One-third Codetermination at Company Supervisory Boards and Firm Performance in German Manufacturing Industries: First Direct Evidence from a New Type of Enterprise Data

Wagner, Joachim Article One-third Codetermination at Company Supervisory Boards and Firm Performance in German Manufacturing Industries: First Direct Evidence from a New Type of Enterprise Data Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschaftsund Sozialwissenschaften Provided in Cooperation with: Duncker & Humblot, Berlin Suggested Citation: Wagner, Joachim (2011) : One-third Codetermination at Company Supervisory Boards and Firm Performance in German Manufacturing Industries: First Direct Evidence from a New Type of Enterprise Data, Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschaftsund Sozialwissenschaften, ISSN 1865-5742, Duncker & Humblot, Berlin, Vol. 131, Iss. 1, pp. 91-106, https://doi.org/10.3790/schm.131.1.91 This Version is available at: https://hdl.handle.net/10419/292321 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ One-third Codetermination at Company Supervisory Boards and Firm Performance in German Manufacturing Industries: First Direct Evidence from a New Type of Enterprise Data By Joachim Wagner* Abstract This paper contributes to the empirical literature on the co-determination –firm performance nexus by using a new type of data that combines information on the co-determination status of enterprises from a commercial data base and supplementary information collected from the firms with comprehensive data on the firms from official statistics. The data allow for the first time a direct comparison of enterprises from the same size class with and without co-determination at the supervisory board level. It is shown that one-third codetermination at the supervisory board level in limited-liability companies from West German manufacturing industries seems to be neither positively nor negatively related to two core firm performance indicators, productivity and profitability. JEL-Classification: J50 Received: 11. October 2010 Accepted: 22. November 2010 Schmollers Jahrbuch 131 (2011), 91 –106 Duncker & Humblot, Berlin Schmollers Jahrbuch 131 (2011) 1 *All computations were done inside the research data centre of the Statistical Office of Lower Saxony using Stata 10.1, and I thank Rita Hoffmeister for her help in preparing the data, running the Stata do-file and checking the output for any violation of privacy. The data are confidential but not exclusive; see Zühlke et al. (2004) for information on how to access the data. To facilitate replication and extensions the Stata do-file used is available from me on request. Many thanks to Sebastian Troch for collecting and preparing the information on the presence or not of a co-determined supervisory board in the enterprises investigated in this study (see Troch, 2009). Furthermore, I appreciate helpful comments on earlier draft versions by John T. Addison, Franziska Boneberg, Nils Braakmann, Bernd Frick, Knut Gerlach, Uwe Jirjahn, Christian Pfeifer, Thorsten Schank, Claus Schnabel, Sebastian Troch and participants at the codetermination workshop at Leuphana University in September 2010. Foremost, I thank Michael Adams who pointed out in private correspondence in April 2007 that Claus Schnabel and I in an unpublished draft paper made a serious mistake when we assumed that all companies who should have a co-determined supervisory board according to the law really do have one. This remark started the project that led to this paper. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 1. Motivation Co-determination of workers can be regarded as an essential element of the system of industrial relations in Germany’s social market economy. Basically, there are two forms of it –employee representation at the level of the establishment (the local production unit) via works councils (i.e., betriebliche Mitbestimmung), and codetermination at the enterprise level (i.e., Unternehmensmitbestimmung) where employees are sitting on supervisory boards. While the economic consequences of German works councils for various dimensions of firm performance have been extensively investigated empirically,1much less is known about the effects of employees as members of supervisory boards. Details aside, we have today three different regimes of co-determination at the supervisory board level: In the (few) enterprises from the coal and steel industries with more than 1.000 employees there is full-parity codetermination (1951 Codetermination Act); in enterprises with more than 2,000 employees we have quasi-parity representation (1976 Codetermination Act) with a chairperson of board (who is elected by the shareholders) who has the casting vote in case of a tie; and one-third codetermination in enterprises with between 500 and 2,000 employees (2004 Third Part Act, or Drittelbeteiligungsgesetz). In the economic discussion of the pros and cons of co-determination at the board level, there are mainly two theoretical lines of arguments that can be summarized in a nutshell as follows (see, e.g., Renaud, 2007). Property rights theory points out that co-determination weakens the residual decision rights of the owners, leads to less efficient or at least delayed decisions, lower productivity, less profitability, and rent shifting in favour of the employees. Participation theory suggests co-determination can improve efficiency (and thus the joint surplus) of the firm due to information exchange, consultation and codetermination (see Freeman / Lazear, 1995 for a formal model in the context of co-determination at the establishment level via works councils). Whether the net effect of supervisory board level co-determination on firm performance is positive or negative, therefore, is an empirical question. Summarizing the findings from the (few) empirical studies on the effects of co-determination at the supervisory board level in a recent survey of this literature 92 Joachim Wagner Schmollers Jahrbuch 131 (2011) 1 1Details aside, a works council is found in establishments with at least 5 employees, provided that one has been elected by the employees. These works councils can have “two faces”. They can use their legal rights to delay or modify management decisions, and to redistribute rents to the employees. And they can improve efficiency (and thus the joint surplus) of the establishment due to information exchange, consultation and codetermination (see Freeman / Lazear, 1995 for a formal model). Whether the net effect on firm performance is positive or negative is an empirical question. The bottom line after some 25 years of econometric research is that these effects are small on average, and that there is no evidence that works councils adversely effect firm performance (see Addison / Schnabel / Wagner, 2004; Jirjahn, 2006; Addison, 2009 for surveys of this literature, and Addison / Schank / Schnabel / Wagner, 2006, 2007 for recent studies). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 Addison / Schnabel (2009) argue that “the German system of codetermination at company level has not had (positive or negative) economic effects of a magnitude that would induce (other) companies (and governments) to adopt the system or to wholly abandon it.”Renaud (2007) draws a similar conclusion based on his survey of the empirical literature and on the results from his own study. This appraisal of the state of our current knowledge regarding the effects of board-level co-determination on enterprise performance is based on a small number of empirical studies. Some of these studies are criticised by Addison / Schnabel (2009) for the methods applied, and most of them are based on rather small samples of data that cover years from the quite distant past. Empirical investigations of the relation between different degrees of co-determination at the supervisory board level (none, one-third, quasi-parity, full-parity) and firm performance are hindered by the lack of any information on co-determination in enterprise surveys from official statistics. Econometric studies on the co-determination –firm performance nexus, therefore, are usually based on data sets collected by researchers using (publicly available) information on publicly-traded companies (Aktiengesellschaften) only.2 One critical point here is that these studies assume that all enterprises from a certain size class (500 –2,000, or >2,000 employees) do have a supervisory board with a certain type of co-determination, i.e. quasi-parity codetermination according to the 1976 Codetermination Act for firms having more than 2,000 employees, or one-third representation in companies with between 500 and 2,000 employees according to the Third Part Act of 2004 (or its forerunner, the 1952 Works Constitution Act). While the assumption that all firms do have a supervisory board is appropriate for publicly traded companies, it is not for the second large group of enterprises that is covered by the German co-determination laws, the limited liability companies (Gesellschaft mit beschränkter Haftung, GmbH). Experts for labour law and industrial relations point out that, contrary to the law, such limited liability companies very often do not have a supervisory board at all, and, therefore, are not co-determined firms.3It should be noted that according to the law there is no direct penalty for limited liability companies that do not install a supervisory board, but that employees do have the opportunity to enforce its installation by going to court which might be seen as a thread for a potential penalty for a firm due to the costs related to court proceedings. One-third Codetermination at Company Supervisory Boards 93 Schmollers Jahrbuch 131 (2011) 1 2Cases in point include Gorton / Schmid (2004) who use data for the largest 250 nonfinancial traded stock corporations for the period 1989 to 1993, and Fauver / Fuerst (2006) where the sample consists of all publicly traded German corporations as of 2003. Stettes (2007) uses data from a survey of CEOs and leaders of supervisory boards for a descriptive study. 3I thank Michael Adams who pointed this out to me in private correspondence in April 2007. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 If there really is such a thing as a large co-determination free zone among limited liability companies that fall under the Third Part Act of 2004,4and if it is known which limited liability companies with 500 to 2,000 employees do have a co-determined supervisory board and which do not, this information can be used to compare the performance of firms from within this size class with and without co-determination. This paper contributes to the empirical literature on the co-determination – firm performance nexus by using exactly this type of information on the presence or not of a co-determined supervisory board in limited liability companies covered by the Third Part Act of 2004. In doing so it follows a suggestion by Renaud (2007) for further research, namely to compare supervisory boardcodetermined enterprises with enterprises without any employee representatives in a board at all. It uses a new type of data that combines information on the co-determination status of enterprises from a commercial data base and supplementary information collected from the firms with comprehensive data on the firms from official statistics. These data (that are for 2006, and, therefore, of a much more recent vintage than most of the data used before to investigate the supervisory board codetermination –firm performance nexus) allow for the first time a direct comparison of enterprises from the same size class with and without a co-determination supervisory board. It has to be pointed out explicitly that in the particular case of one-third codetermination at the supervisory board in limited liability companies one of the two faces of codetermination –the “ugly”one that is at the centre of the property rights theory, and that argues that co-determination weakens the residual decision rights of the owners, leads to less efficient or at least delayed decisions, lower productivity, less profitability, and rent shifting in favour of the employees –can be expected to be more or less absent, or at least not to show up distinctly. The reason for this is that the supervisory board in a limited liability company has only restricted rights compared to the supervisory board in a publicly traded company with 500 to 2000 employees. While in the latter case the supervisory board has the right to “hire and fire”the management board members and to monitor their performance, and to approve the annual balance, this role is fulfilled by the assembly of owners (Gesellschafterversammlung)in the case of a limited liability company. A supervisory board under the Third Part Act of 2004, therefore, can be classified as having mainly information rights, while as a rule decision rights are in the hands of the assembly of owners.5Therefore, it comes as no surprise that the one-third board representation 94 Joachim Wagner Schmollers Jahrbuch 131 (2011) 1 4Note that if this condition holds any type of regression discontinuity design comparing limited liability companies with (slightly) less and (slightly) more than 500 employees can not identify differences between firms with and without one-third codetermination at the supervisory board level, and the same holds for limited liability companies with up to and more than 2,000 employees in the case of one-third versus quasi-parity co-determination. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 option in general, and especially in limited liability companies, is often viewed as an absence of codetermination. However, the “beautiful”face of codetermination that is pointed out by participation theory, suggesting that co-determination can improve efficiency (and thus the joint surplus) of the firm due to information exchange and consultation, might show up here. It is an empirical question that has not been investigated before econometrically whether this is the case, and if so, to which extent. To preview the most important result (which is in line with the conclusions drawn by Addison / Schnabel, 2009 cited above), one-third co-determination at the supervisory board level in limited-liability enterprises from West German manufacturing industries seems to be neither positively nor negatively related to two core firm performance indicators, productivity and profitability. The rest of the paper is organized as follows: Section 2 describes the new data, section 3 contains the empirical investigation, and section 4 discusses the results. 2. Data As said, enterprise surveys from official statistics do not contain any information on the presence or not of a co-determined supervisory board in the firms sampled. Such information, however, is available from a commercial data base, the Hoppenstedt Datenbank Grossunternehmen (see www.hoppenstedt-grossunternehmen.de). This data base contains information on the 25,000 largest enterprises in Germany with at least 200 employees and / or a sales volume of at least 20 Mio. Euro. Coverage for enterprises with 500 or more employees is complete in this data base. In this data base it is reported whether or not an enterprise has a supervisory board (and its size), and whether or not worker representatives are among the board members (and their number). This information on the presence or not of a supervisory board and its composition, however, is not available for all enterprises. In this project, for limited liability enterprises from manufacturing industries in West Germany that had between 550 and 1975 employees6missing information was collected via telephone calls.7 One-third Codetermination at Company Supervisory Boards 95 Schmollers Jahrbuch 131 (2011) 1 5The division of rights between the supervisory board and the assembly of owners might vary from case to case according to decisions taken by the owners; see Fuchs / Köstler (2005) for a detailed discussion. 6The Third Part Act of 2004 covers enterprises with 500 to 2000 employees. The different critical values used in this project were selected to take care of the degree of fuzzy-ness that is often given at the threshold values. 7A detailed description of the data and the process of its collection can be found in Troch (2009). Boneberg (2009) reports comparable data for the West German services sector industries. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 The most important result from an empirical investigation using these data is that only some 60 percent of all limited liability companies from German manufacturing industries that fell under the Third Party Act of 2004 had a codetermined supervisory board in 2007 / 2008 (Troch, 2009). This provides evidence for the existence of a large co-determination free zone among limited liability companies with 500 to 2.000 employees. This fact offers the possibility for an empirical investigation of the relationship between supervisory board level co-determination and firm performance based on a direct comparison of co-determined and co-determination free firms from the same size class with the same legal form. To perform this investigation, information on the presence or not of a co-determined supervisory board in an enterprise (taken from the Hoppenstedt data base, or collected via telephone) was merged with data from a second source, the cost structure survey for enterprises in the manufacturing sector by the Statistical Offices.8 This survey is carried out annually as a representative random sample survey (stratified according to the number of employees and the industries) of around 18.000 enterprises. All enterprises with 500 or more employees are included in each survey. A detailed description of the cost structure survey can be found in Fritsch et al. (2004). Data from the most recent available cost structure survey for 2006 are used to construct measures for two core dimensions of firm performance, productivity and profitability. Productivity is measured as value added at factor costs per employee. Note that any measure of total factor productivity cannot be computed because of a lack of information on the capital stock9in the survey. In the econometric investigation the amount of depreciation per employee (that can be expected to by closely linked to the capital stock per employee) is used as a proxy variable for the unobserved capital intensity.10 96 Joachim Wagner Schmollers Jahrbuch 131 (2011) 1 8Merging was done using information about the register number and register court of the trade register (Handelsregisternummer und Handelsregistergericht) for the enterprise, because this information is available in both the Hoppenstedt data base and in the official register of enterprises (Unternehmensregister) that was linked with the cost structure survey data. Merging firm level data from official statistics and from other sources is legal according to §13a of the Federal Statistics Law (Bundesstatistikgesetz) provided the data from external sources are publicly available. This is the case with the data on co-determination used here, because they are either taken from the publicly (though not costless) available Hoppenstedt data base, or published as an appendix to Troch (2009) that is available from the web free of charge (see www.leuphana.de/vwl/papers no. 128a). 9Information about investment is available from a different survey that can be linked to the cost structure survey, and this information might be used to approximate the capital stock in a firm. A close inspection of the investment data, however, reveals that many firms report no or only a very small amount of investment in many years, while others report huge values in one year. Any attempt to compute a capital stock measure based on these data would result in a proxy that seems to be useless. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 Profits are computed as a rate of return, defined as gross firm surplus (computed as gross value added at factor costs minus gross wages and salaries minus costs for social insurance paid by the firm) divided by total sales (net of VAT) minus net change of inventories. As the data set does not have any information on the capital stock, or the sum of assets or equity, of the firm, it is not possible to construct profit indicators based thereon like return on assets or return on equity. Our profit measure is a measure for the price-cost margin which, under competitive conditions, should on average equal the required rental on assets employed per money unit of sales (see Schmalensee, 1989, 960 f.). Differences in profitability between firms, therefore, can follow from productivity differences, but also from different mark-ups of prices over costs and from differences in the capital intensity (for which the depreciation per employee is used as a proxy variable). From the data base (described in detail in Troch, 2009) that includes all limited liability companies from West German manufacturing industries that are covered by the Third Part Act (Drittelbeteiligungsgesetz) information for 333 enterprises could be matched to the cost structure survey data from official statistics.11 From these enterprises 273 are classified as stable over time with regard to the presence or not of a co-determined supervisory board, because we do not have any information from the Hoppenstedt data base CD for 2005 that the co-determination status was different in 2005 compared to 2007. The 273 enterprises with a stable co-determination status over the period 2005 to 2007 form the sample that is used in the empirical investigation. From these firms 159 (or 58.2) have a co-determined supervisory board, while 114 do not.12 One-third Codetermination at Company Supervisory Boards 97 Schmollers Jahrbuch 131 (2011) 1 10 Note that Bartelsman / Doms (2000, 575) point to the fact that heterogeneity in labor productivity has been found to be accompanied by similar heterogeneity in total factor productivity in the reviewed research where both concepts are measured. Furthermore, Foster / Haltiwanger / Syverson (2008) show that productivity measures that use sales (i.e. quantities multiplied by prices) and measures that use quantities only are highly positively correlated. 11 The data for the other 63 enterprises that were sent to the research data centre of the statistical office of Lower Saxony could not be matched to the data from official statistics. About two thirds of these enterprises were registered not in manufacturing but in other industries (trade or services), so that no information about these firms is included in the cost structure survey that covers manufacturing industries only. For the remaining firms there is either no entry in the official register of enterprises, or the enterprise numbers in the register are not the most recent ones included in our data base. Due to data protection laws it is impossible for me to try to solve these problems with regard to missing matches. 12 Note that this is well in line with the results reported by Troch (2009) on the proportion of enterprises with a co-determined supervisory board among all firms covered by him that are mentioned above. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 3. Empirical Investigation We start the empirical investigation by looking at differences in labour productivity and profits between enterprises with and without co-determination at the supervisory board level to document the existence and size of the unconditional productivity and profitability differential. According to the results of a t-test on mean differences this differential was statistically significant at an error level of 4 percent, and large from an economic point of view, for productivity –enterprises with co-determination are on average 22% more productive than firms without co-determination (see table 1). Contrary to this, the difference in mean profitability between enterprises from both groups is not statistically different from zero at any conventional level of significance. If one looks at differences in the mean value for both groups of enterprises only, one focuses on just one moment of the productivity (or profit) distribution. A stricter test that considers all moments is a test for stochastic dominance of the productivity distribution for enterprises with co-determination at the supervisory board over the productivity distribution for non-codetermined firms. More formally, let Fand Gdenote the cumulative distribution functions of productivity for firms with and without co-determination. Then FðxÞGðxÞ¼0 means that the two distributions do not differ, and first order stochastic dominance of Frelative to Gmeans that FðzÞGðzÞmust be less or equal zero for all values of z, with strict inequality for some z. Whether this holds or not is tested non-parametrically by using the Kolmogorov-Smirnov test (see Delgado / Farinas / Ruano, 2002). Results reported in table 1 indicate that according to the Kolmogorov-Smirnov test the two productivity distributions for firms with and without co-determination at the supervisory board level do differ, and that the distribution for firms with co-determination first-order stochastically dominates the distribution for firms without co-determination. Contrary to this, the two profitability distributions do not differ according to the Kolmogorov-Smirnov test. The next step of the empirical investigation consists in the estimation of empirical models that regress productivity (or profitability) on a dummy variable that indicates the presence or not of a co-determined supervisory board in the firm plus control variables. Note that the regression equations estimated here are not meant to be empirical models that aim to explain labour productivity or profits at the firm level. The data set at hand here is not rich enough for such an exercise. The equations are just a vehicle to test for, and estimate the size of, any (positive or negative) premium associated with the presence of a co-determined supervisory board, controlling for other firm characteristics that are included in the empirical model. Productivity differences at the firm level are known to be notoriously difficult to explain empirically. “At the micro level, productivity remains very much a measure of our ignorance”(Bartelsman / Doms, 2000, 586). The same holds for profits. 98 Joachim Wagner Schmollers Jahrbuch 131 (2011) 1 OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16 would lead to a crossing of the threshold of 500 employees where the Third Part Act of 2004 bites (see, e.g., Adams, 2006), it is important to have empirical evidence showing that there seems to be no such thing as a negative effect of one-third co-determination, at least not in limited liability companies from manufacturing industries in West Germany. On the other hand, the absence of any evidence for a positive effect as pointed out by participation theory, suggesting that co-determination can improve efficiency (and thus the joint surplus) of the firm due to information exchange and consultation, can inform ongoing policy debates over one-third codetermination. While this type of codetermination might be favoured as an important element of a social market economy for wider political reasons, it can not be expected (again, at least not in limited liability companies from manufacturing industries in West Germany) to have positive effects on two core elements of firm performance that are important for economic dynamics, productivity and profitability. From an economic point of view, therefore, there seems to be no argument in favour of enforcing the Third Part Act. References Adams, M. (2006): Die dunklen Seiten der Mitbestimmung, Wirtschaftsdienst 86 (11), 699 –705. Addison, J. T. (2009): The Economics of Codetermination. Lessons of the German Experience, New York. Addison,J.T./Schank,Th./Schnabel,C./Wagner, J. (2006): Works Councils in the Production Process, Schmollers Jahrbuch –Journal of Applied Social Science Studies 126 (2), 251 –283. Addison,J.T./Schank,Th./Schnabel,C./Wagner, J. (2007): Do Works Councils Inhibit Investment? 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(2004): The research data centres of the Federal Statististical Office and the statistical offices of the Länder, Schmollers Jahrbuch –Journal of Applied Social Science Studies 124 (4), 567 –578. 106 Joachim Wagner Schmollers Jahrbuch 131 (2011) 1 OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.131.1.91 | Generated on 2023-01-16 13:36:16