Corporate governance, entrenched labor, and economic growth
The German system of codetermination contributes to the entrenchment of labor. We show in a two-period model of project choice that entrenched labor leads to underinvestment and overstaffing. We provide empirical evidence that German firms subject to codetermination with equal representation of workers on supervisory boards during 1989-93 were, on average, overstaffed. In addition, the fraction of employees in codetermined firms has decreased over time. The expanded reach of codetermination during the mid-1970s therefore may have contributed to the deterioration of German economic growth performance beginning at about that time through underinvestment, overstaffing, and costly migration of business activity away from firms subject to codetermination.
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