German Codetermination and German Securities Markets

5 Colum. J. Eur. L. 199 (1999)

Mark J. Roe. Professor of Law, Columbia Law School.

Germany lacks good securities markets. Initial public offerings are infrequent, securities trading is shallow, and even large public firms typically have big blockholders that make the large firms resemble “semi-private” companies. These “private” firm characteristics of German ownership are often attributed to poor legal protection of minority stockholders, the lack of an equity owning culture, the lack of an entrepreneurial culture (one that would create many new businesses and IPOs), and permissive rules that allowed big banks and bank blockholding to develop and dominate in ways barred in the U.S.

German institutions though provide another, probably additional, potentially alternative, explanation for the weakness of German securities markets. German codetermination (by which employees control half of the seats on the German supervisory board) undermines diffuse ownership for two related reasons. First, stockholders may wish that the firm’s governing institutions have a blockholding “balance of power,” a balance that, given German law’s mandate that half the supervisory board represent employees, diffusely owned firms may be unable to create. Codetermination may raise agency costs, by making it more likely than otherwise that managers would implement strategies that they and employees, but not shareholders, would prefer. Managers have a well-known propensity to expand firms in ways that do not benefit shareholders, but favor themselves (and incumbent employees). Blockholders can sometimes mitigate the increased agency costs by either managing the firm directly or by acting on managers to align them with shareholders.