The Twilight of the Stakeholder Corporation? Germany's Relevance for Japan

Gregory Jackson
Fellow, RIETI

Despite recent legal reforms, widespread ambivalence remains about how to reshape Japan's stakeholder model of corporate governance in light of new pressures from capital markets and international investors. While many continue to advocate the "shareholder-value" practices of U.S. corporations, this approach is also criticized as undermining commitments to other corporate stakeholders. The devil hides in the detail. How might the interests of shareholders and other stakeholders such as employees be linked in an effective system of governance? Here, it is instructive to contrast the Japanese experience with the other leading stakeholder model of Germany.

Which Governance Paradigm?

Over the last twenty years, perceptions of corporate governance have changed dramatically. During the 1980s, Japan and Germany were held up as a positive example where participation of stakeholders such as employees, banks, and suppliers supported long-term investments, trust, cooperation, and strong economic performance. Meanwhile, the United States and Britain were commonly perceived to be plagued by short-termism, takeover raiders, corporate downsizing and a continuous widening of income inequality.

Yet throughout the 1990s, the competitive strength of the U.S. economy dampened criticism. International debates increasingly looked to Anglo-American practices as benchmarks for good corporate governance. Shareholder-value became a battle cry of investors. And the remedy for inefficiency and managerial empire-building was seen as to "downsize and distribute" corporate resources. Shareholder interests were to be safeguarded by "independent" directors, market-oriented accounting and disclosure, and high power managerial incentives. Meanwhile, Japan experienced slowed growth and large corporations struggled with the rapid pace of innovation in high-tech industries. Numerous other countries began reforms in order to place greater emphasis on shareholder interests in corporate governance. Voluntary corporate governance codes proliferated internationally, being issued by the OECD, national stock exchanges and various interest associations. This rapid diffusion of ideas and new normative pressures and sanctions gave the Anglo-American approach to corporate governance a nearly hegemonic status as the model.

Entering a new decade, the bursting of the New Economy bubble and scandals at Enron and Worldcom have cast a new shadow on the U.S. model. A core problem remains that while managers have strong incentives to promote greater shareholder-value, existing institutions are rarely sufficient to guarantee the accountability of management in designing and implementing these measures. For example, while institutional investors professionalize information gathering and investment strategies (exit) within the marketplace, they only rarely play an active monitoring role within specific companies. Indeed, many unresolved issues lie behind catchwords of the U.S. model such as global standards, accountability, transparency, independence, or shareholder-value.

Such questions and doubts reinforce ambivalence among Japanese toward Anglo-American corporate governance. At the same time, Japan does not have the option to simply return to its "old" stakeholder model, because many of its key features have eroded under the pressures of internationalization and liberalization. In particular, monitoring by main banks has seriously weakened and left a large gap in corporate accountability. The debate over the merits of different models must address how different stakeholders are involved in corporate governance.

Different Models of the Stakeholder Firm

Germany and Japan share certain features as "stakeholder" models of corporate governance in contrast to the more shareholder-oriented U.S. model of corporate governance. Some key similarities include:
(1) Ownership stakes are held among shareholders having strong commitment to specific firm and focusing on their strategic interests. This stability of ownership serves to limit an open market for corporate control;
(2) Banks play a central governance role and are the main providers of external finance to industry;
(3) Strong employee voice in corporate decision-making that supports the commitment and integration of labor as a "citizen" within the corporation, as reflected in longer periods of employment and the lower sensitivity of employment to the business cycle;
(4) Management mediates between these stakeholders by pursuing strategies that focus on markets for high-quality products and utilization of high-skill workforces and stable inter-organizational relationships. Management careers were largely internal to their firm, with less division of strategic and operational tasks.

Both can be described as nonliberal models because their institutions limit the marketization of both capital and labor, making both a more sticky and less mobile factor of production. Stakeholders display strong commitment and exercise voice rather than exit in order to and promote the long-term survival of the firm. This contrasts with the U.S., where capital markets are more liquid, labor more mobile, and management more exclusively focused on the creation of shareholder-value.

Despite these broad similarities, Germany and Japan institutionalize the roles of stakeholders in very different ways:
(1) In Germany, ownership tends to be concentrated among blockholders, such as families ownership and vertically-organized conglomerate holding companies (Konzern). By contrast, ownership within Japanese keiretsu groups is more diffused through horizontal cross-shareholding.
(2) German universal banks are involved in lending, holding large blocks of shares, representation in the boardroom, and the exercise of proxy voting rights. Japanese main banks are linked to companies through lending and cross-shareholdings, but play a lesser role on boards and proxy voting.
(3) In Germany, employee participation is vested in the institution of codetermination (Mitbestimmung) that specifies legal rights to information, consultation, and codetermination for works councils. In addition, employees hold between one-third and one-half of the seats on the corporate supervisory board, placing them alongside shareholders in appointing and monitoring management, giving business advice, and ratifying important strategic decisions. In Japan, participation rights are weaker and less formalized in law.
(4) In Germany, industrial relations is less centered on the individual firms. Industry-wide unions conclude uniform collective bargaining agreements with employers associations, making wages more similar across firms and link them to occupation more than seniority. Training is similarly done in a standardized fashion according to publicly recognized occupational profiles. In Japan, collective bargaining, wages and training are strongly enterprise-centered and reinforce the segmentation of firm-internal labor markets.
(5) Board of directors in Germany follow a two-tier model where the supervisory and management roles are legally separated and strong rights are given to the supervisory board whose members include numerous people from outside the firm. In Japan, supervisory functions fall mainly to the statutory auditor, who lacks powers to appoint and dismiss management.

Table 1:The Different Institutional Foundations of Stakeholder Governance
OwnershipHigh concentration among blockholders.Diffuse cross-shareholdings.
BanksLoans, shares, board representation, proxy voting.Loans, shares, occasional dispatched directors.
Employee Participation-Information, consultation and codetermination rights.

-Legally mandated works councils, and industry-wide unions.

-Board representation.
-Usually information and consultation.

-Enterprise unions.

-Informal interpersonal relationships with board.
Wages-Flat age-wage profiles, linked to occupational qualification.

-Industry-wide collective bargaining.
-Steep age-wage profiles

-Enterprise based bargaining.
Skill FormationPublic certification of training within tri-partite apprenticeship system. Firm-internal training.
Board of DirectorsTwo-tier board with separation of supervisory and management functions.Single board, little separation of functions.

These differences can be described in terms of enterprise constitutionalism in Germany and enterprise community in Japan. In Germany, the voice of labor and capital in the corporation is a matter of public interest and supported through politics. Corporations externalize many governance functions onto corporatist associations and the welfare state, as well as internalizing societal interests within the firm through strong legal rights within decision-making. In Japan, stakeholder voice is more closely dependent upon close mutual dependence within the firm. For example, shareholders cannot easily exit from mutual cross-shareholding arrangements and employee commitment is fostered by seniority-related wages and firm-specific skill formation. These differences between the constitutional and community models thus involve a different role of legal coercion and relative importance of horizontal "class" versus vertically segmented "enterprise" interests and identities.

Do these differences matter? Table 2 shows some performance measures of the 20 largest corporations in Germany, Britain and Japan. Comparing Germany and Britain, the first group of indicators show that shareholders in both countries receive a similarly competitive rate of return on their investment. Nonetheless, the second group of indicators show that British corporations are valued much more highly in the stock market relative to their size. These differences in valuation are reflected in very different patterns of real economic activity, as shown in the third set of indicators: German firms occupy markets with lower profitability and employ over the twice the number of persons as their British counterparts. These differences may be thought of as parallel equilibria where "low market capitalization and high employment" and "high capitalization and low employment" each give similar marginal rates of return to capital. By contrast, Japanese corporations seem in a state of disequilibrium, where high employment is combined with a medium level of capitalization to produce dismal shareholder returns.

Table 2:The Performance of the 20 Largest Industrial Corporations, Selected Averages 2000
 GermanyJapanUnited Kingdom
Returns to Capital   
Price-Earnings Ratio17.828.721.5
Dividend Yield2.7%0.8%2.6%
Return on Equity18.2%5.7%20.4%
Market valuation   
Ratio of market value to sales0.510.972.14
Market value per employee0.140.40.97
Price-book Ratio2.53.04.6
Sales, profits, employment   
Sales (mill. Euro)38,12244,57922,015
Return on Sales (EBIT to sales)9.4%14.4%19.2%

Source: Own calculations based on Wrights Investors Information. Sample based on a ranking of sales in 1998.

The Uncertain Road to "Shareholder-Value"

Germany and Japan's national and nonliberal models are now experiencing a growing tension with an increasingly international and liberal economic order. These pressures raise new issues of economic performance, as well as changing the relation between economic power and public accountability. While facing similar challenges, the different approaches to stakeholder governance in Germany and Japan have important consequences for how corporations respond to the challenges of international capital markets and shareholder pressure.

German corporations have adopted a growing range of shareholder-value practices since the mid-1990s. Capital market pressures increased substantially, as witnessed by rising ownership by institutional and foreign investors, and the declining governance role of banks. Moreover, the hostile takeover of Mannesmann by Vodaphone has signaled the growing vulnerability of even very large German corporations to an emerging market for corporate control. Corporate law reforms strengthened the voting rights of shareholders, recognized international accounting standards, and facilitated the implementation of new shareholder-value oriented practices such as managerial stock options, share buy-backs, spin-offs, de-diversification, etc.

Yet, the reality of German corporate governance continues to look quite distinct from Anglo-American practice. While capital has become more market-oriented, recent experiences suggest the possible emergence of new "hybrid" forms of corporate governance based on a weaker or "enlightened" form of shareholder value. German unions have given conditional support to shareholder-value measures, but used their strong influence to "codetermine" the substance to either improve managerial accountability or reduce class conflict by sharing gains with investors. Employees generally favors greater transparency to enhance employee participation and thus improve managerial accountability. Unions also takes a strong interest in managerial remuneration and have attempted to use boardroom codetermination to discourage excessive inequality that damages employee morale, as well as foreclosing short-term misincentives. Moreover, in accepting managerial stock options, unions gained leverage to demand employee share ownership plans.

While the shareholder-value paradigm is meant to promote the long-term interests of shareholders, both investors and management face very short time horizons in the real world. Often myopic strategies redistribute wealth among stakeholders in a zero-sum fashion. A positive-sum relationship among stakeholders may actually depend on the degree to which labor can force management to resist the temptations of pleasing shareholders in the short-term rather than focusing on long-term strategy and resources??e.g., rapid downsizing of personnel, mergers, or spin-offs. Performance targets may be reached by improving productivity, rather than short-term cost-cutting or balance sheet manipulation. Or, faced with inevitable corporate restructuring (e.g., focus on core competence), labor may promote "good" buyers during spin-offs (e.g., those who intend to act as good employers, rather than the highest bidder). Such measures may be compatible with the long-term interest of shareholders, even where short-term returns are sacrificed. Here labor may act as a "beneficial constraint" in blocking the temptations of excessive short-term rationality in responding to capital markets. The same is true in politics, where German unions were critical in lobbying for protections of employee codetermination within the European Union company statute.

Of course, shareholder-value may still come at a price to the employees of corporate giants. Corporations face strong pressures to shed labor and are likely to contribute less to national employment in the future. Yet to the extent such pressures exist, a strong role for labor may help lessen the class conflicts involved in corporate reorganization and bring out the positive sum potential of shareholder-oriented governance practices.

Compared to Japan, Germany appears better endowed to pursue this approach. Germany's constitutional model can accommodate shareholder-value by contractualizing existing legally mandated arrangements, tailoring them to the situation of the specific firm. Yet the strength of legal checks and balances gives these new negotiated outcomes among stakeholders a relatively stable footing. Likewise, industry-wide associations may delegate greater freedom to individual firms to alter collective agreements, but still be effective in promoting minimum standards and limiting labor concessions. By vesting the rights of stakeholders in legal institutions and associations outside the firm, German practice can more easily reconcile the notions of independence and transparency necessary in market relationships with forms of negotiated governance among stakeholders.

In Japan's enterprise community, similar institutional mechanisms outside the firm are developed to a much lesser extent. The recent legal reforms went a long way in allowing more flexible adoption of shareholder-oriented practices, but did little to strengthen real checks and balances among stakeholders that would promote greater accountability. Markets are now eroding the past dependencies between banks and industry, increasing pressures from shareholders and requiring greater labor mobility. But Japan's institutions are having trouble adapting to greater openness to these market pressures, being so rooted in mutually reinforcing firm-specific commitments rather than politically-constructed rights and responsabilities. Thus, these market processes now threaten the very foundations of Japan's model and insiders such as management and core employees often remain resistant to change. In the worst cases, corporate management is left increasingly unchecked and unions are challenged by the growing "social closure" of the corporation to younger generations.

Toward Greater Accountability

The German case suggests that a stakeholder model might be effectively adapted to capital market pressures, and strong employee voice may even contribute to a new hybrid model of a more "enlightened" shareholder-value. Meanwhile, Japan remains vulnerable in the face of change. Does shareholder pressure therefore signal the twilight of Japan's enterprise communities? Creative learning from the German experience may offer a Japan way forward, such as widening the definition of its enterprise communities and placing the rights and responsibilities of stakeholders on a more public footing. Looking beyond the Anglo-American paradigm may not only protect Japan's corporate stakeholders in the long run, but also raise the standards of corporate accountability.

October 01, 2002

October 1, 2002