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UVA-F-1426 Corporate Governance in Three Economies: Germany, Japan, and the United States
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UVA-F-1426
CORPORATE GOVERNANCE IN THREE ECONOMIES: GERMANY, JAPAN, AND THE UNITED STATES
Introduction The basic structure of corporate governance is that there is a set of representatives selected by the stakeholders, who in turn select management to run the corporation. While the basic structure is the same, the manner with which it gets implemented varies from country to country. The variation is in how “stakeholder” is defined and in the relationship between the supervisory board and management. Part of those differences is cultural, but a large part is due to historical happenstance. For example, the role of banks as stakeholders varies internationally. In the United States, banks play almost no role in the corporate governance of firms. In Japan and Germany, however, banks are major players. A good part of this was due to the way banks were chartered in the United States. U.S. banks were chartered by individual states and were prohibited from having branches in other states. In some cases, they could only have branches in a limited area within the state. At one point just before the stock market crash in 1929, there were over 17,000 commercial banks operating in the United States. Even in 1950, there were over 14,000 commercial banks in the United States, while Germany had a little over 200 and Japan only had about 85. This lack of a national banking system made using bond and equity markets more attractive in the United States verses the access to large banks that one found in Germany and Japan, where banks provided most of the long-term financing. The consequence was that banks play a much larger role in corporate governance in German and Japan, than they do in the United States. This type of factor does not fully explain all the differences we see across markets, but it does represent the kind of indirect influence other types of decisions have. In the sections, which follow, we will explore some of the basic differences we see in the corporate governance structure across countries.
German Corporate Governance Structure There are a number of different forms that business units can take in Germany. These include sole proprietorships, partnerships, cooperatives, and limited liability companies. The limited liability companies are closest to the U.S.–U.K. corporate form. The other forms do not
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have limited liability. There are two kinds of limited liability companies in the German economic system. The first and most numerous (over 438,000 in 1999) is the gesellschaft mit beschränkter haftung or GmbH. This is a partnership with limited liability. These firms usually do not issue shares, and transfer of ownership is difficult. The other form is aktiengesellschaft or AG. This is a limited liability company that issues shares. The proportion of total sales by each legal structure is shown in Table 1. It is obvious from Table 1 that the average size of the GmbH is much less than the AG, even though GmbHs do account for the largest proportion of total sales. Although there are some very large firms that maintain the GmbH structure, most large firms are AGs. Table 1. Proportion of total sales by legal structure. 1950 %
1972 %
1986 %
Limited Liability Companies Ag GmbH
17 15
19 17
21 26
Non-limited Liability Partnerships Sole proprietorship Other Total
19 37 13 100
32 24 8 100
31 15 7 100
1999 % Number 20.73 32.60
3,951 438,085
29.00 357,009 12.89 982,527 5.05 49,993 100.00 1,831,565
The corporate governance structure of the AG and the GmbH are somewhat different. For small GmbHs with fewer than 500 employees, there is a simple governance structure. The shareholders appoint a managing director, the geschäftsführer, who is responsible for the management of the firm. For GmbHs with over 500 employees and all AGs, there is a management board known as the vorstand. This group is jointly responsible for all aspects of the management of the firm. Separate from the vorstand is a supervisory board called the aufsichtsrat, which appoints the members of the vorstand, approves capital expenditures, strategic acquisitions, closures, and approval of the dividends. Of this list, appointing the members of the vorstand is the most important, since the vorstand is the group that will manage the firm. In the case of all GmbHs and AGs with less than 2,000 employees, the membership of the aufsichtsrat is made up of two-thirds shareholders’ representatives and one-third employees/union representatives. For larger AGs with more than 2,000 employees, the proportion of shareholders to employee representatives is 50:50 with a neutral individual as the chair. It is important to note that the employee/union representatives do include white-collar as well as blue-collar employees. To the extent that shareholders wish to limit the impact of employees, there is a substantial incentive for a large firm to remain under the GmbH form as long as possible. The shareholder representatives on the aufsichtsrat are appointed for four years by the general meeting of the shareholders. This raises the question of just who are the shareholders.
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From Table 2, there is quite a bit of difference regarding which sector owns shares when comparing the United States and Germany. The distinction is in the roles of banks and other enterprises. Historically, German corporations have received the majority of their outside funding from large banks. From their very beginnings, German banks operated as a combination of commercial bank, investment bank, and investment trust. They were planned primarily as institutions for the financing of industry.1 The result was that as the association between the companies and the banks grew, German banks took on equity stakes in order to monitor the firm. Thus, in Table 2 we see banks holding over 10% of the shares in Germany. It is interesting to note that the United States’ banks hold essentially no shares. Table 2. International comparison of the percentage of total shares in circulation by different sectors: end of 1995.
Shareownership Profile Households Enterprises Public sector Banks Insurance & pension funds Investment trusts & other financial institutions Rest of the world Total
United States Japan Germany % % % 36.30 22.20 14.60 15.00 31.20 42.10 0.00 0.50 4.30 0.20 13.30 10.30 31.30 10.80 12.40 13.00 11.70 7.60 4.20 10.30 8.70 100.00 100.00 100.00
Source: “Shares as financing and Investment Instruments,” Bundesbank Monthly Report (January 1997).
In addition to banks holding shares, there is a tradition of crossholdings in Germany, which results in firms holding each other’s shares. While most discussions focus on crossholdings in Japan, we actually find a large component of German AGs; shares are held by other firms. Consequently, we find a great deal of crossholding of shares between German firms. In these cases, it is common for two firms to each have a representative of the other firm on the supervisory board. This ownership translates into representation on the supervisory board. However, it should be noted that banks have much more influence than their actual holding would represent. Because most shares of German AGs are bearer shares, there are complex rules that result in banks having control of a much larger share of the votes through proxies held for other shareholders. In fact, a study2 of shareholder representatives on supervisory boards in 1979 noted 1
For a more complete description of the role of banks in the industrial development of Germany, see G. Stolper, K. Häuser, K. Borchardt, The German Economy 1870 to the Present, trans. Toni Stolper (New York: Harcourt, Brace & World, Inc., 1967). 2 This figure is cited in Jeremy Edwards, and Klaus Fischer, Banks, finance and investment in Germany (Cambridge: Cambridge University Press, 1994): 211. It is based on the work by E Gerum, H. Steinmann, and W. Fees, Der mitbestimmite Aufsichtsrat-eine empirsche Untersuchung (Stuttgart: Poeschel Verlag, 1988): table D–3, 48.
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that banks held over 16% of the shareholder seats on the supervisory board, but owned only about 10% of the outstanding shares.3 Domestic non-bank firms had about 40% of the shareholder seats on the supervisory boards. This was roughly in the same proportion that domestic non-bank firms held of outstanding shares. The consequence of all this is that the shareholder representation on the aufsichtsrat, or supervisory board, is heavily weighted toward banks and other firms.
Japanese Corporate Governance There are three types of companies in Japan: commercial partnerships, limited partnerships, and limited companies. The limited companies, or kabushiki kaisha,4 are the ones with limited liability and are the basic corporate form in Japan. While there are more than 2 million limited companies in Japan, there are only a little more than 2,000 that are actually quoted. The governance structure of a Japanese corporation centers around the board of directors. Directors are appointed by a general meeting of the shareholders. The guidelines for the board of directors are that it shall decide the administration of affairs of the company and supervise the management. It is required to meet at least quarterly. In larger companies, the actual control of the company rests with its top management committee. In principle, there should be a separation between the board of directors and the top management committee, but in fact that is not the case for Japanese corporations. It is usually the case that the board of directors is composed of “insiders.” These are full-time employees of the company. In 1992, over 75% of the members of the board of directors for Japanese firms were internal management appointees,5 20% are individuals from banks or other companies, and 5% would be classified as other. An obvious question is: Why do shareholders permit this lack of separation between the board and management? The reason has to do with the makeup of the shareholders. There are strong historic reasons why Japanese firms have a particular ownership structure. Japan began to emerge as a modern nation sometime after 1860. During the next 50 years, Japan developed into a modern industrial state. This rapid industrialization was fostered and encouraged by the state. One consequence of the late industrialization of Japan was the opportunity to look for models that Japan could use to bring about rapid industrialization. Germany, which was also late in forming a modern, unified nation state was a model often used by Japan. One consequence of this is that Japan does have a structure of corporate ownership and governance that resembles the one found in Germany. At its base was the use of banks to fund industrial development and the mutual crossholding of corporate shares.
Deutsches Aktieninstitut, DAI Factbook (1999): 8.1–8.2. The exact English translation is stock companies. 5 Jonathan Charkham, Keeping Good Company: A Study of Corporate Governance in Five Countries (Oxford, U.K.: Clarendon Press, 1994): 85. 3 4
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While the structure that existed before the end of World War II had significant impact on the structure of ownership, it was really the post-war experience that determined what we observe in Japan today. The Japanese banking system basically emerged from the American occupation unchanged. There were a small number of specialty banks focused on financing industrial development for the nation and an additional small number of banks, which formed strong relationships with particular industrial groups. These industrial groups existed before the war and were broken up during the American occupation between 1945 and 1952. By the 1960s these industrial groups had essentially reformed. In response to a threat of acquisitions by foreign firms, they exchanged shares with each other in order to create blocks of reliable shareholders. In 1949, only about 5.6% of the outstanding shares were held by business corporations.6 By 1965, the percentage had increased to 18.4%. Capital restrictions in the 1960s and early 1970s restricted firms to issuing new equity in the form of non-transferable par value rights offerings to existing shareholders. This resulted in a dramatic increase in the crossholdings. Since most individual shareholders did not have cash available, the fact that the rights offerings were not transferable resulted in most individual shareholders not being able to participate. Since other firms in the group did have enough liquidity to participate, the result was a dramatic increase in the levels of crossholdings between firms within a particular group. By 1975, the level of corporate ownership of shares had reached 26.3%. In the late 1990s, the level of crossholdings had decreased. For a number of reasons, many banks and group firms are making a concerted effort to reduce the level of crossholding. The result of all this is that a very large proportion of the shares of Japanese corporations are held in the hands of “stable shareholders.” From Table 2, we see that about 44% of the outstanding shares are held by banks and other firms. For some firms the percentage of stable shareholding might exceed 70%. This level of stable shareholding and the degree to which one firm holds shares in another firm within an industrial group contributes to a significant degree to the independence of the management of Japanese firms. Traditionally, hostile takeovers in Japan are unknown. The stable shareholders support incumbent managers.
United States Corporate Governance Like Japan, the United States has partnership and corporate entities. The main feature of the corporate form is its limited liability, (i.e., investors are only liable for the amount of their investment). Unlike Japan or Germany where there is one national corporate or limited liability form, incorporation is by state in the United States. An entity can select the state in which it wishes to incorporate. While in principle the articles of incorporation are very similar, they are different enough that a large percentage of U.S. corporations choose the state of Delaware as the state of incorporation.
Complete data on shareholding in Japan can be found in the 2000 Shareownership Survey, which is available at http://www.tse.or.jp/english/data/research/shareownership.html. 6
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Even though there are some legal differences across states, corporate governance is fairly similar. The shareholders elect the board of directors, which in turn selects the chief executive officer (CEO) of the corporation. The CEO is responsible for the management of the corporation. The relationship between the board of directors and the CEO varies greatly in U.S. corporations. In the not too distant past, the board of director was composed mainly of employees. There has been a tremendous change after a series of scandals in the 1970s. More recently, the majority of directors on boards are now made up with outside directors. The typical board for a large company will have about 12 board members. Exhibit 1 shows the makeup of the board of directors for the Coca-Cola Company for the year 2001. Out of the 12 members, CEO Douglas Draft is the only employee member of the board. Also listed on the exhibit are the main board committees on which Coca-cola’s members serve. The main duties of the board are as follows: •
Elect, evaluate, and oversee senior management;
•
Administer to the corporation’s business by allocating funds and reviewing corporate performance;
•
Oversee corporate social responsibility;
•
Ensure compliance with the law.
Shareholders elect the board. The makeup of corporate shareholders in the United States is quite different from that in either Japan or Germany. Table 2 shows that households make up the largest shareownership segment in the United States. The next largest is insurance and pension funds. Table 3 reports shareownership in the United States over time.7 It is clear that the direct holdings of individuals have decreased dramatically over time, but the total shows much less of a decrease. This is due in large part to the growth in the use of mutual funds by households. The big change in the non-household sector is in the holdings by non-U.S. investors and the growth of the equity holdings of government pension funds. As of 1998, the main shareholders are individuals through either direct holdings, or indirect holding and pension funds. This is very different from either Japan or Germany, where banks and other corporations play a major role.
7
Note that the household sector includes assets held by non-profit institutions. At the end of 1996, these organizations accounted for about 5.3% of the direct household holdings. Deducting this from the numbers reported in Table 3 would place those totals in line with the lines reported in Table 2.
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-7Table 3. Shareownership in the United States.
Direct household holdings
1950 1960 1970 1980 1990 1998 % % % % % % 90.2 85.6 68.0 58.6 51.0 41.1
Indirect household holdings: Bank personal trusts & states Life insurance companies Private pension funds Mutual funds Total indirect household holdings
0.0 1.3 0.0 2.0 3.3
0.0 1.0 0.0 3.5 4.5
10.9 1.5 0.0 4.1 16.4
9.3 2.6 0.6 2.1 14.6
6.0 1.9 8.0 5.1 21.0
3.8 3.5 8.9 11.3 27.5
Total household (direct & indirect)
93.5
90.1
84.5
73.1
72.0
68.6
2.0 0.0 0.8 0.0 3.7 6.5
2.2 0.1 3.9 0.0 3.6 9.9
3.2 1.2 8.0 0.6 2.5 15.5
5.0 3.0 14.9 0.7 3.2 26.9
6.9 7.6 8.8 1.5 3.2 28.0
7.2 11.4 5.6 5.0 2.2 31.4
Non-households: Outside U.S. State & local government retirement plans Private defined-benefit pension plans Mutual funds not owned by households Other non-household investors Total non-household investors Grand total
100.0 100.0 100.0 100.0 100.0 100.0
Source: NYSE Shareownership 2000, www.nyse.com.
Issues •
How do you think the management decisions are affected by the different corporate governance structures in each country?
•
What should be the criteria for allocating capital within the corporation? Should it be the same in each country?
•
How does globalization affect those structures?
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Exhibit 1 CORPORATE GOVERNANCE IN THREE ECONOMIES: GERMANY, JAPAN, AND THE UNITED STATES Board of Directors for Coca Cola Company, 2001 Douglas N. Daft3: Board chair, board of directors, and CEO of The Coca-Cola Company. Peter V. Ueberroth1,4: Board chair of the Contrarian Group, Inc., (a business management company) and co-chair of the Pebble Beach Company. Sam Nunn2,3: Partner in the law firm of King & Spalding, and co-chair and CEO of Nuclear Threat Initiative. Susan B. King4,6: Board chair of the Leadership Initiative of Duke University (non-profit consultants for leadership education). James B. Williams2,3: Board chair of the executive committee, retired chair of the board of directors and CEO of SunTrust Banks, Inc. James D. Robinson III5,6: Co-founder, board chair, and CEO of RRE Investors, LLC; general partner of RRE Ventures GP II, LLC (private information-technology venture investment firms); board chair of Violy, Byorum & Partners Holdings, LLC (a private financial advisory and investment banking firm); and president of JD Robinson, Inc. Cathleen P. Black1,4,6: President of Hearst Magazines. Paul F. Oreffice2,4,5: Retired chair of the board of directors and CEO of The Dow Chemical Company. Herbert A. Allen2,3: President, CEO, director, and managing director of Allen & Company Incorporated (a privately held investment banking firm). Donald F. McHenry3,5,6: Distinguished professor in the practice of diplomacy and international affairs at the School of Foreign Service at Georgetown University and president of the IRC Group, LLC. Ronald W. Allen1,3,5: Consultant, advisory director, retired chair of the board of directors, president, and CEO of Delta Air Lines, Inc. Warren E. Buffett1,2: Chair of the board of directors and CEO of Berkshire Hathaway Inc. (a diversified holding company). _________________________ 1
Audit committee. Finance committee. 3 Executive committee. 4 Compensation committee. 5 Committee on directors. 6 Public Issues & Diversity Review committee. 2
