As mentioned, there are mainly two models of CG based on bank-based model, which are explored below.
2.4.2.1. German model of corporate governance
Germany’s CG model may be better than CG models in the UK and the US. It is especially notable due to Germany’s position as Europe’s largest economy (Wójcik, 2002). Based on its financial system and mode of CG, the model itself demonstrated high stability throughout the post war period until the mid-1990s (Clarke, 2009). This may be attributed to Germany placing more of a focus on long-term relationships between corporations, banks and investors as opposed to profit.
The German model has a board which is two-tiered. It is comprised of a management board (Vorstand), that runs the firm, and a supervisory board (Aufsichtsrat) with outside directors only (Sadowski et al., 2005). The management board and supervisory boards are separated by law, thus a clear separation of duties and functions exists. The German model is sometimes referred to as “an insider, networked, bank-based, or closed system” (Wójcik, 2002:5). This model applies legal rights which are more applicable to direct and active control on appointment and dismissal. The supervisory board has important rights and its members are comprised of numerous external individuals. The model is normally identified by its use of prominent shareholders, cross-holdings, and bank supervision. It promotes the usage of universal banks (Hausbanken) wherein banks have large stakes in companies with significant representatives in the boards. Höpner and Jackson (2001:2) opine that, with “The emergence of a market for corporate control”, Germany cannot be described as having “a bank-oriented, insider, or stakeholder model of corporate governance”. The German model observes a system of codetermination. The German system is thus not legally obligated to only pursue shareholder interests as firms prioritise a broader group of stakeholders (Allen and Zhao, 2007) rather than just a few shareholders. The model is explicit in focusing on efficiency and maximising stakeholder value (Goergen et al., 2005) while also avoiding information costs and allowing for greater managerial control. This differs from the Anglo-American system which is aimed at generating fair returns for investors.
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According to the model, shareholders and employees are responsible for the nomination of board members (Tricker, 1994). As rights and responsibilities are shared via the usage of dual-tier boards, employees are allowed voting rights on certain issues. While the model suggests that the executive board may have transactions which will need the supervisory board’s approval, the composition of the supervisory board is also variable and changes according to the size and type of the company, though its own size is legally set and this cannot be altered by shareholders (Tricker, 1994).
According to the Goergen et al. (2005:2) the “German regime is characterised by the
existence of a market for partial corporate control, large shareholders, cross-holdings and bank/creditor monitoring, a two-tier (management and supervisory) board with co-determination between shareholders and employees on the supervisory board, a non-negligible sensitivity of managerial compensation to performance, competitive product markets, and corporate governance regulations largely based on EU directives but with deep roots in the German legal doctrine”. The supervisory board is also responsible for choosing those in the management board.
The model is also known for being egalitarian in what is often referred to as Rhineland Capitalism (Schmidt and Wahrenburg, 2003), in which decisions are made collectively (Clarke, 2009). This is linked to the model recognising long term goals and stability as significant (Clarke, 2009). Thus, firms are not necessarily obliged to generate high returns to shareholders (Lane, 2003).
In contrast, “In Anglo-American systems there are no supervisory boards, the power of employees is limited, institutional portfolio investors are powerful, capital markets are strong and take-over activities are common” (Wójcik, 2002:5). Keasey et al. (2005), however, doubts that banks play an active monitoring role in most firms, but also notes that this is more likely the case in failing companies. Wójcik (2002) however, claims that banks are more significant in Germany as they possess more influence in companies with representatives in the boards.
In the model, banks may also utilise proxy voting (Edwards and Fischer, 1994) to control other companies (Franks and Mayer, 2001). “Proxy voting rights also give the
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banks’ voice a disproportional vote on the general meetings” (Keasey et al., 2005:15). Thus, the system itself seems to be opposed to outsider control.
Retained earnings are one of the biggest sources of income for German corporations and thus this allows banks to be highly autonomous. Such long-term lending relationships also allow German banks more power, which is further supported by the bank also having a significant voice in the firm’s supervisory board (Keasey et al, 2005). Thus, the scope and significance of bank control in the German model limit the role of portfolio investors and allow more power to be retained with the banks (Blommenstein and Funke, 1998).
In Germany, the massive amount of control afforded to banks via cross-holdings and proxy voting makes the stock market only play a marginal role in controlling German firms (Wójcik, 2002). As far as employee stakeholders are concerned, the system allows them a certain degree of influence with regards to the operations of the firm in matters which may affect them while also entitling them to a share of the surplus.
On matters of ownership, hostile ownership is almost unheard of in German companies. In fact, ownership concentration is high (Wójcik, 2002) with family ownership still being found in large firms. However, despite banks having significant control over the supervisory boards, their ownership in stakes is not high. Thus, it can be said that, with the control of firms by financial institutions in Germany, problems of agency may be mitigated by virtue of the financial institutions acting as external moderators for the large corporations (Allen and Zhao, 2007).
It should be noted that the model does not utilise the securities market very much. Stock markets are insignificant, and therefore play only a small role in governing German companies (Lane, 2003). In fact, “The number of listed companies and their market capitalization are small in relation to the size of the economy” (Wójcik, 2002:4).
2.4.2.2. Japanese corporate governance model
The Japanese model is in some ways similar to certain aspects of the stakeholder model of CG, which has traditionally been linked to broader views related to the efficient resource allocation of stakeholders and shareholders (Allen and Zhao, 2007).
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The model is identified through heavy cross-shareholding5 among participant banks and clients, companies, or conglomerates (Monks and Minow, 1995). Thus, “ownership within Japanese keiretsu groups is more diffused through horizontal cross-shareholding" (Jackson, 2002) and investors remain unaffiliated with corporations as financial institutions play the more important roles in financing the enterprise and moderating the operations.
The model places heavy reliance on debt-financing, characterised as a main-bank6
system due to the borrowing (Okabe, 2004). High bank debt large shareholders are a characteristic of Japanese corporations (Yafeh, 1995). According to the conceptualisation of the model, since banks are the main financiers of the company, they effectively play a part in governing companies through cross-holdings and lendings. However, they lack significant roles in boards (Okabe, 2004). In the model, stakeholders are more committed towards the firms’ long-term survival, as opposed to the shareholder-oriented U.S. model which focuses on maximising shareholder-value. The ownership stakes of Japanese firms “are held among shareholders having strong commitment to specific firm and focusing on their strategic interests” (Jackson, 2002). The strength of Japanese-style management, thus, is of long employee retention and links with main banks. It is a model which promotes unity and encourages staff promotion based on performance and loyalty (Tricker, 1994).
In this model, ownership stability reduces the market for corporate control (Clarke, 2009) as the model relies on inside executive directors and a hierarchical structure. The structure, size of the board and the governance processes are dissimilar to the West, and firm structure influences resource usage (Aoki, 1990). Furthermore, the companies are incredibly competent through the use of fair compensation and long- term employment.
Theoretically, shareholders have more rights than those the US and the UK (Allen and Zhao, 2007). This is shown by the fact that shareholders can directly nominate
5 Cross-shareholding is when new shares are not sold into the market. They are held by the banks or
other allied companies (Okabe, 2004).
6The main-bank system is a relationship between a firm and a bank when: there is continuous large
bank borrowing for a long period; bank is the main shareholders of the firm; bank performs other transactions with the firm; maintain close human relationship and offer rescue in the event of financial distress (Okabe, 2004).
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directors and have a say on the remuneration of management during shareholder meetings. In addition, managers are not directly responsible to shareholders (in terms of the fiduciary relationship) and decision making is done collectively, involving debate and negotiation which is left to the top management’s ratifications. In the model, all directors are non-independent and executive and no committees exist with the sole purpose of monitoring executive management, executive remunerations, or board nominations. Accordingly Grabowiecki (2006:37) states that, “management mediates between stakeholders by pursuing strategies that focus on markets for high- quality products and the utilization of highly-skilled workforces and stable inter- organizational relationships”.
Thus, the fact that there is less of a market for corporate control in Japan seems to indicate that problems of agency are rare (Allen and Zhao, 2007). This, according to Allen and Zhao (2007), is due to the moderating influence of financial institutions on corporations.