Comparative Corporate Governance: Old and New

Martin Gelter is Professor of Law at Fordham University School of Law. This post is based on a forthcoming book chapter by Professor Gelter.

In the forthcoming book chapter, Comparative Corporate Governance: Old and New, I take a bird’s eye perspective on changes in corporate governance systems both in Continental Europe and in the US, and explore their possible impact on the comparative corporate governance literature.

Comparative corporate governance scholarship has focused, among other things, on two core issues. One important issue is ownership structure and capital market development: Why are large corporations in some corporate governance system owned by a multitude of disempowered shareholders, thus effectively giving management free rein? Why are corporations typically governed by a controlling shareholder or a coalition of controlling shareholders in other systems, where management is held on a tighter leash by insiders, but not necessarily more attentive to the interests of outside investors?

A second issue, at least in the developed world, is the role of other ‘constituencies’ of the corporation besides shareholders, of which labor is most central to the debate, as the question of corporate purpose comes into play more directly. Some jurisdictions explicitly give labor an influential voice in corporate affairs, whereas in others its influence is developed through factual power or through either unintended or subtly intended consequences of legislation. On the level of theory, since the 1920s, legal scholars and economists have struggled with the question whether corporations should pursue a higher social purpose beyond the financial gain of shareholders. The debate has captivated the interest of theorists and practitioners since the Berle-Dodd debate in the early 1930s US, and the discussion in the Germany of the 1920s and 1930s about the Unternehmen an sich—a term aptly coined by opponents of the writings of Walther Rathenau, who seemed to endorse a public purpose for the corporation. Since then, the discussion has flared up with predicable recurrence both in common law and civil law jurisdictions over the past century, and without clear winning arguments, even if one model or the other has dominated at times.

The chapter explores the interaction between firm ownership and labor, focusing on the United States on the one hand and Continental Europe (particularly Germany) on the other. It distinguishes between “old” and “new” comparative corporate governance. “Old comparative corporate governance” refers to the dichotomy between dispersed and concentrated ownership studied by scholars of comparative corporate governance throughout much of the second half of the 20th Century. US corporate governance was characterized by management-oriented corporate law, dispersed ownership originally with a relatively large share held by retail investors, and collective action problems that inhibited shareholder coordination and thus influence on management. Labor, in the mainstream view influenced by agency theory, was at best a distraction. If barely accountable managers did not make sufficient efforts to keep labor in line, they were likely to squander more shareholder wealth. At worst, they were, in the purely shareholder-focused agency perspective, actively collaborating with employees against shareholders. However, pension plans were often jointly administrated by firms and unions and seen as a way of securing labor peace. Since pension wealth often tied workers to the firm, they may sometimes have been exposed to opportunism on behalf of shareholders, from which they were, if anything, possibly protected by shareholder disempowerment. “Old” Continental European corporate governance, by contrast, was characterized by powerful blockholders, but also by powerful unions and pro-employee corporate and employment law policies, including employee representation on the board in some countries, thus yielding a very different equilibrium between capital and labor.

“New comparative corporate governance” refers to the situation emerging after a transitional period that began in the late 1990s. In the US, the change has its roots in the 1970s, when pension plans began to convert from the defined benefit to the defined contribution structure, thus beginning a gradual process in which share ownership became more intermediated. The new institutional shareholders were in a better position to coordinate, and advocates of “good” corporate governance began to put their hopes first in takeovers, then executive compensation, and finally various forms of shareholder activism. At the same time, an increasing proportion of Americans’ pension wealth came to be indirectly tied up in the stock market, thus truly turning the US into a nation of somewhat reluctant capitalists.

From the 1990s onwards, capital markets began to garner greater interest in those parts of Continental Europe where they had hitherto largely been dormant. Various reforms were implemented to improve the accountability of management, and at the same time, governments attempted to strengthen capital markets and solve the demographic time bomb of aging societies by incentivizing citizens to invest in pension plans instead of relying on government provision of retirement income. Institutional investors from the US and the UK contributed to a growing trend in convergence in corporate governance.

As we stand today, recent changes, heralded by intermediated, but widespread share ownership are leading us to a new equilibrium whose contours have only begun to emerge. Over the past decades, outside investors have gained power both in the United States and in Continental Europe. However, neither in the US nor in Continental Europe has the traditional corporate governance system been completely superseded by a new one. The US remains to a considerable extent manager-centric. Continental Europe retains powerful, albeit somewhat diminished large shareholders. Labor as an independent force has remained more important than in the United States. Outside institutional investors—sometimes from the US—have become a player to be reckoned with, thus adding an additional layer of complexity to the system. The underlying substrate, rooted in the respective “old corporate governance,” continues to shape important features of the respective “new corporate governance.”

The full paper is available for download here.

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