European Corporate Governance Models

Since mid-1980s corporate governance has attracted attention world-wide. From board of directors' composition and operation to relationship between shareholders, managers and directors, it has evolved into holistic company control system amidst global competition, weighing all stakeholders' interests1. Each country's corporate governance model is characterised by distinctive legal, cultural and other contexts, but broadly comparable countries can form corporate governance systems.

Anglo-American outsider system favours shareholder value maximisation in influential capital market, while continental European insider system, German and Dutch models, favours broader stakeholder approach in socially-orientated market economy2. This work shall consider following corporate governance areas: capital markets' financial role, ownership and control, shareholder rights and financiers' protection, external market for corporate control and anti-takeover defences, board system, disclosure rules and accounting standards, company's role and accountability.

Capital markets' financial role – market capitalisation ratio in 1975-2000 has grown in all continental countries3, catching up with UK on equity raised through IPOs4 in 1998-19995. Germany progressed less than UK in IPOs; British companies attracted far more outside finance in 1990s, though both countries had similar average growth, German companies experiencing steeper downfalls and higher increases6.

Some countries, particularly Netherlands, are becoming more financial market-orientated as foreign investment increases, augmenting capital market's relevance, facilitating convergence with Anglo-American outsider system. Other countries still lag behind – Germany and Belgium7, where companies' enduring corporate or individual long-term profit management with internal production factors prevents sharetrader attitude, making shares unattractive, the market subsequently lacking liquidity to attract outside investors.

This creates divergence from UK, where disclosure and insider dealing prohibition maintain market liquidity8. New stock exchanges' creation in 1990s, consolidation of Amsterdam, Paris, Brussels, Lisbon and one London exchange into Euronext9 and introduction of internet exchanges (Tradepoint)10 enhances (inter)national equity trade and is expected to increase transparency and financial information disclosure to secure investor finance. European countries with weaker markets shall become more exposed to capital market finance.

Unfortunately, national legal corporate governance regimes stifle this growth; the Takeovers Directive11 aiming to develop European capital market has yet to be implemented by 200612. Ownership and control – while financial investors dominate market- orientated countries still, like UK, non-financial sector dominates Germany and Spain13. All continental countries14, except Netherlands and Italy, have nevertheless been diverting from non-financial shareholders in 1990s, increasingly converging with market-orientated countries15.

However, in Germany in 1999 there were still 30% more non-financial and 15% less financial shareholders than in UK16. Non-financial owning companies – majority in Germany, where group law is well-developed, and also Belgian pyramidal holding structures – monitor entrepreneurship and emphasise group interests rather than profit maximisation in individual companies, risking conflict of interests and weak mutual monitoring. In contrast, UK has very few company shareholdings.

The many individual/family shareholders in German companies favour risk management and ration their capital to prevent losing control through IPOs and SPOs17; 6 years after flotation they retain majority votes in more companies than UK counterparts18. British companies' ownership becomes public sooner, while German shareholders may keep benefiting privately at minority shareholders' expense19. Less companies in all countries, however, have been owned corporately or individually20 by late-1990s.

Public authority shareholders favour social welfare and employer-friendly goals, rather than profit-maximisation, but government ownership in Europe lacks today due to privatisation21; only Dutch and French government minority shareholders exercise influence through golden shares with exceptional nomination rights and veto against mergers22. Institutional investors – biggest number in UK, second in Germany – diversify their large investment over long periods, require transparency and prefer liquidity and risk spreading by maximum ownership ceilings.

Insurance companies – most in UK, less in Germany – being financial conglomerates and behaving comparably with non-financial companies, and banks – most in Germany and negligible in UK – being owners-investors risking conflict of interests, do not favour share value maximisation. Pension funds, however – UK's largest actors23, while not present on the continent – are original proponents of 'shareholder activism movement'. Investment funds are rising, mostly in Germany and UK; some, like pension funds, neither vote nor monitor actively24.

In British companies much interest is owned by peculiar to UK profit-maximising insurance companies and pension funds, while continental companies mainly attract stable long-term commitment finance with smaller, more frequent profits. Foreign ownership is rising especially due to large Anglo-American institutional investors financing continental companies, forcing them to adopt new corporate governance principles. For example, CalPERS25 invests in German and French companies actively monitoring them26, as do British funds (Hermes) particularly persuading them to put their remuneration reports for shareholders' vote in general meeting27.

Continental pension funds have doubled their exposure to foreign equity in 1994-199928. This arguably facilitates future convergence with outsider models on disclosure and shareholder rights, decreasing their takeover defences. This involvement, however, is apparently less aggressive29; one-to-one meetings with management are preferred and few Anglo-American investors vote in continental companies30. Foreign ownership affects Germany less than UK; Germany and Italy are more likely to diverge from Netherlands, Spain and France31.

Traditionally concentrated ownership is weakening in continental Europe32. German companies have largest voting blocks – median, 57% (1996)33 – while British companies only 10% (1992)34. In biggest companies (>5 bn. Euro), however, major shareholder has on average smaller voting block35. Most importantly, continent-wide second and third largest voting blocks are far smaller – in Germany, less than 5%36 – while in UK much closer to controlling block, so relatively equal shareholders' coalitions are common37 (Vodafone Airtouch38) and can exert control comparable to continental blockholders39.

The largest average majority stake in Germany (62%) is held by domestic companies with second biggest, after individuals, number of voting blocks – in UK significantly less – while insurance companies hold only 12% vote and significantly less voting blocks – in UK insurance companies40 come first, then directors. So, many German companies are controlled by passive non-financial domestic companies and holdings over long periods whereas institutional investors do not even obtain blocking minority.

Banks may monitor companies through long-term relationships, representatives on supervisory boards, voting members' shares lodged with them as authorised41 and offering wide services42, but they have recently been withdrawing43. Many British companies are controlled by active insurance companies and pension and investment funds more influentially than others, though restricted by trade-active market and mandatory bids. Continentally, 'private control bias' with disproportionate voting power characterises Germany44 and modest 'management control bias' – Netherlands.

Continental companies do not part with at least blocking minorities (Germany) partly for smaller free float percentage and lower shares trade45, but also for control advantages. Evidence exists of large shareholder monitoring positive effects on company performance46, but lacking minority shareholders' legal protection (Germany47) is counter-productive48. However, by late-1990s French and German companies became increasingly widely held and controlled49 with lower cash flow/voting rights deviation50. Shareholder rights and financiers' protection – shares carry voting rights in directors' election and other corporate matters.

Strong argument exists that countries with better legal protection obtain more external finance on better terms from higher-valued capital markets51. La Porta reports, inter alia, that British company law does not require shares' deposit before meeting, provides strong minority shareholder protection mechanisms52, which explains significant outside capital in UK from financial investors with small stakes, allows pre-emptive rights to new issues, but has no mandatory dividend rule53. Comparatively, Germany loses out on these54. Deminor55 shows that one share-one vote rule is observed absolutely in Belgium.

In Germany, 69% of companies respect it – UK-54% – and 23% have non-voting shares – UK-20%. Both German and British companies allow non-voting shares similarly, but more British companies use fixed voting ceilings, ownership ceiling and golden shares, while German companies retain control simply through large shareholdings and non-voting shares56. Sweden, France and Netherlands use multiple voting rights heavily. Such divergent practices are unlikely to be challenged other than by supranational measures – OECD Principles57 (non-binding) and EU Directives58 – under growing institutional investors' impact.

Unfortunately, Second Council Directive59 is creditor-oriented and ambiguous on shareholder protection60, while the more important for protecting minority shareholders EU take-over legislation has yet to be implemented. Directives' minimum standards, options and public policy restrictions prevent uniform European corporate governance61. Alternatively, many institutional investors, including British (though only advisory), have voted on disclosure issues, particularly board remuneration, and strikingly achieved strict legal prescriptions in Netherlands, Belgium, France62.