Corporate Governance and the Erosion of Deutschland AG

The following post comes to us from Wolf-Georg Ringe, Professor of International Commercial Law at Copenhagen Business School.

The conventional view in comparative corporate governance research holds that German corporations are characterized by the prevalence of large blockholders, making it the typical example for a system of concentrated ownership. In my recent paper, Changing Law and Ownership Patterns in Germany: Corporate Governance and the Erosion of Deutschland AG, which has been made publicly available on SSRN, I show that the traditional ownership patterns in German corporations are currently undergoing a major change. The old “Deutschland AG”, a nationwide network of firms, banks, and directors, is eroding along three dimensions: the concentration of ownership is diffusing, the role of banks in equity participations is weakening, and the shareholder body is becoming increasingly international. It appears that these changes are more pronounced the larger the corporation. I present new data to support these developments and explore the consequences in governance and in law that have been taken or that need to be drawn from this finding.

Consistent with market-based theoretical accounts on corporate law, I argue that the changes currently underway are mainly a response to global market pressure: German banks divested their equity stakes mainly as a consequence of increased international competition. These groundbreaking changes have led lawmakers to adjust the legal framework to accommodate the new realities, and they should continue doing so. Against this backdrop, we can learn important lessons for our understanding of corporate law and the drivers for law reform.

First, my findings endorse a market-based understanding of corporate law. I identify globalization in the financial markets as the main driver for the beginning of equity dispersion by banks and the subsequent legal changes. This is consistent with the previous literature. My analysis then goes on to expand this account by making two additional points that can serve as valuable components of any theoretical account of law reform.

The first is that the market may not drive legal change alone, but rather the inverse may also be true. Market competition and legal rules may interact like corresponding vessels, that is, they can influence each other. As the dispersion of “Germany Inc.” demonstrates, it is not only market pressure which pushes the case for a change in legal rules, but it can also be the other way around: legal rules, in the form of a 2000 tax reform abolishing taxation on the divestiture of equity holdings, created great incentives for equity dispersion and thus prompted an acceleration of competitive forces.

The second insight is that ownership structure matters, both as a medium for driving legal reform and as an intermediate step between changed circumstances and the law reform that it triggers. The dispersion of Germany Inc. is thus a case in point, as it illustrates that our previous two-step analysis of legal change may sometimes have to be expanded to a three- or even multi-step procedure. In my example, it is an exogenous shock (market pressure plus taxation reform), which leads to changes in ownership structure, which in turn requires an adaption of legal rules. The case for legal changes may be more urgent and credible in situations such as these, where market pressure is translated via a modified ownership structure.

In sum, I offer a case study on the changes in the German corporate landscape and laws in the 1990s and early 2000s as an illustration of market-led changes to corporate law and governance. This is a rare opportunity to study the real-time changes to ownership patterns that in turn necessitate functional adaptations to legal rules.

The full paper is available for download here.

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