Sen. Warren, Germany’s board plan won’t work here
A slice of bratwurst won’t hack it — not in terms of making capitalism accountable.
Sen. Elizabeth Warren, D-Mass., borrowed just one element of German corporate governance in drafting her Accountable Capitalism Act: employee participation.
She proposed a new federal charter for very large companies that requires them to have 40% of their directors selected by employees, the intention being that the directors consider the interests of all corporate stakeholders — from employees to the communities in which the companies operate. But just giving employees more say over the running of their companies won’t work.
The argument that it was this and this alone which made Germany prosperous does not stand up to scrutiny. Employee participation took a very specific form in a very different structure of capitalism. That needs to be understood before the U.S. starts borrowing bits and pieces of German corporate governance.
Employees in German companies with 500 to 2,000 staff or more elect employee representatives or trade union officials through their work councils or trade unions to a supervisory board. Depending on the size of the company, one-third to one-half of the supervisory board is made up of employees or trade union officials. The rest of the members are elected by the shareholders, meaning the banks providing funding to the company.
The chair of the board, always a shareholder representative, has the casting vote in favor of the shareholders in the event of a tie. The supervisory board oversees and appoints members of the separate management board and must approve major business decisions.
This so-called co-determination was enshrined in law in 1976 under Chancellor Helmut Schmidt. But it is a far cry from Warren’s limited version, which does not even make it clear whether employees elect employees to the board or not. She would have to adopt the whole structure if she really believes that co-determination makes capitalism accountable.
The German economy at that time was dominated by largely domestic bank-centered companies, not funded by the capital markets. Dresdner, Commerzbank and Deutsche Bank held most of the debt of Germany’s highly leveraged companies with seats on the boards of 70 of them. Ownership concentration, the chair’s casting vote, and interlocking directorships characterized German capitalism and limited worker power.
The legal obligation to keep all of the supervisory board’s proceedings confidential and to act in the “best interests of the company” does not leave much room for Warren’s extended list of stakeholders.
The German courts have generally upheld an “enlightened shareholder value approach.” That would be a better way of taking shareholder interests into account in that a well-managed company would and should, for example, make sure that its customers get a fair deal.
Co-determination has its roots in Germany’s history and culture. After World War II and the division of the country into East and West Germany, the latter had to be rebuilt.
That required employees and owners of capital to work together in a way that drew on earlier traditions. This cooperation was essential to the country’s prosperity. If the country had been torn apart by the belief that workers and the owners of capital should be opposing forces, then the postwar period of growth may not have taken place so quickly.
German’s prosperity also depends on a wide swath of small to midsize family-owned firms, the backbone of the economy. These companies and the larger limited liability companies can rely on a highly skilled and flexible workforce, the product of Germany’s exceptional vocational training system.
So co-determination alone is not responsible for the country’s prosperity. The issue is more complex than that.
Germany itself has begun to change. The dominance of the big banks has declined sharply since the financial crisis. Dresdner Bank was merged with Commerzbank, which was bailed out in 2009.
Deutsche Bank’s woes have been well-publicized. Large German companies, partly because they are now global players, look to the stock markets for funding. German limited liability companies can now become “Societas Europaea” companies and move the registered office to another EU member state without worker participation rules, as some have already done.
Despite EU regulations designed to protect worker board membership, the obligation may become weaker.
Not everyone in Germany sees worker participation in quite such glowing terms as Warren does. Employee participation has been criticized because too much of the board’s time has been taken up with labor issues and not, say, with the increasingly complex global markets in which companies operate.
Nor does it necessarily prevent scandals such as Volkswagen’s long-standing use of a device to cheat on government emissions tests on their diesel engines. Some employees claimed that they knew what was going on, but their employee representatives, if they were informed, failed to make the board take any action.
A few rich shareholders no longer dominate the boards of U.S. corporations. Legislative and tax changes in the late 1970s and 1980s led to the shift away from individual stock ownership to a situation where many people — in fact, just over half of all U.S. households — own shares indirectly through pension funds and mutual funds.
Warren uses one dramatic figure to decry the concentration of share ownership. It is, of course, a statistic designed to shock: 84% of all American-held shares are owned by the top 10% of the richest households.
But it misrepresents reality. Most of the S&P 500 companies are owned by about 20 institutional investors — that is, pension and mutual funds. About 10% to 15% of the shares are held by three passive indexers, BlackRock, State Street and Vanguard.
Many shares also are held by vast pension funds such as the California Public Employees Retirement System, or Calpers. All of these, in turn, have many millions of investors for whom this is a safer way to invest than the riskier path of individual share ownership. This system has been particularly beneficial for those investing in index-linked mutual funds over recent years in a rising stock market.
None of this is to say that U.S corporate governance is not in need of reform. It is. That includes rethinking the membership of the board.
The answer, though, is not a matter of extending board membership to any particular class of individuals, but instead appointing independent board members on the basis of relevant skills, knowledge and experience, including managerial experience, as assessed by an open and transparent selection process with strict term limits of board membership.