27] For example, those other key stakeholders into the company such as banks, employees,[28] supplier, and the government.[29] All these actors have a special concern to company’s success. In this paper, we are going to concentrate on banks as a supplier of debt capital.[30] [31]

3 Corporate Governance as a System: Historical and Political Context

3.1 Origins of US Shareholder Capitalism

To differentiate corporate governance systems, they can be classified according to the interests to which they are committed. In an interest-monistic approach, the interests of equity owners are crucial for the organization of the company's management. This shareholder-oriented management is mainly found in Anglo-American countries.[32]. For the last decade, the shareholder value model is playing a key role in determining the enterprise's value.[33]

However, this has not always been organized this way. Even in the early 19th century, much of the voting rights were divided among big banks and insurance companies. The financial market was relatively underdeveloped and market capitalization in relation to national output was 1913 smaller than in France. From 1860 onwards, several policy measures have been imposed, which should prevent mergers of large financial institutions. This movement, however, was not just economically motivated, rather a populist movement of peasants, small businessmen, and small shareholders, who wanted to curb the power of financial monopolies.[34] After the crash of 1929, a risk-averse mood arose, which demanded financial market regulation of the government. Thus, henceforth, commercial and investment banks must be separated from each other. The consequence is the system, what we know in the US today: local banks, small shareholders and fragmented ownership structures.[35]

After the1960s and 1970s which promoted "manager-domination" in the enterprise, it seems today that shareholder taken control again.[36] On the one hand, it was a consequence of a nationally and internationally deregulation wave, and new trading, information and communication paths across the globe. On the other hand, it was obvious that Manager apparently not acted in the sense of shareholders and they were poorly controllable through small shareholder groups. At the same time, the capital markets have grown considerably by institutional investors, whose obviously were not satisfied with the performance of their investments. This led to a wave of restructuring and hostile takeovers.[37] The shareholder value movement was born.[38]

The overall objective of the management, as a guiding principle, is to maximize the value that shareholders can realize with their investment.[39] In doing so, this stakeholders' interests group will get a significant impact on corporate policy. This means, that a short-term increase in the stock value is sufficient to meet the demands of equity investors. Radical adjustments in the product portfolio, company organization and number of employees are deemed necessary by the investors. In other countries, such an profit approach may seem unsocial, but appear corresponded to a liberal market economy, as embodied in the US.[40] These practices are also taken into account by the US legal system, which preferentially treats the shareholders.[41]

The most fundamental differences in German and American CG-systems are mainly the result of divergent ownership structures and corporate financing.[42] In contrast to many other developed economies, the company shares are widely spread in the US, which means that the influence of individual shareholder blocks remains extremely low.[43] As we may see in Table 1below , the median in percent of the largest shareholder in the US is less than 5 percent, unlike economies like Italy, Germany, Austria and Belgium, where the median size of concentrations of voting rights is up to 54,4 percent.[44]

Hence, the importance of capital markets, consisting of liquid assets, in the US, is also reflected in their system of control mechanisms.[45] The discipline of management, resulting from the agency-conflict, is primarily to be solve through capital markets, in which ownership fractions are widely traded by many investors. If corporate policy is not geared to the interests of shareholders - or rather, resources are not being used optimally – and it threatened a loss, investors choose an "exit”– strategy and sell their shares on liquid markets. Since these broadly diversified investments represent only a small part of the overall portfolio, they are being replaced by more profitable investment projects.[46] This contains a risk that management will be replaced by new shareholders via the market for "company control".[47]

Table 1: Median of the biggest Owner Block in 1999

Abbildung in dieser Leseprobe nicht enthalten

Source: Barca / Becht (2001), p. 19.

To safeguard, that managers shape corporate governance in the interests of shareholders and to ensure a better return on investment, their remuneration has been linked more and more to variable components such as stock options over the past decades, thus minimizing the conflicts of objectives between management and investors.


[1] See v. Werder (2009), p. 2; Schewe (2009), p. VI.

[2] Detailed see North (1971, 1991, 1994); Witt (2002), and Voigt (2002), p. 96; Hopt (2009), p. 28; Vitols (2001), p. 262; Gerum / Mölls (2013), p. 196; König (2013), p. 1.

[3] See Sauer (2015), p. 62, and Gerum / Mölls (2013), p. 196.

[4] For example, La Porta et al. (2002), p. 1147; Brühl (2009), p. 3; Bassen et al. (2006), p. 1.

[5] For many see Kaplan (1997); Roe (1993); Vitols (2001), and Sick (2008).

[6] See König (2013), p. 2.

[7] See Kenyon / Vitols (2004), p. 3

[8] See Baums (2001), p 3.

[9] See Sauer (2015), pp. 62-76, also König (2013), p. 213. The legal standard design is sometimes referred as a "hybrid" form; see Kirchner / Schmidt (2006).

[10] See Höpner / Jackson (2003), S. 165; Gerum (2007), pp. 40–41; Kenyon / Vitols (2004), p. 33; Haller / Fuhrmann (2013), p. 243; Freidank (2016), p. 221; Vitols / Kluge (2011), p. 3; Velte / Stawinoga (2016), p. 1.

[11] For critics see Pejovich (1978); Jensen / Meckling (1979); Furubotn (1985, 1988, 1989); Furubotn / Wiggins (1984); Picot / Michaelis (1984).

[12] See Gerum (2007) and La Porta et al. (1998).

[13] See Hackethal /Schmidt (2000), p. 4-5.

[14] See König (2013), p. 7; Sauer (2015), p. 32, and Witt (2002), p. 1.

[15] See Gerum (2007), p. 6-9.

[16] See Weiss (2010), p. 13.

[17] See Zingales (1998), p. 497-502, and Tirole (2001).

[18] See Zingales (1998), p. 499.

[19] The allocation of the property rights according to the coase-theorem influences the efficiency of the allocation of resources - if there are transaction costs and information asymmetries - the function of the efficiency assurance and the function of the distribution of surges cannot be examined separately from each other; see Coase (1960); Alchian / Demsetz (1972), and Williamson (1984). Summarizing; see Witt (2002), and Tirole (2001).

[20] See Lindenthal (2001), and Osterloh (2005).

[21] First critical considerations about the separation between ownership and control in joint-stock companies; see Smith (1789) and Marx (1894). To classics in the scientific discussion advanced Berle / Means (1932); Jensen / Meckling (1976). A further discussion; see Fama (1980); Fama / Jensen (1983), and Schleifer / Vishny (1997).

[22] In the sense of the human image of the "homo oeconomicus"; see Kirchgässner (2008), p. IX.

[23] Likewise, Picot / Dietl (1994), p.4.

[24] First to the information asymmetries on the Market for “Lemons”; see Akerlof (1970).

[25] See Williamson (1975, 1984, 1985).

[26] See Ballwieser (2005b).

[27] For a differentiated perspective; see Rajan / Zingales (1998, 2000, 2001a, 2001b). Regarding this purely capitalist-oriented corporate governance, criticism was also expressed in the fact that the actual conflicts were caused by the asymmetries of information and power between minority shareholders and lenders ("outsiders") on the one hand, as well as majority shareholders and managers ("insider") on the other hand. Differences in the ownership structure therefore require varying levels of power relations and protection requirements; see Sauer (2015), p. 30.

[28] Since employees provide company-specific human capital for enterprises and generate quasi-pensions (under the assumption of incomplete contracts), they are just as risk-taking as financial investors; see Blair (1997, 1999, 2005) and Blair / Stout (1999). If these risks cannot be adequately institutionalized, considerable inefficiencies can occur. Because the risk of holding-up by shareholders is great for employees and therefore incentives for investing in specific qualifications therefore correspondingly low; see Thelen / Turner (1998), p. 155; Dilger / Frick / Speckbacher (1999), p. 29; Göbel (2002), p. 236. However, the participation of employees in company decisions by mandates in the Supervisory Board generated considerable resistance for property-rights theorists. From this standpoint, this cannot lead to a Pareto-optimal state; for the sole reason that it has been imposed by law. The property rights include all rights connected with possession of a good. The more these rights are institutionally restricted or distributed among several individuals, the lower the value of this good. Any enforcement of property rights is subject to transaction costs. A further thinning of the property rights by employee determination would lead to a reduction in the allocation efficiency; Alchian (1984); Furubotn (1985; 1988; 1989).

[29] For a profound insight to the stakeholder theory; see Freeman (2010).

[30] See Freeman / Martin / Parmer (2007).

[31] Currently, the question posed in science, how the best possible corporate governance conceives, goes beyond a purely capitalist understanding. Over the years, different theories have developed to solve different agency conflicts. These stakeholder-oriented approaches see the success of a company as a function of the resources made available by all stakeholders; see Freeman (1984) and Acedo / Barroso / Galan (2006).

[32] See Metten (2010), p. 22, and Velte (2012), p. 33.

[33] The shareholder value model based on Rappaport (1986).

[34] See Roe (1993), pp. 21-23

[35] See Kenyon / Vitols (2004), pp. 23-24. For more detailed information to the legal measures of US; see König (2013).

[36] Equally Höpner (2003), p. 23.

[37] See Holmström / Kaplan (2001), pp. 121-123.

[38] First, see Rappaport (1999), similar to it Lazonick / O'Sullivan (2010), p. 15.

[39] See Grieger (2001), p. 77, and Wenger / Leonhard (1999), pp. 433-445.

[40] See König (2004), p. 45.

[41] See Sauer (2015), p. 55, and Schmidt / Spindler (2008), pp. 112-113.

[42] See Brühl (2009), p. 11.

[43] La Porta et al. (1998): suggest that the lion share of ownership on corporations around the world is family-dominated.

[44] See Barca / Becht (2001), p. 19.

[45] See Hackethal / Schmidt (2001), p. 12; similarly, Zöllner (2007), p. 28.

[46] See Höpner / Jackson (2003), p. 147; Dutzi (2005), p. 16, as well as Velte / Winkler (2012), p. 479.

[47] See Jensen (1993), pp. 850-852; Brühl (2009), p. 17, and Zöllner (2007), pp. 28-29.

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Corporate Governance, Regulation and Financial Markets. Germany's Pathway to a Market-Based System?
University of Leipzig  (Wirtschaftspolitik)
Development of Financial Markets and Institutions
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corporate, governance, regulation, financial, markets, germany, pathway, market-based, system
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Alexander Behne (Author), 2015, Corporate Governance, Regulation and Financial Markets. Germany's Pathway to a Market-Based System?, Munich, GRIN Verlag,


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