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Capital, Labor, and The Firm: A Study of German Codetermination

Author

Listed:
  • Gary Gorton

    (University of Pennsylvania and NBER)

  • Frank A. Schmid

    (Federal Reserve Bank of St. Louis)

Abstract

Under the German corporate governance system of codetermination, employees are legally allocated control rights over corporate assets through seats on the supervisory board-that is, the board of nonexecutive directors. The supervisory board oversees the management board-the board of executive directors-approves or rejects its decisions, and appoints its members and sets their salaries.We empirically investigate the implications of this sort of labor participation in corporate decision making. We find that companies with equal representation of employees and shareholders on the supervisory board trade at a 31% stock market discount as compared with companies where employee representatives fill only one-third of the supervisory board seats. We show that under equal representation, management board compensation provides incentives that are not conducive to furthering shareholders' interests, possibly because labor maximizes a different objective function than shareholders. We document that, under equal representation, companies have longer payrolls than their one-third representation peers have. Finally, we provide evidence that shareholders respond to the allocation of control rights to labor by linking supervisory board compensation to firm performance and by leveraging up the firm. (JEL: G32, G34) Copyright (c) 2004 by the European Economic Association.

Suggested Citation

  • Gary Gorton & Frank A. Schmid, 2004. "Capital, Labor, and The Firm: A Study of German Codetermination," Journal of the European Economic Association, MIT Press, vol. 2(5), pages 863-905, September.
  • Handle: RePEc:tpr:jeurec:v:2:y:2004:i:5:p:863-905
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    More about this item

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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