Publications of the Society for Economics and Management at Humboldt-University

Editors

Prof. Dr. Dr. h.c. mult. Horst Albach Waldstr.49 53177 Bonn

Edzard Reuter Epplestr. 225 70567

Springer Berlin Heidelberg New York Barcelona Hong Kong London Milan Paris Singapore Tokyo Joachim Schwalbach Editor Corporate Governance

Essays in Ronor of Horst Albach

With 31 Figures and 8 Tables

Springer Prof. Dr. Joachim Schwalbach Humboldt-University Berlin Institute of Management Spandauer Str. 1 10178 Berlin

ISBN -13: 978-3-642-63998-2 e-ISBN-13: 978-3-642-59499-1 DOI: 10.1007/978-3-642-59499-1

Library of Congress Cataloging-in-Publication Data applied for Die Deutsche Bibliothek - CIP-Einheitsaufnahme Corporate governance: essays in honor of Horst Albach I /oachim Schwalbach ed. - Berlin; Heidelberg; New York; Barcelona; Hong Kong; London; Milan; Paris; Singapore; Tokyo: Springer, 2001 ISBN-13: 978-3-642-63998-2 This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illus• trations, recitation, broadcasting, reproduction on microfllm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag. Violations are Iiable for prosecution under the German Copyright Law. Springer-Verlag Berlin Heidelberg New York a member of BertelsmannSpringer Science+Business Media GmbH http://www.springer.de

© Springer-Verlag Berlin . Heidelberg 2001 Softcover reprint of the hardcover 1st edition 2001 The use of general descriptive names, registered names, trademarks, etc. in this publica• ti on does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Hardcover-Design: de'blik, Heidelberg SPIN 10841759 4212202-5 4 3 2 I 0 - Printed on acid-free paper List of Contents

Foreword Joachim Schwalbach ...... VII

Introductory Remarks Edzard Reuter ...... IX

Summary Remarks Horst Albach ...... X

I. Corporate Governance in Transnational Companies ...... 1

Corporate Governance in a Transatlantic Company: DaimlerChrysler Manfred Gentz ...... 2

Governance of a Company in a Fast Changing Business and Technology Environment Yrjö Neuvo, Samppa Ruohtula and Joachim Schwalbach ...... 14

11. Corporate Investors and Firm Control ...... 25

Law and Finance Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert W Vishny ...... 26

Firm Control Colin Mayer ...... 69

Concept of the Firm and Corporate Governance in Japan Hiroyuki ftami ...... 91 VI

111. Corporate Governance, Managerial Incentives and Human Capital ...... 104

Managerial Stock Option Contracts and Firm Performance Stefan Winter...... 105

Human Capital and Corporate Governance John Roberts and Erie van den Steen.. 128

IV.Corporate Governance and PrincipaI/Agent-lssues ...... 145

Labour Co-Determination and Corporate Governance in Germany: The Economic Impact of Marginal and Symbolic Rights Dieter Sadowski, Joachim Junkes and Sabine LindenthaI...... 146

Corporate Governance - The Viewpoint of a Large Institutional Investor Christian Strenger ...... 163

V. Corporate Governance and Challenges for Management...... 172

Managerial Capitalism Revisited Lars Engwall ...... 173

Corporate Governance - Challenges of Increased Management Accountability Thomas R. Fischer ...... 192

List of Contributors ...... 202 Foreword

Joachim Schwalbach

Corporate Governance is of major interest to academics, investors, and politicians all over the world. Corporate governance issues arise in institutions when there is a potential conflict of interest among the stakeholders and the resulting transaction costs cannot be eliminated. Various economies have evolved different mechanisms to resolve corporate governance issues. Anglo-Saxon systems differ from those in Europe and Japan, and Eastern Europe and China, for instance, experiment with the way private organisations should be governed. Despite the major interest and intense debate, there is still only little empirical evidence on the effectiveness of various governance systems. This book brings together most current contributions that deal with the subject from various perspectives and from an international angle. The contributions cover topics relevant for firms operating in highly dynamic competitive environments while being confronted with different governance systems. Other papers deal with the pattern of ownership and control of corporations across countries. Several authors analyse the effects of increasing importance of human capital in corporate governance. And finally, so me other contributions concentrate on the challenges for corporate top-management derived from different and changing governance systems. The collection of contributions in this book is a selection of the papers presented at the 1" Humboldt-Forum on "Corporate Governance" held at Humboldt-University Berlin on June 4th and 5'\ 1999. The Humboldt-Forum was the first of its kind and was organized in honor of Horst Albach who became professor emeritus the same year. The organizers of this forum wanted to honor Horst Albach as a scholar who influenced the scientific world in a very significant way. To mention his full academic record would take many pages. Therefore, I will confine myself to only a few: He became a fuH professor at the age of 30 wh ich is exceptional by German standards, where the average age is cIose to 40. During his academic life he published 350 articIes and 34 books. Horst Albach received many awards, grants and prizes incIuding eight Honoris Causa. After having been a member of the faculty of law and economics in Bonn for almost 30 years he moved to Berlin to become President of the Berlin Academy of Science and Technology in 1987 and scientific director at the Wissenschaftszentrum Berlin in 1990. He helped building up the Humboldt Faculty of Economics and Management from the start and joined the faculty later in 1994. Being in Berlin at the center of the German unification, Horst Albach engaged hirnself in the analysis of the dynamics of transformation of East Germany's planned economy into a market economy. During his academic Iife, the topic of "Corporate Governance" had fascinated hirn a great deal. His approach to corporate governance is not mainstream. If one reads his writings correctly, it becomes cIear that he considers companies as complex social systems where each company has VIII Joachim Schwalbach its own history. This history is deeply rooted in the legal and social systems of its respective country. For German companies this means that management takes social responsibility into account in managerial decisions, acknowledging the role of the firm as a corporate citizen may certainly serve the long-run interests of the shareholders. This thesis and more of Horst Albach's point of view ab out corporate governance can be studied by reading his summary remarks at the beginning of this volume. The 1" Humboldt-Forum was sponsored by the Society for Economics and Management at Humboldt-University Berlin, the Faculty of Economics and Management at Humboldt-University, the Science Center Berlin, and the Sonderforschungsbereich 373 of the German Science Foundation. Their support is gratefully acknowledged. In addition, I want to thank many fine people who contributed to the great success of the 1" Humboldt-Forum, among them Claudia Diefenbach, Brigitte Erlinghagen, Manfred Fleischer, Sabine Lang, Marco Nix, Anja Schwerk, and Achim Winkler. Introductory Remarks

Edzard Reuter

The 1SI Humboldt-Forum on Corporate Governance was held in honor of the imminent retirement of Horst Albach. Even if Iwanted to, it would be difficult for me to speak about Horst Albach only in a semi-official capacity. Our long-standing acquaintance has been renewed and refreshed over the years by frequent encounters. I came to know a man who stands out from the field. Undoubtedly, he is an academic of the highest international standing. I am not exaggerating in the slightest if I refer to hirn as the heavyweight of German business management. Nevertheless - or precisely for that reason - he has always kept his feet firmly planted on the ground and has never lost his head to the fashionable ideas of the moment. And that includes the fashionable idea that in the age of globalization the best yardstick of a company's performance is its shareholder value, as gleaned from the price of its shares on the financial markets. This was typical of the man I worked with and came to know. He is someone who has always had a talent for dispassionately balancing practical expertise with academic learning. No amount of rubbing shoulders with the supposedly great and eminent personages of this world ever tempted hirn to abandon his coolly objective judgement. Occasionally, his dispassionate perceptions could be unwelcome, as I know only too weH from my own experience! But out of aH this, and much else besides, there developed a personal closeness and attachment. For this I should like to take the opportunity to thank Horst Albach once again. Looking back, my own life would certainly have been poorer without hirn .... And looking to the future, one thing I know is for sure: we shall continue to hear Horst Albachs's voice - incorruptible, vigilant and more than occasionally wise. Summary Remarks

Horst Albach

1. ACknowledgements

This has been a wonderful conference. Wonderful in two respects. We have heard most interesting and highly stimulating conference papers. The conference has also been an emotional event of cordiality, friendship and style. Above all, I would like to thank Joachim Schwalbach who put this conference and this great program together. We all have appreciated this amazing combina• tion of scholars and practitioners that have shared with us their insights into a most complex and highly relevant topic. They have stimulated a high level discussion, and I think we all agree that the conference has greatly benefited from discussions and the questions from the audience. Thanks go also to the Wirtschaftswissenschaftliche Gesellschaft of the Faculty of Economics and Management of our University which has made this conference possible. The chairman of the board of trustees of the association, Edzard Reuter, has given a welcome address that has moved me deeply. These were words of c10se relations and shared interests that have gone much beyond the present occasion. I am very grateful to hirn for his Laudatio. Let me emphasize on this occasion of setting the final keynote to this great conference that I have always had the greatest admiration for Edzard Reuter and his thoughtful style of management. I should like to add that I have always supported his vision for the future of the automobile industry in general and for Daimler-Benz in particular. There is published record of this support. I have had the privilege and the pleasure to serve on the board of AEG Corporation together with Edzard Reuter and Manfred Gentz, and, therefore it is more than the occasioned gratitude for the CEO of the Wirtschaftswissen• schaftliche Gesellschaft when I say that I thank Dr. Gentz not only for making this conference possible, but also for his opening address. It provided a deep insight into the values of the most prominent German company that underlie its corporate identity and its governance structure. His speech has made us get a feeling of the tremendous task of shaping a world-c1ass global player by the name of Daimler• Chrysler out of a company which was still more of the "Swabian Nest" that Gottlieb Daimler had taken with hirn from Kalk near Cologne to Feuerbach near Stuttgart than a truly German company, leave alone aglobai player, when we first met 25 years ago. Thanks go to Wulff Plinke who as acting Vice-President of the Wirtschafts• wissenschaftliche Gesellschaft has been instrumental in making this conference co me to life. Finally, I would like to express my gratitude to the two organizations wh ich have stewarded this great conference in my honor: the Humboldt-University of Berlin and its president, Professor Dr. Hans Meyer, and the Berlin Science Center Summary Remarks XI and its president, Professor Friedhelm Neidhardt. The university has generously offered its beautiful senate hall for our conference, and president Meyer has wel• comed the participants in an address which has brought near to us all the great history of this fine university. President Neidhardt due to his recent heart attack could not welcome the participants at the reception which was given by the WZB in its imperial conference hall. I have greatly missed hirn and I am sure you share with me in wishing hirn a speedy and full recovery. Professor van den Daele wel• comed us all at the reception, and I am very grateful to hirn for his kind collegial words. I also thank David Soskice for his words of friendship. My research fellow Silke Neubauer gave an unexpected and wonderful new interpretation of a German Senpai-Kohai-relationship. It was formal as well as affectionate, heart warming and greatly appreciated.

2. Corporate Governance - The Learning Experience

2.1 Market Control

What have we learned during these two days of our conference on corporate gov• ernance? In what follows I will give a highly subjective view of the conference. I will try to tell you what I have learned. My learning experience can be grouped under three headings: market control and governance control systems analysis and partial analysis dynamic analysis and comparative statics.

2.2 Product Market Control

Market control over companies comes, as we have been taught for two decades now, from product markets, capital markets, labor markets and in particular from manager markets. In this conference strong emphasis was laid on product markets and capital markets. Control of management by shareholders is a greater problem when markets are imperfect than when they are perfect. Yrjö Neuvo showed that the highly com• petitive and dynamic telecommunications markets on which Nokia is active exert very efficient control over management. The stronger the market forces, the smaller the profits that can be distributed to the shareholders in the form of divi• dends, but the smaller also the latitude for management to reduce dividends by incurring agency costs. The market pressures are so strong that companies are presently feel forced to change their governance systems to maintain competitiveness. The firms, how• ever, find themselves entrenched in legal systems that accommodate the necessary adaptations too very different degrees .. The firms have experienced that their XII Horst Albach competitiveness depends on the flexibility of the respective legal systems to allow for the necessary adaptations within the firms or on the willingness of the political system to change the legal framework for corporate governance. The paper delivered by F1orencio Lopez has brought this point out very cIearly. If the market pressures should force companies into making short-term rather than long-term decisions, corporate governance systems should not give in to such demands on decision-making. Rather, the firms should resist it. The board of directors would be ill-advised if it reacted to short-term market pressures. The court decision in the Time-Warner case explicitly states that the board is entitIed to stick to its long-range strategy even if profits in the short run might be higher. Furthermore, the firms have learned how to influence market pressures by good investor relations (Neuvo, Fischer). The rather general term "market pressures on corporate governance systems" was specified in the course of our forum. Market press ures come from market dynamics. It is no longer the inertia of changing huge corporations of real capital (machinery and equipment) under the influence of technological progress that determines the speed of change in the market. It is the flexibility of the human brain that determines the speed of change in the markets. Brains have become a key productive factor. Neuvo talked about a "re-emergence of Kar! Marx" in this respect because now the means of production get back into the heads of the workers while in the industrial revolution the means of production were taken out of the hands of the workers and owned by the capitalists. Itami spoke about the same phenomenon, when he said that "brains own the firm". Itami deduced from his analysis that the production function of the future will emphasize "brains over brick" the forecast that the Japanese and the German consensus systems with their emphasis on internal labor markets and long-term business relations will make the firms more competitive than the American firms. This does obviously not go as far as to assurne that the present system in Germany of co-determination and of industry unions will be the best governance systems of the future. An interesting point was made by Jeremy Lever. Market control of corporate governance depends on antitrust law. If takeovers are prevented by antitrust courts on the basis that otherwise dominant positions might be created, capital market control may be rendered ineffective. This again would increase the need for board reform, for stock options and, in the final end, for legal reform of corporation law.

2.3 Capital Market Contral

Press ure to improve the efficiency of the governing boards of corporations has come from the capital markets with increasing intensity of late. In particular, pressure from institutional investors has become very strong. They press compa• nies to change their corporate governance systems and to adopt systems that they are familiar with. This leads to the dominance of the system of corporate govern• ance established in the US firms, regardless of their relative efficiency (Engwall, Fischer). Lopez went a step further and inferred from rational behavior of the institutional investors that the US corporate governance system is the best system. John Roberts argued that the US system is in fact more efficient than the German one because it puts more emphasis on capital than on labor. Since capital is more Summary Remarks XIII mobile than labor and competitiveness today depends on mobility and flexibility, the American system is better than the German system.

2.4 Labor Market Control

Control by labor markets or by manager markets did not playa role in the papers and in the discussions of the forum. As one of the participants put it: "Labor relations plays second fiddle to investor relations!" However, this does not nec• essarily apply to internal labor markets. David Soskice showed that the product markets have a strong impact on the internal labor markets. The market press ures according to Soskice force companies to develop long-run customer relationships (in order to economize on transaction costs). This has a direct influence on the internal labor markets: long-run employment contracts become more important. On the other hand, the present internailabor market systems for scientists are the cause for deficiencies in the present patterns of innovation. Long-run customer relationships, however, depend on the ability of firms to innovate.

3. Systems Analysis and Partial Analysis

3.1 The Interdependence of Markets

The methodological result has been: partial analysis may produce misleading results. In discussing improvements in corporate governance it is highly advisable to look not only at the legal rights and the performance of boards of directors only. Their work is clearly influenced by market forces. The product markets exert the most effective control, but the product markets are closely linked to the capital markets. The institutional investors have become very strong critics of the given systems of corporate governance. It is important to understand the relationships between product markets, capital markets, research institutes and business associations as weil as the internal labor market.

3.2 Corporate Governance and Internal Organization

The problems of corporate governance derive from the discretion that managers have in serving the different interests of the various stakeholders in the company as weil as from the ability of the different stakeholders to make their interests feit by management. lt is, therefore, important to study the voting rights of voting blocks and the consequent allocation of membership rights and contractual rights (Colin Mayer). Dieter Sadowski drew the consequences from such a shift in thinking: We have to move from a contractual theory of the firm to a constitu• tional theory of the firm. In such a theory, the workers would be co-owners of the firm. Their interests would no Ion ger be expressed by contractual agreements alone, but by constitu- XIV Horst Albach tional rights as "members" of the organization. Co-determination is an obvious consequence of such a treatment of employees. But since co-determination is a pubJic good, a co-determination law is required to make co-determination an effective institution (Sadowski). Itami underscored this point. Japan will not go in the direction of strengthening the shareholders' rights. Rather, Japan will strengthen the voice of employees. Labor will have to have a say in the selection of the CEO. In the discussion the following line of argument was developed: If co• determination is imposed by law, each company has to treat its employees fairly. This improves the willingness of mobile workers to stay in the company. This reduces the average cost of search for employees by the company. In a stationary environment this leads to long-term employment with firm-specific knowledge and long-term customer relations. This enhances competitiveness and hence justifies the co-determination law. In a turbulent environment where high flexibility and mobility of the workers is decisive for competitiveness, long-term contracts with labor are conducive to competitiveness only, if the firm does not incur costs of severance or mobiJity of its work-force that exceed its search costs. Under the German system of co-determination, the cost of mobility is higher than the cost of search. Therefore, co-determination is a barrier to competitiveness. In Japan, the cost of mobility and the cost of search are low. Therefore, the Japanese system of labor relations dominates the German system of co-determination. Corporate governance and the internat organization of the firm have to be analyzed simultaneously. The internat organization does not only encompass the employees, but all the "international providers" (Lars Engwall). It was under• scored that the same system of corporate governance may have different effects in a functional and in a divisional organization.

3.3 Incentives

If we acknowledge the possibility of agency costs, the question has to be answered how shareholders can control for them if they cannot observe management behavior. Stock options are considered to be an efficient instrument far changing managerial incentives so that they coincide with the shareholder interests. The presentation on the efficiency of stock option plans by Stefan Winter received divided comments particularly from the side of corporate participants. Winter defined efficiency on the basis of five criteria: Index options, tax deductibility, multiple grants, dividend and capital increase shelters, average stock prices over more than ten days. He conc1uded that only one out of 44 German stock option plans met aB the five criteria, and only six met four our of the five criteria. Participants voiced the opinion that changes in the legal provisions for the governance system might be more effective and less expensive than stock options in controlling agency costs. A participant was of the opinion that "stock options get the people moving" without obviously realizing that this gives strong support to the productivity theory of wages that is used as a basis for excessive wage demands by trade union: wage increases force management "to get moving" for higher productivity which without this pressure management would not fight far. John Roberts in a game-theoretical model analyzed the incentives of the share• holders and the workers. If the input of labor in the production function of the firm Summary Remarks xv is contractual, the firm will be controlled by shareholders. If the input of capital is contractible, the firm will be sold to the employees and controlled by them. Since both inputs are not contractible, we have a situation of incomplete contracts. In such a situation the firm has to decide between different mechanisms of added value allocation, profit sharing, exposed bargaining, and commitment to respect the interests of the two groups. Depending on the value of the "brains", Roberts showed that corporate governance is either shareholder capitalism or strongly influenced by labor representatives on the corporate board. The incentives for banks to sit on the board of companies in order to control their loans has been reduced very significantly in the United States by the high damages board members have to pay if they do not observe their fiduciary duties properly. In Germany, control through board membership has been maintained not because of the incentive to reduce the cost of control but because of the high tax barriers for exit under German tax law. However, despite equity ownership, the banks have set up policies of, on principle, not serving as chairmen of the board (Dresdner Bank) or withdrawing from board membership aU together (Strenger).

4. Dynamic Analysis and Comparative Statics

The economics of law is not an easy subject, and the economics of corporate governance is barely emerging. Most of the analyses followed the comparative statics approach. In fact, whatever dynamics we heard was economic and legal history and not rigorous economics dynamies. The presentations con\'inced us that this is by no means Cl methodological deficiency. Rather, comparative staties provide us with deep insights in the strueture of li Illlting cases and in the points of systems change when we vary important parameters continually. It was a great conference from the contents point of view as weil as from the methodological point of view. I have been deeply impressed and deeply moved. Thank you aU very much!