Anatomy of a Governance Transformation: The Case of Daimler-Benz

DENNIS E. LOGUE [*] JAMES K. SEWARD [**] I INTRODUCTION In 1996, the McKinsey Global Institute released a study posing the following question: If savings rates in Germany and Japan have been so high for a long time relative to those in the United States, why have their per capita gross domestic products ("GDP") not grown to be much greater than that of the United States? [1] Surprisingly, the answer is that capital productivity in the United States has been significantly greater than capital productivity in Germany and Japan. Indeed, over the period of 1974 to 1993, the study found that the real after-tax rate of return to all investment in the corporate sector averaged 9.1% per annum in the United States, but only 7.4% per annum in Germany and 7.1% per annum in Japan. [2] Capital has been invested much more efficiently in the United States than in Germany or Japan. More detailed analysis indicates that there is much over investment in Germany and Japan and, hence, unutilized capacity. In particular, Germany has witnessed much "gold-plating" of capital investment, that is, the installation of equipment that is much better - and more expensive - than is required. [3] Moreover, there has been no offsetting improvement in labor productivity. Consequently, despite heavy investment, living standards have not improved significantly in Germany or Japan relative to those in the United States. Why is there inefficient investment in Germany and Japan? It is not caused by lack of investment tools because managers in both countries have access to the same tools that U.S. managers use to identify productive investments and to operate them efficiently. The over-investment must be caused by German and Japanese managers' decisions leading to excessive investment relative to the standards of economic efficiency. This article suggests that there is inefficiency by design, induced by the goals and systems of corporate governance in these countries. An article in this volume by Bradley et al. provides some theoretical insight into this issue. [4] The authors categorize corporate governance systems as either "contractarian" or "communitarian. " At the risk of oversimplification, a contractarian system encourages firms to focus on shareholder value. A communitarian system, in contrast, responds to all "stakeholders:" creditors, employees, customers, and communities where corporate operations are located and, finally, stockholders. The concern for a much broader constituency may lead to over-investment, often to the detriment of shareholders. Over-investment helps creditors, particularly when firms diversify because of co-insurance effects, and it helps employees because diversifying investment creates jobs and improves job security. Furthermore, it aids customers by creating more consumer choice, and it helps the community by broadening the tax base. Approaching the governance question from another perspective, La Porta et al. find that countries without common law traditions and strong shareholder protections do not have well-developed external capital markets. [5] Not only does this mean that companies must look to the banking sector for financing, but it also means that neither activist shareholders nor the market is imposing much external discipline on companies for corporate control. The result is that banks control corporate financing and investment decisions, and, in their positions primarily as lenders and secondarily as equity holders, they encourage corporations to invest up to inefficient levels so long as credit quality remains sufficiently high. Though many scholars believe the two systems of corporate governance -- contractarian and communitarian -- can co-exist in a globally competitive world, [6] Bradley et al. argue otherwise. [7] They contend that the forces of globalization and worldwide competition for capital will eventually force corporations -- and the countries in which they are domiciled -- to shift to the contractarian paradigm to set corporate goals and implement governance systems. …