Co-Determination in Germany: A Socio-Political Model with Governance Externalities

Abstract

The paper analyzes the socio-political roots of co-determination with special emphasis on the factors that led to the adoption of the 1976 Law, and discusses the impact of this law on corporate governance. The paper argues that co-determination was not designed with firm level corporate governance -- that is the control of management by the owners of the company -- in mind. Rather, its purpose was to bridge the gap between capital and labor in society, or to provide social governance over private capital. It is generally held that co-determination has achieved this socio-political goal. However, co-determination also affects firm level governance, or produces governance externalities. This has become increasingly evident in recent years when -- in times of economic difficulties and international competition -- problems in the existing corporate governance structure surfaced. The paper suggests that while co-determination cannot be made responsible for most of the inherent weaknesses in the existing corporate governance system, it has raised the costs of firm level governance and affected the dynamics among the three major parties involved in corporate control, shareholders, employees, and managers. Management is the party that benefits most from this arrangement, because it is in a position to choose its coalition partner from two fractions, who, because of their inherent antagonism as representatives of labor and capital, are less likely to cooperate with each other. This outcome also casts some doubts over the effectiveness of co-determination as social governance over private capital.

JEL Classification: G34, G38, K22