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E-MailJens Dammann is the Ben H. and Kitty King Powell Chair in Business and Commercial Law at the University of Texas at Austin School of Law and Horst Eidenmueller is a Statutory Professor for Commercial Law at the University of Oxford Faculty of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).
The idea that corporations should be managed primarily in the best interest of shareholders has long had its critics. However, the practical relevance of that debate has remained limited for decades. As long as shareholders retain the right to select corporate managers, corporations will ultimately be managed in their interest. Moreover, there is little reason to believe that the commitment to shareholder wealth maximization has weakened. On the contrary, over the last decades, the rise of institutional investors and legal reforms such as say-on-pay or proxy-access have arguably increased shareholders’ power over corporations.
Now, however, important voices are calling for a fundamental shift away from the shareholder primacy model and towards a more stakeholder-oriented approach to corporate governance. Two of the most influential figures on the political left, Senator Elizabeth Warren of Massachusetts and Senator Bernie Sanders of Vermont, have put forth proposals that would allow the employees of large corporations to elect 40% or even 45% of all corporate directors. These proposals essentially build on the German system of codetermination, in which employees of large companies can elect one-third or one-half of all board members, depending on the size of the company.
The fact that Senator Warren’s and Sanders’s proposals would, if implemented, amount to a dramatic shift in U.S. corporate law, does not imply that they are inefficient or undesirable. In a way, they certainly capture the Zeitgeist. In 2019, the Business Roundtable published a statement, signed by 181 CEOs, that corporations ought to serve not just the interests of shareholders, but also those of other stakeholders (see https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans). Meanwhile, the newest book by French star economist Thomas Piketty, Capital and Ideology, also proposes codetermination, albeit in the name of democratizing the economy (Thomas Piketty, Capital and Ideology 495-504 (2019)).
But would codetermination increase efficiency? In a recent paper, we analyze the prospects for codetermination in U.S. corporations, taking into account the German experience.
We argue that while codetermination may work reasonably well in Germany, there are compelling reasons to think that it would be a poor fit for the United States.
Drawing on the economic theory underlying codetermination and considering the different institutional, social, and economic environment in both countries, we show that many of the core benefits that Germany reaps from codetermination are much less likely to materialize in the United States. For example, codetermination plays a key role in the German system of rules which facilitate collective bargaining between capital and labor. In the United States, the role of collective bargaining in its economy is much smaller.
At the same time, some of the indisputable costs of codetermination would likely be much higher in the United States than they are in Germany. Codetermination might undermine the board’s ability to monitor managers effectively, and it might also make removing (employee) directors more difficult. These costs would likely be much higher in the United States than in Germany because German public corporations have a mandatory two-tier structure (management board and supervisory board), and codetermination affects the supervisory board but not the management board. Furthermore, codetermination inhibits the market for corporate control and corporate risk-taking which are historically and economically more important in the United States than in Germany. Moreover, codetermination does not sit well with the U.S. bankruptcy law concept of “debtor in possession.” Finally, it would necessitate enacting many mandatory corporate law rules to prevent regulatory arbitrage, thereby undermining the current enabling structure of U.S. corporate law.
In sum, while mandatory codetermination may well be an efficient and desirable regime for Germany, the United States would be ill-served by following in Germany’s footsteps.
Of course, it is conceivable that the pertinent institutional, economic, and social differences diminish over time. For example, perhaps labor unions will once again play a dominant role in setting U.S. wages, which would allow codetermination to play an important role in avoiding conflicts between unions and employers. Perhaps U.S. securities law and capital markets will become less effective at allowing investors to monitor corporations, which would render codetermination more attractive as an alternative monitoring mechanism.
At this point, however, there is no reason to believe that these and other relevant changes will occur anytime soon. For the foreseeable future, therefore, proposals seeking to import mandatory codetermination ought to be put to rest.
The complete paper is available here.
