Golden Gate University Law Review
Volume 45 | Issue 2 |
Article 3 |
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May 2015
Emulating the German
Eric Engle
Tetiana Danyliuk
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Eric Engle and Tetiana
Danyliuk, Emulating the German
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Engle and Danyliuk: A Stakeholder Theory of the Firm
ARTICLE
EMULATING THE GERMAN
ERIC ENGLE & TETIANA DANYLIUK*
INTRODUCTION
The U.S. corporate governance system failed in 2002, and again in 2008, leading to the deepest economic downturn in the United States since the Great Depression. Germany, in contrast, suffered neither wide- spread regulatory failure nor market collapse. Important differences in the U.S. and German corporate structure and capital markets may explain the divergent economic performance. This Article examines whether and how to emulate German corporate governance structures in the U.S. mar- ket, a theme which may be of interest to German corporations consider- ing locating operations in the United States, such as Volkswagen in Tennessee.1
This Article is structured in three parts. In Part I, we present hypoth- eses about the causes of the U.S. market collapse, which we hypothesize was not merely a result of endogenous corruption and fraud but also due to exogenous macroeconomic factors. This Part includes a description of the German capital market and German economic theories. Part II ex- amines theories of the corporation. Part III examines the corporation in
* Many thanks to Professor Christine Windbichler (Humboldt, Berlin) for reading and commenting on an earlier version of this article. Professor Windbichler’s comments were insightful and very helpful. The authors also wish to thank the editorial team of the Golden Gate University Law Review for their tireless attention to detail in cite checking.
1 Justin Bachman, As Union Moves In,
Volkswagen Will Build Its SUV in Tennessee,
BLOOM- BERG BUSINESS (July 14, 2014),
69
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practice. The Article concludes that
although restructuring the U.S. legal system is likely
impossible due to
I.THE FINANCIAL CRISIS
The causes of the collapse of U.S. capital
markets in 2008 are com- plex. Monetary policy, lowered
lending standards, and reduced regula- tion of banks are all
possible partial explanations2 of
the collapse. These causes, in conjunction with executive
Although we might ask one of the best minds in corporate law for finer details on those points, lesser lights, perhaps dazzled by the com- plexity and confusion of the crisis, have outright misstated the law.7
2Lynn A. Stout, Derivatives and the Legal Origin of the 2008 Credit Crisis, 30 No. 12 Banking & Fin. Services Pol’y Rep. (CCH) 13, 22 (Dec. 2011).
3Lucian A. Bebchuk, The Wages of
Failure: Executive Compensation at Bear Stearns and Lehman
4Stout, supra note 2, at 22.
5Id. at 14 (“[T]he credit crisis was not due to ‘innovations’ in the markets or the legal sys- tem’s failure to ‘keep pace’ with finance. The crisis was caused by changes in the law.”).
6Dialectical materialism is the idea that reality is structured through comparison of the mate- rial facts that competing viewpoints express. On dialectical materialism, see, e.g., Eric Engle, MARXISM, LIBERALISM, FEMINISM: LEFTIST LEGAL THOUGHT 3, 10 (2010).
7Cherie Owen wrote about the
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These are cautionary tales about the
difficulty of correctly analyzing complex economic history.
Thus, in this introductory section, we merely present some hypotheses regarding the economic
crisis. Our hypothesis is that the economic crisis of 2008 was
a “perfect storm” for the United States: a confluence of
exogenous material facts on the market and
structural regulatory failure. The crisis was caused by
a combination of war debt and
bank may not underwrite, distribute, sell,
or deal in corporate securities, except on its own account.
The Act also states that banks may not affiliate with any
company engaged principally in underwrit- ing securities.
Commercial banks are prohibited from managing a company
engaged primarily in the securities business, and investment
banks may not accept deposits. Although there have been move-
ments to repeal this act, and commercial banks have had some
success in expanding their powers, the current law forbids the
trespass of banks into the securities market.” Cherie J. Owen,
Board Games: Germany’s Monopoly on the
8The Bear Stearns collapse was a contributor to
the 2008 market collapse. See,
e.g., Robert D. McFadden, Alan C.
Greenberg, 86, Dies; Led Bear Stearns in Good Times and Bad,
N.Y. TIMES, July 25, 2014,
9Greed all too often leads to
10Ian Salisbury & Paul J. Lim, 6 Years Later, 7 Lessons from Lehman’s Collapse, MONEY
(Sept. 15, 2014),
11Bernard Madoff perpetrated history’s largest
ponzi scheme. A ponzi scheme uses
12Enron was, to that date, one of the largest frauds in corporate history, due to market manip- ulation and pension fraud. See, e.g., Behind the Enron Scandal, TIME, http://content.time.com/time/ specials/packages/article/0,28804,2021097_2023262_2023247,00.html (last visited Oct. 31, 2014).
13See, e.g., Pratap Chatterjee, Dick Cheney’s Halliburton: A Corporate Case Study,
THEGUARDIAN.COM (June 8, 2011), http://www.theguardian.com/commentisfree/cifamerica/2011/jun/
14See, e.g., Owen, supra
note 7, at
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by fraudulent accounting15
to manipulate share prices16 via
Most analyses of the economic crisis
consider only the banking as- pects thereof, i.e., endogenous
microeconomic factors.20 Here, we
point out those endogenous microeconomic factors in the
crisis. However, we also point out the exogenous and
macroeconomic factors: military spend- ing, which led to
massive budget deficits, which then resulted in an in- crease
in national debt, leading to inflation, and thus resulting in
foreign disinvestment on the U.S. capital markets. We also
describe a hypothe- sized unstated policy of
evasion. The indictment, coupled with concerns about the use of corporate funds for the personal benefit of the CEO and general counsel of the corporation, caused Tyco International’s market capi- talization to fall by $100 billion . . . . After Global Crossing Ltd. filed for bankruptcy, the former chairman and founder of the corporation was questioned regarding sales of over $700 million of his stock in the corporation in 1999. At the time of the sale, the stock had reached a high of $60 per share. However, by the end of 2001, the company filed for bankruptcy following allegations that the [corporation’s] revenues were inflated due to exchanges that were without economic substance.” (footnotes omitted)).
15“One of the major problems facing corporate
governance today is directors’ use of account- ing methods
that, although not wholly illegal, are intended to mislead
shareholders into believing that corporate value is greater
than it actually is.” Lauren J. Aste, Reforming French Corporate Governance: A Return
to the
16Margaret M. Blair, Directors Duties in
a
17Special purpose entities “financed Enron’s activities, shifted debt from Enron’s books, and hid Enron’s credit risk. These SPEs were used in many different ways to disguise risk and debt, and to create the appearance of liquidity and profitability.” Owen, supra note 7, at 169 (footnote omitted).
18
19Corruption reduces demand on the publicly traded stock market. “In the wake of the recent corporate scandals such as Enron and WorldCom, investors have lost faith in the stability of the American securities markets. Consequently, stock prices have rapidly declined over the past year and investors have lost billions of dollars.” Owen, supra note 7, at 167 (footnotes omitted).
20Although the EU Larosiere report does consider macroeconomic aspects of the crisis in- cluding the role of Chinese and Arab monetary policies and investments, it does not factor in issues such as massive U.S. war deficits and the oil price spike resulting from those wars as causes of the
crisis. See J L ` ., R H L G F S
ACQUES DE AROSIERE ET AL EPORT OF THE IGH
EVEL ROUP ON INANCIAL U- PERVISION IN THE EU
.html.
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stock markets, which explains why the
collapse of the housing market was much worse than a similar
housing crash, the
A.MACROECONOMIC
Our hypothesis is that the U.S. Federal
Reserve Board was following monetarist policies aimed to
encourage an alternation of cyclicity in the housing market
and the stock market23 from 1982 to
2008. The objective of
21Stephen Labaton, F.D.I.C.
Sues Neil Bush and Others at Silverado, N.Y. Times,
Sept. 22, 1990,
22“Shortly after Sept. 11, George W. Bush
interrupted his inveighing against evildoers to crack a
joke. Mr. Bush had repeatedly promised to run an overall
budget surplus at least as large as the Social Security
surplus, except in the event of recession, war or national
emergency. ‘Lucky me,’ he remarked to Mitch Daniels, his
budget director. ‘I hit the trifecta.’” Paul Krugman, Hitting The Trifecta, N.Y. TIMES, DEC. 7,
2001,
23On the stock market, this policy was known as
“the Greenspan Put.” See, The
Greenspan Put, MONEY WEEK (May 24, 2013),
24“Results suggest a weak cycle of six to eight
years for the interaction between home appre- ciation and
stock returns. Specifically, high (low) stock returns three
to four years ago suggest weak (strong) home appreciation
now. Similarly, strong (weak) home appreciation now weakly
suggests low (high) stock returns three or four years from
now.”
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ado”). The 2001 stock market crash was
similarly coincident with a housing construction boom. The
fact that the business cycle of new housing construction and
the business cycle of stock market performance are a few years
out of phase is empirically observable: peaks in the realty
capital market and peaks in the speculative capital market are
about two to four years
Housing and Stock Markets: Countercyclical with a Wavelength of Six to Eight Years25
25 Source: Id.
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transport, and lubrication. Expensive oil means everything else is also expensive.26
B.EXOGENOUS FACTORS: MILITARY SPENDING LEADING TO
INFLATION AND DEFICITS RESULTING IN FOREIGN
DISINVESTMENT
The economic problems facing the United States are not only due to irresponsible corporate corruption. The great recession was also caused by the massive war debt the United States incurred and continues to in- cur,27 illustrated in the following charts:
“Global War on Terror”: More Costly than Vietnam War28
This chart shows that military spending has
been a major contributor to the U.S. federal deficit. What
about inflation? A
26(“Natural gas as a fuel is used to produce
items such as steel, glass, paper, clothing and brick. It
also is an essential raw material for paints, fertalizer,
plastics, antifreeze, dyes, photographic film, medicines and
explosives.”) Energy Primer, FED. ENERGY REG. COMM’N, p. 1, 10 (USGPO, 2012), available at
27Eric A. Engle, Rethinking the ‘War on Teror’: Legal Perspectives on Containment and Development Strategies, 2 CITY U. OF H. K. L. REV. 67, 73 (Jan. 1, 2010), available at http:// ssrn.com/abstract=1543267.
28Source data: U.S. GPO, https://web.archive.org/web/20110205031644/http://
www.gpoaccess.gov/usbudget/fy11/sheets/hist06z1.xls;
Graphic source: SAN DIEGO VETERANS FOR PEACE,
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on terror”, a war which, fifteen years later, continues with no end in sight.
The resulting inflation statistics follow:
Inflation: Managable and Even Declined after the 2008 Crisis29
We hypothesize that the inflation from
29 Source: Paul
Krugman, The Conscience of a Liberal,
N.Y. TIMES BLOG,
(June 2, 2011), available at
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Inflation Adjusted Federal Deficits are Well Above World War 2 Levels30
Budget deficits, in turn led to increased national debt, illustrated as follows:
Public Debt as a Percentage of GDP is well below World War II Levels31
30 Source:
RandomNonviolence, Our Taxes Are Off to
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Inflation had the effect of devaluing the worth of the U.S. treasury bonds. Inflationary devaluation of U.S. treasury bond obligations finally led for- eign lenders investing in U.S. treasury bills such as China32 and Saudi Arabia to switch to other investments, such as real estate33 and invest- ments in the EU, for fear of a debt default or inflationary destruction of their investments by the United States.
300 |
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265.3 |
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250 |
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239.8 |
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200 |
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167.4 |
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150 |
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122.8 |
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100 |
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87.1 |
86.9 |
80.7 |
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68.5 |
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63.9 |
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40.6 |
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50 |
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0 |
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2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
|
Source: U.S. Department of the Treasury.
Note: Data for
June 2013 are
Annual Change in China’s Holdings of U.S.
Treasury Securities:
Although the efficient, i.e. proximate cause of the economic crisis was indeed the burst securitized mortgage bubble, we argue that the great recession was not only the result of irresponsible lending in combination with fraudulent accounting; it was also the result of inflation brought about by war debts and Arab and Chinese35 disinvestment36 in the
31U.S. Budget Deficit, Debt Compared With GDP, NPR, http://www.npr.org/news/graphics/ 2009/feb/deficit/ (last visited Jan. 30, 2015).
32How China Owns $1.2 Trillion of American
Deficit, DAILY MAIL (June 4, 2011),
http://
33Thilo Hanemann, Chinese Investment: Europe vs. the United States, RHODIUM GROUP
(Feb. 25, 2013),
34Wayne M. Morrison & Marc Labonte, China’s Holdings of U.S. Securities: Implications for the U.S. Economy, CONGRESSIONAL RESEARCH SERVICE, 9 (Aug. 19, 2013), http://www.fas.org/ sgp/crs/row/RL34314.pdf.
35DAILY MAIL, supra note 32.
36Jim Krane, Sept. 11 Fuels Boom in Gulf: Arabs Divested from American and Reinvested Tens of Billions at Home, Angered by U.S. Hostility, LAKELAND LEDGER (Aug. 26, 2005), http://
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United States. Macroeconomic exogenous market factors, i.e., war and deficit, as well as endogenous regulatory failure, i.e., corporate corrup- tion, both contributed to the economic crisis.
C.ENDOGENOUS REGULATORY FAILURE
The repeal of a portion of the
news.google.com/newspa- pers?nid=1346&dat=20050826&id=PVJIAAAAIBAJ&sjid=H_4DAAAAIBAJ&pg=1866,4888909;
How 9/11 caused an economic boom in the Gulf
Oil States from
37
38Banking Act of 1933, ch.89, §§ 20, 32, 48 Stat. 162, 188, 194 (1933) (codified as amended in 12 U.S.C. §§ 78, 377 (repealed 1999).
39A bank run occurs when many depositors become convinced that their bank is insolvent and seek to withdraw their funds. See “Run: Banking” JOHN DOWNES & JORDAN GOODMAN, DIC- TIONARY OF FINANCE AND INVESTMENT TERMS (2010); Bank Run, INVESTOPEDIA, available at http://
www.investopedia.com/terms/b/bankrun/asp
(last visited Feb. 18, 2015). Since banks typically only
retain around 13% of deposits in liquid form, when enough
investors seek to withdraw their funds from the bank the
bank collapses. Bank runs were one of the key factors in the
1929 depression. Consequently, the United States, like many
other countries, introduced bank insurance for “small”
depositors – the FDIC guarantees to cover bank savings up to
100,000 U.S. Dollars, which has prevented bank runs in the
United States. See, e.g.,
Historical Timeline: The 1930s,
FDIC, https:// www.fdic.gov/about/history/timeline/1930s.html
(Last Updated Jan. 2, 2014). Regarding the restric- tions on
banking and securities underwriting intended to prevent bank
runs see, e.g., David Murphy, UNRAVELLING THE CREDIT CRUNCH
123 (2009); Susanna Powers, ENHANCED
TRANSPARENCY OF THE FEDERAL RESERVE: IMPACT ON FEDERAL
FUNDS RATE
FORECAST ERRORS
35 (2008); Helen A. Gar- ten, WHY BANK REGULATION
FAILED: DESIGNING
A BANK REGULATORY
STRATEGY FOR THE 1990S,
40Z. Jill Barclift, Too Big to Fail, Too Big Not to Know: Financial Firms and Corporate Social Responsibility, 25 J. OF CIV. RTS. & ECON. DEV. 449, 455 (2010).
41“Securitization is the process of pooling consumer mortgages and selling the pooled mort- gages as a separate security.” Id. at 456.
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of the mortgage package for financing and sale as a security to unsus- pecting third parties. The resulting securitization was, moreover, based on a chain of irresponsibility:
“Because financial firms had to sell the
securitized assets, the origina- tor of the loan held no
responsibility for the quality of
the loan, and the ultimate owner of the consumer mortgage had
no concern for the consequences of
the loan on the consumer. Moreover, the financial institution
selling the
To make matters worse, in order to create
mortgage based securities that could be sold to Wall Street
financial firms, lenders increasingly pushed
Prior to the housing bubble, people had long thought that one’s own house is the safest and most secure investment of all, especially in the United States, where the norm is universal home ownership. The fact that people’s housing is their most important investment explains why U.S. banks were willing to make risky loans with low or no down pay- ment. The banks believed, whether by hook or by crook, people would make their mortgage payments. However, when housing prices outstrip- ped mortgagees’ ability to pay, loan defaults rendered the securities mortgage “investments” worthless, which led in turn to the collapse of several banks and a global economic crisis.
The
42Id.
43
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not lead to tariff walls which would, like
1929, have worsened the reces- sion. Consequently, 2008 did
not unleash war with China
D.EXOGENOUS CAUSES OF THE CRISIS
The collapse of the housing bubble in 2008
might have been offset by a rising stock boom, as happened in
cases prior to 2008. The 1987 stock market crash did not
result in a global recession because of the housing boom
occurring at that time. Likewise, the 1990 housing crash
caused by the savings and loan scandal was contemporaneous
with a ris- ing stock market. In line with this trend, the
2001 stock market crash was contemporaneous with a housing
boom. However, the hypothesized policy of alternating
While the U.S. stock market has since recovered, the United States remains awash in debt and trapped in expensive wars, and political paral- ysis exemplified by the federal spending sequester. Although employ-
44“The sequester” is the idea that the U.S. Federal Government cannot lawfully spend with- out a Congressional budget, which is basically true because all financing of the federal government must originate in the legislative branch. This constitutional principle, that Parliament holds the power of the purse is rooted in Magna Charta and prevents executive dictatorship. See, e.g., What is the Sequester, THE WHITE HOUSE, http://www.whitehouse.gov/issues/sequester (last visited Jan. 30, 2015).
45Heleen Mees, How China’s Boom Caused the Financial Crisis and Why it Matters Today, FOREIGN POLICY (Jan. 17, 2012), http://www.foreignpolicy.com/articles/2012/01/17/ how_china_s_boom_caused_the_financial_crisis.
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ment figures and productivity are improving
in the United States, U.S. enterprises remain underperformers
in comparison to economies in East Asia (China,46 Southern Korea,47
Singapore,48 to name a few
examples of
As a result of these events, the U.S. dollar is no longer the world’s sole reserve currency: the Euro now is a second global reserve cur- rency.51 Our hypothesis is that the various stresses on the Euro may be a result of factions within the United States seeking to undermine the Euro because the Euro is the Dollar’s only credible competitor for global capi- tal, a second global reserve currency. Regardless of speculation, it is certain that when Iraq redenominated its oil contracts in Euros instead of Dollars, the United States soon thereafter invaded Iraq and deposed Sad- dam Hussein, Iraq’s former head of state, executing him in the process.52
46“Since initiating market reforms in 1978, China has shifted from a centrally planned to a market based economy and experienced rapid economic and social development. GDP growth aver- aging about 10 percent a year has lifted more than 500 million people out of poverty.” China: Overview, WORLD BANK (Apr. 1, 2014), http://www.worldbank.org/en/country/china/overview.
47“South Korea over the past four decades has
demonstrated incredible growth and global integration to
become a
48The Singapore Economy, MONETARY AUTHORITY OF
SINGAPORE, http://www.sgs.gov.sg/
49Unlike the United States, employment rates in Germany were largely unaffected by the great recession of 2008. See, e.g., Florian Hoffmann & Thomas Lemieux, Unemployment in the Great Recession: A Comparison of Germany, Canada and the United States (Sept. 2013), available at http://faculty.arts.ubc.ca/fhoffmann/HL_Great_Recession_Oct13.pdf.
50See, Eric Engle, Rethinking the ‘War on Teror’: Legal
Perspectives on Containment and Development Strategies, CITY UNIVERSITY
OF HONG KONG
LAW REVIEW, VOL. 2, NO. 1, pp.
51Alan W. Cafruny, A Ruined Fortress? Europe and American Economic Hegemony, 19 CONN. J. INT’L L. 329, 329 (2004).
52Philippa Winkler, The War Against Iraq:
Whose Ends, Whose Means, 9 NEXUS 163, 167
(2004). “The deciding factor was when Saddam Hussein pegged
the dinar to the dollar bloc’s com- mercial rival, the euro.
Something more drastic had to occur: a land grab, 21st
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To present, financial crises in Greece,
Spain, and Cyprus echo the U.S. real estate crash, but have
not split the Atlantic partners or caused the Euro to be
abandoned. The Euro survived the economic stresses of
Even if the United States were intent on
breaking the Euro, despite the obvious implications of that
move for transatlantic trade and NATO, Europe itself would
seek to maintain the Euro. Germany’s tragic historic
experience of hyperinflation53 and
the terrible wars that caused and fol- lowed it are why the
European Central Bank (ECB) will never abandon prudent
policies. The ECB’s prudent monetary policies were modeled on
the German
Again, these are our hypotheses, and obviously will require further research and the passage of time to prove or refute. However, the com- petition between the Euro and the Dollar54 is not merely for denomina- tion of oil contracts or other financial transactions outside of North America and Europe. It is also to attract capital in the form of bond investments. The United States has never defaulted on its bond obliga- tions, which is why the United States consistently attracted so much for- eign capital so cheaply. Thus, the ECB will likely be very cautious, and rightly so, concerning the introduction of Eurobonds. In any case, the presence of the Euro as a real alternative for Russia, China, and the Mid- dle East as a stable international currency will likely reduce demand for the Dollar, and possibly also for U.S. Treasury Bonds. This, in turn, would exacerbate the difficulties facing the United States to attract Arab and Chinese capital.
53Timothy A. Canova, Financial Liberalization, International Monetary Dis/order, and the Neoliberal State, 15 AM. U. INT’L L. REV. 1279, 1297 (2000).
54See, e.g., Robert
Fisk, The Demise of the Dollar, THE INDEPENDENT (Oct. 6,
2009), http://
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E.THE GERMAN CAPITAL MARKET
The collapse of the U.S. economy can be
contrasted with the higher performance of the German economy.
For years, U.S. analysts argued that German policies of
assuring worker representation and trade union participation
in the management of enterprises, known as
U.S. analyses that rejected
55Blair, supra note
16, at
56Lucian Bebchuk, Alma Cohen, & Allen
Ferrell, What Matters in
Corporate Governance? THE REV. OF FIN. STUD., 6
(2008), available at http://www.law.harvard.edu/faculty/bebchuk/pdfs/
57Blair & Stout, A Team Production Theory of Corporate Law, at 745.
58William W. Bratton & Joseph A. McCahery, Comparative Corporate Governance and the Theory
of the Firm: The Case Against Global Cross Reference,
38 COLUM. J. TRANSNAT’L L. 213,
59Marleen O’Connor, Labor’s Role in the American Corporate Governance Structure, 22 COMP. LAB. L. & POL’Y J. 97, 100 (2000).
60Bainbridge, supra note 56, at 670.
61Blair, supra note 16, at 908.
62Regarding the facts, Worker participation enables feedback on working conditions: e.g., “these practices are dangerous to life and limb; those tools and precautions are necessary.” Regard- ing the law, Worker feedback also provides supervision to other workers: e.g., “don’t come to work sleepy, ill, or drunk.” Masahiko Aoki, TOWARD A COMPARATIVE INSTITUTIONAL ANALYSIS, 164 (2001).
63Alison Morantz, The Elusive Union Safety Effect: Toward a New Empirical Research Agenda, 137 (June 1, 2009), available at http://assets.conferencespot.org/fileserver/file/120639/ filename/2009_369.pdf.
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research from South Korea, a country which models its economic and political system on the United States, unequivocally shows the common sense fact that labor unions improve production by preventing accidents at work.64
In the United States, safer workplaces are
obtained through the Oc- cupational Safety and Health
Administrations’ standards and workers’ compensation. However,
labor unions also contribute to the regulation of safety at
the workplace by publicizing standards and advocating better
enforcement and improvement of safety standards,65 In Europe, works councils,66 which are
German corporations are more efficient
producers than U.S. corpo- rations due to greater labor
participation and better governance mecha- nisms. Worker and
trade union participation in management provides a check to
prevent fraud, increases employees’ willingness to work well,
and enable a
64Kwan Hyung Yi, Hm Hak Cho, & Jiyun Kim, An Empirical Analysis on Labor Unions and
Occupational Safety and Health Committees’ Activity, and
their Relation to the Changes in Occupa- tional Injury and
Illness Rate, 2(4) SAFE HEALTH WORK
65See generally, Job Safety, AMERICAN FEDERATION OF LABOR - CONGRESS OF INDUSTRIAL
ORGANIZATIONS,
66Works council systems are institutionalized
bodies for representative communication be- tween employers
and employees. See, e.g., Daniel
Little, Works Councils and US Labor
Relations, UNDERSTANDING SOCIETY (Feb. 9 2010, 7:46 PM), http://understandingsociety.blogspot.de/2010/02/
67“Germany . . . has a corporate structure that separates those who manage the business of the corporation from those who oversee the management.” Owen, supra note 7, at 168.
68See, e.g., Alice De Jonge, TRANSNATIONAL CORPORATIONS AND INTERNATIONAL LAW, 9
(2011).
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F.CORPORATISM
Corporatism is the idea that labor and
management should interact cooperatively to take advantage of
the strengths of workers’
69See, e.g., Maria Brouwer, GOVERNANCE AND INNOVATION: A HISTORICAL VIEW, 144 (2008); Sol Picciotto, REGULARINF GLOBAL CORPORATE CAPITALISM, 123 (2011).
70See, e.g., Howard J. Wiarda, CORPORATISM AND COMPARATIVE POLITICS: THE OTHER
GREAT “ISM”,
71See, e.g., Id. at
72“The institutions which underpinned the success
of the German model of capitalism, the
&Pascaline Winand (eds.), NEW EUROPE, NEW WORLD?: THE EUROPEAN UNION, EUROPE, AND THE CHALLENGES OF THE 21ST CENTURY, 53 (2010).
73Peter Muchlinski, The Development of German Corporate Law Until 1990: An Historical Reappraisal, 14 GER. L.J. 339, 370 (2013).
74See, e.g., Frank P.
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effects.75 Thus,
in
Although corporatism became central to French and German under- standings of political economy, the corporatist model never really took root in U.S. law. Thus, alternative forms of sustainable enterprise such as the Cooperative form of corporate enterprise (in German: Genossen- schaft) never became widely adopted in U.S. law, possibly due to an inability to obtain credit, i.e., bank loans.78 Can U.S. law somehow take up Germanic conceptions of corporatism in an effort to attain higher pro- ductivity and less corruption as a part of its economic recovery?
G.EMULATING THE GERMAN CORPORATION IN THE U.S. MARKET
Legislatively mandated
75See, e.g., Organisation for Economic
76Muchlinski, supra note 73, at 371.
77Blair & Stout, supra note 56, at 771.
78Oliver Williamson, Corporate Governance, 93 YALE L.J. 1197, 1226 (June, 1984).
79Bainbridge, supra note 56, at 689.
80Marleen O’Connor, Corporate Malaise - Stakeholder Statutes: Cause or Cure?, 21 STET- SON L. REV. 3, 18 (1991) (arguing that it there is little possibility that codetermination will be transferred to the United States because of political aversion).
81See, e.g. Claude Menard, Mary M. Shirley, HANDBOOK OF NEW INSTITUTIONAL ECONOM- ICS, 375 (2008); William B. Gould AGENDA FOR REFORM: THE FUTURE OF EMPLOYMENT RELATION- SHIPS AND THE LAW 146 (1993); O’Connor, supra note 59, at 99.
82The kolkhoz (lit: collective posession) and Sovkhoz (lit: council posession) were the two
principle forms of cooperative enterprise in the Soviet system. The Genossesnchaft was (and is) a cooperative form of enterprise in Germany. These forms are roughly homologous to the cooperative
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schaft) were key
producers in Eastern European and even some Western European
economies,
A question for German corporations seeking
to enter into the U.S. market by incorporating or taking over
subsidiaries, as well as for U.S. businesses that wish to take
advantage of the German model, is how to emulate German
corporate governance structures privately within U.S. law.83 The German
II.THE CORPORATION IN THEORY
At the root of the questions of
enterprise form
83We are not the first to suggest this, see Owen, supra note 7, at 189.
84“According to the German Stock Corporation Act
of 1965, it is mandatory for all German stock corporations (Aktiengesellschaften) to have two
boards: the management board (Vorstand)
and the supervisory board (Aufsichtsrat).
The supervisory board members are either shareholder repre-
sentatives or labour representatives. Simultaneous membership
of the management board and the supervisory board is not
permitted.” Carsten Jungmann, The
Effectiveness of Corporate Governance in
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A.THE CHARTER THEORY OF THE CORPORATION: THE CORPORATION
AS STATE POWER
Historically, the corporation arose as a
delegation of state power to private societies85 through granting of a corporate
charter with an express or implied monopoly power over a given
area, whether geographic or economic, which we call the charter theory. The prototypical
common law examples here are the Massachusetts Bay Company,
The Hudson’s Bay Company, and the British East India Company;
the Dutch East India Company is the prototypical civil law
example. These institutions were both private market actors as
to their economic functions, acto iure
ges- tionis, and institutions of government as to
their sovereign functions, acto iure
imperii.86 From its roots
as an exceptional instance of dele- gated state power, the
corporation became de facto increasingly
a matter of “private” enterprise. Eventually the corporation
charter became a gen- eralized document that could be obtained
by compliance with simple for- mal requirements.87 This theory of the corporation as an
instance of
B.THE TRUST THEORY OF THE CORPORATION
The trust theory of the corporation emerged from the charter theory, as the corporate form became more widespread and taken up for purely economic, and not governance purposes. For the trust theory of the cor- poration,88 like the charter theory, the corporation is a separate legal per-
85Bainbridge, supra note 56, at 668 (the delegation of state power to the board of directors then enabled further delegations from the board to employees and agents of the corporation – a finely made chain of delegated state power, subtle and supple in its effects.).
86See, e.g., Bernard Maria Gavouneli & Ilias Bantekas, International Decision: Prefecture of Voiotia v. Federal Republic of Germany, 95 AM. J. INT’L L. 198 (2001); (“The distinction between acts jure imperii and jure gestionis is effected on the basis of the law of the forum and using as a basic criterion the nature of the act carried out by the foreign state, i.e., whether it involves the exercise of a sovereign power.”) Id. (quoting Prefecture of Voiotia v. Federal Republic of Germany, Case No.11/2000 (Areios Pagos (Sup. Ct. of Greece)), May 4, 2000); Saudi Arabia v. Nelson, 507 U.S. 349, 360 (1993).
87Tom Campbell & Seumas Miller, HUMAN
RIGHTS AND THE MORAL
RESPONSIBILITIES OF CORPORATE AND PUBLIC
SECTOR ORGANISATIONS
88“The trustee holds legal title to the trust property and the beneficiaries have the equitable, or beneficial, interests. Two categories of issues arise from this splitting of legal and equitable ownership: (1) the powers and duties of the trustee and the corresponding rights of the beneficiary with respect to the trust property and against the trustee (governance), and (2) the effect on the rights of third parties with respect to the trust property versus the personal property of the trustee (asset partitioning).” Robert H. Sitkoff, Trust Law as Fiduciary Governance Plus Asset Partitioning, HARVARD UNIVERSITY LAW & ECONOMICS DISCUSSION PAPER NO. 711, at 429 (Nov. 21, 2011), available at http://ssrn.com/abstract=1962856.
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son apart from and greater than its members, growing out of and analogical to the common law trust89 - a type of property. This theory of the corporation as a synergy is consistent with the charter theory from which it evolved sketched out here in the prior paragraph. The trust the- ory of the corporation however implies fiduciary duties90 of loyalty and trust91 in lieu of the (mercantilist) command of the state that character- ized the charter theory. Historically, fiduciary duties were nearly abso- lute: today, like so many other rights, they are relativized and contextualized.92 Historically, the trustee (in the corporate context, the board of directors) owed fiduciary duties to the trust grantor (in the cor- porate context, the shareholders). However, the trust theory of the corpo- ration93 is less current today94 than in the past.95
89Henry Hansmann & Ugo Mattei, The
Functions Of Trust Law: A Comparative Legal And Economic
Analysis, 73 N.Y.U. L. REV. 434,
90Fiduciary duties arose out of the trust. Fides
is however more than mere good faith. Mere good faith is but
actual honesty. The fiduciary duty in contrast is a higher
duty of loyalty: the fiduciary must in fact act on behalf of
and for the benefit of the person or persons to whom they
owe this duty of highest loyalty. See,
e.g., Smith v. Van Gorkom, 488
A.2d 858, 872 (Del. 1985) (“A director’s duty to inform
himself in preparation for a decision derives from the
fiduciary capacity in which he serves the corporation and its
stockholders. [internal citations omitted] Since a director is
vested with the responsibility for the management of the
affairs of the corporation, he must execute that duty with the
recognition that he acts on behalf of others. Such obligation
does not tolerate faithlessness or
91Trusting is economically efficient, yet trust
cannot be purchased and is difficult to obtain. Robert
Cooter & Melvin Eisenberg, Fairness,
Character, and Efficiency in Firms, 149 U. PA. L. REV.
1717,
92Sitkoff, supra note
88, at 432; “Most fiduciary obligations are default rules that yield to the
contrary agreement of the parties . . . . Even the fiduciary
duty of loyalty is subject to modification. If the principal
gives informed consent to certain
93Id. at 430; “The traditional but now outmoded governance strategy for protecting the bene- ficiary’s interests was to negate the agency problem by disempowering the trustee. Under traditional law, the trustee had no default powers to engage in market transactions over the trust property. The trustee’s powers were limited to those granted expressly in the trust instrument. The problem with this disempowerment strategy is that in protecting the beneficiary from mis- or malfeasance by the trustee, the law also disabled the trustee from undertaking transactions useful for the beneficiary. As trusts have come increasingly to be funded with liquid financial assets that require alert management in the face of swiftly changing financial markets, modern trust law has come to give the trustee
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The shareholder primacy
theory arose with modernity and industri- alization.
The shareholder primacy theory is rightly rooted to the trust
theory of the firm, again illustrating the evolutionary nature
of corporate theory: the directors, as fiduciaries
of the shareholder’s property (still) have duties of
loyalty and fairness. Thus, in the case where the corpora-
tion is entirely liquidated, the directors have a fiduciary
duty to maximize the profit to the shareholders in the sale of
the corporation.96 That is the only
broad powers to undertake any type of transaction, subject to the trustee’s fiduciary duties. Modern law gives the trustee ‘all of the powers over trust property that a legally competent, unmarried individual has with respect to individually owned property.’ However, ‘in deciding whether and how to exercise the powers of the trusteeship,’ the trustee is subject to and must act in accordance with the [trustee’s] fiduciary duties.”Id.
94Id.
95For a history of this transformation from the corporation itself as the trust beneficiary to the corporation’s directors as trustees of shareholder investment – the definite trend of the era ca. 1600- 1900, see Colin Arthur Cooke, CORPORATION, TRUST AND COMPANY: AN ESSAY IN LEGAL HISTORY
96Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).
97See, e.g., Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919). Lynn Stout cogently argues that Dodge v. Ford was badly decided and ought not be a part of the U.S. corporate law canon. Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford, UCLA SCHOOL OF LAW LAW
&ECON RESEARCH PAPER SERIES RESEARCH PAPER NO.
.ssrn.com/sol3/papers.cfm?abstract_id=1013744.
(However the fact is that Dodge v. Ford is
still good law. The case held that “A business corporation is
organized and carried on primarily for
the profit of the stockholders. Dodge v. Forde Motor Co., 170
N.W. 668, 684 (Mich. 1919).” That is, the corporation
may do things in addition to making profit but indeed a
98Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919).
99Simon Deakin, Squaring the Circle? Shareholder Value and Corporate Responsibility in the U.K., 70 GEO. WASH. L. REV. 976, 977 (2002); Douglas G. Baird & M. Todd Henderson, Other People’s Money, JOHN M. OLIN LAW & ECONOMICS WORKING PAPER NO. 359, 2d Series (2007), available at http://ssrn.com/abstract_id=1017615 (“In the last part, we suggested that corporate law might sensibly adopt the principle that directors owe a fiduciary duty to the corporation as a whole.”); Andrew Keay, Moving Towards Stakeholderism? Constituency Statutes, Enlightened Shareholder Value and All That: Much Ado About Little?, UNIVERSITY OF LEEDS, SCHOOL OF LAW
WORKING PAPER, 11 (Jan. 4, 2010), available at http://ssrn.com/abstract=1530990.
100Marleen O’Connor, Restructuring the
Corporation’s Nexus of Contracts: Recognizing a Fiduciary Duty
to Protect Displaced Workers, 69 N.C. L. REV. 1190, 1191, 1194
(1991). (Marleen O’Connor goes on later to argue that
fiduciary duties toward employees ought to be imposed by the
courts, in order to fulfill “implicit” contracts and
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ployee relationships are governed by
contract, not trust. They are arms- length
C.THE NEXUS OF CONTRACTS THEORY OF THE CORPORATION
The corporation is presented most often in current discourse not as a mercantilist or corporatist institution of government; nor as a variety or outgrowth of the common law trust, i.e. as an instance of property law. Instead, most often, the contemporary corporation is currently and inac- curately portrayed as merely a nexus of contracts.102 Supposedly, the contemporary corporation is but a series of contractual and not fiduciary relationships that are independent and separable elements, and thus, im- plicitly carry no synergies. According to the nexus of contracts theory of the corporation:
Employees provide labor. Creditors provide debt capital. Sharehold- ers initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm’s inputs. The firm is a legal fiction representing the complex set of contractual relationships between these inputs. In other words, the firm is not a thing but rather a nexus or web of ex- plicit and implicit contracts establishing rights and obligations among the various inputs making up the firm.103
When Milton Friedman first, and most famously, argued that the only duty of the corporation is to maximize shareholder wealth, he based his arguments on a theory of the corporation as contract and agency,104
the moving party, and since equity is an exceptional discretionary remedy the likelihood of the courts imposing “ghost contracts” is just about nil. A better reform effort would be to draft model statutes, model charters, model bylaws, and model proxy statements to represent worker’s interests directly, concretely and democratically rather than by the uncertain and unpredictable judicial pro- cess. It is also worth pointing out that O’Connor admits that as a matter of existing positive law the directors do not owe fiduciary duties to employees. The reason is because fiduciary duties are in rem, not in personam, and employment contracts are in personam.) Marleen O’Connor, Labor’s Role in the American Corporate Governance Structure, 22 COMP. LAB. L. & POL’Y J. 97, 103 (2000).
101Blair, supra note 16, at 889.
102Bainbridge, supra note 56, at 660.
103Judd F. Sneirson, Green Is Good: Sustainability, Profitability, and a New Paradigm for Corporate Governance, 94 IOWA L. REV. 987, 1016 (2009).
104Milton Friedman, The Social
Responsibility of Business is to Increase its Profits, N.Y. TIMES (Sept. 13, 1970), available at http://www.colorado.edu/studentgroups/libertarians/issues/
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not on fiduciary
duties. Friedman regards directors as employees
of the shareholders, bound by contract. Coase, like
Friedman, also regards the corporation as a contract.105 Coase states that corporations come
into being to reduce transaction costs106 by
entering into one
The problem is, the theory that the corporation is but a nexus of contracts and that, consequently, the directors are mere agents, whose only duty is the maximization of shareholder’ wealth is legally inaccu- rate and economically simplistic.111
The nexus of contracts theory is inaccurate
legally, since it ignores the
fiduciary nature of at least some corporate relationships –
contract is not trust, and property is not contract.
Logically, there can be no “owner” of the corporation under
the nexus view,112 because a
contract is an executory instrument in
personam, not a vested title in
rem. Trust relationships entail fiduciary duties of
loyalty. Contractual relationships in contrast are
105Ronald Coase, The Nature of the Firm, 4 ECONOMICA 386, 391 (1937), available at http:// www.colorado.edu/ibs/eb/alston/econ4504/readings/ The%20Nature%20of%20the%20Firm%20by%20Coase.pdf.
106More recent theorists reprise Coase on this
point: Bainbridge, supra note
56, at 662 (“firms come into existence when the costs of
bargaining are higher than the costs of
107Coase, supra note
105, at
108Bainbridge, supra note 56, at 662 (“Organizing economic activity within a firm . . . may lower search and other transaction costs associated with bargaining”).
109Id. (“Organizing production within a firm can also lower costs associated with uncertainty, opportunism, and complexity.”).
110Coase, supra note 105, at 404.
111Melvin Eisenberg, The Conception that the Corporation is a Nexus of Contracts and the Dual Nature of the Firm, 24 J. CORP. L. 819, 820 (1999).
112Id. at
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wrong idea that the principal113 or even sole114 purpose of the corpora- tion is maximization of profit to shareholders of corporation stock.115
The corporate director in U.S. law is a
trustee116 and fiduciary,117 not an employee of the
shareholders. Corporate directors are of course agents,118 but they are agents of the corporation, not of any
shareholder or group of shareholders, and their agency is
coupled with fiduciary du- ties119 as
trustees120 of shareholders’
property and to the corporation.121 Directors
owe fiduciary duties of loyalty122 to
the corporation and its shareholders.123 Consequently,
directors may not engage in
113“The dominant purpose of corporations is to maximize shareholder wealth.” Hope M. Babcock, Corporate Environmental Social Responsibility: Corporate “Greenwashing” or a Corpo- rate Culture Game Changer? 21 FORDHAM ENVTL. L. REV. 1, 11 (2010).
114E.g., the “single purpose [of corporations] is shareholder wealth maximization.” Ruth O. Kuras, Corporate Social Responsibility: A Canada - U.S. Comparative Analysis, 28 MAN. L.J. 303, 303 (2002).
115“Critics of corporate social responsibility
(CSR) have asserted that businesses should solely focus on
increasing profit, rather than being distracted by social
goals” (Friedman 1970; Mc- Williams & Siegel 2000).
Roger Stace,
116That the director is a trustee of the
corporation is fairly evident. See,
e.g. Zweifach v. Scranton Lace Co., 156
F. Supp. 384, 396 (M.D. Pa. 1957) (“a director is a
trustee” citations omit- ted). That the director is also a
trustee of individual shareholders is less obvious. At its
most attenu- ated is the question whether the corporate
director is a trustee of the corporation’s creditors, a
position we reject, as do the courts with better reasoning.
Sutton v. Reagan & Gee, 405
S.W. 2d 828,
117Pepper v. Litton, 308
U.S. 295, 306 (1939) (“A director is a fiduciary”)
(citing
118Guthrie v. Harkness, 199
U.S. 148, 155 (1905) (“The right of inspection rests
upon the proposition that those in charge of the corporation
are merely the agents of the stockholders, who are the real
owners of the property” (citing Cincinnati Volksblatt Co. v.
Hoffmeister, 56
N.E. 1033 (Ohio 1900)); Shaw v.
119See The American Law Institute, RESTATEMENT OF THE LAW (SECOND) AGENCY § 1 (1958) (defining agency as “the fiduciary relation which results from the manifestation consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act”).
120Grognet v. Fox Valley Trucking Service, 45
Wis.2d 235, 242 (1969) (Majority view: director
trustee to corporation; minority view: director trustee to
shareholder: argues for minority view); Selheimer v.
Manganese Corp. of Am., 423
Pa. 563,
121Blair & Stout, supra
note 56, at
122Id. at
123Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) (“direc- tors owe fiduciary duties of care and loyalty to the corporation and its shareholders”).
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ing124 or exploit
corporate opportunities125 without
permission of a ma- jority of disinterested directors and/or
shareholders.126 The directors’
fiduciary duty of loyalty is not merely the
The shareholder wealth maximization theory is also contradicted by the business judgment rule. Directors are entrusted with the direction of the corporation, and so will not be judged in negligence for their good faith but erroneous business judgments128 because it is their duty to bal- ance the competing interests, goals, and desires of shareholders, employ- ees, clients and communities and resolve those conflicts in the best interest of the corporation as a whole.129 The existence of the business
124E.g., United States v. Lee, 359
F. 3d 194, 204 (3rd Cir. 2004); (“A person who owes a
duty of fidelity or loyalty may not engage in
125Int’l Bankers Life Ins. v. Holloway, 368 S.W. 2d 567, 577 (Tex. 1963) (“A corporate fiduciary is under obligation not to usurp corporate opportunities for personal gain, and equity will hold him accountable to the corporation for his profits if he does so.”); Perlman v. Feldmann, 219 F.2d 173 (2d Cir. 1955); For theory thereto, see Blair & Stout, supra note 56, at 320.
126“A challenged transaction found to be unfair to the corporate enterprise may nonetheless be upheld if ratified by a majority of disinterested directors or the majority of the stockholders.” Gearhart Indus., Inc. v. Smith Int’l. Inc., 741 F.2d 707, 720 (5th Cir. 1984).
127Guth v. Loft, Inc., 23 Del.
Ch. 255, 5
A.2d 503, 510 (1939) (“A public policy, existing
through the years, and derived from a profound knowledge of
human characteristics and motives, has established a rule
that demands of a corporate officer or director,
peremptorily and inexorably, the most scrupulous observance
of his duty, not only affirmatively to protect the interests
of the corporation committed to his charge, but also to
refrain from doing anything that would work injury to the
corporation, or to deprive it of profit or advantage which
his skill and ability might properly bring to it, or to
enable it to make in the reasonable and lawful exercise of
its powers. The rule that requires an undivided and
unselfish loyalty to the corporation demands that there
shall be no conflict between duty and
128Lynn A. Stout, The Shareholder as Ulysses: Some Empirical Evidence on Why Investors in Public Corporations Tolerate Board Governance, 152 U. Pa. L. Rev. 667, 693 (2003) (internal citations omitted).
129Forinash v. Daugherty, 697 S.W.2d 294, 304 (Mo. Ct. App. 1985) (“Since directors, with respect to their exercise of their management functions, owe fiduciary duties to the corporation to exercise unbiased judgment in the best interests of the corporation as a whole, any attempt by direc- tors to favor one intracorporate group to the detriment of another breaches such duties to the corpo-
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judgment rule contradicts the theory that the directors are mere agents of the shareholders. That the directors are not mere agents of the sharehold- ers is also shown by the fact that directors do not take orders from the shareholders: shareholders may pass resolutions, but generally speaking shareholders cannot command the directorate they elect – that is the “cost” and justification of their limited liability. Although directors must not invade the entrusted capital, as long as they do not engage in self- dealing, waste, fraud, or abuse, how they apply the entrusted capital will not be reviewed by the courts of law.130
The shareholders’ wealth maximization theory
does however have at least one expression in the positive law.
Directors have an affirmative duty to maximize shareholder
wealth in the case of a complete liquida- tion of the
corporation – the Revlon duties.131 Winding up, i.e. dissolv- ing the
corporation, entails maximizing shareholder
As a matter of economics,
the shareholders’
ration and, in a sense, violates the implied term in the share contract between the corporation and any oppressed shareholder to the effect that corporate affairs will be managed in the best interests of the corporation. . . .”) (internal citation omitted); Blair & Stout, supra note 56, at 288 (“Corporate law does not treat directors as shareholders’ agents but as something quite different: independent hierarchs who are charged not with serving shareholders’ interests alone, but with serving the inter- ests of the legal entity known as the “corporation.”).
130See, e.g., Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
131Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).
132Id. at 182.
133Id. at
134See, e.g., N.Y., L.E., & W.R. Co.
v. Nickals, 119
U.S. 296,
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value which the group creates. However, as Adam Smith showed in Wealth of Nations, specialization and standardization are facts which ex- plain why corporations are more productive than the sum of their mem- bers’ labor.
According primacy to maximizing shareholder
wealth ignores the fact that the corporation is a delegation
of state power, which entails: 1) legal personality, and 2)
investors’ limited liability. The corporation is a delegation
of state power.135 Thus, the state
may rightly condition the exercise of corporate power by
placing the corporation within the greater social context. The
corporation is a productive element of a national, and now
global, economy that maximizes social wealth,
not just the wealth of shareholders or directors, but also of
the employees and the commu- nity. Thus, companies can
lawfully engage in charitable activities136
and their actions are not considered to be waste of the
entrusted assets unless some form of fraud or abuse of
fiduciary duty is shown (e.g.
135Janet Dine, THE GOVERNANCE OF CORPORATE GROUPS, 124 (2000).
136Model Bus. Corp. Act § 3.02(13) (2008), available at http://books.google.de/books?id=rf
Su
13726
U.S.C. §170 authorizes taxpayers to deduct charitable
contributions from their taxable income, available at
MANUAL (IRM) ART 7., CHAPTER
25. EXEMPT ORGANIZATIONS, SECTION 3. RELIGIOUS, CHARITABLE, EDUCATIONAL, ETC., ORGANIZATIONS
(2014), available
at
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Even without tax benefits, incidental charitable works to generate good will, an intangible asset, can be justified economically and fall within the protection of the business judgment rule.138
In sum, the nexus of contracts theory of the corporation and its co- rollary, the shareholder wealth maximization theory, is incomplete,139 even incoherent.140 A stakeholder theory of the corporation more accu- rately explains the observed phenomena without contradiction between theory and practice.
D.THE STAKEHOLDER THEORY OF THE CORPORATION
Literature critical of the nexus theory and
shareholder wealth max- imization theory appeared as a
response to the weaknesses of the nexus of contracts theory.141 The stakeholder approach,142 a more accurate the- ory of the
corporation emerged143 from the
critical literature and takes into account synergies and
The stakeholder theory better reflects actual market practice than the nexus theory: “Companies, especially those operating in global markets, are increasingly required to balance the social, economic and environ- mental components of their business, while building shareholder value.”145 The stakeholder theory also coheres with the legal characteri- zation of the directors’ duties as fiduciary in nature, and not merely con- tractual. Finally, as well as corresponding to the common law ascription of fiduciary duties to directors, the stakeholder theory is finding its way
Regan v. Taxation with Representation of Wash., 461 U.S. 540 (1983) (finding 2501(c)(3) constitu- tionally sound).
138A.P. Smith Mfg. Co. v. Barlow, 13 N.J. 145, 98 A.2d 581 (1953).
139Eisenberg, supra note 111, at 820.
140Id. at 830.
141Andrew R. Keay, Ascertaining the Corporate Objective: An Entity Maximisation and Sus- tainability Model, 71 MOD. L. REV. 663 (2008), available at http://ssrn.com/abstract=1889236.
142Roda Mushkat, Corporate Social Responsibility, International Law, and Business Eco- nomics: Convergences And Divergences, 12 OR. REV. INT’L L. 55, 67 (2010).
143E.g., Keay, supra note 99, at 2.
144Id. at 6.
145Risako Morimoto, John Ash, & Christopher Hope, Corporate Social Responsibility Audit: From Theory to Practice 1 (University of Cambridge, Judge Institute of Management Working Pa- per No. 14/2004, 2004), available at http://ssrn.com/abstract=670144.
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into contemporary corporate legislation,146 although the legislation has not yet worked its way through the appellate courts.147
The stakeholder approach is holist, not atomist; accordingly, it con- siders all factors in the governance equation,148 the “totality of circum- stances.” Thus, the stakeholder approach takes into account synergy and fiduciary relationships. It is coherent with the trust theory of the corpo- ration and, thus, will likely continue to prevail since the nexus of con- tracts theory of the corporation suffers from legal and economic inaccuracy, unlike the trust theory.
The stakeholder theory is consistent with an emulation of the Ger- man corporation (in German: Aktiengesellsschaft) in U.S. law and most closely corresponds to commercial facts. It is also consistent with ex- isting corporation law and thus is the theoretical basis of this Article.
For the stakeholder theory, the directors have the discretionary149 task of balancing competing claims, to attain the optimum wealth distri- bution for all stakeholders in a sustainable long term prudent view of the business as a going concern.150 The objective of the firm, according to the stakeholder theory, is maximization of value of the company as a whole - not just the wealth of the shareholders.151 As a matter of law, the stakeholder theory of the corporation is consistent with the business judgement rule.152
146Keay, supra note
99, at 15; 15 PA.
CONS. STAT.
§ 516 (1990), available at http://
147Keay, supra note 99, at 16.
148“An analysis that seeks to identify which provisions matter should not look at provisions in isolation without controlling for other corporate governance provisions that might also influence firm value. Thus, it is desirable to look at a universe of provisions together.” Bebchuk, Cohen, & Ferrell, supra note 56, at 1.
149Blair & Stout, supra note 117, at 434 (directors in fact and law enjoy autonomy).
150Andrew Keay, Ascertaining the Corporate Objective: An Entity Maximisation and Sus- tainability Model, 71 MOD. L. REV. 663 (2008), available at http://ssrn.com/abstract=1889236.
151Douglas G. Baird & M. Todd Henderson, Other People’s Money 5 (John M. Olin Law & Economics Working Paper No. 359, 2d Series, 2007), available at http://ssrn.com/ab- stract_id=1017615 (“The directors must adopt the course that, in their judgment, maximizes the value of the firm as a whole. This principle of value maximization could also be coupled with a strong business judgment rule. Courts lack information and expertise that would allow them to effectively and efficiently police director decisions, and cannot easily determine under any set of facts whether a particular decision was, when made, designed to maximize firm value. Hence, the directors must enjoy a large measure of discretion, and claims by one class of investor against another alleging breach of a fiduciary duty would fail so long as the directors acted reasonably to enhance firm value.”).
152“The business judgment rule is the crutch courts use most often to navigate around the maxim that directors owe a fiduciary duty to shareholders, at times in ways that distort the idea of fiduciary duty beyond recognition.” Id.
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E.THE AGENCY PROBLEM
Conflicts of interest inevitably arise in the corporation because the corporate directors manage other people’s money – the shareholders, principally. This is the known as the agency problem.153 “When outside investors provide capital to a public firm, they face the risk that the insid- ers who influence the firm’s decisions will act opportunistically and ad- vance their own private interests.”154 The separation of ownership and control, the hallmark of the corporation, also creates an ever present per- vasive risk of abuse, e.g. by opportunism.155 This risk is greater where there is little or no awareness on the part of the shareholder of the risk.
The agency problem “is addressed in all
jurisdictions, but what ex- actly they consider to constitute
a conflict of interest varies considera- bly.”156 Likewise, most countries seem to
recognize the corporate opportunities rule: that a director
may face certain economic opportuni- ties, which they must
disclose to the company.157 How we
view the agency problem may be influenced by whether we see
the corporation as a
III.THE CORPORATION IN PRACTICE
Having understood the theory of the corporation as a stakeholder- trust relationship, we can now look at the German capital markets in
153Lucian Bebchuk & Assaf Hamdani, The
Elusive Quest for Global Governance Standards, 157 U. PA. L. REV. 1263,
154Id. at 1281.
155Cooter & Eisenberg, supra note 91, at 1732.
156Paul L. Davies & Klaus J. Hopt, Corporate
Boards in
157Id. at 354.
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comparison with U.S. capital markets to see if there are relevant differ- ences in those markets that may affect optimal corporate structure.
A.THE GERMAN CAPITAL MARKET
The German capital market is different from the U.S. capital market in that 1) companies tend to be owned by few large shareholders, often financial institutions, as opposed to a dispersal of shares among a greater number of much weaker stockholders and, perhaps at least in part as a consequence, 2) there are fewer hostile takeovers of German corporation, and finally, 3) shareholder rights are somewhat different between the two systems, which also may affect the determination of the optimal corpo- rate structure.
1.Shareholder Concentration
Whether the company has many small shareholders (“dispersed”) or concentrated shareholding in a few major blocks158 is of vital importance to governance questions.159 “At a very general level, there are two fac- tors that heavily influence the role of the board in public companies. The first is the either dispersed or concentrated nature of the shareholder body. The second is the extent to which corporate law in any particular jurisdiction seeks to address the agency problems of stakeholders other than shareholders, in particular of employees.”160
In Germany, unlike the United States, the
publicly traded Aktien- gesellschaft (AG) and the closely held
Gesellschaft mit beschr¨ankter Haftung (GmbH) have
158“According to the predominant account, corporate governance systems can be classified in two groups, the diffuse shareholder model and the concentrated blockholder model.” Martin Gelter, Review of Political Power and Corporate Control: The New Global Politics of Corporate Govern- ance, by Peter A. Gourevitch & James Shinn, Independent Review, Vol. 12, No. 1, p. 1 (Summer 2007), available at http://ssrn.com/abstract=1117267.
159See generally, Bebchuk & Hamdani, supra note 153.
160Davies & Hopt, supra note 156, at 303.
161“At least traditionally, institutional investors and especially banks have held large propor- tions of shares in Germany. This was regarded as a major advantage for effective corporate control. However, in Germany as well as in the UK, there is a now general tendency towards a less dispersed ownership.” Jungmann, supra note 84, at 434.
162Id. at
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man corporations.163 Corporations with few large shareholders are sub- ject to tighter control over management by shareholders because dispersed shareholders face significant coordination costs and are thus rationally passive164 due to their lack of power165 and imperfect informa- tion.166 The question of corporate governance is a question of finding the optimum distribution of imperfect information that is asymmetric in its initial distribution167 - and is, thus, an example of Hayek’s theory of money as a quantum of information. For Hayek, the function of money is to convey information, functioning as a signaling system, thereby channeling patterns of consumption and investment.168 Contemporary corporate governance recognizes the central role of information flow as a regulatory and managerial control element.169
In companies with dispersed shareholders,
the usual case in the United States, but not Singapore, a
wealthy common law country with single boards170 and concentrated
– notwithstanding a slight trend to the contrary – from their still significant blocks of shares of the largest German stock corporations.”).
163Owen, supra note 7, at 179.
164Bainbridge, supra note
56, at
165Davies & Hopt, supra
note 156, at
166Bainbridge, supra note 56, at 668 (“bounded rationality and complexity . . . make it effi- cient for corporate constituents to specialize.”).
167Id. at 682.
168M. Bruce Johnson, Hayek and Markets, 23 SW. U. L. REV. 547, 548 (1994) (“Hayek argued that markets coordinate the various bits of information and knowledge scattered among indi- viduals spontaneously, without design or comprehension by any human mind.”).
169Christine Windbichler, Zukunft des Gesellschaftsrechts: Orientierungen f¨ur die kapitalmarktorienterte Aktiengesellschaft, in : Grundmann/Kloepfer/Paulus/Schr¨oder/Werle (Hrsg.),
¨ |
¨ |
BERLIN. GES- |
FESTSCHRIFT 200 JAHRE JURISTISCHE FAKULTAT DER |
|
CHICHTE, GEGENWART UN ZUKUNFT,
170Corinne Hui Yun Tan, The
171(“Corporate governance in Singapore has
previously been described to be largely govern-
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nant shareholders, however, the agency problem is likelier to be conflicts between dominant shareholders and minority shareholders.172
2.Hostile Takeovers
Hostile takeovers, a fairly common occurrence on the U.S. stock market, are less common on the German market.173 Legal responses to takeovers include law reforms such as the EU Directive on Takeover Bids.174 At the managerial level, one response by management to the risk of hostile takeover is entrenchment: by way of staggered boards of directors, shareholder rights plans (“poison pills”),175 supermajority and quorum requirements176 and managerial severance plans (“golden parachutes”).177 Entrenchment of the corporation’s board of directors tends to correlate with lower value of the corporation so entrenched,178 because entrenchment makes hostile takeover more expensive.179
Although entrenchment of the board of directors behind the articles and/or charter may encourage managerial irresponsibility, “by weakening
172Davies & Hopt, supra note 156, at 304 (“in dispersed shareholding companies the most pressing agency problem exists between management and shareholders as a class; in concentrated shareholding companies the agency relationship is more problematic between majority and minority shareholders.”).
173Jungmann, supra note 84, at 434 (“we have to recognise a lack of hostile public takeover bids in Germany.”).
174Directive 2004/25/EC of 21.04.2004 on takeover
bids, available at
.eu/LexUriServ/LexUriServ.do?uri=CELEX:32004L0025:EN:NOT.
175A “poison pill” is an
176Supermajority requirements mandate that more
than 50% of the directors must vote on certain events, e.g.
merger or dissolution. Quorum requirements mandate that at
least a certain per- centage of directors must be present to
vote on certain decisions, e.g. dissolution or merger. See, e.g., Berlin v.
Emerald Partners, 552
A.2d 482,
177Golden parachutes are premium severance packages offered to key employees to promise
them more than adequate compensation in the
event they are fired (e.g. due to a hostile takeover).
Schreiber v. Burlington N., Inc., 472
U.S. 1,
178Bebchuk, Cohen & Ferrell, supra note 56, p. 1 (“We put forward an
entrenchment index based on six provisions: staggered boards,
limits to shareholder bylaw amendments, poison pills, golden
parachutes, and supermajority requirements for mergers and
charter amendments. We find that increases in the index level
are monotonically associated with economically significant
reduc- tions in firm valuation as well as large negative
abnormal returns during the
179(“We find that staggered boards are associated with an economically significant reduction in firm value . . .”) Lucian A. Bebchuk & Alma Cohen, The Costs of Entrenched Boards, 78 JOUR-
NAL OF FINANCIAL
ECONOMICS
NO. 478, available at http://ssrn.com/abstract=556987.
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the disciplinary threat of removal and
thereby increasing shirking, em-
The two boards are strictly separated, and
simultaneous membership on both boards is expressly prohibited
by law.183 Oversight is strength-
ened by the fact that larger German corporations are required by law to include a
significant number of labor representatives on the supervisory
board of directors, including trade union representatives.184 The system works because it is
intended to work, not to foster
3.The Rights of Shareholders
Shareholders’ rights are also somewhat
different in German law and U.S. law. German shareholders
elect the supervisory board of directors and the supervisory
board of directors, in turn, appoints the executives, i.e.,
the managerial board.185 This is
also the case in
180Bebchuk, Cohen & Ferrell, supra note 56, at p. 6.
181Id.
182AktG (German Stock Corporation Act), § 30, available in English translation at http://
183AktG §100.
184AktG §104(4). Most of the provisions on
185AktG § 119(1); Owen, supra
note 7,
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ers.186 German shareholders also have the power to amend the articles of incorporation,187 which is often the case in U.S. corporate law, but not always. Shareholders in German corporations can declare dividends,188 which is generally not the case in U.S. corporate law.
These differences in the corporate environment partially explain the regulatory divergence and different economic performance of the U.S. and German capital markets of the last few years. We now look at the differences in the internal structure of the corporation itself, which also explain the observed divergent economic performances.
B.THE GERMAN CORPORATION
A
The board of directors under U.S. law has
two functions: supervision of the management and operation of
the daily business of the corpora- tion.190
That is not the case in German law. In German law, as
in the early common law, the supervisory board of directors
has only one role: oversight of the management it appoints,
who then in fact run the busi- ness, i.e., the managerial
board. German corporations (AG, GmBH) are constructed on a
186See, e.g., Robert Kleiman, Board of Directors, available at http://www.referenceforbusi-
187AktG § 119(1); Owen, supra
note 7, at
188Owen, supra note
7, at
189Paul L. Davies, Board structure in the UK and Germany: convergence or continuing di- vergence?, 2 INT’L & COMP. CORP. L. J. 435 (2000), available at http://ssrn.com/abstract=262959.
190Jungmann, supra note
84, at
191See, e.g., AktG § 95, § 104.
192See, Aufsichtsrat, leo.org, available at http://dict.leo.org/#/search=aufsichtsrat.
193§ 30 AktG, § 76 AktG
194See Vorstand, LEO.ORG, http://dict.leo.org/#/search=vorstand.
195See Betriebsrat, LEO.ORG, http://dict.leo.org/#/search=betriebsrat.
Works councils are gov- erned by the provisions of the Works
Constitution Act, available in translation
at http://www.
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The directors of a publicly traded U.S. corporation may also be man- agers:196 that is not the case in German law.197 German supervisory board members may not also be managerial board members.198 In U.S. law there is no prohibition on managers, directors, or employees from owning shares in the corporation. In practice, U.S. corporate directors are usually also managers, but not always.199
The differences in structure of U.S. and
German publicly traded cor- porations lead to different
practices,200 resulting in
different outcomes. The recent outcomes on the U.S. capital
market are clearly undesirable and do not seem to have
occurred to the same extent, if at all, on the German capital
market, partly because closely held businesses are more
important on the German capital market.
As a general principle, the U.S.
corporation’s internal structure may be established as the
incorporators who form the corporation see fit, though
naturally, the corporation may not be used for illegal
purposes and if it is it faces risk of dissolution.201 It is thus possible to emulate the
German corporation’s
1.The Supervisory Board
The role of the supervisory board is
196See, e.g., N.Y. BSC. LAW § 701: NY Code - Section 701: Board of Directors, available at http://codes.lp.findlaw.com/nycode/BSC/7/701#sthash.513cfcQm.dpuf.
197See, e.g., AktG §105.
198AktG § 105.
199See, e.g., Mike Volker, The Board of Directors (2008), available at http://www.sfu.ca/ ~mvolker/biz/bod.htm.
200Davies & Hopt, supra
note 156, at
201See, e.g., Brent Fisse, Reconstructing Corporate Criminal Law: Deterrence, Retribution Fault, and Sanctions, 56 S. CAL. L. REV. 1141, 1163 n. 96 (1983).
202AktG § 111(1) (supervisory board supervises the management).
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pervisory board has no managing directors. One may either be a supervi- sor or a manager but cannot be a member of both boards simultaneously.203 Likewise, no person may simultaneously serve as a director of more than ten different German corporations under German law,204 which is another limitation on board membership. Proposals to impose minimum qualifications on directors such as age, gender, educa- tion, or experience meet with the point that sometimes outside, unusual, and/or diverse expertise is desirable on either the managerial or supervi- sory board.205
The supervisory board has one function - the supervision, i.e. over- sight, of the corporation’s operations and assets. The Supervisory board usually has 3 members,206 but may have as many as 21 members. How- ever, the number of members must be divisible by three, so as to avoid deadlock.207
The separation of managerial and
supervisory functions is one justi- fication of limited
liability.208 Investors are not to
be held collectively liable beyond their investment because
they do not have the final word in how the funds that they
have entrusted to the corporation are to be used.209 This logic explains why the limited
partners in a U.S. limited partnership may only participate as
employees with no decisional power; the silent partner in a
limited partnership brings cash to the table, and that is all
– and thus the silent partner, i.e., the limited partner,
enjoys limited liability and will not be held to answer in
contract or tort beyond the extent of their actual investment.210 Strictly speaking, shareholders who
are also managers and directors ought to be personally liable,
as a matter of logic. Thus, separation of managerial and
supervisory functions may be an argument to shield corporate
personnel from individual liability for the actions of the
company. The
203AktG § 105(1); Davies & Hopt, supra note 156, at 311.
204(“A couple of years ago, it was not uncommon to be a member of more than twenty supervisory boards. The number of mandates is now limited to ten by Sec. 100 of the German Stock Corporation Act of 1965 [AktG], and being the chairman of a supervisory board counts as holding two seats.”) Jungmann, supra note 84, at 464.
205See, e.g., Id. at
206AktG § 95.
207AktG § 95.
208See, e.g.,
Meyer, H ¨ R K
AFTUNGSBESCHRANKUNG IM ECHT DER APITALGESELLSCHAFTEN
209Id.
210Carden v. Arkoma Associates, 494
U.S. 185,
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determination, are justifications of limited
liability: “the mandatory im- position of a
As well as oversight, “the supervisory board
from an early stage in the nineteenth century was regarded as
having a networking function as well as a monitoring function.
Appointments to the supervisory board were a method of
establishing and maintaining links between the com- pany and
other financial and
2.The Managing Board (Vorstand)
The supervisory board appoints the
managerial board by a resolu- tion.218 The
managerial board consists of the corporation’s executives.219 The managerial board directs the
business of the corporation (AG, GmbH) on a
211Davies, supra note 156, at 453; cf. Klaus Hopt (ed.) COMPARATIVE CORPORATE GOVERN- ANCE 230 (1998), available at http://books.google.com/books?isbn=3110157659.
212Davies, supra note 156, at 453.
213Owen, supra note 7, 176 (2003).
214Id. at 178.
215Id. at 175.
216AktG § 84(1) (supervisory board appoints management board).
217Davies & Hopt, supra note 156, at 311.
218AktG § 84(1) & § 108; Owen, supra note 7, at 178.
219Owen, supra note 7, at 178.
220AktG § 76(1) (managerial board is directly responsible for the management of the company).
221AktG § 90.
222Jungmann, supra note 84, at 453.
223Williamson, supra note 78, at 1208.
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ment.224 The managerial board promulgates the corporation’s bylaws, but only by unanimous vote.225
3.Corporate Convergence?
Corporate governance theories, rules, and
outcomes, like law, are converging to common positions.226 The convergence of the shareholder
primacy and the stakeholder models of corporate governance to
a con- sensus of sustainable profitability is one example;227 convergence of the
224“Direct contact of
225Owen, supra note 7, at 178.
226For an early example recognizing convergence of
law see Christine
Windbichler, Zur Trennung von
Gesch¨aftsf¨uhrung und Kontrolle bei amerikanischen Grobgesellschaften:
Eine “neue” Entwicklung und europ¨aische Regelungen im
Vergleich, Zeitschrift f¨ur Unternehmens- und
Gesellschaftsrecht (ZGR) 14(1), p.
227Christine Windbichler, Cheers and Boos
for Employee Involvement:
228Davies & Hopt, supra
note 156, at 312 (“there is considerable convergence
between the seemingly divergent
229E.g., the E.U. corporation (Societas Europaea) may either have a single or two tier board. Article 38 of the Council Regulation (EC) No. 2157/2001 of October 8, 2001 on the Statute for a European company (SE); See generally, Jungmann, supra note 84; Aste, supra note 15, at 35 (not- ing that the societas europaea permits a single or two tier board).
230Bratton & McCahery, supra note 58, at
231Id. at
232Id. at 217 (“Comparative governance has
this tentative, reactive quality because no one has any
direct, empirical answers to its basic questions. It follows
that the principal assertions made in comparative discussions
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respected,234 are
The
C.WORKER PARTICIPATION
THROUGH
1.
Another key difference between larger German corporations (AG) and publicly traded U.S. corporations240 is that under German law, as in many other countries,241 workers have a legally guaranteed right to rep-
be falsified. They can be evaluated only indirectly, through appraisal of the theories of the firm and of competitive evolution that support them. Unsurprisingly, the comparative governance literature holds out alternative theoretical frameworks that support conflicting hypotheses.”).
233Id. at 228 (“Which of the two systems, market or blockholder, has comparative advan- tage? Most comparative governance discussants decline to answer this question, preferring a work- ing hypothesis of equal competitive fitness.”).
234Klaus J. Hopt, New Ways in Corporate Governance: European Experiments with Labor Representation on Corporate Boards, 82 MICH. L. REV. 1339, 1353 (1984).
235For example, Klaus Hopt seems
236Jungmann, supra note 84, at 448 (“it is hardly possible to deem one board system superior to the other.”); Corinne Hui Yun Tan, supra note 170, at p. 33 (“there is no clear superiority of any board system over another. Political, social, economic, legal and cultural contexts, as well as owner- ship concentration of corporations, have a large role to play in terms of shaping the effect of any board system on corporate governance practices in a country.”).
237Amir N. Licht, The Mother of all Path
Dependencies Toward a
238Aste, supra note 15, at 32.
239Id. at 36.
240While mandatory employee participation on the
board of a U.S. corporation is simply non- existent,
employees of a German SE may elect up to 50% of the
administrative organ members. Cornelius Wilk, U.S. Corporation Going
241
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resentation242 on
the corporations’ supervisory board of directors (in German:
Aufsichtsrat). This is known as
The extent of mandatory worker
representation on the German su- pervisory board depends on
the size of the business. There is no mandatory employee
representation for small businesses with fewer than 500
employees.244 Businesses with
between 500 and 2000 employees must allocate
Some of the advantages of
jurisdictions, therefore, the board has a
role in facilitating the company’s acquisition of labor input
as well as input of capital.” Davies & Hopt, supra note 156, at
242The relevant German
243Muchlinski, supra note 73, at 371.
244§1(1) Gesetz uber¨ die Drittelbeteiligung der Arbeitnehmer im Aufsichtsrat (Hereafter, Drittelbeteiligungsgesetz - DrittelbG) (May 18, 2004).
245§1(1), §4(1) DrittelbG (May 18, 2004).
246Hopt, supra note 234, at 1346; § 7 Gesetz uber¨ die Mitbestimmung der Arbeitnehmer (Hereafter, Mitbestimmungsgesetz - MitbestG) (May 4, 1976).
247Davies & Hopt, supra note 156, at 342.
248§ 7 MitbestG.
249Jungmann, supra note 84, at 455.
250Davies & Hopt, supra note 156, at 342.
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1)Workers who are represented at the board of directors will be more effective due to greater commitment and improved communication;251
2)Added oversight improves corporate transparency;252 and
3)Worker representation on the board of
directors leads to fewer la-
In practice, whether these possible benefits
are in fact obtained will depend somewhat on the actual facts
of the business: “one size will not fit all.”254 Empirical evidence regarding the
effects of
The best structure for the board of directors must thus be contextual- ized by the question of labor relations, generally