Universal Banks Are Not the Answer to America’s Corporate Governance “Problem”: A Look at Germany, Japan, and the U.S.
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Recent scholarship on the governance of the large, publicly held corporation has been critical of the American tradition. Our corporate governance is routinely depicted as having “sharply constrained the development of multidimensional governance relationships.” In particular, the U.S. is seen as offering mechanisms of monitoring and control of corporate managers that are grossly inferior to those operating in Germany and Japan. American firms are described disparagingly as “Berle-Means” corporations, with widespread share-ownership, separation of management and risk-bearing, and significant agency conflicts between managers and shareholders. Despite some protestations of agnosticism, the tome makes it clear that the American system of corporate governance is viewed as inferior because it does not foster the sort of “relational investing” that leads to effective monitoring by sophisticated intermediaries. This modern tendency to hold up for emulation the German and Japanese corporate governance systems turns on the role played by commercial banks. The dominant idea is that market forces, if allowed to function free of regulation, result in an economic system in which banks have great influence on the business affairs of borrowing corporations. However, U.S. law, “by restricting the size of banks and the scope and geographical range of their activities,” has caused bank influence to wane below the optimal level. Thus, for example, some commentators have been quite explicit in their view that, without major changes in American banking law and practice, “the United States is likely . . . to lag behind its European and Japanese competitors.” Focusing on the roles played by major German banks and Japanese main banks, critics suggest that American banks should play a much larger role in the management of the firms to which they loan money. U.S. banks are said to lack the “power and incentive” to monitor their borrowers. As a consequence, “the monitoring role in the American corporate governance system is relegated to those who provide the equity capital to the corporation – the shareholders. This characteristic has forced American governance institutions to follow a unique Berle-Means pattern of successive efforts, ranging from independent directors to hostile takeovers, to bridge the separation of ownership and management in the face of dispersed shareholdings." Our objective in this article is to cast doubt on the accepted wisdom concerning the desirability of commercial bank involvement in corporate governance. We argue that the current scholarship ignores important costs of the Japanese and German systems of bank-dominated corporate governance, as well as important benefits of the American system of equity-dominated corporate governance. Current theory also ignores critical differences between the monitoring incentives of debt holders. Much of the confusion in the current debate stems from a failure to appreciate the economics of commercial banking. We begin by describing the conflict of interest that exists within publicly held firms between the interests of banks and other fixed claimants on the other. Understanding this conflict is critical to analyzing the supposed advantages of the German and Japanese systems over the American system. We show that the core assumption of the current thinking about the role of banks in corporate governance – namely, that what is good for a nation’s banks is also good for the nation’s borrowers – is flawed. Using basic principles of corporate finance, we show that to the extent banks control the firms to which they lend money, their incentive are to reduce the levels of risk-taking below the levels that are optimal from a social perspective. Next, we discuss the German and Japanese systems of corporate governance in light of banks’ incentives as both lenders and stockholders. In both the German and Japanese systems, banks are far more influential in corporate decision-making than in the U.S. And, in both of these systems, the banks have used this influence to reduce risk-taking among borrowers and to suppress the market for corporate control. Current wisdom holds that the German and Japanese banking systems are a substitute for a robust market for corporate control in reducing agency costs and improving managerial performance. We argue that the Japanese and German bank-dominated systems of corporate governance are better viewed as the root cause of the lack of a robust market for corporate control in these countries. In the final part of the article, we explore the implications of our theory for the ongoing debate about American corporate governance. We argue that simply giving banks more power over borrowers is not the answer to the perceived problems in American corporate governance. Rather we argue that strengthening the “voice” of American equity holders by eliminating restrictions of the market for corporate control would be more effective in improving firm performance. Moreover, we argue that other U.S. laws – notably, environmental law, partnership law, and lender liability rules – reduce American banks’ ability to control moral hazard problems with borrowers to the same extent as European banks. Finally, we argue that the expected “convergence” among these three national corporate governance systems does not seem likely. Despite recent weaknesses, German and Japanese banks will continue to be successful in resisting the encroachments of local capital markets onto their turf. And, in the U.S., the recent proposals to liberalize Glass Steagall and the Bank Holding Company Act may encourage some banks to play a somewhat greater role in corporate governance. But the highly developed U.S. capital and corporate control markets will continue to ensure that such a role is a relatively small one.
Source Publication
The Revolution in Corporate Finance
Source Editors/Authors
Joel M. Stern, Donald H. Chew, Jr
Publication Date
2003
Edition
4
Recommended Citation
Macey, Jonathan R. and Miller, Geoffrey P., "Universal Banks Are Not the Answer to America’s Corporate Governance “Problem”: A Look at Germany, Japan, and the U.S." (2003). Faculty Chapters. 2026.
https://gretchen.law.nyu.edu/fac-chapt/2026
