Contingent Capital: Short-term Investors and the Evolution of Corporate Governance in France and Germany

Contingent Capital

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Contingent Capital Short-term Investors and the Evolution of Corporate Governance in France and Germany Michel Goyer

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Great Clarendon Street, Oxford OX2 6DP Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide in Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States by Oxford University Press Inc., New York # Michel Goyer 2011 The moral rights of the author have been asserted Database right Oxford University Press (maker) First published 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer British Library Cataloguing in Publication Data Data available Library of Congress Cataloging in Publication Data Data available Typeset by SPI Publisher Services, Pondicherry, India Printed in Great Britain on acid-free paper by MPG Books Group, Bodmin and King’s Lynn ISBN 978–0–19–957808–5 1 3 5 7 9 10 8 6 4 2

Table of Contents

Preface

vii

List of Figures

xiii

List of Tables

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1. Introduction

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2. Short-term Capital Mobility in France and Germany: Differentiated Empirical Data

51

3. Law and Economics and Capital Mobility across Advanced Capitalist Economies

84

4. Complex Causation and Contextualized Capitalisms

106

5. Coordination and Institutions: France and Germany Compared

129

6. Conclusion

158

Bibliography

172

Index

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Preface

Will the globalization of finance, investment, and trade lead to convergence across national systems of corporate governance? The growing fragmentation of ownership of continental European companies in the form of the arrival of UK/US-based shareholder value-oriented institutional investors has led to the resurgence of interest in issues of the institutional foundations of comparative corporate governance (Roe, 2003; Gourevitch and Shinn, 2005). Two institutionally distinct systems of corporate governance existed in separate spheres before the mid-1990s, indicating how the integration of national stock markets lagged behind other forms of financial globalization, which by this stage were more advanced (Cohen, 1996; see also Prowse, 1995). The policy of international diversification of Anglo-American institutional investors has led to increased interactions between these different national systems of corporate governance, but without the emergence of an accommodating hybrid model due to the presence of many differences in institutional starting points (Soskice, 2009: 134; see also Bebchuk and Roe, 1999). The increased importance of AngloAmerican institutional investors as major shareholders has raised important questions for the process by which firms are controlled and operated. Moreover, the presence of shareholder value-driven funds in the capital structure of continental European companies also raises moral and practical concerns. The 2008 financial crisis has revealed the man behind the curtain – that is, the profound shortcomings associated with the sole focus on shareholder value as the guiding star for listed companies in the United States. The role of institutional investors in the transition process toward the prominence of shareholder value in the strategy of companies has been well documented.1 Perhaps more importantly is the fact that shareholder value is embedded in the overall financialization of the American economy (Davis, 2010). Deregulated

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For instance, compare Jacoby (1997) with Jacoby(2005) and Davis (2009).

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markets profoundly affect the way Americans live today. For instance, the subprime housing crisis has been made worse by the behavior of homeowners who viewed their dwelling as an investment whose value was assumed to be constantly rising. The subprime housing crisis illustrates how the “portfolio investment” behavior of American homeowners reinforced existing financial problems. The pursuit of material self-interest, operationalized in the obsession with wealth acquisition, is seen as the most important factor for the shrinking sense of collective purpose in American society (Judt, 2010). What happens when these same shareholder value-oriented institutional investors proceed to blockholding acquisitions in large French and German companies – two systems of corporate governance not previously exposed to the shareholder value mantra? This book is about the investment allocations of short-term investors – namely hedge funds and actively managed mutual funds – in France and Germany and their consequences for the evolution of these two systems of corporate governance. The research question of this book constitutes a middle-range project that aims to account for the causes of diversity within classes of a changing phenomenon. The empirical evidence on the investment allocation of short-term, impatient investors highlights the greater attractiveness of French blue-chip companies over their German counterparts by a ratio of 2 to 1. But what are some of the key factors that influence the investment allocation of short-term-oriented shareholder value institutional investors, and what is the impact of these on the two systems of corporate governance? The investigation of the uneven short-term capital allocation in France and Germany is structured around the insights of two institutionally based theoretical perspectives: law and economics (Shleifer and Vishny, 1997; LaPorta et al., 2000) and the varieties of capitalism (Hall and Soskice, 2001; Hall and Thelen, 2009; Soskice, 2009). The selection of these two perspectives is motivated not only by their importance in studies of comparative corporate governance (see Gourevitch and Shinn, 2005: 27–94) but also reflects different aspects of the governance of corporations and of the investment decision-making process of institutional investors. The law and economics perspective emphasizes the importance of institutional arrangements that protect the rights of minority shareholders. The presence of constraints and incentives that flow from the presence of specific sets of institutions is seen as crucial for the pursuit of shareholder value-enhancing strategies by corporate executives. Minority shareholders need assurance that they will get a return on their investment before parting with their financial assets. Their willingness to acquire equity stakes in companies is contingent viii

Preface

upon the extent to which they are protected from shareholder valuedestroying actions by managers or large controlling owners (Coffee, 2005). The varieties of capitalism perspective highlight the importance of the institutional frameworks by which firms coordinate their activities and build their innovative capabilities. Advanced capitalist economies are distinguished by their specific configuration of institutional arrangements that translate into divergent distributions of authority at the firm-level (Whitley, 2003). The varieties of capitalism perspective emphasizes the ability of corporate executives to implement strategies of shareholder value, not merely whether the preferences of managers fit with those of shareholders insofar as they have internalized the importance of financial market considerations. The analysis of the importance of these two perspectives for the investment allocation of short-term investors departs from traditional research design in an original manner. On the one hand, the presentation of the insights of these two perspectives should not be interpreted as a paradigm war of the two approaches made to be tested against each other. The research design of scholars in social sciences often entails holding constant one set of variables while the presence of variation on another one is assumed to reveal its importance. One problem with this strategy is that both sets of variables can be changing – that is, nothing is constant (Gourevitch, 1999). Moreover, social scientists increasingly recognize that important political and social outcomes have more than a single cause (Hall, 2003, 2010a). Processes of complex causation highlight the importance of intersections of causal factors (Ragin, 1987). One the other hand, the focus on institutional variables as part of processes of complex causation is ontologically correct but potentially neglects an important issue, namely the relative weight of different causal factors (Goldthorpe, 1997). The relative strengths of different combinations of institutional variables, or of a single variable within a process of complex causation, remain unexplored. This shortcoming is potentially crucial since advanced capitalist economies have been responding in different ways to exogenous and endogenous challenges (Hall, 1999, 2007; Hall and Thelen, 2009). I argue in this book that the simultaneous analysis of complexity and hierarchy between causal variables is not only feasible but actually essential in order to capture the respective contributions of the law and economics and varieties of capitalism perspective for the value taken by the dependent variable, namely the marked preference for French companies by short-term investors. Moreover, the integration of causal complexity with hierarchy between causal variables extends beyond the (apparently) narrow dependent variable of this study. The ix

Preface

institutional variables of work organization identified by the varieties of capitalism perspective constitute a hierarchically superior causal variable that offer greater insights into the complex causal process of underlying the investment allocations of short-term investors. The notion of the institutional arrangements of work organization as a hierarchically superior causal variable is operationalized in two ways. First, the institutional basis for the coordination of activities at the firm-level in the two countries differs substantially and impacts on the value taken by the dependent variable. Firm-level institutions in France are characterized by the concentration of power in top executives that, in turn, makes it easier to implement strategies of shareholder value that fit with the preferences of short-term investors. In contrast, the institutional arrangements of large German companies provide employees with voice and quasi-veto power over important corporate decisions, thereby resulting in lengthier negotiations that do not fit well with the short-term horizon of impatient investors. Second, the contribution of the varieties of capitalism perspective also lies in the mediation of the relationship between the other causal variable (law and economics, with its focus on the legal protection of minority investors) and the dependent variable. For the law and economics perspective, the investment allocation of short-term investors is primarily driven by the quality of institutional arrangements that protect the rights of minority shareholders. The prediction is that the presence of ownership diffusion constitutes the most important and determining factor for the introduction of strategies of shareholder value in France and Germany – institutional legal arrangements in the two countries being better at preventing managerial opportunism than at curbing the value-destroying actions of the large shareholder. However, the relationship between the presence of ownership dispersion and investment allocation of short-term investors differs across the two cases: it is positive in France, since the quasi-totality of companies with ownership diffusion have been targeted by short-term investors; it is weak in Germany, given that many corporations with ownership diffusion have still not been targeted by these same impatient investors. The disappearance of large shareholders in France constitutes the removal of an important stumbling block for the implementation of short-term-oriented strategies of shareholder value but remains largely insufficient in Germany given the strength of organized labor at the firm-level. In the course of this research project, I have been fortunate to rely on a group of top-rated scholars who have also become friends over the years. Chief among them are Suzanne Berger, Peter Hall, and Bob Hancke´. Not x

Preface

only have they provided insightful comments and perceptive questions on the book, each one of them has contributed in profound ways to my thinking and intellectual development as a scholar. The influence of Suzanne Berger has been crucial at an early stage of my academic career and has been long-standing since then. She helped me define, redefine, refine, draft, redraft my dissertation topic in graduate school. She has transmitted an intellectual gift that still amazes me, namely the ability to ask the right questions. In an age of democratization of access to knowledge, intellectual contributions often result from the presentation of problems and intellectual puzzles in an innovative manner. On the specific issue of the French and German political economy, I always remember her point of not trying to compete with country specialists who will always be the first to comment on a specific event. She has taught me the value of original thinking. Peter Hall has encouraged me toward the study of “what is the big picture.” In an age where academic contribution is often measured on the ability to make a contribution on a small point within a well-established debate, the broad and integrated nature of his works set the standards for scholars with uncompromising passion for original work. My raw intellectual thinking has been guided toward creative ends in great part from Peter’s works. Moreover, his patience, intellectual rigor, and his extremely insightful and detailed comments provide the perfect picture of professionalism in the current context of academics being overloaded. Bob Hancke´ has also been there from the beginning. Bob’s no-nonsense approach has been immensely helpful in the contextualization of my work. No man is an island, purposively or inadvertently. Bob Hancke´ has forced me to think about the relevance of one’s work and the importance of engaging with others in order to highlight the relevance of one’s own research. It is always easier to hide behind members of one’s own tribe than to engage with the wider community, even with those who disagree. Moreover, Bob’s friendship throughout the years has been instrumental in maintaining my sanity and enabling me to put into context what I am doing. The corporate governance community is a dynamic and thriving one. Over much of the past decade, I have been fortunate to interact with a group of scholars whose thinking has been highly influential. Chief among them are Peter Gourevitch, Ruth Aguilera, Pepper Culpepper, David Soskice, Glenn Morgan, and Richard Deeg. They have been gracious with their time during the course of my research and have commented over numerous papers that I have presented at conferences and workshops over the years. The book is far more interesting as a result of

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their suggestions and unselfish criticisms. These are the members of my tribe! Likewise, I also received feedbacks to parts of the argument from David Bach, Alex Boersch, Richard Bronk, Brian Burgoon, Steve Casper, John Cioffi, Steve Coulter, Frieda Fuchs, Orfeo Fioretos, David Furch, Miguel Glatzer, Margarita Gomez-Reino, Frederick Guy, Barbara Haskel, Ilir Haxhi, Martin Hoepner, Simon Johnson, Daniel Kinderman, Jette Knudsen, Soo Hee Lee, Jonah Levy, Andre´ Mach, Hudson Meadwell, Guglielmo Meardi, Kenneth Oye, Vivien Schmidt, Marco Simoni, Arndt Sorge, Mark Thatcher, Gunnar Trumbull, Rocio Valdivielso del Real, Inger Weibust, and Richard Whitley. Interviews with Donald Cassidy (Fidelity, Boston) and Selina Siak (St. Albans Commodities, London), and fund managers at State Street (Boston), GLG Partners (London), and Hermes (London) were also insightful. Financial and institutional support has been important at various stages of the preparation and writing of the book. In particular, I would like to thank David Soskice, then at the WZB in Berlin (summer 1999), Wolfgang Streeck at the Max Plank Institute in Cologne (February 2001 – September 2002), Christian Levesque at the CRIMT in Montre´al (summers 2006 and 2008), and Arndt Sorge at the WZB in Berlin (autumn 2009). Each one of them made me feel welcome and provided a congenial place to do research and interact with colleagues. I would also like to thank David Musson and Emma Lambert of Oxford University Press. Their patience and encouragement were pivotal. Special thanks are due to Rocio Valdivielso del Real. Finally, this book is dedicated to my parents – Murielle Ouellet and Pierre Goyer. Buying world atlases for me at an early age proved to be the critical juncture in the development of my path. Michel Goyer Coventry, December 2010

xii

List of Figures

4.1 Necessary and Sufficient Conditions

116

4.2 Trivially Necessary Conditions

118

xiii

List of Tables

1.1 Concomitant Variation: Causal Variables and Investment Allocation by Short-term Investors

39

2.1 Educational Background of German CEOs in Nonfinancial Sectors (1998 and 2009)

60

2.2 Work Experience inside the Firm of German CEOs in Nonfinancial Sectors (1998 and 2009)

60

2.3 Weight of Top Ten Holdings in Selected Funds

68

2.4 Price–Earnings Ratio, French and German Stocks

75

3.1 French Firms with Deviations to One-ShareOne-Vote Principle (in %)

92

xiv

1 Introduction

The topic of corporate governance – the system by which firms are controlled and operated, the rules and practices that govern the relationship between managers and shareholders, and the overall process by which investment capital is allocated – has become an important issue for policymakers and scholars in recent years in the wake of financial scandals both in Europe and in the United States (Coffee, 1999, 2002, 2005; Shinn and Gourevitch, 2002). The 2008 financial crisis, and the two preceding decades prior to its occurrence, has highlighted the shortcomings associated with unbridled pursuit of shareholder value as the guiding star for listed companies in the United States. In the context of the heightened influence of institutional investors, some of them largely unregulated, such as hedge funds, the strategy of corporations has essentially been oriented toward financial objectives (market valuation) with little consideration for the interests of stakeholders – most notably employees. The creation of shareholder value in the form of share price appreciation is seen as a reflection of the quality of corporate executives, the latter group being increasingly compensated through variable pay such as stock options (Davis, 2009). In addition to the neglect of the interests of employees, the focus on shareholder value has incentivized corporate executives to develop a short-term focus that has sometimes resulted in earnings manipulation designed to create an earnings spike (Coffee, 2005: 202). What happens when these same institutional investors diversify their financial assets in settings traditionally not open to the concept of shareholder value? I investigate in this book the evolution of corporate governance in the wake of increased capital mobility in the form of portfolio investment in France and Germany – two settings previously insulated from strategic investments by Anglo-American shareholder value-oriented institutional investors (Achleitner et al., 2010; Dafsaliens, various years).

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Contingent Capital

I focus on the investment allocation of two categories of impatient short-term oriented investors, namely hedge funds and actively mutual funds from the United Kingdom and the United States. The empirical evidence on the investment allocation of short-term, impatient investors highlights the greater attractiveness of French blue-chip companies over their German counterparts in a ratio of 2 to 1. What are the causes of this disparity in investment allocation of short-term-oriented investors and what are the consequences for the French and German model of capitalist economies? These apparently narrow empirical questions entail crucial political issues and also constitute important inquiries for research methods. The argument presented in this book builds on an impressive literature that emphasizes the importance of institutions in defining the scope and nature of new problems (Locke and Thelen, 1995), its impact on the process of preference formation of actors (Berger, 1981; Hall, 2010a), and its structuring influence on the process of interactions between actors (Hall, 1986: 19). More specifically, I argue that the firm-level institutional arrangements of workplace organization in France and Germany provides important insights to account for the divergence in the investment allocation of short-term investors. Hedge funds and actively managed mutual funds possess a short-term horizon and high incentives to maximize the value of their portfolio. The content and speed by which portfolio companies implement strategies of shareholder value matter to them. The issue is not about shareholder value per se, but rather concerns the presence of impatient investors aiming at portfolio companies implementing short-term oriented strategies designed to boost their market capitalization and/or secure the release of dividend payments (Clark and Wojcik, 2007; Brav et al., 2008; Klein and Zur, 2009; see also the discussion in Chapter 5). The Varieties of Capitalism (VoC) perspective offers important insights on this question. The institutional basis for the coordination of activities at the firm-level in the two countries differs substantially (Soskice, 1999; Hall and Soskice, 2001).1 The attractiveness of French companies lies in the concentration of power in the CEO that, in turn, allows for a rapid reorganization of the workplace under the guidance of a small number of corporate officials. The decision-making process of large French firms is management-led with the exclusion of the workforce

1 See Culpepper (1999, 2003), Hancke´ (2002), Woywode (2002), Whitley (2003), Sorge (2005), and Goyer (2006a) for an institutional perspective on the organization of work in France and Germany and the impact of this on the process by which firms coordinate their activities. To provide for a comparative-longitudinal perspective, see also Gallie (1983), Maurice et al. (1986), Thelen (1991), Soskice (1994), and Boyer (1995).

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Introduction

from important aspects of the decision-making process. The investment strategies of hedge funds and actively managed mutual funds, in contrast, do not fit well with the firm-level institutions found in Germany. Firm-level institutions impose several constraints on the ability of management to develop and implement strategies in a unilateral fashion. The process of adjustment to external pressures in Germany is the result of negotiation between management and employee representatives as several legal obstacles stand in the way of a rapid and unilateral reorganization of the shop floor. Nonetheless, and despite the statement that institutions matter, the role of institutional analyses remains in some ways undetermined in social sciences for several factors. How do institutional arrangements affect corporate governance outcomes? Institutional analyses of comparative corporate governance raise many issues also found in other areas of the social sciences. The focus of many corporate governance inquiries might be specific to particular subfields – determinants of ownership structures, legal protection of minority shareholders, impact of the market for corporate control, and many others – but questions and insights about the role of institutions are present across disciplinary boundaries. Three key debates stand prominently in social science discussions with significant implications for the argument presented in this book. The first one concerns the extent to which scholars assign analytical primacy to institutions. This debate often pits institutionally based versus interest-oriented theoretical perspectives. The first group highlights the ways in which differences in national institutional arrangements result in different trajectories regarding patterns of policymaking, economic performance, and clusters of innovative specialization (Soskice, 1999; Whitley, 1999; Hall and Soskice, 2001). Institutions matter because they independently shape the distribution of power among social actors (Berger, 1981; Hall, 1986; see also Moe, 2005). The second group, in contrast, emphasizes how institutions reflect something perceived to be deeper in society – the usual suspect being the underlying distribution of power among groups (Pontusson, 1995; Howell, 2003). These critiques of institutional perspectives point to two alternative scenarios that lessen the importance of institutions: coalitional and policy realignments can take place within stable institutions, and institutions themselves become the objects of struggle if they are so influential over outcomes (see e.g. Gourevitch, 1977, 1986, 1999). A second debate concerns the nature of interaction of institutions with other features. Scholars working from an institutional perspective rarely advance the notion that only institutions matter for outcomes. For some, institutions are mid-level variables (as distinct from macrostructures) 3

Contingent Capital

that act as a midrange theory (Thelen and Steinmo, 1992; see also Merton, 1968). For instance, Katzenstein (1977) analyzes how variations in institutional frameworks provided for divergent political responses to the changes in the world economy in the 1970s – but does not seek to account for the origins of these important macro changes. Institutions are highly important at a given analytical level and, moreover, refract the impact that results from the occurrence of external developments. For others, institutions are part of a phenomenon of complex causation whereby an outcome results from potentially different combinations of conditions (Ragin, 1987; Mahoney, 2004). A third source of debate is methodological and takes two forms. First, the dichotomy between institutional-based and interest-oriented theoretical perspectives often entails specific research design choices that mirror the other perspective’s approach. Institutionally oriented researchers hold preferences constant with the aim of showing how changing institutions produce different outcomes. Interest-driven scholars, on the other hand, hold institutions constant to show how changing interests lead to different results. A problem with this often necessary but incomplete ploy is that both institutions and interests can be changing – that is, nothing is constant (Gourevitch, 1999; see also Frieden, 1999). Moreover, this methodological ploy neglects the importance of causal complexity whereby outcomes result from the intersection of variables. Second, the presence of change (or stability) of institutional frameworks is riddled with problems of assessment. For instance, the occurrence of institutional change is not always interpreted as leading to behavioral change. Comparative political economy scholars increasingly distinguish between institutional change that does not affect the process by which firms coordinate their activities versus institutional transformation that implies a transformation of coordination (Culpepper, 2005; Goyer, 2006a; Hall, 2007; Hall and Thelen, 2009; see also Sorge, 2005: 142–83). Distinguishing between radical and incremental institutional change becomes crucial (Campbell, 2004; Hall, 2010a; see also Deeg, 2001, 2005b). On the other hand, the presence of institutional stability can be associated with substantial modifications in the behavior of actors. The occurrence of functional conversion – whereby institutions are redirected to new purposes in the presence of formal institutional stability – complicates analytical inquiries (Gilson, 2001; Thelen, 2003, 2004). The practice associated with an institution can change without a corresponding transformation in its formal structure. The above overview of the debates surrounding institutional analyses in contemporary capitalism points to the difficulties in assessing how 4

Introduction

institutions matter for corporate governance outcomes. Should one attempt to account for institutional variation across national systems of corporate governance? Or, in contrast, should the analytical focus revolve around differences in corporate governance outcomes among advanced capitalist economies? Important political questions lie beneath these methodological questions. For some authors, the process of piecemeal-incremental institutional change reflects the strategic behavior of actors seeking to erode the existing functions of institutions rather than to abolish their formal existence (Hyman, 2001; Streeck, 2008; see also Crouch, 2004). Why, this behavior suggests, aim for a full confrontation if the achievement of one’s goal could result from incremental changes? However, institutional change is often full-scale as illustrated by the removal of control on capital flows – an important stimulus for the research question of this book (Abdelal, 2007; see also Berger, 2003, 2010). The ability of actors to aim for full-scale institutional change is often contingent upon the visibility and politicization of issues (Culpepper, 2010). Actors are more likely to seek institutional change if important issues are under the political and social radar.2 Thus, the nature and role of institutions do not lend themselves to a single viewpoint. Inquiries highlighting the importance of institutions should also avoid inferring a mechanical relationship between institutional stability/change and outcomes. These issues are important in the assessment of the meaning and extent of convergence across national VoC (Gourevitch, 2003b: 328). To overcome these conceptual and methodological issues, this introductory chapter is organized in the following manner. First, I present the theoretical foundations of politically inspired institutional analyses on comparative corporate governance. I proceed to review their contributions to the analysis of diversity in both institutional arrangements and outcomes across national systems of corporate governance. These approaches are also characterized by substantial internal diversity as regard the role of institutions – thereby increasing the analytical variety of inquiries. Second, I present the main argument of the book which is organized in three interrelated blocks: institutional diversity and the settlements of conflict, hierarchical character of institutional variables that are part of a process of complex causation, and the importance of context. The first building block highlights the importance of historical developments characterized by location-specific settlements of conflict negotiated 2 Full-scale institutional change is also the result of the specifics of the settlements of conflicts negotiated in different advanced capitalist economies and constitutes an important theme for the study of comparative corporate governance (see Roe, 2000, 2003).

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Contingent Capital

across advanced capitalist economies (Hall, 1984, 1986; see also Berger, 1979; Gourevitch, 1986; Roe and Gilson, 1999). The process of incorporating socialist parties into the democratic liberal frame, the reconciliation of organized labor to the capitalist mode of accumulation, the entry of women into the labor force, the higher sets of expectations of the electorate, the transition to a service-based sector economy, and the normalization of religion constitute the major challenges faced by advanced capitalist economies (Berger, 1985; Hall, 1999; Iversen and Wren, 1998; Kepel, 2004). Moreover, the content and the extent to which these important sources of conflicts are settled exhibit significant differences among advanced capitalist economies. As a result, international and domestic developments do not translate into common pressures for actors (countries, firms, policymakers, trade unions). Diversity in pressure intensity reflects substantial differences in institutional starting points as well as the fact that the practices and behavior that follow from these institutional frameworks carry different meanings – two features inherent in the settlements of political conflict (Thelen, 1993; Locke and Thelen, 1995; see also Kogut et al., 2002). In particular, I investigate the construction of the distribution of authority inside French and German companies that, in turn, proved crucial in terms of their attractiveness to short-term-oriented institutional investors. The investigation focuses on the choices of French labor organizations to rely on the state in order to achieve their objectives versus the commitment of German trade unions to securing full participation in economic decision-making. The second building block of the argument presented in this book highlights the hierarchical character of institutional variables in mediating the impact of external (and internal) developments on the evolution of advanced capitalist economies. Qualitative studies in social sciences (small-N) are increasingly geared toward an understanding of causation in terms of necessary, sufficient, and insufficient but necessary parts of a condition which is itself unnecessary but sufficient for the result (Mackie, 1965; Lieberson, 1985, 1991; Ragin, 1987; Mahoney, 2004, 2008). Important political, economic, and social outcomes are rarely generated by the presence of one cause alone; they occur as the result of specific intersections of conditions (Hall, 2010a).3 The study of social

3 The presence of complexity makes it no easy task to identify the decisive causal causation, thus the methodological importance of the increasing sophistication in the design of techniques by which cases can be divided into sets according to their values on the studied dependent variable. For instance, the use of Boolean algebra and the development of a “fuzzy-set” approach have been crucial in the reduction of significant amounts of

6

Introduction

phenomena is almost invariably characterized by complexity and attempts at presenting a single-variable explanation are bound to disappoint. Nonetheless, the notion of causal complexity should not obscure the fact that some (institutional) variables are more influential on outcomes than others (Goldthorpe, 1997). The relative weight of different institutional arrangements constitutes part of an intersection of conditions that generate a specific outcome and this remains an important issue that has not been tackled in qualitative research.4 As a result, the importance of different paths of conflict settlements across advanced capitalist economies entails that what is necessary and/or sufficient in one setting will not be a causal variable in another. The diversity of institutional arrangements across advanced capitalist economies reflects context-specific settlements of political and social conflicts, thereby highlighting that radical change entails “capturing” different sets of institutions across time and space (Thelen, 1993; Gourevitch, 1999; Amable, 2003; Hall, 2010a).5 The early work of Katzenstein (1977) illustrates how new developments are mediated by domestic institutional frameworks. The notion of hierarchy presented in this book highlights the fact that not every single institution in the economy will contribute equally to this process of refraction. I investigate how and why certain causal variables are more important than others even if the logical inference of my argument relies on the notion of causal complexity. In other words, phenomena of complex causation are characterized by hierarchy in the causal effects of institutional variables. Third, and following on from the previous point, I argue that the contribution of the hierarchically superior causal variable in a process of complex causation lies at two levels. The first one is that the hierarchically superior causal variable increases the likelihood of the outcome. The presence of the hierarchically superior causal variable directly acts upon the dependent variable and thus should be referred to as a cause. The second level at which the hierarchically superior causal variable operates is through the provision of the context for assessing the impact of other causal variables on the studied variable/research question The context (C) influences the relationship between other hypothesized independent variables (x1, x2, . . . , xN) and the dependent variable (Y) (Goertz, 1994). The hierarchically superior causal variable

information to manageable levels (Ragin, 1987, 2000). See also Kogut and Ragin (2006) for an analysis of legal institutional arrangements of corporate governance with Boolean algebra. 4

For an exception, see Goertz (2006). See also Deeg (2001, 2005b) and Campbell (2004) for subtle analyses of the differences between radical and incremental change. 5

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Contingent Capital

influences whether other hypothesized independent variables generate the outcome of interest on the dependent variable. An important implication of this is that the relationships between variables will differ across settings/time – but not in a capricious manner. For instance, x1 appears to constitute a necessary and sufficient/sufficient/necessary causal variable for the dependent variable in situation A/point T, but not in situation B/point T+1. Should one conclude that it is pointless to attempt at inferring a causal relationship between x1 and Y on the basis that the hypothesized relationship between the two variables exhibits variation across settings/time? The issue is that what is often an important factor lies in the background in the form of context (Mackie, 1965; Goertz, 1994). The context (C) does not contribute to the value taken by other hypothesized independent variables (x1, x2, . . . , xN), but rather impact on the nature of the interaction between these other hypothesized independent variables and the dependent variable (Y). The context embodies the notion of hierarchy and influences the relationship between other variables among themselves – for example, positive relationship between x1 and Y in one setting but not in another. Thus, the study of the interaction between a hypothesized causal variable (x1, x2, . . . , xN) and the dependent variable do not necessarily result in the occurrence of the outcome of interest since it is contextually bounded by the hierarchically superior causal variable (see e.g. Falleti and Lynch, 2009). Instead, the causation resides in the influence of the context on the interaction between the hypothesized independent variables and dependent variables. In turn, the presence of contexts – which are the result of historically and location-specific settlements of conflict – entails important methodological implications for the analysis of change. The institutional hierarchy inherent in context makes some types of changes more feasible than others – thereby providing a healthy warning against the illusion of differences (see e.g. Ragin, 1987: 44–9). The nature and degree of institutional change has been impressive across advanced capitalist economies, but how do we distinguish between radical versus incremental change? (Campbell, 2004; see also Deeg, 2001, 2005b). A key insight of this book is that one must distinguish between the character of coordination and the institutional framework that supports it (Hall, 2007; Hall and Thelen, 2009; see also Goyer, 2006a). Change in the latter does not entail a modification in the former. The sustainability of national models of corporate governance and capitalism cannot rest on the total absence of institutional change (Thelen, 2004). The hierarchically superior causal variable matters in two ways: it directly impacts on the value taken by 8

Introduction

the dependent variable; and it shapes how other hypothesized independent variables themselves impact on the dependent variable. For the argument presented in this book, the hierarchically superior causal variable is operationalized in the form of the institutional arrangements of workplace organization identified by the VoC perspective. Differences in the distribution of power at the firm-level, as embodied by the institutional arrangements of workplace organization, impact on the investment allocation of institutional investors. Shortterm-oriented fund managers prefer firms governed by a small group of top executives with significant concentration of power around them since it is easier to implement strategies of shareholder value in a quick fashion (Rebe´rioux, 2002; Goyer, 2006a). Portfolio firms with many stakeholders are less attractive given the short-time horizon of this category of institutional investors. Moreover, the arrangements of workplace organization identified by the VoC perspective also serve as the institutional context (C) that impacts on the nature of the interaction between other hypothesized causal variables and the dependent variable. More specifically, I focus on the extent to which legal–institutional arrangements result in greater protection for minority shareholders. The other hypothesized independent variable in this study is the legal protection of minority shareholders as emphasized in the law and economics literature, and the dependent variable is whether or not French and German companies are targeted by short-term investors. The second contribution of the hierarchically superior causal variable (the institutional arrangements of workplace organization) lies in providing the context that shapes the relationship between the legal protection for minority shareholders and the investment allocation of short-term investors. The presence of ownership diffusion constitutes the most important and determining factor for the law and economics perspective in terms of being targeted by short-term investors (see e.g. Shleifer and Vishny, 1997; LaPorta et al., 2000; Coffee, 2005). However, the relationship between ownership dispersion and investment allocation of short-term investors differs across the two cases: it is positive in France since the quasi-totality of companies with ownership diffusion has been targeted by short-term investors; it is weaker in Germany given that several corporations with ownership diffusion have not been targeted by these same impatient investors. The variation in the relationship across space highlights the importance of domestic firm-level institutional contexts. The disappearance of large shareholders in France constitutes the removal of the last stumbling block for the implementation of short-term-oriented strategies of shareholder value given the concentration of power in top 9

Contingent Capital

management. By contrast, the strength of organized labor at the firmlevel in Germany explains why the removal of large blockholders inside companies does not result in managerial autonomy to quickly implement strategies of shareholder value. This autonomy is blocked by the strength of organized labor at the firm-level. The VoC institutional context influences the nature of the relationship between variables. The same variable – the emergence of ownership diffusion – has different effects in two nonliberal market but institutionally distinctive economies, namely France and Germany. Thus, politics matters but in a very specific and asymmetric manner. Politics is reflected in the settlements of conflict across advanced capitalist economies that are translated into specific institutional arrangements. However, the importance of the contribution of politics to institutional origins varies tremendously across issue areas. Politics might not be overbearing in the sense that the values taken by institutions in one area do not impact on the value of institutional arrangements in other spheres of the economy. Political dynamics are often different across issue areas and over time. Nonetheless, the institutional arrangements associated with the hierarchically superior causal variable (i.e., the context) mediate the relationship between institutions in other spheres of the economy and on the value taken by the dependent variable. As a result, the influence of politics over the institutional content of the hierarchically superior causal variable is more important than the influence of politics over the constitution of the institutional configuration of other causal variables. The mobilization of groups over political and social questions results in different outcomes across issue areas and over time.

1.1 Politics and Institutional Diversity in Corporate Governance How do institutional arrangements shape corporate governance outcomes? What institutional factors account for the disparities in the investment allocation of short-term-oriented institutional investors in France and Germany? Early studies of corporate governance focused on the divergence of interests between the principal and the agent (Berle and Means, 1932; Jensen and Meckling, 1976; Fama and Jensen, 1983). The key idea is that unmonitored managers will pursue goals that are not in the interests of shareholders – ranging from actions that allow them to profit personally (embezzlement, misappropriations) to empire building. Compounding this problem of agency is the issue of free riding whereby a 10

Introduction

shareholder owning a small amount of stocks possesses no incentive to monitor corporate executives, and the impossibility of predicting all future contingencies that results in the inability of dispersed shareholders to write complete contracts that would serve as a constraint on the behavior of corporate executives (Grossman and Hart, 1981). Thus, the focus of early law and economics studies was organized around a puzzle – namely why would minority investors provide funding to companies run by unaccountable, dominant managers. The answer provided was that inefficient firms would be punished in financial and product markets if they deviated for profit maximization and efficiency-based norms, thereby providing corporate executives, shareholders, and other actors with incentives to design institutions aimed at reducing agency costs (for a critical analysis, see Davis, 2005). Notwithstanding the functionalist bias of these early law and economics analyses of corporate governance, a second problem proved to be more important. Empirically, the separation of ownership and control does not constitute a universal proposition. In many countries, ownership is highly concentrated thereby exposing the lack of comparative focus of the early studies of corporate governance in law and economics. In such settings, the controlling shareholder has both the incentive and the power to discipline management (Morck et al., 1988). The main issue in ownership-concentrated systems of corporate governance concerns the divergence of interests between the controlling shareholder and minority investors. The concentration of ownership, with its associated control over corporate policies, is valuable since the controlling shareholder is able to transfer value from the firm at the expense of minority shareholders – that is, the private benefits of control (Zingales, 1998). As a result, the field of law and economics underwent a major regeneration from the early 1990s onward with the aim of accounting for diversity in ownership structures across national systems of corporate governance. The core argument is that differences in ownership structures across national systems of corporate governance are accounted for by the extent to which legal–institutional arrangements protect minority investors from expropriation by managers or controlling shareholders (LaPorta et al., 2000). There are two types of agency costs: separation of ownership from control (ownership diffusion) and divergence of interests between the large owner and noncontrolling shareholders (ownership concentration) (see e.g. Coffee, 2005). The investigative starting point is that minority shareholders need assurance that they will get a return on their investment (Shleifer and Vishny, 1997). If legally unprotected, (potential) minority shareholders are 11

Contingent Capital

significantly less likely to invest in equities with the result that corporate ownership is dominated by large blockholders. The law and economics perspective has generated impressive empirical results whereby differences across national systems of corporate governance in regard to ownership structures, size and depth of securities markets, number of listed firms, dividend payments, and rates of IPO correlate with the extent to which legal–institutional arrangements protect minority shareholders (LaPorta et al., 1999, 2006). Nonetheless, the focus of the law and economics perspective on the rights of minority shareholders has been criticized on empirical and theoretical grounds. Empirically, changes in ownership structure across national systems of corporate governance have been more frequent over the course of the twentieth century as compared to the overall stability of legal systems especially viewed from the common law/civil law angle – thereby making it difficult to explain variation with a quasi-constant (Rajan and Zingales, 2003; Gourevitch and Shinn, 2005: 4–10; Morck, 2005; Herrigel, 2008a: 479–88; see also Aguilera and Williams, 2009). Theoretically, the importance of institutional arrangements in protecting the legal rights of minority shareholders does not cover every instance where corporate executives can destroy firm value even under the best-case scenario of American and British corporate law. Legal arrangements in these two countries, which are comparatively highly protective of the rights of minority shareholders, are insufficient to account for the presence of ownership dispersion. Corporate law is generally, although not always, effective at dealing with agency costs that take the form of diversion of value by executives (stealing, embezzling, and shirking) – but is largely unconnected to a second type of agency costs related to value destruction in the form of managerial mistakes (Roe, 2002). The issue is not one of a misfit between institutions and the type of agency costs faced by firms – but rather of the limits on the extent to which legal arrangements can cover every instance of shareholder value destruction in either concentrated or dispersed ownership settings. These shortcomings associated with the law and economics perspective have been addressed by political perspectives on corporate governance (Roe, 1993, 2003; Gourevitch and Shinn, 2005). Two political variants have been prominent. The first variant is associated with the groundbreaking work of Mark Roe (1993, 1999, 2000, 2003; see also Roe and Gilson, 1999). His core argument is that the introduction of legal– institutional arrangements of corporate governance protective of the rights of minority shareholders is not driven by concerns related to agency costs and economic efficiency. Instead, a myriad political and societal concerns stand out prominently in accounting for institutional 12

Introduction

diversity across national systems of corporate governance. The presence of diversity of institutional arrangements represents the outcome of political, social, and economic struggles specific to countries and cannot be reduced to efficiency considerations. An underlying assumption is that the law and economics perspective overlooks a key first-order condition for financial markets to develop and ownership to become dispersed – namely the political legitimacy of capitalist economic arrangements (Roe, 1998). Therefore, differences in ownership structures reflect the extent to which the political climate and orientation of a polity is conducive to the pursuit of market-oriented policies. In systems of corporate governance characterized by ownership concentration, governments have traditionally emphasized distributional considerations that privileged employees over shareholders – such as those occurring in postwar European social democracies and in Japan. The outcome is one whereby employees benefit from a greater degree of protection from the shareholder value-enhancing measures that minority stockholders (and managers) would like to implement such as proceeding to significant layoffs. Social democracies make it harder for corporate executives to pursue unbridled shareholder value strategies with the upshot that minority shareholders shied away. The obvious implication of Roe’s argument is that the main reason accounting for the reluctance of minority shareholders to invest on stock markets is not primarily driven by issues of managerial opportunism or self-dealing by the controlling shareholder, but by an antecedent factor. The political environment of social democracies constrains the range of actions of corporate executives and induces them to implement alternative strategies to the maximization of shareholder value. The institutional arrangements related to the protection of minority shareholders are not sufficient to explain the diversity of corporate governance. The presence of legal arrangements protective of minority shareholders sometimes result in ownership dispersion, but not in all countries (Roe, 2002). In fact, Gourevitch and Shinn (2005) found a closer correlation between ownership structures and the institutions of VoC – of which legal arrangements to protect the rights of minority shareholders only constitute one institutional subset – than between ownership structures and legal protections for minority shareholders (see also Culpepper, 2005). The analysis of Mark Roe carries two important assumptions for the role of institutions in corporate governance. The first one is that institutions are secondary to politics. The absence of institutional arrangements that would protect the rights and promote the interests of minority shareholders in advanced capitalist economies cannot be 13

Contingent Capital

attributed to technological shortcomings or financial issues (Roe, 2002). The political climate in European social democracies and Japan militates against the introduction of specific strategies of shareholder value whose distributional consequences would negatively affect employees and other stakeholders.6 The second implication is that the presence of institutional variation within families of corporate governance is not central to the argument (Roe, 2003: 27–46). The presence of ownership concentration, or ownership diffusion, can be achieved in a number of ways. The politics of corporate governance in Germany resulted in formal institutional arrangements, namely Codetermination. In France, political settlements provided for a strong role for the state in the regulation of economic outcomes. In Japan, informal arrangements and social norms protect core employees of large firms against market fluctuations. Nonetheless, the presence of varieties in institutional arrangements in these three countries should not mask the concentration of corporate ownership that results from a political environment that deters minority shareholders from investing on the stock market. The groundbreaking work of Mark Roe has substantially contributed to our understanding of major issues in comparative corporate governance. The politically influenced institutional differences in the authority structure of firms result in important consequences for the allocation of resources in the economy. It is no wonder, then, that politics should be intimately linked to the study of corporate governance. Nonetheless, and despite its theoretical elegance, the conceptualization of politics in Roe’s presentation has been challenged on two grounds. Politics is immensely important, but what form does politics take and what is the resulting impact on corporate governance? The first issue regarding Roe’s conceptualization of politics concerns the nature of the process of coalition formation. The model is essentially one of class conflict, namely workers against an alliance of managers and owners. The interests of employees prevail in the social democracies of mainland Europe, the capitalist alliance of corporate executives, and shareholders’ triumphs in liberal America and Britain. However, this coalition scenario represents one potential outcome – the other two coalition lineups being sectoral conflict (managers and workers vs. owners) and property and voice conflict (owners and shareholders vs. managers) (Gourevitch,

6 In developing economies, by contrast, financial and technical issues – as well as politics – militate against such institutional innovations (Roe, 2002, 2003). Conversely, the presence of shareholder value-enhancing institutions in dispersed ownership economies reflect the prior acceptance of market principles that privileges, or does not discriminate against, the preferences of minority shareholders.

14

Introduction

2003a; Gourevitch and Shinn, 2005).7 In particular, the presence of cross-class coalitions in continental Europe was often critical in the development of welfare state policies and arrangements of labor market rigidities that, in turn, made it attractive for firms to develop strategies devoid of shareholder value orientation (Swenson, 2002; Mares, 2003 ).8 The second set of criticism of Roe’s social democratic thesis deals with the specific content of conflict settlement and forms the core of the argument of this book. The importance of political, social, and economic struggles in the introduction of institutional arrangements of corporate governance is paramount and cannot be denied – but nonetheless constitutes a too broad category to capture the evolution of national systems of corporate governance. For Roe, the specific content of how settlements of conflict are negotiated and become the basis for the institutional diversity across national systems of corporate governance represents a second-order variable. The notion of functional equivalence stands prominently in the social democratic thesis: the importance of social democratic values in the first postwar decades translated into codetermination in Germany and into state activism (dirigisme) in France – with the ultimate outcomes being highly concentrated ownership and strategies of shareholder value shunned. Nonetheless, the introduction of strategies of shareholder value has taken place in the two countries in the last fifteen years (Hoepner, 2001; Fiss and Zajac, 2004; Djelic and Zarlowski, 2005; Fiss, 2006; Goyer, 2006b). How, then, could we assess the consequences associated with the introduction of strategies of shareholder value in France and Germany? These two economies have experienced significant liberalizing measures in the last twenty-five years (Djelic and Zarlowski, 2005; Streeck, 2008). Nonetheless, the impact of economic liberalization, trade integration, exchange rate stability, and capital mobility across borders on France and Germany has been uneven. Specific patterns of conflict settlement prior to the introduction of shareholder value are important for understanding the evolution of corporate governance in the two countries. In France, the advent of the above liberalizing measures have been associated with a specific pattern by which shareholder value was introduced – namely through the one-sided unilateral imposition of managerial power over the implementation of flexibility and other strategic measures in the workplace (Hancke´, 2002; Goyer and

7 See also Aguilera and Jackson (2003) for an analysis of coalitions in corporate governance from a sociological perspective. 8 Sectors – such as export vs. public sector employees – constitute an increasingly important source of cleavages in continental Europe (see e.g. Pontusson and Swenson, 1996).

15

Contingent Capital

Hancke´, 2005; Goyer, 2006b). Strong and extensive legal rights of firmlevel works councils were not developed in France since the state exercised a preponderant influence over securing outcomes (Hall, 1986: 131– 191; Sellier and Silvestre, 1986; see also Levy, 1999; Howell, 2006). At the firm-level, the skills of the bulk of the blue-collar workforce were both limited and narrow, thereby limiting managerial incentives to implement strategies of adjustment through negotiations (Maurice et al., 1986; Sorge, 1991). In other words, the previous absence of shareholder value in France highlighted the importance of politics mixed with the exclusion of the workforce in the governance of corporations. An important unintended outcome of the ability of French top executives to restructure the firm in a quasi-unilateral fashion is explored in this book – namely the relative importance of the arrival of short-term institutional investors, such as hedge funds and actively managed mutual funds (Goyer, 2006a, 2007).9 In Germany, in contrast, firm-level institutions impose numerous constraints on the ability of management to develop and implement strategies in a unilateral fashion (Muller-Jentsch, 2003). Several legal obstacles stand in the way of a rapid and unilateral reorganization of the shop floor, so that the introduction of strategies of shareholder value has been the result of negotiation between management and employee representatives (Thelen, 1991; Hoepner, 2001; Vitols, 2004; Sorge, 2005).10 These differences in the introduction of shareholder value strategies reflect the specific content by which settlements of conflict were negotiated in the two countries – and institutional arrangements of work organization were set up – in the high days of social democracy (see also Crouch, 1993). The reliance on the state in France left firm-level unions ill-prepared for the advent of economic liberalization (Howell, 1992); the strength of works councils in Germany, in contrast, is contingent on the combination of legal rights and on their contribution by which firms develop their innovative capabilities (Markovits and Allen, 1984; Thelen, 1991; O’Sullivan, 2000; Whitley, 2002). A second variant of the political perspective on corporate governance focuses on the enlargement of the range of coalitional possibilities (Gourevitch and Shinn, 2005). This political variant is built around the interaction of economic preferences and political institutions. On the side of preferences, actors could choose different types of coalitions – class, sectoral, and property and voice coalitions – to pursue their

9 See also Morin (1998) and Clift (2004) for analyses of the role of foreign institutional investors in French corporate governance. 10 See Bo¨rsch (2007) for an analysis of foreign institutional investors in German corporate governance.

16

Introduction

objectives. Gourevitch and Shinn provide a three-actors coalitional model. The preferences of actors are not monolithic – thereby enlarging the coalitional possibilities. Each group of actors can stress different objectives by making different coalitions with one of the other factions. Shareholders have two coalition options: minimization of agency costs arising from managerial shirking that affect the competitive position of the firm – a shared preference with workers; and resentment over government legislation that would restrict the ability of corporate executives to pursue an extensive range of shareholder value strategies – a shared preference with managers. Employees have also two coalition options: job security that could be threatened by the implementation of strategies of shareholder value thereby favoring an alliance with management; and suspicions of managerial entrenchment that would lead to affect the competitiveness of the firm and/or affect the value of their pension fund via its effects on the stock market capitalization of the firm in retirement systems based on capitalization, thereby inducing a coalition with shareholders. Finally, managers are concerned about two scenarios that could threaten their autonomy: shareholder activism regarding the processes by which they run the firm, and workers’ claims over the control of the firms’ cash flow rights. The next step in the Gourevitch–Shinn model consists in linking coalition formation with institutions. The process of preference formation is not contingent solely upon the dynamics of negotiation among these three actors. The preferences of actors are insufficient to result into coalition formation. Something is missing from this conceptualization – namely institutions. The translation of preferences into policy outputs necessitates an analysis of prevailing institutional configurations (Garrett and Lange, 1995). The process of coalition formation depends on institutional frameworks since it is they which shape the range of possible outcomes. On the side of political institutions, therefore, Gourevitch and Shinn distinguish between majoritarian/first-past-the-post systems and consensus/proportional representation systems. In majoritarian systems, the occurrence of small shifts of votes can translate into a substantial impact on public policy. A single party is more likely to be in control of the executive and legislative branches since single-member districts are won by a plurality of the votes. In consensus systems, small shifts of vote have little impact on public policy. The electoral system rewards political parties in proportion to the votes they received – usually with a threshold of 5 percent. The importance of the different institutions of political systems lies in their degree of impact on the ability of actors to issue credible commitments. Consensus political systems enable actors to make credible commitment to each other 17

Contingent Capital

since they know that public policy outcomes are unlikely to change dramatically. The ability to issue credible commitments is essential for the sustainability of institutional arrangements in coordinated market economies whereby the coordination of firm activities rests on a high degree of interdependence among various actors (Hall and Soskice, 2001). Extensive spillovers in specific innovation niches require the inclusion of stakeholders in the development of the innovative capabilities of firms (Tylecote and Visintin, 2008; see also O’Sullivan, 2000). The possibility of developing a long-term, interactive relationship with other actors in the firm constitutes a crucial factor for employer and employee investment in the development of firm/sector-specific skills (Estevez-Abe et al., 2001; Culpepper, 2003). Majoritarian political systems, in contrast, encourage the formation of institutional frameworks in liberal market economies that reward actors that can adjust quickly to take advantage of market shifts (Soskice, 2007). The presence of a majoritarian political system makes it risky for actors to invest in specific skills and, therefore, contributes to the prominence of transferable skills (Hall and Soskice, 2001; see also Deakin et al., 2002). The outcome of the interaction between political institutions and preference aggregation via coalition making is the formation of different institutional VoCs in the areas of corporate governance, employment relations, skill formation, and interfirm relations. Firms coordinate their activities in different ways (Soskice, 1999; Hall and Soskice, 2001; Berger, 2006). The nature of firm coordination is shaped by the institutions found in the four above-mentioned spheres – which are themselves the product of politics – that is, the interaction between political institutions and preference aggregation via coalition making.11 The final element in the Gourevitch–Shinn political variant is that the differences in the VoC among advanced capitalist economies, in turn, translate into different ownership structures. The major institutional features of liberal market economies enable firms to take risks and to adjust quickly to shifts in demand through market-based mechanisms of coordination and, as a result, are also congruent with an exclusive focus on the interests of minority shareholders. In coordinated market economies, the institutional features of firm coordination build on the incorporation of the skills of the bulk of employees. The importance of issuing credible commitments to stakeholders implies different types of adjustment to shifts in market conditions compared to those in liberal market 11 In other words, institutional arrangements of corporate governance are shaped by the interaction between political institutions and preference formation via coalition formation and constitute one set of institutional variables that affect firm coordination.

18

Introduction

economies. The interests of minority shareholders do not enjoy a privileged status with the consequence that investments in equity markets do not constitute as attractive a proposition as in liberal market economies. The Gourevitch–Shinn political variant results into two models of corporate governance based on three dimensions. The first model is associated with coordinated market economies and is characterized by a consensus political system, coordinated market institutions in employment relations and innovation, and concentrated ownership. The second model is associated with liberal market economies and is characterized by a majoritarian political system, liberal market institutions in employment relations and innovation, and dispersed ownership. The Gourevitch–Shinn political variant is based on three methodological stages. The independent variable is the interaction between political institutions and the preferences of actors embedded in specific coalitions. The intervening variable is the types of institutional varieties from which firms coordinate their activities. The dependent variable is the structure of ownership of listed companies.12 This second variant of the political perspective significantly contributes to the study of institutional analysis in comparative corporate governance. In addition to stressing the importance of power and conflict in politics, as in Roe’s social democratic thesis, the analysis of Gourevitch–Shinn presents a sophisticated differentiation between and within categories of actors. The upshot of this finer-grained analysis is the enlargement of coalitional possibilities and the undetermined

12 Gourevitch and Shinn (2005: 23) also recognize the presence of potential feedback loops in their model. In particular, and building from the VoC perspective, they highlight how the presence of institutional complementarities can constitute an important – albeit not the sole – determinant for processes of institutional creation and change (see Hall, 2005, 2007). An important insight of the VoC perspective lies in its specification of the importance of interacting institutions between different institutional spheres. The impact of a single institution should not be seen in isolation since its effects are contingent upon the specifics of its interaction with other institutions. Its impact varies according to the national institutional configuration in which it is embedded with important implications for the assessment of endogenous/exogenous developments that resulted in piecemeal institutional change (Hall, 1994; Hall and Franzese, 1998; see also Hall and Gingerich, 2009). Thus, the institutional arrangements of the VoC-type matter – intervening variable in the original formulation – in the process of adjustment as actors often seek institutional and functional equivalents to preexisting forms of coordination with the implication that the direction of causality is reversed (see Hall and Thelen, 2009). Institutional arrangements influence preferences in a self-reinforcing manner. Actors in coordinated market economies have developed an interest in preserving the nature of their firm-specific skills that, in turn, reinforce commitments to training and in the stability of political institutions. A feedback loop can operate between the intervening variable (VoC institutional types) and the independent variable (interaction between preferences and institutional arrangements of political systems) (see e.g. Pierson, 1993).

19

Contingent Capital

nature of preferences as actors can stress different objectives by making bargains with different partners. Nonetheless, an issue remains potentially unsolved regarding the explanatory power of the second political variant. The direction of causality in Gourevitch–Shinn’s political variant could be expanded to incorporate notions of hierarchy and of context. The direction of causality is relatively straightforward in this political variant: the interaction between political institutions and the preferences of actors leads to different institutional arrangements in the spheres of corporate governance, industrial relations, and skill formation that, in turn, impact on the ownership structure of companies; alternatively, the institutional arrangements in the above-mentioned spheres can shape the preferences of actors in a process of feedback loop. However, the impact of one variable on others is not always as straightforward as presented in the Gourevitch–Shinn variant. The impact could vary according to the context – that is, it is not always constant (see e.g. Goertz, 1994). The context can influence the relationships between variables in a noncapricious manner. To preview the empirical evidence presented in Chapter 3, the growing ownership diffusion of companies translates into different consequences in France and Germany. Privatization, liberalization, the removal of barriers to capital mobility, and the strategy of international expansion of AngloAmerican institutional investors have all contributed to internationalize the ownership structure of French and German companies and, moreover, have led to increases in the free float of shares – albeit in an unequal manner across firms. But the impact of this development varies between France and Germany. All but one French company with dispersed ownership and a free float over 95 percent have been targeted by short-term-oriented institutional investors from the United Kingdom and the United States. By contrast, several equivalent German firms have not been targeted by short-term institutional investors. Why the contrast? The argument presented in this book highlights the importance of context and the hierarchical relationship between variables. In France, the decline of ownership concentration constitutes a major positive development toward the implementation of strategies of shareholder value that fit with the preferences of short-term-oriented investors. The concentration of power in the CEO and top management makes it easier for French firms to implement in a unilateral fashion strategies of shareholder value – a process facilitated by the relative weakness of organized labor. In Germany, in contrast, the growing diffusion of ownership is far from sufficient for the implementation of strategies of shareholder value as compared to France. The stronger position of organized labor entails a process of negotiation of the 20

Introduction

terms by which shareholder value is introduced (Hoepner, 2001; Deeg, 2005a, 2010).

1.2 Contextualized Capitalisms, Contingent Capital: The Argument The institutional argument presented in this book highlights the importance of three interrelated factors for the study of change with a specific focus on movements of concentrated short-term capital in French and German equities. These three elements are: the importance of historical developments that shape the settlements of conflict across advanced capitalist economies; the hierarchical character of the relationship among institutional variables in the process of causal complexity that characterize the evolution of national systems of corporate governance and that of political economies; and the importance of the institutional context through which change is mediated.

1.2.1 Historical Specificities of Conflict Settlements The first element emphasizes the specificity of important historical developments through which advanced capitalist economies settled important conflicts – the role of the state in maximizing economic growth while simultaneously distributing its benefits widely and minimizing economic dislocations, the reconciliation of the working class to private property and the capitalist mode of production, the management of the transition from a rural-based economy to one characterized by the dominance of the tertiary sector, the higher expectations of citizens with new sets of values, and the integration of religious forces into a liberal democratic framework being the most important issues confronted by policymakers (Berger and Piore, 1980; Berger, 1985; Gourevitch, 1986; Iversen and Wren, 1998; Roe, 1998; Hall, 1999; Kepel, 2004). The settlements of these conflicts, in turn, matters for corporate governance since the achievement of social peace constitutes a prerequisite for nations to generate economic wealth (Roe, 2003: 1–10). However, the process of securing social peace diverges across advanced capitalist economies given different historical developments around dissimilar struggles (Hall, 1984, 1986; see also Berger, 1979; Roe and Gilson, 1999). In regard to the topic of this book, I argue that the most critical source of conflict is related to the choices made by national labor organizations in France and Germany in regard to the nature of their participation in the strategic direction of the firm. 21

Contingent Capital

Institutional arrangements in the sphere of work organization, and within the context of two EU advanced capitalist economies, matter tremendously for the strategic direction of the firm in terms of corporate governance. The greater attractiveness of French firms to short-term investors relative to German corporations reflects the unequal distribution of authority between the two countries. French companies are characterized by the relatively greater concentration of power at the top of the managerial hierarchy that, in turn, makes it easier to implement strategies of shareholder value within a shorter time period and thus provides an excellent fit with the preferences of short-term investors (Rebe´rioux, 2002; Goyer, 2006a; see also Maurice et al., 1986; Sorge, 1991, 2005; Schmidt, 1996; Hancke´, 2002). German firms, in contrast, are characterized by the imposition of substantially greater institutional constraints on managerial autonomy as well as by the participation of the workforce in important aspects of the decision-making process (Maurice et al., 1986; Sorge, 1991, 2005; Thelen, 1991; Streeck, 1992; Muller-Jentsch, 2003). The greater diffusion of power inside German corporations, in turn, stands in the way of a rapid and unilateral reorganization of the firm and does not fit well with the preferences of shortterm investors (Rebe´rioux, 2002; Goyer, 2006a). The question then is why are these two systems of corporate governance characterized by such significant institutional differences in regard to the distribution of authority within companies. The different responses of trade unions and labor organizations in the first three postwar decades in France and Germany have been influential for the evolution of the distribution of authority in corporate governance. Differences in the strategic behavior of labor reflected the political and economic contexts in which they were embedded, the specific ideologies of trade unions, and the character of policymaking as it shaped the interaction between labor organizations and the state.13 In

13 I do not wish to argue that class conflict in France was driven exclusively by the political choices of trade unions. Postwar settlements between capital and labor, although characterized by different terms, constituted important means of class reconciliation in Austria, Britain, Germany, and Scandinavian countries. The French case, in contrast, is characterized by the absence of historical compromises in the immediate postwar decades (Howell, 1992: 37–60). Collective bargaining was not institutionalized until the late 1960s, the position of trade unions was legally weak at the firm-level, and leftish political parties were largely excluded from power until the early 1980s. Moreover, employers have shown a constant preference to maintain managerial authority inside the firm. Nonetheless, the position of French trade unions is interesting in two regards. First, it serves as an insightful point of comparison with Germany where trade unions encountered managerial hostility in the first ten to fifteen postwar years. The development of the coordinated character of the German economy did not emerge suddenly (Markovits and Allen, 1984; Thelen, 1991). Second, managerial hostility toward organized labor in France went

22

Introduction

France, trade unions have traditionally pursued, until the mid-late 1980s, a maximalist strategy characterized by the refusal to accept any form of responsibility in the strategic direction of companies and in the broader management of economic crises at the national level (Lange and Ross, 1982; Ross, 1982; see also Howell, 1992). Issues associated with the competitive strategy of companies, and the economic crisis at the national level, were seen as being resolvable only in the form of rupture with existing social and economic arrangements. Attempts to play any form of role in the management of firms were seen as being futile without broader socioeconomic changes. In the then French context of the first four postwar decades, this choice made by labor organizations translated into two strategies: promotion of the political fortunes of left-wing political parties, and, more importantly, in terms of lasting consequences, the reliance on the state for achieving specific labor market outcomes. First, both of the two largest French trade unions, the Communist-oriented CGT and Socialist-leaning CFDT, have devoted most of their efforts, at least until the mid-1980s, to promote the political success of the Left either as stand-alone organizations or as a joint force in the form of the Union de la Gauche in the 1970s. Their support for left-wing political parties was not limited to the ballot box, but was predominantly characterized by mass mobilization at the national level in the form of a series of periodic one-day strikes, especially, but not exclusively, from the early 1970s onward (Ross, 1982: 51–5). These massive tactical strikes were designed to deepen working class support for left-wing political parties and for specific measures – but they also served as a substitute for action at the firm level where labor organizations were weak (see below). Nonetheless, the ultimate aim of these mass public demonstrations went beyond the mobilization of rank-and-file members; they were meant to highlight that labor market actions constituted a temporary solution to the victory of the Left at the ballot box. The politicization of French industrial relations reflected the fact that the prime target of these rank-and-file movements was the government itself – a situation that made it more desirable as well as more difficult for French policymakers to scale back their interventionist apparatus (Hall, 1984: 41–2; Hall, 1986: 185–91; see also Levy, 1999). through cycles. Most notably, the post-May 1968 context witnessed the emergence of a reformist political class under Prime Minister Chalban-Delmas government which sought to provide greater legal rights to organized labor at the firm level (Howell, 1992: 111–41). The timing was poor as the two main trade unions – CFDT (Socialist-leaning) and the CGT (Communist-affiliated) – joined forces in the wake of the electoral alliance between the Socialists and Communists.

23

Contingent Capital

Second, labor organizations in France pursued a state strategy solution characterized by seeking intervention from policymakers to achieve labor market outcomes they could not achieve on their own (Ross, 1982: 1–16; Sellier and Silvestre, 1986). The state was not only the prime target of mass mobilization by trade unions, it was also the source of relief from labor market outcomes that eluded them due to their weakness at the shop floor level. The focus on capturing the state highlighted the specificity of the pattern of economic policies in France in the first four postwar decades that translated into important incentives for labor organizations to focus on the state. The distribution of power among groups implicit in the organization of capital, labor, and the state resulted in French policymakers having significant powers and interventionist tools – thereby highlighting the appeal of the state strategy solution (Hall, 1984). Following the economic stagnation of the Third Republic (1870–1940) characterized by a neutral but weak state which could do little more than observe profound cleavages (Hoffmann, 1963), the French economy embarked on a path of state-led growth (Hall, 1986: 139–91). Among the panoply of policy apparatus of the French state was a meritocratic set of elites in the civil service formed at state schools (ENA, Polytechnique) inculcated with a sense of strategic purpose and responsibility for the performance of the French economy, a Ministry of Finance (and Treasury) in charge of fiscal and monetary policy and with significant control over the actions of the central bank, and a system of indicative planning whereby resources could be allocated to sectors deemed crucial for the growth of the economy. Perhaps more important was the organization of the financial system that enabled policymakers to exercise significant influence over the allocation of funds (Zysman, 1983; see also Hall, 1984: 29–33). On the one hand, the French financial system was characterized by the heavy dependence of firms on debt credit (i.e., bank loans). The ratio of external sources of finance (debt/equity capital) was not only heavily tilted toward bank loans; the internal sources of finance (retained earnings) were limited, thereby distinguishing France from Germany – another bank-based economy (Mayer, 1988; Loriaux, 1991; Bertero, 1994; Corbett and Jenkinson, 1996). On the other hand, the state was able to gain preponderant influence over the banking sector as a result of several factors: the three largest banks had been nationalized after the war, several quasi-public financial institutions had specific mandates that fitted with the priorities of the state-led growth strategy, selective credit ceiling policies were implemented as a tool to contain inflation, and the central bank was extremely generous in its rediscounting policies in order to enable financial institutions to provide long-term loans to the 24

Introduction

industrial sector (Morin, 1974; Bellon, 1980; Loriaux, 1991; Goodman, 1992). The focus on the state could be interpreted as perfectly logical given the importance of the actions of policymakers over important outcomes. For instance, policymakers possessed significant leverage over resources that had an indirect and direct bearing on firm profitability: the workings of the financial system provided firms with external financial resources for investment projects; state policies in the areas of price controls, procurement policies, and exchange rates impacted directly on the balance sheet of companies (Levy, 1999: 234–92; see also SaintEtienne, 1996). The focus on capturing the state, even if trade unions aimed at a profound transformation of the French economy, was further incentivized with the consolidation of the political system under the Fifth Republic (Suleiman, 1978, 1994; see also Clift, 2008). The state strategy focus also fitted well with the ideological interpretation of the role of the state in the then specific French variety of capitalism. The political consolidation of the political system combined with the ability of policymakers to influence economic outcomes led trade unions, the Communist-oriented CGT in particular, to develop an interpretation of the French economy based on the Marxist “State Monopoly Capitalism” theory (Lange and Ross, 1982: 247–50). The state apparatus was, then, crucial to the mode of accumulation. Nonetheless, the state strategy solution, while it did bring at times some immediate benefits to trade unions, ultimately further weakened labor organizations at the firm-level. The first issue is that the politicization of French industrial relations took place at the expense of the labor market activities and firm-level capabilities of organized labor. French trade unions did not seek to build, and possibly extend, their influence over the shop floor. They rather sought to promote the electoral victory of left-wing-oriented political parties. The activities of labor organizations were geared toward the political arena for national symbolic and electoral purposes since the French capitalist economy was seen as impossible to reform in its current parameters with the consequence that “this process diverted the attention of workers upwards, away from the shop floor towards very general economic concerns, and outwards, towards politics. In essence, such a strategic course had the effect of undermining the capacities of rank-and-file workers at the point of production” (Ross, 1982: 54). The activities of trade unions at the level of the firm essentially focused on wage increases in order for employees to maintain their purchasing power (Linhart, 1991). Labor organizations were not interested in issues of training and skill of the workforce until the mid-1980s (Sellier and Silvestre, 1986: 203–7). They 25

Contingent Capital

rather relied on the rigid system of job classification as a source of protection against managerial intrusion. This strategic orientation took place in a context of weakness at the firm-level and was characterized by a rhetorical posture put in extremely general economic terms.14 The Communist-oriented CGT developed a “State Monopoly Capitalism” theory of the French economy with an assessment of the economy based on the French-specific state-centered mode of accumulation embodying its basic internal contradictions (see above). The Socialistleaning CFDT also couched its assessment of the French economy in Marxian vocabulary, but sought to promote workers’ control (autogestion) as a solution to the contradictions inherent in capitalism (Ross, 1982: 29–34). Nonetheless, the respective visions of both trade unions were highly abstract and removed from immediate issues related to the operation of the shop floor. They further contributed to the view that significant changes would come from outside the activities of the firm. The second issue with the state strategy solution is that the state is not a neutral actor in French industrial relations. The actions of policymakers contributed, although inadvertently at times, to the weakness of trade unions.15 The undertaking of some policies was meant to compensate for the relative weakness of trade unions at the firm-level. However, policymakers often preferred to undertake such policies themselves rather than providing labor organizations with the institutional/ legal/organizational capacities to perform them. French policymakers have been fearful of the consequences of unfettered market forces, but have also refrained from providing social partners, especially trade unions, with significant powers (Sellier and Silvestre, 1986; see also Levy, 1999). For instance, policymakers have sought to increase predictability at the workplace through the “most representative union” clause whereby contracts signed by one such union could be made compulsory for all employees within the firm or at the industrial level; and by giving large unions a monopoly on proposing candidates in the first round of elections for workers’ councils.16 The consequences of these policies have been unanticipated. The largest two trade unions (CGT, CFDT) have generally refrained from signing agreements partly out of ideological opposition while smaller, but still representative unions, have been

14 Moreover, the absence of institutionally sanctioned dues check-off procedures meant that the membership of trade unions fluctuated significantly and that members had to be constantly re-recruited thereby further weakening unions (Ross, 1982: 20). 15 See Sellier and Silvestre (1986) for an overview of this thesis. 16 A second round of elections for works councils in French firms is required only in the absence of a quorum – that is, where the total of votes cased in the first round is inferior to half of the registered eligible employees.

26

Introduction

more proactive and more involved in wage bargaining with employers. France’s largest two trade unions experienced a decline in legitimacy as well as a hold on seats on works councils as workers increasingly considered the actions of smaller unions (and of nonunion bodies) to be more realistic (Lange and Ross, 1982: 273–4; Sellier and Silvestre, 1986: 184–7; Goetschy and Rozenblatt, 1992). The ideological posture of the largest two trade unions has also been (inadvertently) encouraged by another state policy, namely the practice of legal enactment. The latter refers to the passage of legislation by the French parliament in the event of nonagreement on important issues at the national level – such as the level of unemployment compensation. The practice of legal enactment has often served as a substitute for the collective bargaining process but with the consequences of further driving away trade unions from assuming responsibility in the management of economic affairs at the firm level as well as sharpening the lack of incentives for workers to become union members (Sellier and Silvestre, 1986: 174–8).17 These examples highlight the importance of state autonomy in French industrial relations (see also Howell, 2006). I issue one final comment on the French case. The political maximalist strategy of trade unions has left profound imprints on the French political economy despite its abandonment since the mid1980s. The disillusionments associated with the Socialist experiment of the first Mitterrand government have brought into sharp relief the limitations associated with the state reliance strategy in terms of achieving market goals. Labor organizations have broadened their interests and have embraced firm-level goals – such as training. Nonetheless, the shift in political attitudes of labor organizations in France toward the state and the market has not led to the introduction of the nonmarket forms of coordination that are prevalent in coordinated market economies. The transformation of the French economy since the mid-1980s has been characterized by the growing importance of market mechanisms (Hall, 2006). This outcome is partly related to the timing of the transition process. Faced with ballooning budget deficits and the lack of competitiveness of domestic firms, policymakers chose to provide firms with greater strategic autonomy and reaffirmed their commitment to the European Monetary System rather than pursuing reflationary policies behind protected borders (Hall, 1986: 192–226).

17 The structural features of the minimum wage in France have also served as a substitute to the collective bargaining process in France. A significant proportion of wages in the French economy is linked to the minimum wage with the consequences that increases in the latter are also reflected in the remuneration of employees with higher salaries.

27

Contingent Capital

Moreover, French policymakers pursued a specific monetary policy based on the achievement of firm competiveness through disinflation (Lordon, 1998). High real interest rates and the disindexation of wages from prices were meant to enable French companies to underbid their rivals. The transformation of the French political economy is also deeply structural and extends beyond the characteristics of the mid-1980s context when policymakers had to orchestrate some form of strategy away from dirigisme. The context of the transition seriously constrained the ability of policymakers, but its importance has receded over time.18 An important structural issue standing in the way of the introduction of coordinated market mechanisms is the absence of institutional capacities by actors to engage in strategic relationships at various levels: employer associations are not able to target wavering firms with the provision of information that would convince them to invest in vocational training (Culpepper, 2003), regional governments do not possess the institutional capacities to encourage local actors to collaborate (Levy, 1999), business associations have periodically experienced internal conflict between large and small companies (Woll, 2005), and the ability of trade unions to serve as equal interlocutors inside companies had been inadvertently curtailed by state policies precisely designed to compensate for their weaknesses (Sellier and Silvestre, 1986). The development of mechanisms of strategic coordination constitutes a far more difficult task than the dismantlement of existing policies (Soskice, 1999). Moreover, the introduction of institutional arrangements in coordinated market economies has often been the result of fortunate events or was undertaken for radically different reasons than their current uses (see Thelen, 2003, 2004). The German case, in contrast, is characterized by significant differences in the strategic behavior of labor organizations embedded in historically specific political and economic contexts. The ideologies of trade unions, and the character of policymaking that shaped the interaction between labor organizations and the state, resulted in significant constraints on managerial autonomy regarding the distribution of authority at the firm-level. In the negotiation of the postwar settlement, German trade unions sought to extend control at the shop floor via the Codetermination system (Markovits and Allen, 1984; Thelen, 1991, 2004; Kotthoff, 1998). Labor organizations aimed at full participation in economic decision-making at the firm-level along nonpartisan and 18 For instance, French employers rediscovered in the mid-1990s the limits on their autonomy from the state with the introduction of the 35-hour week (Trumbull, 2002).

28

Introduction

industrial lines. The Weimar experience has been influential in two respects: the advent of formal political democracy and the focus on securing victory at the ballot box have not been sufficient for the full democratization of society; and divisions between competing, politically oriented union confederations weakened the labor movement as well as constituted a source of division at the plant level between employees with variations in skills. The post-1945 strategic choice of aiming at taking responsibilities for the management of the firm contrasted sharply with the decisions of British trade unions who conceptualized union power in the form of autonomy in the collective bargaining process (Bornstein and Gourevitch, 1984) as well as with the state-centered strategy of trade unions in France (Lange and Ross, 1982; Ross, 1982). However, the objective of seeking voice and influence at the shop floor level was initially framed within a much broader set of demands characterized by full participation in economic decision-making at all levels of society – not simply at the firm-level. Trade union leaders sought to transform relations between capital and labor not only through extensive legal rights at the firm-level but also via their involvement in state-orchestrated economic planning, socialization of key industries, and participation in national-based economic councils that would pursue employment friendly monetary policies (Markovits and Allen, 1984: 94–100). These objectives were not achieved. The postwar position of Germany in the international system strongly militated against the implementation of the most radical demands of labor unions. In countries where the electoral victory of the forces of the Left was credible, France and Italy, the policy of the United States in international monetary affairs was guided by the political goal of containing Soviet influence rather than imposing monetary discipline (Cohen, 1977; Loriaux, 1991). Germany was in no such position of autonomy: the Communist (and National-Socialist) party was banned and the Bundesbank was given significant independence. The point was not simply to impose penalties on Germany for its behavior in the international system but also to avoid a repeat experience of the inflationary explosion of the early 1920s. Moreover, postwar Germany was located at ground zero in the Cold War – thereby further highlighting its importance for the United States and the rest of Western Europe. The consequence was that the demands of German labor organizations were issued within a specific distribution of power among capital, labor, and the state (Hall, 1984, 1994). Policymaking in the German postwar settlement, and beyond on some issues, took place in a context characterized by the strict division over fiscal and monetary policy between the 29

Contingent Capital

Ministry of Finance and the Bundesbank, thereby limiting the incentives to “capture” the state.19 Labor organizations had to deal with the prominence of a deflationary bias within the central banks that, in an unintended manner, acted as a conducive factor for wage coordination (see Hall and Franzese, 1998). Nonetheless, German labor organizations were able to achieve success in the introduction of Codetermination – the detailed legalistic and overarching framework that has provided for the participation of employees in the strategy of the firm. The system of Codetermination operates at two levels: the representation of employees on the board of directors and the legal rights provided at the company level through the works councils. The 1976 law on Codetermination extends to equal representation for employees and shareholder-elected directors on the supervisory board – the previous legislation (Works Constitution Act of 1952) only assigning one-third of the seats to employees. The second aspect of Codetermination rights refers to the firm-level works councils that possess extensive legal rights with variation across issues: the legal participation rights of works councils are strong in social matters, weaker over personal issues, and modest in economic and financial matters.20 The introduction of firm-level works councils in 1952 initially constituted an attempt by conservative policymakers to circumvent and weaken trade unions since councilors are legally required to represent the interests of employees while simultaneously preserving cooperative relations with management – for instance, works councils cannot initiate strikes and other similar forms of industrial action. Nevertheless, and quite soon after the passage of the 1952 legislation, trade unions “colonized” the works councils via an active and successful campaign to fill seats with their own members (Jacobi et al., 1992). Nonunion representatives have occupied a minority of seats on works councils.21 The institution of works councils has been crucial for the involvement of labor organizations in the strategy of German companies. Firm-level works councils have provided employees with significant influence over many aspects of work reorganization – such as the introduction of new technologies, investment decisions, and the design and implementation of firm-level internal flexibility (Markovits and Allen, 1984: 153–69; Thelen, 1991: 209–14; Fuchs and Schettkat, 2000). Moreover,

19 Moreover, the pivotal position of the FDP in the political system also dampened the attractiveness of the state solution strategy. 20 Prigge (1998: 1013). 21 Moreover, and in comparison to France, nonunion candidates can run on the first round of elections for seats on works councils.

30

Introduction

the institution of works councils has been a stable source of influence in the face of changing political and economic conditions. On the political side, the participation of labor in the process of adjustment of firms has been independent of the composition of governments – a situation that contrasts sharply with the importance of the Social Democratic party (SAP) in Sweden (Thelen, 1993). On the economic side, the influence of labor has been maintained in the context of a major shift in the relative power between national unions and firm-level works councils. The increasing volatility of markets and the need to adjust quickly has increased the prominence of firm-level works councils and reduced the importance of national unions – under a stable institutional framework (Thelen, 1991: 16–21; Muller-Jentsch, 1995, 2003). The newly acquired prominence of firmlevel works councils reflects the rise in the importance of flexibility. The advent of flexibility is a response to the economic problems faced by advanced capitalist economies since the mid-1970s. Its introduction is associated with the decline of fordism as a mode of production (Piore and Sabel, 1984). The fordist model was based on mass production of standardized goods whose demand was sustained by expansionist Keynesian policies and by the power of labor to secure constant increases in real wages (see Boyer, 1988: 3–25). Moreover, it was viable since a virtuous circle existed between increasing domestic consumption and production. In other words, productivity levels kept up with rising real wages. However, the model ran its course with the growing ineffectiveness of Keynesian policies in increasingly trade-dependent and financially liberalized Western economies that, in turn, forced governments to turn to supply-side economic policies in order to stimulate growth (Garrett and Lange, 1991; Scharpf, 1991). The new (and current) economic regime forces firms to deal with the permanently higher levels of uncertainty associated with rapidly shifting demand (Streeck, 1987). In this context, managers have sought to redesign the production process in order to improve their ability to adjust rapidly to numerous and unexpected changes in a host of markets. The volatility of markets has led to uncertainties of demand that, in turn, affect the demand for labor. Management seeks to respond in a highly flexible manner since there is a high premium placed on the ability of firms to adapt quickly to constantly changing uncertain markets.22 The exhaustion of fordism as a model of production provides both constraints and opportunities for firms to implement flexibility. The legal anchoring of the system of

22

See Sorge (1985) for an early exposition of this argument.

31

Contingent Capital

Codetermination has provided the basis for flexibility in the dual system of industrial relations that, in, turn, has enabled employees to negotiate the terms of adjustments at the plant level since the mid-1970s (Thelen, 1991, 2004). The latest development in the story of Codetermination is related to how it has mediated new developments in German corporate governance – such as the decline in bank monitoring, the rise in the importance of equity-based finance, and the opening of the market for corporate control (see Jackson, 2005a: 246–9). Detailed case studies and empirical studies have highlighted the negotiated, and politically contested, processes by which practices of shareholder value have been introduced (Hoepner, 2001; Fiss and Zajac, 2004). Their introduction by German companies did not represent the unilateral assertion of managerial authority. The incorporation of employees in the decisionmaking process in regard to decisions related to shareholder value practices has meant that they were able to significantly influence the design of their content and the terms of their implementation (Hoepner, 2001; Jackson et al., 2005). For instance, several German companies have sought to focus on a more limited number of activities and reshape the relationship with their suppliers in order to remain competitive in world markets (Herrigel, 2008b, 2010). However, the new focus on core activities significantly differed from the process by which American firms broke up conglomerates in the 1980s especially in regard to employment issues. A little over half of the 100 largest German companies have negotiated in the second decade of the 1990s a “location agreement” or “employment pact” with their works councils in the last five years (Streeck, 2001: 204). These negotiated agreements entail the trading of wages for job security for two to four years – even if units of the firm are sold off. A little fewer than twenty firms of the largest 100 have also included specific investment plans for the next two to four years in exchange for more flexible work shifts and for a reduction of company premiums and wages (Kotthoff, 1998; Streeck, 2001: 205).

1.2.2 Hierarchical Character of Institutional Variables in Complex Causation The second building block of the argument presented in this book highlights the hierarchical character of institutional variables embedded in a process of complex causation, that is, some causal variables matter more than others at specific points in time within a given context. Qualitative, case study-oriented research is particularly well suited to the analysis of the phenomenon of complex causation inherent in 32

Introduction

processes of historical sequences – the settlements of political conflicts in French and German corporate governance constituting two great instances of complexity. The importance of causal complexity is increasingly seen by social scientists as an essential feature of political and social life since outcomes of interest have usually more than a single cause, and are generated by the interacting and combined effects of causal–institutional variables (Hall, 2010a). Qualitative-oriented research is ideally placed for addressing issues where outcomes result from the intersections of conditions, thereby highlighting the importance of multiple and conjunctural causes in phenomena of complex causation (Ragin, 1987). Conversely, standard regression analysis and statistical techniques are less suited to the analysis of phenomena of complex causation despite the increased sophistication of regression analyses. Quantitative analyses can indeed cope with interaction effects between variables (see Braumoeller, 2003; Gordon and Smith, 2004; Braumoeller and Kirpichevsky, 2005). This is not the issue. Rather, the shortcomings in the use of quantitative analyses for the study of complex causation are the following: first, an assumption of statistical analyses is that causes are additive thereby leading to the assertion that the effect of a cause is similar across all other contexts regardless of the values of other causal variables (see Ragin, 1987: 32–3). Causal complexity takes many forms: conjunctural causation (Ragin, 1987), substitutability (Braumoeller, 2003; Ragin, 2006), necessary and sufficient conditions (Braumoeller and Goertz, 2000), institutions as barriers (Goertz, 1994), INUS conditions (Mackie, 1965; Lieberson, 1991), and SUIN conditions (Mahoney et al., 2009). What all of these forms of causal complexity have in common is that the impact of the independent variables on the dependent variable, though cumulative, is not additive across cases and contexts (Braumoeller, 2003: 212). Second, and building on the previous point, quantitative analyses assume unit homogeneity in the sense that a change in the value of the independent variable is assumed to result in a change in the value of a dependent variable of the same magnitude across all other cases (see Hall, 2003: 381– 3; Hall, 2010a: 5–9). Third, the conceptualization of causation differs sharply between qualitative and quantitative approaches with significant consequences for the process by which causal inferences are asserted, that is, the extent to which one (or several) variable (x) exerts a causal effect on the dependent variable (y) (Mahoney and Villegas, 2007; Mahoney, 2008; Mahoney and Terrie, 2008). Qualitative researchers seek to uncover the specific values taken by the causal variables that generated the occurrence of an outcome of interest. The identification of the particular causes in specific cases is crucial since complex causation entails the 33

Contingent Capital

presence of multiple or conjunctural causal variables – that is, different conditions combining in specific or different ways. Quantitative researchers, in contrast, seek to estimate the average effects of a hypothesized independent variable across a large number of cases rather than specifying its impact in a specific context/situation. The aim is to generalize from an assessment of the average causal weight of independent variables within a large-N sample. The importance of causal complexity figures prominently in the analysis of the investment allocation of short-term investors in France and Germany. Several factors shape the flows of short-term funds in the two countries.23 The organization of this book is structured around the insights of two institutionally based theoretical perspectives: law and economics and VoC. The selection of these two perspectives is motivated not only by their importance in studies of comparative corporate governance (see Gourevitch and Shinn, 2005: 27–94) but also reflects different critical evaluations of the investment process of institutional investors. The law and economics perspective emphasizes the importance of corporate executives choosing to implement strategies of shareholder value over seeking to secure private benefits of control at the expense of minority shareholders. Institutional arrangements that protect the rights of minority shareholders are seen as crucial for the provision of incentives toward shareholder value-enhancing strategies (Shleifer and Vishny, 1997; Laporta et al., 2000). The VoC perspective, by contrast, highlights the impact of institutional frameworks on the process by which firms coordinate their activities. Advanced capitalist economies are distinguished by their specific configuration of institutional arrangements that translate into divergent distributions of authority at the firm-level (Hall and Soskice, 2001; see also Maurice et al., 1986; Culpepper, 1999; Soskice, 1999; Gourevitch and Shinn, 2005; Sorge, 2005). The focus of this perspective is on the ability of corporate executives to implement specific types of strategies of shareholder value – not merely whether corporate executives have internalized the importance of financial market considerations and share price appreciation (see Goyer, 2007).

23 Studies by financial economists have pointed out the range of possible actions of institutional investors. For some, the strategy of activist short-term funds is geared toward targeting more financially profitable and healthy firms with large cash flows and high dividends (Klein and Zur 2009). The aim is to force portfolio companies to release dividends and/or proceed to share buybacks. In contrast, others have emphasized how funds select undervalued firms with potentially superior growth potential and push for the implementation of strategic and operational changes (Brav et al., 2008).

34

Introduction

The importance of institutions as a critical independent variable has been prominent in the social sciences. From the early days of fixed crossnational institutional differences impacting on outcomes, institutional analyses have become more sophisticated and open to alternative perspectives. Scholars working with an institutional perspective rarely advance the notion that only institutions matter for outcomes. For some, institutions are mid-level variables that act as a midrange theory between statecentered and society-centered analyses (see Hall, 1984, 1986; Thelen, 2004). Institutions matter because they independently shape the distribution of power among actors (Berger, 1981). For others, institutions are part of a phenomenon of complex causation whereby an outcome results from potentially different combinations of conditions (see Lieberson, 1985; Ragin, 1987; Mahoney, 2004). Institutions might be critical independent variables but they are never the sole cause of outcomes since they result from the presence of combinations of conditions (Hall, 2010a). The analysis of the disparities of asset allocation by short-term investors in France and Germany builds on these institutional analyses in a specific way. The focus on institutions as part of a process of complex causation is methodologically sound but obscures an important issue, namely the relative weight of different causal factors. Institutions are shown to be causally important but no assessment of the relative strengths of different combinations of variables is attempted (Goldthorpe, 1997: 7). This issue is particularly important since advanced capitalist economies have been responding in different ways ¨ rsch, to exogenous and endogenous challenges (Hall, 1999, 2007; Bo 2007; Hall and Thelen, 2009). The protection of minority shareholders (law and economics) and the ability of corporate executives to implement strategies of shareholder value (VoC) constitute important variables influencing the investment allocation of short-term-oriented institutional investors, but is one more important than the other? I argue that the VoC perspective offers greater, but not exclusive, insights into the complex causation process of the investment allocation of short-term investors in France and Germany than the institutionally based law and economics perspective. First, the institutional basis for the coordination of activities at the firm-level in the two countries differs substantially (see Maurice et al., 1986; Sorge, 1991, 2005; Culpepper, 1999, 2003; Hancke´, 2002; Whitley, 2003). The coordination of activities is shaped by firm-level institutional arrangements that result in different restructuring strategies. In particular, the VoC perspective highlights how workplace organization in France is characterized by the concentration of power in top executives that, in turn, provides for a better fit with the preferences of short-term 35

Contingent Capital

investors. The weakness of organized labor inside the firm facilitates the implementation of short-term oriented restructuring schemes. In contrast, the institutional arrangements of large German companies provide employees with voice and quasi-veto power over important corporate decisions. The coordination of activities in German firms is characterized by the involvement of the bulk of employees, thereby resulting in lengthier negotiations. The implementation of strategies of shareholder value in Germany does not fit well with the short-term horizon of impatient investors since they have to be negotiated with the workforce. Thus, firm-level institutional arrangements identified by the VoC perspective matter since they provide top management with diverging capacities to implement shareholder value-oriented restructuring schemes within a short-term horizon (Goyer, 2006a). In other words, VoC-type institutional arrangements of workplace organization directly impact on the value taken by the dependent variable. Second, the contribution of the VoC approach also shape the distribution of necessary/sufficient conditions across advanced capitalist economies, thereby illustrating the importance of the context in which political and social life occur. The investment allocation of short-term investors is embedded in a process of complex causation – but what is necessary/sufficient to produce change is asymmetrically distributed in a noncapricious manner across economies.24 Outcomes

24 The use of the concept of necessary/sufficient conditions and the nature of causal inference presented in this book should be understood in heterodox-probabilistic terms, not in a deterministic fashion (Mahoney, 2008: 415–20; see also Lieberson, 1985, 1991). The latter refers to attempts to infer the existence of a causal relationship through the presence of correlations between two variables. Working through elimination, the researcher seeks to uncover which independent variable covaries with the dependent variable across a small number of cases – and which independent variables do not. The implication is that the presence of a given factor that covaries with the dependent variable across all cases will produce the specified outcome when present (see Mahoney, 1999, 2000b, for a critical review). A heterodox-probabilistic understanding of causation, by contrast, is more modest. It stipulates that the impact of a given factor, when present, is greater for the occurrence of a specified value on the dependent variable as compared to other factors. Moreover, the hetereox-probabilisitc understanding of causation presented in this book is not based on the notion of “probability raiser” whereby the presence of a specified value on a variable increases the probability that an outcome will occur (see Gerring, 2005, for a presentation of causation as probability-raiser). Causation can take place without probabilistic dependence – X causes Y to happen, but it did not increase the probability of Y to happen (Menzies, 1996). The impact of X (or non-X) on the dependent variable remains the same before the event (potential) and after the event (actual). The impact of X on Y should be compared to the impact of Z (not the counterfactual of non-X) on Y. For the argument presented in this book, the concentration of power in top management (VoC-type institutional arrangements of workplace organization) and the presence of ownership diffusion (law and economics focus’ on protection of minority shareholders) increase the likelihood of being targeted by shortterm institutional investors – but the former is substantially more influential than the latter in this process.

36

Introduction

are the result of different combinations of conditions across advanced capitalist economies. The firm-level institutional context of the French and German economy provides for variation in the relationship between the law and economics perspective and the investment allocation of short-term investors. From the law and economics perspective, the investment allocation of short-term investors is primarily driven by the quality of institutional arrangements that protect the rights of minority shareholders (Laporta et al., 2000). The prediction of this perspective is that the presence of ownership diffusion constitutes the most important and determining factor for the introduction of strategies of shareholder value in France and Germany – corporate law in the two countries is better at lessening agency costs driven by managerial opportunism than at curbing the value destroying actions of the large shareholder (Schmidt, 1999; Roe, 2002; Enriques and Volpin, 2007). However, the relative weight of the law and economics perspective in the overall complex causation through which short-term investors acquire equity stakes in French and German corporations is not as important as that of the VoC perspective. The relationship between the presence of ownership dispersion (the favorite scenario for the law and economic perspective) and the investment allocation of short-term investors differs across the two cases: it is positive in France since the quasi-totality of companies with ownership diffusion have been targeted by short-term investors; it is weaker in Germany given that several corporations with ownership diffusion have not been targeted by these same impatient investors. The presence of ownership diffusion constitutes a quasi-sufficient condition for being the recipient of a concentrated investment stake by impatient investors in France, but not in Germany. The disappearance of large shareholders in France constitutes the removal of a major, and perhaps the remaining, stumbling block for the implementation of short-term-oriented strategies of shareholder value given the concentration of power in top management.25 By contrast, the strength of organized labor at the firm-level in Germany explains why the removal of large blockholders in Germany does not result in managerial autonomy to quickly implement strategies of shareholder value. This autonomy is blocked by the strength of organized labor at the firm-level. The VoC institutional context influences the 25 Moreover, the pluralities of French and German firms targeted by Anglo-Saxon institutional investors are characterized by ownership concentration – the least likely scenario for the law and economics perspective, given the legal arrangements of shareholder protection in the two countries (see Chapter 3). In other words, legal arrangements of protection for minority shareholders do not constitute a necessary condition understood in heterodox-probabilistic terms as being the recipient of a targeted investment stake by short-term-oriented funds.

37

Contingent Capital

nature of the relationship between variables. The presence of a similar value on a specific variable – ownership diffusion – has different effects in two institutionally distinctive economies, namely France and Germany. In other words, the presence of ownership diffusion does not constitute a sufficient condition understood in heterodox-probabilistic terms in Germany reflecting a missing element, namely the concentration of power in top management. The methodological implication is that the relationship between variables in the process of causal complexity is characterized by the hierarchization of institutions. The presence of a specific value on the hierarchically superior causal variable (i.e., concentration of power in top management) is paramount for the magnitude effect of the other variable (ownership diffusion) to occur. The relationship between these two causal variables is not symmetrical; it is one of hierarchical interaction. Moreover, the nature of the interaction between the two causal variables in this study – institutional arrangements of workplace organization and of legal protection of minority shareholders – should be seen as specific to the comparison between France and Germany regarding the investment allocation of short-term investors. The institutions of workplace organization constitute the most important, but not the sole, causal variable to account for the marked preference of short-term investors for French companies over their German counterparts by a ratio of 2 to 1. The generalization of this argument to other contexts should also incorporate the full range of interacting variables. The method of concomitant variation, seeking to infer causality between values on ordinally measured causal and dependent variables based on the degree to which a phenomenon is present, is useful in this regard (see Mahoney, 2000b: 399–406). The value taken by the institutional arrangement of legal protection of minority shareholders against occurrences of managerial opportunism (first causal variable) is high in France and Germany – reflecting the importance of legal reforms in recent years (Cioffi and Hoepner, 2006; Tiberghien, 2007). The value taken by the degree of concentration in top management associated with the institutional arrangements of workplace organization (second causal variable) is high in France and low in Germany, thereby significantly contributing to the gap in the investment allocation of short-term investors in the two countries. The incorporation of the American case in the setting of the method of concomitant variation strengthens this claim. The American system of corporate governance is characterized by the presence of high values on institutional arrangements of legal protection of minority shareholders and on the concentration of power in top management – and 38

Introduction Table 1.1. Concomitant Variation: Causal Variables and Investment Allocation by Short-term Investors

Germany France United States

Legal protection

Concentration of power

Ability to dismiss

High High High

Low High High

Low Low High

Investment Low >2 as Germany At least >2 as France

also on some other important legal features that matter for the implementation of strategies of shareholder value, such as the ability of firms to quickly dismiss employees (third causal variable) (OECD, 1999) (see Table 1.1). The absence of significant legal constraints on the numerical shifts (external flexibility) to the composition of the workforce fits with the preferences of short-term investors (Capelli et al., 1997; Farber and Hallock, 2009). In turn, the presence of different values on these three causal variables for France, Germany, and the United States is associated with different values on the dependent variable. Data on blockholding acquisitions by hedge funds in American companies from 1998 to 2005 is slightly inferior to an average of one per firm and, therefore, illustrate that the presence of short-term investors in American companies is significantly superior as compared to their investment allocation in the French market (Clifford, 2008: 326).26 The method of concomitant variation highlights the importance of institutional arrangements of workplace organization for the comparative study of France and Germany – but also provide for the limits on the generalization of the claim to other contexts. Finally, the analysis of the relative weight of the insights associated with the law and economics approach versus those of the VoC perspective should not be interpreted as a paradigm war between two theories made to be tested against each other. Rather, it has been designed to capture the importance of causal complexity in social sciences (see e.g. Braumoeller, 2009: 241). The simultaneous analysis of complexity and hierarchy between causal variables is crucial to capture the respective contributions of the law and economics and VoC perspective for the value taken by the dependent variable, namely the marked preference for French companies by short-term investors. The insights of the law

26 It should also be noted that the data on American firms does not incorporate acquisitions above the 5 percent threshold by actively managed mutual funds from 1998 to 2009 and by hedge funds from 2006 to 2009 – thereby highlighting the magnitude of the investment allocation of short-term investors in the United States.

39

Contingent Capital

and economics approach do matter even if their relative weight in accounting for the disparities of investment allocation of short-term investors is not as great as that of the VoC perspective. The hierarchically inferior position of the law and economics perspective implies that the variable possesses less importance in terms of accounting for the presence of the dependent variable in the current period. The hierarchy between institutional variables presented in this book reflects the uneven patterns of change across advanced capitalist economies, namely that changes in corporate governance have been more prominent than the evolution of institutional arrangements in employment relations and skill formation. The long-standing institutional differences in the organization of work in France and Germany did not prove significant to questions of corporate governance before the mid-1990s. France and Germany constituted two advanced political economies where the importance of shareholder value in the strategic direction of companies was previously marginal. Developments in the early to mid-1990s in the sphere of corporate governance transformed the “dormant” character of institutions of work organization. Legal reforms to protect minority shareholders and the spread of ownership diffusion starting in the mid-1990s, previously preceded by the removal of capital controls and the decision by Anglo-American institutional investors to diversify their investment allocation beyond their national borders, have been more impressive as compared to the relative stability by which companies build their innovative competencies.27 Policymakers have found it easier, and even highly attractive in some cases, to pass legislation designed to protect the legal rights of minority shareholders than to confront organized labor through market deregulation (Beyer and Hoepner, 2003; Cioffi and Hoepner, 2006; Tiberghien, 2007). Policymakers have also found it more politically convenient to deregulate labor markets for potential “outsiders” via the liberalization of fixedterm contracts rather than directly confronting “insiders” (Blanchard and Landier, 2002; Smith, 2004; Rueda, 2007; Palier and Thelen, 2010). The impact of these developments in the sphere of corporate governance, however, has been structured by institutional variations in the character of labor relations and skill formation in each country (Hoepner, 2001; Goyer, 2006b).

27 On changes in corporate governance, see Culpepper (2005), Cioffi and Hoepner (2006), Enriques and Volpin (2007), and Deakin and Rebe´rioux (2009). On the relative stability by ¨ rsch (2007), Culpepper (1999, which firms develop their innovative capabilities, see Bo 2003), Whitley (2003), Thelen (2004), Sorge (2005), Palpacuer et al. (2007), and Thelen and Busemeyer (2008).

40

Introduction

The German case is particularly important in this regard. Changes in German corporate governance have been important but have not been matched by correspondingly significant transformations in employment relations and skill formation. An implication is that potential changes in the regulation of labor markets, the decline of the prominence of firm-specific skills, and the declining appeal of vocational training would increase the attractiveness of German companies to short-term investors by increasing the concentration of power in top management. The gap between the occurrence of change in German corporate governance and the overall stability of the process by which domestic companies build their innovative capabilities is the outcome of political circumstances and, moreover, illustrates the importance of causal complexity and provides a healthy warning against piecemeal analyses focusing on a single institutional variable. A second implication is that impressive changes in French corporate governance took place in a setting whereby significant concentration of power already resided in top management. The move toward ownership diffusion in France was highly conducive to the arrival of short-term investors since the organization of work favors the relatively rapid implementation of new strategies of adjustment. The removal, or significant reduction, in the agency problem in the form of the large owner paved the way for the rise of a short-term version of shareholder value. Nevertheless, one question remains unanswered: what is the relationship between legal reforms of the rights of minority shareholders (law and economics in this book) and institutional arrangements of employment relations/skill formation (VoC in this book)? Are these two spheres characterized by institutional complementarities displaying the interaction between different institutions in separate spheres (Milgrom and Roberts, 1994, 1995)? Are these two spheres illustrating the presence of compatibility given the lack of corresponding and coordinated evolution between them (Hoepner, 2005; Deeg, 2007)? I now turn to this issue.

1.2.3 Hierarchy as Context What form does institutional hierarchy take? I argue that the hierarchically superior causal variable serves as the context that mediates the interaction between other causal variables and the dependent variable – in addition to the hierarchically superior variable exerting an important influence on the dependent variable. As constituting the context, the hierarchically superior institution does not affect the value (s) taken by the other hypothesized independent variables (x1, x2, . . . , xN) in a process of complex causality. The presence of institutional arrangements with 41

Contingent Capital

specific values in different spheres does not impose insurmountable constraints on the design of a new institution. Rather, I stress that an important, and often forgotten, form of institutional hierarchy lies in the impact of the context on the relationship between variables (see Goertz, 1994). The hierarchically superior institutional variable is operationalized as the context that shapes the relationship between other causal variables (x1, x2, . . . , xN) and the dependent variable (Y).28 The implication is that hypothesized causal variables (x1, x2, . . . , xN) do not cause outcomes by themselves and must be seen within the context in which they are embedded before marking causal inferences (Falleti and Lynch, 2009). The context has often being relegated as a background factor in assessing the relationship between variables. However, context changes over time/ across space – thereby constituting an essential part of the causal process (Mackie, 1965; Hall, 2010a). In this study of the investment allocation of UK/US-based institutional investors, the hierarchically superior causal variable is operationalized as the VoC-type institutional arrangements of work organization and the associated distribution of power inside companies. The institutional arrangements of workplace organization shape the process of adjustment and the terms by which strategies of shareholder value are introduced and implemented (O’Sullivan, 2000; Hoepner, ¨ rsch, 2007). Short-term oriented institutional 2001; Goyer, 2006b; Bo investors prefer firms characterized by the absence of many stakeholders with a voice in the process of adjustment given the short-term horizon of their trading strategy (Rebe´rioux, 2002; Goyer, 2006a). Moreover, the VoC-type institutional arrangements of workplace organization also serve as the context that impacts on the nature of the interaction between the legal protection of minority shareholders (other causal variable) and being targeted by Anglo-American institutional investors (dependent variable). The presence of ownership diffusion, an essential feature for the law and economics perspective given the configuration of French and German corporate law – almost invariably results in French firms being targeted by Anglo-American institutional investors while this is not the case for their German counterparts. The reason is that 28 The argument presented in this book differs from that of Goertz (1994) in that the institutional variable that serves as the context (C) not only shapes the outcome of the interaction between other hypothesized causal variables and the dependent variable but also directly acts upon the value taken by the dependent variable. In other words, the influence of the hierarchically superior institutional–causal variable is dual. The hierarchically superior institutional–causal variable impacts on the value of the dependent variable and it shapes whether (and how) other hypothesized causal variables impact on the value taken by the dependent variable. For Goertz, the context does not directly act upon the dependent variable and, thus, does not constitute a causal variable.

42

Introduction

the presence of ownership diffusion is contextually bounded. French firms with ownership diffusion are attractive to short-term investors not only because of the absence of a large owner with incentives to secure private benefits of control but also for the concentration of power at the top of the managerial hierarchy that makes it easier to implement strategies of shareholder value. German firms with a more egalitarian distribution of power, in contrast, are not as attractive to short-term investors despite the removal of the large owner whose interests are likely to lie outside that of shareholder value. The distribution of power inside German companies provides employees with significant opportunities to delay the introduction of strategies of shareholder value designed to generate short-term benefits. The importance of context highlights the shortcomings associated with an analysis of causal inference based on invariant patterns of association – that is, the presence of covariance between the values taken by a hypothesized independent variable and the dependent variable. The introduction of legal reforms in France and the growing ownership diffusion of French companies have been associated in terms of timing with the rise of blockholding acquisitions by short-term foreign investors. Nonetheless, the timing between the change in the values taken by the law and economics institutional variable (ownership concentration ! ownership diffusion) and the dependent variable should not be interpreted as the proof of the causal influence of the former. The growing ownership diffusion of French companies occurred in a setting characterized by the concentration of power in top management while the corresponding rise of ownership diffusion in Germany did not result in similarly important rise of shortterm foreign ownership since the coordination of activities inside German companies is characterized by the involvement of many parties. The presence of the concentration of power in top management is paramount for the magnitude effect of ownership diffusion to take place. The context as the hierarchically superior institution in a process of causal complexity is highly insightful for the study of the investment allocation by short-term-oriented institutional investors in France and Germany. However, the importance of the concept of context extends beyond this study. From a methodological perspective, the notion of context significantly contributes to our understanding of complexity in social sciences. Previous studies have highlighted that the absence of a correlation between two variables across time and space should not be interpreted as an indication that there is no relationship between them (Ragin, 1987; Goertz, 1994). An important insight is that the presence of different relationships between variables over time/across space is not necessarily capricious. It can be quite systematic in reflecting the 43

Contingent Capital

importance of variation in the context.29 Moreover, the notion of context presents interesting methodological insights in its differentiation from that concept of an intervening variable. The presentation of institutions as intervening variables (as distinct from macrostructures) acting as a midrange theory has been important in social sciences (Merton, 1968). It reveals an element of modesty as scholars working from an institutional perspective rarely advance the notion that only institutions matter for outcomes (Hall, 1984, 1986; Thelen and Steinmo, 1992; Hall and Taylor, 1996).30 Nonetheless, causal mechanisms as a chain of intervening factors with an intervening variable should be distinguished from complex causation as an intersection of variables leading to an outcome. The context as an institutional variable does not impact on the value(s) taken by other institutionalized variables (Falleti and Lynch, 2009: 1146). Causal complexity does at times require researchers to distinguish between macrostructures and the institutional elements within such structures (Merton, 1968); causal complexity could also involve the investigation of the different institutional arrangements as part of an intersection of conditions that generate a specific outcome (Ragin, 1987). I also argue that the notion of context of the hierarchically superior institutional variable in a process of causal complexity presents additional important methodological advantages. The concept of context provides significant insights for the analytical treatment of sufficient conditions – an issue that has been relatively underdeveloped.31 Sufficient conditions bring to the forefront the importance of institutional hierarchy. The argument runs as follow: a potential objection to the argument presented in this book is that I confuse the notion of context with that of conjunctural causation. An alternative explanation is that the institutional arrangements of workplace organization and the legal protection of minority investors should be seen as two necessary, but not sufficient, conditions for being targeted by Anglo-American institutional investors. French firms characterized by the concentration of power in top management and with ownership diffusion have been targeted by short-term foreign investors. The issue for the German case 29 The systematic character related to the absence of a relationship between two variables would be difficult to integrate in quantitative-oriented analyses since the impact of X on Y as measured by the â is not constant (Goertz, 1994: 15). 30 The notion of intervening variable has also been a useful tool for methodological scholars seeking to present causal mechanisms as a chain of variables that connect the original hypothesized cause with its effects on the dependent variable (see Rueschemeyer et al., 1992; King et al., 1994: 85–7). 31 Analyses of necessary conditions, in contrast, have been characterized by extensive theoretical sophistication (see Braumoeller and Goertz, 2000; Mahoney, 2004).

44

Introduction

is that there are too many firms characterized by a more even distribution of power that, in turn, deter short-term investors despite the growing ownership diffusion. The implication would be that the reduction in the power of labor organizations in Germany would pave the way for the massive arrival of short-term-oriented institutional investors given the growing number of firms with ownership diffusion. This interpretation, however, is incorrect on several grounds. The use of context as a concept serves to illustrate the importance of sufficient conditions understood in heterodox terms. The presence of ownership diffusion – most favorite scenario for the law and economics perspective – does not constitute a necessary condition for the occurrence of the dependent variable. The pluralities of French and German firms targeted by shortterm-oriented institutional investors are characterized by the presence of ownership concentration and, moreover, there are twice as many French companies targeted in comparison to their German counterparts (see Chapter 2). The presence of ownership concentration has not deterred short-term institutional investors from investing in both Germany and, especially, in France. We cannot refer to two institutional variables that are necessary, but not sufficient, and are part of a phenomenon of conjunctural causation. Instead, an important focus of this book deals with sufficient conditions. What happens when French and German firms become characterized by ownership diffusion – the ideal scenario for the law and economics perspective? What are the consequences associated with market-enhancing developments across advanced capitalist economies? As previously mentioned, the quasi-totality of French firms with ownership diffusion has been targeted by short-term institutional investors while a significant number of German firms with a similar ownership structure have not. The context, VoC-type institutional arrangements of workplace organization, shapes the impact of the ownership structure on the dependent variable. The use of the context as an institutional variable is important for methodological considerations in four ways: assessment of the importance of market-driven changes, the reembedding of the concept of institutional complementarities, the assessment of the importance of sufficiency, and the role of politics in complex causation. First, developments in the world economy during the last thirty years have witnessed the increased importance of market forces in economic relationships (Frieden, 1991; Loriaux, 1991; Hall, 2006) but without a corresponding convergence in the organization of firms and of capitalist economies (Hall and Soskice, 2001; Sorge, 2005; Berger, 2006). Differences in institutional starting points (Thelen, 1993; Locke and Thelen, 1995; see also Locke and Thelen, 1995; Kogut et al., 2002), interactions between stable institutions and newly introduced institutions (Hall, 45

Contingent Capital

1994; Hall and Franzese, 1998), and actors seeking functionally equivalent institutional reforms to existing modes of coordination (Hall, 2007; Hall and Thelen, 2009) account for the gap between the market-driven processes of change and the reproduction of diversity in its consequences. From a methodological perspective, these factors highlight the importance of context as specific institutional arrangements that influence the process by which market-enhancing developments impact on some pre-specified dependent variables. In particular, the implications associated with reforms designed to protect the legal rights of minority shareholders (Cioffi and Hoepner, 2006; Enriques and Volpin, 2007; Tiberghien, 2007) require an investigation of the institutional arrangements of workplace organization in which firms are embedded (Maurice et al., 1986; Sorge, 1991, 2005; Soskice, 1999; Whitley, 2003; Jacoby, 2005; Goyer, 2006a). This is why the study of sufficient conditions understood in heterodox-probabilistic terms is important. It refers to an investigation of the consequences associated with the introduction of market enhancing developments. The advent of institutional change in advanced capitalist economies is undeniable. The real issue, however, is to distinguish between radical, path-breaking change versus coordination-reinforcing change. The assessment of the impact of institutions (and institutional change) on major issues requires the operationalization and specification of the nature of illusory differences (see e.g. Ragin, 1987: 44–9). The illusion of change characterizes situations whereby processes of institutional change do not entail a modification in the behavior of actors (Culpepper, 2005; Goyer, 2006a; Hall, 2007). The concept of context in assessing whether a variable constitutes a sufficient condition provides significant insights into the importance of marketenhancing developments for the evolution of advanced capitalist economies.32

32 The importance of the issue of whether market-enhancing developments are sufficient to induce changes has been enhanced by a recent paper by Hall (2010a) where politics is presented as an structured process across spaces and over time and characterized by the interaction between variables in a given context. Hall points out that coalition formation is not an automatic and easy process despite the occurrence of favorable external developments since actors need to reinterpret their interests and assemble the resources that are essential for the process of coalition formation. These are not easy tasks even in some of the most favorable circumstances. The successful process of coalition formation requires the occurrence of several interacting factors. The connection between this insight into the process of coalition formation and the argument presented in this book is that some changes will be sufficient to generate the outcome of interest in one contextual setting, but not in another. The nature of the interacting factors and the presence of a hierarchically institutional variable will condition the process of adjustment of firms and countries. The notion of sufficient conditions highlights how the presence of multiple causal variables can be overcome, a rather rare historical occurrence, for the outcome of interest to occur.

46

Introduction

Second, the notion of context provides for a reembedding of the concept of institutional complementarities. The most severe, and insightful, critics of the VoC have focused of the perceived shortcomings associated with the concept of institutional complementarities (Amable, 2003; Boyer, 2004; Crouch, 2005; Hoepner, 2005; Deeg, 2007). A common element associated with these works is the nature of change across institutional spheres. What happens when one institution which is part of a complementary framework undergoes a transformation? Would other institutions also change in a symmetrical fashion? Does institutional design in one sphere of the economy depend on the presence of institutions located in other areas? These critics have targeted an aspect of the VoC perspective, namely the influence associated with the presence of institutional complementarities on the strategic choice of actors. The process of institutional change is shaped by the existence of complementarities with the implication that actors will either resist change or seek calibrated change: institutional change that reproduces complementarities whereby the coexistence of two or more newly introduced institutions still enhances the functioning of each (Hall, 2005). These critics have instead advocated the notion of a gap in the character of institutional change across the different spheres of the economy. The process of institutional change is disjointed across spheres. For Deeg (2007), the issue is that the distribution gains associated with the presence of complementary institutions are unequally distributed in the economy. For Hoepner (2005), institutions could be compatible without being complementary – so, the presence of one institution could enhance the functioning of others but its presence is not necessary for the proper working of others. For Amable (2003: 66–73) and Boyer (2004: 28–33), institutional design reflects the power of important social groups with the implication that institutional change will be more easily implemented in areas where dominant groups have fewer vested interests. The notion of context, in contrast, highlights the possibility of disjointed institutional transformation (change in one sphere not commensurately matched in other spheres), while keeping the core notion of institutional interaction that generates complementarities.33 The context shapes the nature of the interaction between other hypothesized causal

33 Moreover, Hall and Soskice (2001: 57–8) indicated reservations over the notion of commensurate institutional change, emphasizing how institutional stability does not derive its political support for any alleged contributions to the national economic welfare. Instead, self-interested actors seek institutional change, or to preserve institutional stability, for the benefits the institutional arrangements generate for them. The implication is that apparent incommensurate changes in patterns of institutional complementarities can occur without affecting the insightfulness of the concept of institutional complementarities.

47

Contingent Capital

variables and the dependent variable; the context does not influence the value taken by other hypothesized causal variables. Disjointed change between the values taken by the variable of the context and that of other hypothesized variables can take place without affecting the relationship between the context and the dependent variable. For the argument presented in this book, the evolution of the values taken by the context (VoCtype institutional arrangements of workplace organization) and that of the other hypothesized causal variable (the ownership structure of companies) have displayed significant divergence. The (different) values taken by the former in both France and Germany have exhibited substantially greater stability as compared to the greater importance of ownership diffusion for companies in the two countries. In other words, the institutional arrangements of workplace organization do not impact on the ownership structure of companies. However, the complementarities between institutional arrangements of workplace organization and the preferences/strategies of Anglo-American institutional investors remain unchanged. The fit between the concentration of power in top management in France and the preferences/strategies of short-term investors still remains strong – and vice versa for the German case. In other words, the presence of complementarities reflects different degrees of strength across institutional spheres – an observation previously illustrated by Hall and Gingerich (2009: 464, figure 3). Third, the notion of context serves to provide an assessment for the importance of the concept of sufficient conditions. In everyday language, one is almost invariably impressed by the notion of sufficiency. The mere presence of a value taken by a variable is sufficient for the outcome to occur! The intervention of one factor in itself causing the expected outcome to occur is often seen as a sign of strength. However, the argument presented in this chapter highlights potential problems of interpretation associated with sufficient conditions. As previously mentioned, all (but a few) French firms with ownership diffusion have been targeted by shortterm-oriented institutional investors. This empirical finding should not be interpreted as a source of the supposed superior explanatory power of the law and economics perspective. The occurrence of growing ownership diffusion in France took place in a context characterized by the concentration of power in top management. The value of ownership diffusion led to a specific result in France, but not in Germany, as a result of the value by the hierarchically superior variable of the context.34 Sufficient conditions 34 Moreover, Goertz (2006) illustrated that there are several potential sufficient conditions in a given process of complex causation. The most important of these sufficient conditions is the one that happens most frequently since it contributes more often to the occurrence of

48

Introduction

should not be seen in a piecemeal fashion but as part of the context in which they are embedded. Fourth, the notion of context captures the contribution and limits of politics. The settlements of political conflicts across advanced capitalist economies result in institutional diversity. What happens next? How does politics matter? The answer to these questions depends on the issue area. Politics impacts on the content of institutional formation across different spheres of the economy but without uniformity. The values taken by institutional arrangements in one area of the economy do not impact on the content of institutions in other spheres. Disjointed institutional evolution can occur, namely the presence of change in one sphere not being commensurately matched in other spheres. The more important issue, however, is not the presence of disjointed institutional evolution that has been interpreted as a shortcoming of the concept of institutional complementarities. Instead, the importance of politics lies in its influence of the institutional arrangements that later become the context. The hierarchically superior causal variable that constitutes the context is important not only for its impact on the dependent variable but also because of its mediation of the relationship between other causal variables and the dependent variable. The presence of institutional change on the hierarchically superior causal variable is more important than the evolution of institutional arrangements in other areas. The advantage of this conceptualization of politics is that it allows for the presence of the institutional hierarchy within complex causation and in the presence of disjointed institutional evolution. One variable can be more influential while outcomes are still being generated by an intersection of conditions. It also provides for the presence of different degrees of political salience across issue areas (see Culpepper, 2010).

1.3 A Roadmap The remainder of the book is presented in the following manner. Chapter 2 presents the empirical data on the investment allocation of shortterm Anglo-American institutional investors in France and Germany. Shareholder value-oriented funds possess many strategies and preferences, and a sophisticated differentiation between categories of investors and strategies is needed in order to avoid making faulty inferences. Pension funds are not nearly as threatening for the process by which the desired outcome. A sufficient condition that occurs infrequently is significantly less important.

49

Contingent Capital

companies coordinate their activities in coordinated market economies as are hedge funds; short-selling strategies are not connected to the implementation of strategies of shareholder value as are long-only acquisition of a significant stake in a listed company. Chapter 3 provides an analytical overview of the system of corporate law in France and Germany and illustrates how both countries are fairly effective at dealing with agency problems related to the actions of managers (ownership diffusion) but often unable to restrain attempts by the large owner to secure private benefits of control at the expense of minority shareholders (ownership concentration). Chapter 4 presents the research methodology of the book and illustrates how causal complexity could be incorporated with institutional hierarchy – that is, one set of variables being more important than others. Chapter 5 provides an overview of the institutional arrangements of work organization in France and Germany and illustrates how previous choices made by actors have shaped current differences in the degree of power concentration inside companies. Chapter 6 concludes by summing up the argument and by briefly illustrating how the 2008 financial crisis, an ongoing development, and the response of governments to its advent are unlikely to change the institutional contours of the economy – thereby highlighting that varieties of capitalism are alive and well and playing in Greenwich (CT), Paris, and Wolfsburg.

50

2 Short-term Capital Mobility in France and Germany: Differentiated Empirical Data

2.1 Developments in International Finance The world of international finance, production, and trade is one of significant change marked by both deregulation and innovation that has resulted in impressive cross-border flows. As regards currency transactions, daily flows of foreign exchange across borders reached $1,900 billion in 2004 – more than three times the level recorded for 1989 (Glynn, 2006: 66). In the area of international trade, the aggregate value of exports plus imports increased from about one-quarter of worldwide gross domestic product in 1970 to over 45 percent by 1997 (Garrett, 2000: 947). The political implications resulting from these staggering figures have been analyzed most notably, but not exclusively, in regard to their effects on government macroeconomic and monetary policies (Frieden, 1991; Garrett and Lange, 1991; Cohen, 1996), political preferences of actors (Rogowski, 1989; Frieden, 1991; Hiscox, 2002), and on the development of legal rules and norms in international finance and trade (Barton et al., 2006; Abdelal, 2007). I examine the dynamics associated with the latest set of developments within the current parameters of the Mundell–Fleming conditions for France and Germany – namely capital mobility, fixed exchange rate, and the absence of monetary policy autonomy. The focus of the book is on some of the key factors that facilitate/constrain the acquisition of concentrated equity stakes by Anglo-American institutional investors in listed companies and how outward capital flows are mediated by the specific variety of capitalism of continental Europe’s two largest economies. While studies of international finance are not new, the analysis of 51

Contingent Capital

cross-border investments via equity purchases has not been extensively covered. The reason for this neglect reflects the prior lack of capital mobility across borders for national stock markets which had previously been far less integrated than other forms of cross-border capital flows such as bank lending and the trading of currencies (Frieden, 1991: 428–9; Cohen, 1996: 270). However, the greater international integration of stock markets since the early 1990s has made it imperative to investigate the consequences of cross-border portfolio investments. In particular, the French and German systems of corporate governance have each, respectively, experienced an important transformation resulting from a series of cumulatively far-reaching changes. These developments have decreased the importance of debt finance as a source of external finance and have heightened the importance of stock markets (see e.g. O’Sullivan, 2003). Five factors stand out prominently in recent developments in international finance. First, the bank-based character of the financial system of major advanced capitalist economies has crumbled.1 Financial systems underwent a massive process of deregulation: the use of credit ceilings as a means to control inflation has been replaced by the discipline of central bank independence and of high real interest rates, capital controls have been removed under pressure from the European Monetary System (EMS) and also from the prior suspension of the dollar’s convertibility into gold, and the bond market has been deregulated.2 Moreover, the liberalization of financial markets has created an environment that not only raised interest rates as banks were forced to compete for deposits with new competitors but also removed the impediments to the developments of direct finance that led to the introduction of new financial instruments for raising capital (Loriaux, 1991; Goodman, 1992; Goodman and Pauly, 1993; Story, 1996). Second, processes of financial liberalization have facilitated the mobility of capital across borders. The greater ability of actors to shift capital across domestic stock markets reflects the decisions of national governments to remove capital controls. The effectiveness of attempts 1 The bank-based financial systems of France and Germany were characterized by the high debt–equity ratio of corporations and by their concentrated ownership structure in the hands of friendly cross-shareholdings among companies, a large owner in the form of a family firm, banks’ direct share and proxy voting in Germany, and extensive public sector in the French case (see Morin, 1974; Zysman 1983: 69–75; Franks and Mayer, 1997). 2 However, the use of credit ceilings to control inflation never took root in Germany. The bank-based character of the German financial system reflected the preferences of nonfinancial corporations for bank borrowing. It was not dependent on the reproduction of restrictive regulations, as was the case in many “repressed” financial systems such as France or Japan (See Lukauskas, 1994, for an analysis of repressed financial systems). Nonetheless, it is still insightful to treat France and Germany as two bank-based financial systems for which the importance of stock market consideration has increased at the expense of debt finance.

52

Short-term Capital Mobility in France and Germany

by policymakers to ascertain their authority over the direction of capital flows had become seriously curtailed by the internationalization of the activities of large domestic corporations. The integration of markets increased the exit options of producers that, in turn, enabled them to escape the constraining nature of these controls (Goodman and Pauly, 1993; Cornelius and Kogut, 2003). Moreover, the greater international integration of stock markets has also been facilitated by a process of harmonization of norms among market participants about new economic practices deemed legitimate that have gradually replaced the predominance of the national preferences of domestic actors.3 The integration of stock markets has been encouraged by the development of a new orthodoxy, namely that freedom for capital movements should prevail (Abdelal, 2007). The restoration of capital controls is interpreted as a sign of failure in policymaking and should possess a temporary character. Third, another set of policies that have facilitated the mobility of capital across borders is the decision of the bulk of EU members to adopt a single currency. The creation of the Euro zone has removed foreign exchange risk between participating members (Frieden, 2002: 839). The provision of exchange-rate stability has reduced uncertainties for portfolio investors seeking to take advantage of market trends by shifting capital across borders. Thus, portfolio investors, especially short-term-oriented ones, can allocate a significant portion of their assets to invest in other advanced capitalist economies without incurring recipient-country currency risks and restrictions on their ability to repatriate invested funds. Fourth, the process of integration of stock markets also reflects the growth and international diversification of Anglo-American institutional investors. The total assets held by UK and US institutional investors grew from US$9,242.5 billion in 1992 to US$22,543.8 in 1999 – a growth of 143 percent (Conference Board, 2002: 26). This growth has been particularly marked for the two categories of institutional investors under consideration in this book. The assets managed by hedge funds experienced a significant increase from an estimated US$38.9 billion in 1990 to nearly US$1 trillion by mid-2006 (Fung and Hsieh, 2007: 56). The most important category of institutional investor, however, remains mutual funds. The assets under their management grew from $150 billion in 1980 to a little over $8 trillion in late 2005. A substantial component of this growth, moreover, has translated into cross-border 3 See Finnemore (1996) for an analysis of the importance of social norms in international political economy.

53

Contingent Capital

portfolio equity investments (Gourevitch and Shinn, 2005: 107). For instance, foreign equity held by American investors increased from US $128.7 billion in 1988 to US$1,787 in 2000 (Conference Board, 2002: 39). The value of cross-border transactions in equities (and bonds) as a percentage of GDP for France and Germany experienced a sharp increase from 1908 to 1998 – from 5 to 415 percent for the former, from 7 to 334 percent for the latter. This strategy of international diversification, in turn, has resulted in the substantial presence of foreign ownership in continental European economies previously characterized by ownership concentration in the hands of large domestic banks and nonfinancial firms. The average percentage of foreign ownership for the members of the Euro Stoxx 50 – the leading index for bluechip continental European companies – stood at 44.4 percent as early as 2002 (Tricornot, 2002: 20).4 The rise of foreign ownership often came at the expense of domestic cross-shareholdings among large domestic companies which experienced a major decline.5 Fifth, the proliferation of financial techniques and commercial valuation models through which corporate and managerial performance are disclosed and modeled has contributed to transform the external environment in which French and German companies are embedded: economic value added, cash flow return on investment, and many others. These newly created financial metrics are important since they allow for a comparison and ranking of performance. The ability to compare corporate performance does not entail that French and German companies are now subject to the dictates of Anglo-American institutional investors. The influence of these financial matrixes depends not so much on their adoption by companies, but rather on the scrutiny and the effects of knowing that one is being examined and evaluated (Roberts et al., 2006). A central concern of corporate executives is to avoid surprising financial markets with unexpected bad news (Zorn et al., 2005; Hendry et al., 2006: 1119). Corporate executives do not want their actions to be misrepresented. Getting the right expectations into play enables managers to secure access to external finance at reasonable costs if needed, and avoid exposing the firm to potential unwanted takeover activities following a sharp drop in its stock market capitalization. In turn, however, serious considerations to new financial techniques and commercial valuation models can contribute to shape the subjectivity

4 The percentages of foreign ownership for French and German companies that are members of the Euro Stoxx 50 in 2002 were, respectively, 42.6 and 39.0 percent. 5 See Hoepner and Krempel (2004) for Germany and Morin and Rigamonti (2002) for France.

54

Short-term Capital Mobility in France and Germany

of the finance directors and other highly placed corporate executives, thereby potentially channeling and sustaining shareholder value-oriented demands from external investors. There is a difference between creating shareholder value and managing the indicators of that value, but the justification of corporate activities is increasingly taking place through a reference frame influenced by the financial considerations of AngloAmerican institutional investors (Fiss and Zajac, 2004; Djelic and Zarlowski, 2005). Moreover, large French and German companies might also be paying greater attention to the decisions of rating agencies regarding their credit worthiness (Windolf, 2002: 222). The issue of bonds and convertible loans remains less expensive than contracting traditional bank loans – but leaves them more sensitive to the decisions of rating agencies such as Moody’s and Standard & Poor’s. The increased importance of stock market integration has raised the sensitivity of French and German firms to financial considerations. The assessment of the consequences associated with this new development, however, should not be interpreted as the manifestation of the uncontested power of financial capital. The concept of shareholder value is itself characterized by several components whose implementation has been selective across advanced capitalist economies (Goyer, 2006b; ¨ rsch, 2007). In other words, there are many different strategies of Bo shareholder value that impact on share prices, thereby providing companies with the ability to resist the introduction of those whose conflict potential with stakeholders is higher. The implication is that developments in finance do not imply that companies (and countries) are now subject to the dictates of foreign financial actors. To echo Cohen’s earlier analysis of developments in the world economy, the interesting question is not whether the increasing importance of stock markets constitutes a constraint for firms, but how and under what conditions (Cohen, 1996: 288).

2.2 Economic Sociology and the Evolution of the Background of Top Corporate Executives: Control Variable I argue in this section that the differences in the investment allocation of Anglo-American institutional investors in France and Germany cannot be accounted for by changes in variables identified as crucial by economic sociologists for the governance of firms. The analysis of the (potential) increase in the prominence of stock markets, and of the associated importance of shareholder value in the strategic direction of 55

Contingent Capital

companies, cannot be limited to the incorporation of crucial developments external to the French and German economies. Economic sociologists have emphasized the importance of the process of economic elite recruitment – in the form of the training and career patterns of top executives – as well as the tightness of networks in which these executives are embedded (Lane, 1995; Kogut and Walker, 2001; Windolf, 2002). Why are these features significant and what is their explanatory power in the study of the investment allocation of Anglo-American institutional investors? The mode of selection and institutionalization of economic elites differs significantly between countries – be they the importance of the CFO in the United States, the centrality of the University of Tokyo in Japan, and the crucial role of advanced university degrees in scientific/technical subjects for the nonfinancial sector in Germany (Lawrence, 1980; Bauer and Bertin-Mourot, 1999; Windolf, 2002). Institutionally oriented sociologists have emphasized the importance of embedded contexts of specific social norms and practices for the strategic governance of firms.6 Institutional arrangements contribute to the provision of cognitive scripts that shape the range of actions deemed legitimate and, in turn, enable actors to interpret the complexity of the world around them (Meyer and Rowan, 1977). The strategic behavior of firms is highly contingent upon the institutional context in which they are embedded with the implication that practices of corporate governance that provide a better fit with the local context are more likely to be adopted.7 Institutionally oriented sociologists have also emphasized the importance of social capital in networks for issues of corporate governance (see e.g. Davis, 1991; Davis and Greve, 1997). The development of social capital is based on a series of personal connections and interpersonal interaction that facilitates the coordination of actions based on the common values and experiences of participants. Social networks can provide the basis for cohesion that enables people to cooperate with one another and achieve goals that would be difficult to meet on an individual basis. Sociological perspectives on comparative corporate governance have highlighted the importance of the specific characteristics of the educational background and career patterns of corporate executives in the formation of these networks (Aguilera and Jackson, 2003; Fiss and Zajac, 6 See Aguilera and Jackson (2003, 2010) and Fiss (2006) for excellent analytical overviews of economic sociology treatment of institutions in corporate governance. 7 See Davis and Greve (1997), Aguilera and Cuervo-Cazurra (2004), Fiss and Zajac (2004), Sanders and Tuschke (2007), and Haxhi and van Ees (2010) for discussions related to diffusion and corporate governance. For a more general treatment of diffusion and local fit, see Strang and Macy (2001).

56

Short-term Capital Mobility in France and Germany

2004). These two sociological features – education and career pattern – constitute determining variables in the construction of the specific embedded character and social capital of national systems of corporate governance. Top corporate executives with specific types of educational and working experiences direct their attention to certain types of innovation and experimentation at the expense of others – thereby rendering them more (or less) open to learning and borrowing from other countries (see e.g. Sanders and Tuschke, 2007).8 Moreover, these two sociological features of national business systems also reflect the political contests regarding the strategic direction of the corporation (Fligstein, 1990, 2001; Ocasio and Kim, 1999). Struggles among the different groups of corporate executives translate into instability and changes in formal authority at the top of large firms. The cases of French and German corporate governance are quite interesting for the study of the background of corporate executives from an economic sociology perspective. These two advanced capitalist economies have traditionally been characterized by the presence of corporate executives whose educational background and career patterns differ and are context specific.9 The process of economic elite formation in the two countries highlights nation-specific, highly standardized career paths that differ from those of the rest of the population as well as from those of other countries. In France, the path of access to top corporate executive positions has been dominated by two features. First, attendance at one of the Grandes Ecoles – that is, selective elite institutions of higher education outside the traditional universities – has been essential for assisting (or impeding) access to top corporate positions (Schmidt, 1996; Windolf, 2002). Two institutions figure prominently among this group and have traditionally accounted for the plurality of corporate executives serving as top managers and/or directors: Ecole Nationale d’Administration (ENA) and Ecole Polytechnique. Second, securing employment (a first job) in the civil service with one of the prestigious civil service corps, commonly called the Grands Corps, has also been crucial for access to top corporate executive positions at later stages of one’s career (Schmidt, 1996; Maclean, 2002). Among the most 8 For instance, the split between the financial versus functional orientation of managers translates into differences regarding the degree of integration of strategic and operational functions (Aguilera and Jackson, 2003: 458; Whitley, 2003). The financial orientation of corporate executives translates into stronger separation between strategic and operational activities with financial mechanisms of control being important. By contrast, firms governed by managers whose qualifications reflect the acquisition of specialist knowledge are more likely to be characterized by greater integration of operational functions. 9 See Bauer and Bertin-Mourot (1987, 1996), Whittington and Mayer (2001), Windolf (2002), and Zorn (2004) for analytical overviews.

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Contingent Capital

prestigious Grands Corps is the Inspection des Finances where only five to six graduates from ENA are recruited from each annual cohort, the Corps des Mines, and the Corps des Ponts et Chausse´es.10 Membership of one of the Grands Corps presents a significant advantage. Although technically civil servants, its members are able to switch to a more highly paid job in the private sector and come back to their original job if needed (Bauer and Cohen, 1981; Bauer and Bertin-Mourot, 1987). The French-specific path of corporate elite recruitment has been conducive to the development of coordination through networks (Hancke´ and Soskice, 1996; Maclean, 2002). Attendance of common elite educational institutions and similar career trajectories thus enabled the development of social capital both within and across generations.11 The process of economic elite formation in Germany has traditionally been characterized by a highly standardized career path that differs substantially from those of American and British executives – as well as from the prevalent path that has been dominant in France. First, the educational background of top German corporate executives is characterized by the importance of advanced university degrees, typically a Ph.D., in technical fields such as engineering and chemistry for nonfinancial companies (Lawrence, 1980; Maurice et al., 1986). Top German corporate executives have been praised for the high level of technical expertise that results from their productionist, engineering-oriented focus (Herrigel, 1996). The profile of top German executives stands in sharp contrast to that of their American colleagues, where the emphasis on finance has been dominant in the last twenty-five years. Second, and in contrast to France and AngloAmerican economies, the path to top corporate executive positions (for both financial and nonfinancial companies) does not pass through specific elite institutions of higher education (Windolf, 2002: 99–123). Instead, the importance lies in obtaining specialized and higher education qualifications – self-made men being consciously quasi-absent – rather than attending one specific institution of higher education over others (ibid.: 149). Moreover, and as in the French case, social background constitutes an important variable for pursuing higher education studies that, in turn, constitutes the standardized path for gaining access to top corporate positions (Hartmann, 2007).

10 Nguyen-Dang (2008: 12). Moreover, the great majority of CEOs in the banking and insurance sectors in France started their careers at the Inspection des Finances. 11 For instance, CEO interlocking directorship in France is strongly influenced by attendance at either ENA or Ecole Polytechnique. The board of directors of firms governed by CEOs that graduated from one of these two elite schools is (a) more likely to be composed of directors that also graduated from the same school; and (b) less likely to dismiss elite, schooleducated CEOs for poor performance (see Nguyen-Dang, 2008).

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Third, the external labor market for German executives has traditionally been limited because of the prominence of internal recruitment practices and in-house careers (Hauskarrieren) for both financial and nonfinancial companies. Access to top corporate position takes place after there has been long tenure in the firm (Windolf, 2002: 119). The tenure of CEOs has typically been long and characterized by a transition of becoming the head of the supervisory board rather than seeking employment with another firm. The implication is that the process of selectivity of corporate elites in Germany is sharply different than that of France (ibid.: 130). In France, the selection of elites takes place in Grandes Ecoles which is, obviously, early in the course of a life. In Germany, in contrast, elite selection is postponed to a much later period and takes place through the internal labor market of large listed companies. Fourth, the structure of interlock directorates in Germany has traditionally been extremely tight and comprehensive with few large companies not connected to others in the form of shared directors and, although to a lesser extent, cross-shareholdings (Kogut and Walker, 2001; Windolf, 2002: 35). Contrary to the French corporate network coordinated around executives with substantial experience as civil servants, the network of German companies has traditionally been highly diffused and comprehensive, thereby reflecting the broader corporatist tradition of imposing limits on economic competition with the result that fewer firms are not integrated (Djelic, 1998; Windolf, 2002: 1–18). The educational background and career paths of top executives, as well as the tightness of the corporate networks in which firms are embedded, exert considerable influence on the strategic direction of companies. It is within this perspective that the evolution in the sociological features of top managers in France and Germany matter. Nonetheless, the values taken on the dimensions identified by economic sociologists remain incomplete to account for disparities in the investment allocation of Anglo-American institutional investors. First, the educational background and career patterns of extensive work experience inside companies have experienced modest variations in Germany. I present in Table 2.1 the educational background for German CEOs outside the banking and insurance sectors – two areas where advanced university degrees in technical fields have traditionally been important. I compare the educational background of German CEOs for 1998 and 2009 – the period under consideration for this study. The data highlights the presence of modest changes. I also present in Table 2.2 the number of years spent inside the company before acceding to the position of CEO in nonfinancial companies in Germany. The rise of outsiders and recently recruited CEOs has also been rather modest. Finally, the links 59

Contingent Capital Table 2.1. Educational Background of German CEOs in Nonfinancial Sectors (1998 and 2009) Chemistry/engineering/ medicine/physics

Economics/finance/law/ management

22 17

19 21

1998 2009

Note: Total numbers vary between 1998 and 2009 since they reflect the delisting and introduction of new companies between these two years. Source: Hoppenstedt Darmstadt, Hoppenstedt Aktienfu¨hrer; and own calculations from annual reports.

Table 2.2. Work Experience inside the Firm of German CEOs in Nonfinancial Sectors (1998 and 2009)

1998 2009

Outsider

0–5 years

Over 5 years

5 6

4 9

30 25

Source: Hoppenstedt Darmstadt, Hoppenstedt Aktienfu¨hrer; and own calculations from annual reports.

between the sociological features of German executives and the investment allocation of short-term institutional investors highlight the fact that the presence of insiders with firm-specific skills and long-career trajectory within companies has not deterred the acquisitions of blockholding stakes. Of the twelve instances of acquisitions of a large equity stake in nonfinancial companies, nine took place in firms governed by CEOs with a technical background (Chemistry/Engineering/Medicine/ Physics) with only three of them awarded to firms headed by CEOs with a more business-oriented educational background.12 Moreover, eleven instances of such acquisitions took place in firms where the CEO had been working for seven years or more. Second, the tightness of the corporate networks in the two countries has experienced erosion in some dimensions. Patterns of domestic crossshareholdings among large domestic firms in France have collapsed in the last ten years – and have become somewhat less intense in Germany.13

12 Complete data on blockholding acquisitions by short-term investors in German companies is presented in section 2.4. 13 See Culpepper (2005, 2010) for an excellent analysis of these developments. See also Hoepner and Krempel (2004) for data on the German case, and Morin and Rigamonti (2002) for an empirical analysis of the French case. However, data for Germany does not take into account the small world character of networks (see Kogut and Walker, 2001).

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However, two qualifications must be added. The first is that the decline in the cross-shareholdings network in France has not been matched by a similar transformation of interlocking board networks. In fact, the tightness of interlocking directorates remains high in France (Dudouet and Gre´mont, 2010). Network analysis reflects unequal access to power in capitalist democracies – thereby the importance of different modes of coordination based on either directorates or ownership (Kogut, 2012). Moreover, French firms without ownership concentration have increasingly relied on deviations from the one-share-one-vote practice to protect themselves against takeovers via the introduction of unequal voting rights and voting ceilings (Clift, 2009: 69). This development is significant since it does hinder the shareholder activism of short-term-oriented institutional investors (see e.g. Bessiere et al., 2010). The second qualification is that the restructuring of corporate ownership in Germany did not lead unequivocally to diffusion. Instead, restructuring was characterized by German companies selling to other domestic firms already part of a common network of directors and/or owners (Davis et al., 2012).

2.3 The Rise of Short-term Capital: Methodological Issues Developments in international finance are potentially profoundly disequilibrating. The decreased ability of national governments to control cross-border flows, even if they have political incentives to do so, has facilitated large-scale portfolio investments by Anglo-American institutional investors in continental Europe. Nonetheless, theoretical inferences cannot be drawn simply from the growing importance of capital mobility across borders. An analysis of developments in international finance requires a nuanced understanding of the preferences and strategies of investors. Several serious methodological issues remain important in the assessment of how the increased integration of stock markets matters for the governing of capitalist economies. First, institutional investors – even, and especially, Anglo-American ones – do not constitute a monolithic bloc since they possess widely diverging preferences (Gourevitch, 2006; Goyer, 2006a). Four critical features set different categories of institutional investors apart with systemic consequences for comparative corporate governance: mode of issuing payments, time horizon and liquidity constraints, remuneration and managerial incentives, and the process of picking portfolio companies.

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Contingent Capital

Different categories of institutional investors differ markedly regarding the process by which payments are made to contributors/investors. Pension funds operating on defined benefits (DB) schemes guarantee the level of benefits the fund will pay and the method of determining those benefits, but not the amount of the contributions. DB schemes guarantee a fixed payment in the future. The level of contributions in the current period is determined actuarially on the basis of the benefits expected to be paid to the retirees who contributed to the fund and the assumed rate of return. Pension funds operating on defined contribution (DC) schemes, on the other hand, specify the level of contributions but not the amount of the benefits to be paid. The amount available to the beneficiaries results from both the portfolio performance and the amount initially invested. For mutual funds, assets are managed almost exclusively on a DC scheme (Pozen, 1998: 397–423). This is not surprising since mutual funds are investment companies that pool funds from individuals and corporations with the provision that the money invested is redeemable on demand. The funds paid to investors are dependent on the market performance of the mutual fund. It is also important to note that pension funds do manage directly only a small percentage of the assets collected by them – mutual funds serving as external fund managers. The pension fund industry is increasingly dominated by reliance mutual fund managers for asset management since 401(k) plans allow corporations to more easily outsource direct contribution pension plans to external DC fund managers.14 For hedge funds, investors typically face an initial lockup period of one year and subsequent restrictions to quarterly intervals (Fung and Hsieh, 1999). Hedge funds collect funds from wealthy investors willing to assume higher levels of risk in exchange for potentially superior results. Moreover, the time horizon of institutional investors diverges considerably in regard to their patterns of trading. The annual average turnover rate of American public pension funds in 1997 was 19.3 percent (Conference Board, 1998). The similar figure for mutual fund managers and external money managers from 1997 to 2009 was 57 percent – although with significant variations between actively and passively managed mutual funds (Investment Company Institute, various years). The time horizons of actively managed mutual funds, in particular, are extremely

14 However, pension funds do retain some form of control by issuing specific guidelines on investment decisions to external money managers. Moreover, pension funds often change external money managers that deviate from investment guidelines by taking excessive risks even for superior financial performance. See Del Guercio and Hawkins (1999) and Del Guercio and Tkac (2001).

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short. The average time a share is held for Fidelity (mutual funds) was 2.63 years in 1999 (Bandru et al., 2001: 125). For passively managed mutual funds, in contrast, their investment strategy is based on the view that it is difficult to beat the market through active trading, thus their time horizons are significantly longer than hedge funds and actively managed mutual funds (Malkiel, 2003). The niche of passively managed mutual funds – Vanguard being a prominent example – lies in the provision of broad access to financial markets through low management fees for their investors. The acquisition of concentrated blockholding positions does at times occur but is not of a short duration since trading is less frequent. The remuneration of fund managers is formally based on the overall size of financial assets under management, but the turnover rates of portfolio stocks are relatively low. Similarly, most public pension funds have longer term horizons as witnessed by their turnover rates: Florida state (12.5 years) and California State Teachers (7.6 years) (Bandru et al., 2001: 126). Pension funds do not face similar liquidity constraints to actively mutual funds and external money managers, since payments to retirees are regular and predictable. Hedge funds also display reliance on short-term trading, albeit in a different way from mutual funds (Ackermann et al., 1999). The investment strategies of hedge funds entail high turnover and aggressive trading on short-lived information, but not as intensively because of liquidity concerns since investors face an initial lockup period of one year and subsequent restrictions to quarterly intervals. Instead, the short-time horizon of hedge funds results from their investment strategies. Hedge funds practice statistical arbitrage that involves balancing positions in assets (equity, government bonds, and national currencies) that are believed to be undervalued against others that are expected to fall in value. In other words, hedge funds operate on the notion of contracts, that is, laying bets that an asset will go above a designated target or will fall below it. Moreover, hedge funds tend to quickly sell their positions in assets once these targets have been reached, thereby accounting for their propensity to rely on short-term trading strategy.15 Another factor that contributes to sharply differentiate between categories of institutional investors concerns the financial incentives of asset managers. Increases in the level of the financial compensation of

15 The most famous embodiment of this investment strategy was George Soros’ Quantum Fund and the devaluation of the British Pound in 1992. This hedge fund placed a bet on the devaluation of the British Pound on September 11 and took it off on September 22 after the devaluation became effective, thereby experiencing a gain of 25.5 percent for that month and gaining more than $1 billion in a single day.

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fund managers at hedge funds and mutual funds can come from maximizing the value of assets under management or from attracting new investors to the fund. In other words, managerial remuneration is based on the volume of assets under management and on the performance of the portfolio. Public pension fund managers, however, face constraints that deter them from maximizing the value of their portfolio despite incentives associated with the increase of assets under management. The first constraint consists of state regulations that impose caps on the salary of managers (Woidtke, 2002). In other words, the link between compensation and size of assets under management does not hold above a certain level – thereby resulting in overall lower salaries for public pension fund managers relative to their mutual fund and private pension fund counterparts. Moreover, the number of beneficiaries in public fund schemes is limited by the size of the contributing workforce – a factor over which public pension fund managers have no control. The second constraint on public pension fund managers lies in the absence of any financial incentives tied to fund performance. The primary objective of DB public pension funds is to generate a certain minimum amount of revenues through the management of the assets under their control. Contributions are determined actuarially on the basis of the level of the benefits expected to become payable to the retirees. The payouts to beneficiaries are independent of the funds’ endowment. Fund managers earn a civil service salary and would not receive proportional extra rewards for achieving returns beyond the mandated averages (Monks and Minow, 1995: 125). Performing below the market index, on the other hand, is a sure cause for dismissal since the risks are borne by the pensioners. Finally, public pension fund managers are elected state officials or political appointees facing different types of pressure from their mutual fund counterparts (Romano, 1993). Pension fund managers have to consider the demands of powerful interest groups that often clash with the interests of their fiduciaries. The incentives faced by actively managed mutual fund and hedge fund managers stand at the opposite end of the spectrum from those of their public pension fund counterparts. In the first place, compensation for mutual fund managers is based on a percentage of assets under management without any caps (Elton et al., 2003). Moreover, the behavior of investors in mutual funds exhibits a marked tendency to flock to “winners.” Mutual funds displaying high returns during an assessment period will experience an inward surge of new investment inflows in the fund in subsequent periods. In particular, capital inflows are highly correlated with a fund outperforming a market benchmark (Del Guercio and Tkac, 2001). In other words, managerial remuneration depends on 64

Short-term Capital Mobility in France and Germany

the relative performance of the fund vis-a`-vis that of others. As a result, mutual fund managers desirous to increase the value of the fund – and to boost their compensation – face extremely powerful incentives to maximize the volume of assets under management by attracting inflows of new investment. This strategy invariably entails the revision of the composition of the portfolio.16 As well as being relative to the performance of other funds, moreover, the compensation of mutual fund managers is also driven by internal performance and rankings. The great bulk of mutual funds use a ranking system in the form of a league table to evaluate their managers and compare the quarterly performance of the fund (Roberts et al., 2006: 282). At Fidelity, for example, each manager’s returns are compared to benchmarks reflecting the risk specificity of the particular fund they manage (McDonald, 2003: M5). Fund managers outperforming benchmarks at Fidelity are rewarded with higher rankings vis-a`-vis their own colleagues, more generous financial compensation, and faster internal progression.17 The incentives of hedge fund managers are also greatly heightened by important financial considerations. Managers of hedge funds are also compensated on the basis of the volume of assets under management and are given mandates to beat recognized financial benchmarks, often regardless of the market environment. However, the financial incentives of hedge fund managers differ in one fundamental way from those prevalent at mutual funds. Their total compensation comprises both the amount of assets under management as well as substantial incentives fees, the latter being paid only when hedge fund managers make a positive return. The typical remuneration contract of hedge fund managers is characterized by 1–2 percent of assets under management and 5–25 percent of profits realized (Brown and Goetzmann, 2001: 2). Thus,

16 Mutual fund managers whose fund’s performance lags behind rivals at the midpoint of an assessment period are likely to shift the composition of their portfolio by investing in a greater number of riskier companies, thereby increasing the volatility of the fund and also the probability of increasing its performance (Brown et al., 1996; Chevalier and Ellison, 1997). 17 This process of internal ranking entails profound consequences for fund managers and corporate governance that are well illustrated by the case of Fidelity. The foreign segment of the Boston-based mutual funds amounts to only 10 percent of its overall stock portfolio. The French market only represents 0.5 percent of its stock portfolio (Commission des Ope´rations de Bourse, 1998). Nonetheless, managers of the European (or French) funds of Fidelity possess the same types of financial incentives as their counterparts managing bigger funds comprised of American companies. Financial compensation and progression within Fidelity require fund managers to outperform benchmarks whether their particular fund is composed of American, European, or other types of funds. This point also illustrates the lack of creativity of actors in this outside-in perspective on the transformation of French and German corporate governance. The size of these two markets is insufficient to warrant a change in the strategy and tactics of fund managers from those that prevail in the domestic market.

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Contingent Capital

financial incentives shape in diametrically opposite ways the pressures faced by hedge, mutual, and public pension fund managers.18 Categories of institutional investors are also sharply differentiated by the process by which fund managers select companies for investment, thereby resulting in a different composition of the stock portfolio. The composition of the stock portfolio for the great majority of public and private pension funds is increasingly based on an index strategy. By late 1995, the percentage of assets managed on an index by American pension funds had climbed to 60 percent (Commission des Ope´rations de Bourse, 1998: 15). This figure is even higher for some of the most activist funds. For example, around four-fifth of the stock portfolios of CalPERS and TIAACREF were indexed in 1997 (Del Guerco and Hawkins, 1999: 302). The growing recourse to indexing by pension funds reflects their assessment that active management of the equity portfolio produces results inferior to market indexing. Pension funds in the United Kingdom and in the United States often lack the firm-specific knowledge needed to take actions aimed at transforming the strategy of portfolio companies (ibid.: 305–6). For passively managed mutual funds, the selection of target firms is driven by their business strategy, namely that it is difficult to beat the market through active trading. Their strategy is based on the reduction of management fees, not on the timing of buying and selling of shares (Malkiel, 2003). Passively managed mutual funds target well-governed companies that are already paying high dividends and exhibiting less discrete spending – the implication being that long-term investors prefer financially safer companies for which active shareholder activism and the acquisition of detailed firm-specific knowledge are less needed. The relatively limited role of variable compensation and the long-term horizon of passively managed mutual funds do not favor the selection of portfolio companies based on rapid stock price changes following the implementation of operational changes. Actively managed mutual funds, by contrast, do not acquire an equity stake in a corporation because it is part of an index. Managers are in stiff competition with other funds for the assets of investors that, in turn, can be redeemed at any moment. The structural characteristics of the mutual fund industry compel managers to achieve high returns, not simply match an index. Mutual funds behave like stock pickers and are in many ways the

18 Private pension fund managers face a hybrid situation. Because the salaries have no caps, managers’ compensation can reflect the total value of the fund. The average base salary for private pension fund managers is 33 percent higher than that of their public pension fund counterparts. See Woidtke (2002: 103).

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Short-term Capital Mobility in France and Germany

mirror image of DB pension funds (Pozen, 1994: 140–9; Monks and Minow, 1995: 163). Finally, the compensation of hedge funds managers derives from the amount of assets under management and, to a substantial extent, from incentive fees. These incentive fees are paid only in the event of the returns on the portfolio exceeding financial benchmarks (Brown et al., 2001). The raison d’eˆtre of hedge funds is to pursue flexible and aggressive strategies that entail above-normal risks and potentially high returns under a framework of limited government oversight. Hedge funds are greatly interested in the business strategy and management of corporations (Kahan and Rock, 2007; Klein and Zur, 2009). Their investment strategies highlight defined preferences regarding specific corporate policies that enhance shareholder value: refocusing on core activities and spin-off of noncore assets, asset divestitures, mergers and acquisitions, share buybacks, dividend policies, and firm leverage (Brav et al., 2008: 1731–45; see also Watson, 2005, for a clinical case study of the involvement of hedge funds in Deutsche Borse). The criteria and processes by which hedge funds (and actively managed mutual funds) select portfolio companies invariably involve the acquisition of firm-specific information. The importance of specific firms for the overall financial performance of the fund also illustrates the differences in the composition of the portfolio of actively managed mutual funds and pension funds. The use of an index as an investment strategy by pension funds entails that their aim is to reproduce as closely as possible the economic profile of a sector/country. The investment strategy of actively managed mutual funds, in contrast, aims at picking undervalued firms that are likely to outperform the market in the short-term. These different investment strategies, in turn, entail diverging degrees of dependence on the performance of specific portfolio companies. The top portfolio companies for actively managed mutual funds account for a greater percentage of their overall investment than the top portfolio companies for pension funds. I present in Table 2.3 the relative weight of the top ten holdings for selected mutual and pension funds.19 For pension funds, I report that percentage accounted for by the top ten holdings in either their

19 Hedge funds do not have to reveal the composition of their portfolio, and materials distributed to investors are often available on a restricted basis and published at irregular intervals. The low profile and secretive nature of hedge funds is designed to minimize the regulatory and tax oversights. As a result, it is impossible to acquire credible data on the holdings of hedge funds and to compare them with mutual and pension funds. On the other hand, however, financial regulation in the European Union obliges shareholders to disclose equity stake above the 5 percent threshold. Thus, it becomes possible to track the investment targets of hedge funds when their equity stake exceeds this threshold.

67

Contingent Capital Table 2.3. Weight of Top Ten Holdings in Selected Funds Pension funds Name of institution California Teachers Illinois Teachers New York State Teachers Pennsylvania Teachers Texas State Employees

Mutual funds

Fund type

%

Institution

Fund type

%

Domestic

14.2 (2003)

Domestic

23.7 (2004)

Domestic

10.8 (2003)

Domestic

28.0 (2004)

Domestic

14.2 (2003)

Fidelity Growth Fidelity Magellan Fidelity UK

Continental Europe

24.3 (2003)

International

12.6 (2002)

Domestic

43.8 (2004)

Domestic

17.4 (2002)

International

30.5 (2004)

Janus Growth Janus Worldwide

Source: Annual reports.

domestic or international portfolios. Actively managed mutual funds, on the other hand, manage several dozen funds: thus I selected the most important funds in regard to assets under management for some of the biggest institutions. As Table 2.3 highlights, the financial returns of actively managed mutual funds are more dependent on the performance of a selected number of top portfolio companies than they are for their pension funds counterparts. Therefore, the assessment of the consequences associated with financial liberalization and the international strategy of diversification of institutional investors on the evolution of corporate governance in France and Germany requires a sophisticated differentiation between categories of institutional investors. The incentives of pension funds managers lie in the generation of a certain minimum amount of revenues in order to cover regular payments to retirees. Pension funds constitute a category of investors with a long-term horizon that are primarily driven by diversification concerns. This goal results in an index investment strategy, namely acquiring a small stake in a large number of companies according to their market capitalization. Passively managed mutual funds are organized around a low management fee strategy underlying the notion that it is difficult to beat the market through active trading – thereby resulting in lower compensation incentive for fund managers and a longer trading horizon (Malkiel, 2003). Actively managed mutual funds are geared toward maximizing assets under their management by picking firms currently undervalued on financial markets (Brown et al., 1996). Managers possess a shorter term 68

Short-term Capital Mobility in France and Germany

horizon since they face greater liquidity concerns given that financial assets under their management are redeemable on demand by investors. Their investment strategy consists of timing their buying and selling of shares by correctly anticipating market movements in order to outperform rival asset managers. Hedge funds are largely unregulated limited partnerships that collect funds from wealthy investors assuming higher levels of risk for potentially superior returns as well as being willing to accept limits on their ability to redeem their invested assets (Fung and Hsieh, 2007). Hedge funds do, however, share common features with actively managed mutual funds – short-term horizon trading strategies of their stock holdings and heightened managerial incentives to achieve results superior to those associated with the index investment strategy of pension funds. The above discussion has highlighted the methodological problem associated with the differences between categories of Anglo-American institutional investors for the study of corporate governance in France and Germany. Three other methodological issues remain. First, institutional investors possess multiple niche investment strategies even under specific objectives (Gourevitch, 2006; Goyer, 2007). Fund managers with a bottom-up strategy behave like stock pickers, that is, selecting the companies to buy (and sell) after undertaking research analyses that seek to discover undervalued stocks with potential higher returns than securities in the same category. The investment timing for this category of fund managers is driven by their ability to predict the outcome of potential corporate decisions. Top-down managers, in contrast, seek to anticipate evolving market trends and price changes in capital markets rather than primarily analyzing individual companies. A top-down strategy is characterized by fund managers building their portfolios based on the analysis of macroeconomic factors associated with different countries. The statistical analysis of the timing of economic cycles, rates of GDP growth, balance of trade, exchange rates, and the state of public finance constitute key variables in the investment-making process of top-down fund managers. Geographical allocation is decided first, and only then does the fund manger proceed to select which stock to invest in. Second, mutual funds are often themselves characterized by substantial internal diversity. They do not stand alone as a business entity but rather form part of a family of funds with different investment strategies. For example, Fidelity Spar International is an index managed fund focused on foreign stocks with a turnover of just 6 percent in 2005.20 In 20 The turnover rate of a fund is defined as the percentage of the portfolio’s holding that has been bought and sold in the previous twelve months. For example, a turnover rate of 100 percent indicates that the manager changes the entire portfolio within a year. Fund managers

69

Contingent Capital

contrast, Fidelity Europe is focused on European stocks but is a shortterm, aggressive fund that had a turnover of 99 percent in 2005. Third, the disclosure requirements imposed on institutional investors vary substantially across categories. For instance, mutual funds are subject to an extensive number of regulatory constraints that are not applicable to hedge funds – most notably the obligation to fill in semi-annual reports listing the amounts and values of the stocks they own. The above description highlights how the investment decisions of funds are guided by many considerations that, in turn, potentially impede the assessment of the consequences associated with the greater mobility of capital across national stock markets. What types of data on capital mobility should be collected for the analysis of the impact of capital mobility on distinctive national varieties of capitalist economies? Contributions in social sciences in recent years have emphasized the importance of distinguishing evolutionary shifts from more groundbreaking developments (Campbell, 2004; Hall and Thelen, 2009; see also Deeg, 2001, 2005b). The rise of foreign ownership in the form of shareholder value-oriented institutional investors does not by itself constitute a radical transformation of the French and German varieties of capitalism since there are many components and strategies of shareholder value (see Goyer, 2006b; Bo¨rsch, 2007). Greater focus on shareholder value does not necessarily entail the transformation of processes by which firms coordinate their activities. The provision of a sophisticated analytical differentiation between categories of investors is needed. In particular, the argument presented in this book highlights the importance of the content and speed of adjustment associated with the implementation of strategies of shareholder value in France and Germany – a novel development for these two countries – not simply their mere introduction. The issue is not about shareholder value per se, but rather concerns the presence of impatient investors aiming at portfolio companies implementing short-term-oriented strategies designed to boost their market capitalization.

2.4 The Rise of Short-term Capital: Empirical Data The compilation of data in the presence of potentially radical, groundbreaking foreign ownership is based on the new disclosure standards under the transposition by France and Germany of the European with high turnover rates are short-term oriented and trade frequently – holding stocks for shorter periods.

70

Short-term Capital Mobility in France and Germany

Union’s Large Holdings Directive. Securities Laws in the two countries have required disclosure by institutional investors of equity stakes in listed companies in excess of 5 percent since 1997. Shareholders are required to notify national securities regulation authorities if their holdings reach, exceed, or fall below the 5 percent threshold of the equity capital of a company. The acquisition of concentrated positions in companies is highly significant for the study of the effects of capital mobility since it highlights the strategic behavior of investors seeking to time the purchase and sale of securities in reaction to some shareholder value-oriented measures of firm-level restructuring. Thus, I recorded data on equity stakes above the 5 percent threshold from September 1997 to December 2009 by UK- and US-based hedge funds and actively managed mutual funds as an indicator for the presence of short-term, impatient capital.21 The focus on American and British funds reflects differences in the portfolio turnover of institutional investors based on geographic factors. The behavior of funds in regard to their time horizon and turnover strategy differs across varieties of capitalism and highlights the importance of specific institutional contexts (Dupuy et al., 2010). Institutional investors behave differently across national contexts based on their remuneration structure, mode of collection of funds, and return expectations of investors. The international strategy of diversification does not simply constitute an issue of portfolio diversification.22 The sample selection is the largest sixty firms in both France and Germany by stock market capitalization as of December 17, 2003. The selection of these 120 firms is justified in that they are all part of the Euro Stoxx 1000 index, they represent a wide range of economic sectors, and they also constitute the primary investment targets of Anglo-American institutional investors in continental Europe (see e.g. Clark and Wojcik, 2007: 120). The selection of December 17, 2003, as the date of reference for data collection is designed to capture the effects of companies entering and leaving the stock market via delisting, mergers and acquisitions, and more recent listing. The disadvantage with the choice of a date of reference closer to 1997 is that several companies will have dropped out of the list of the largest sixty in each country by the late 2000s; on the

21 I collected data from the two official governmental databases of the financial regulation authority of the two countries: www.amf-france.org and www.bafin.de. The collected data was cross-checked with the two annually published business directories: DAFSA Annuaire des ¨ hrer for Germany. Socie´te´s for France and Hoppenstedt Darmstadt’s Hoppenstedt Aktienfu 22 For instance, American institutional investors invest primarily in Canada and the United Kingdom when going abroad – two markets with high correlation with the domestic American market – rather than diversifying their assets in markets with lower correlation rates such as Germany and Japan (Tesar and Werner, 1995).

71

Contingent Capital

other hand, the selection of a reference year closer to 2009 entails missing important capital transactions that took place before the recent listings of selected firms.23 The compilation of the data was subjected to the four following conditions. First, I discard movements of capital above and below the 5 percent threshold within a thirty-day period. Movements above and below the 5 percent threshold might reflect a share buyback program by a portfolio corporation rather than an intended strategy by an institutional investor. Moreover, and more importantly, short-term holding of less than a month by hedge funds may reflect short selling, not a strategy based on gaining from the appreciation in value of portfolio companies. Second, I discarded holdings held by subcustodian firms such as State Street. The 1940 Investment Act in the United States requires mutual funds to place their funds with subcustodian firms for issues of shareholder protection. Thus, the holdings of such financial agents simply reflect holding the financial assets of mutual funds clients rather than a strategic investment decision. Third, I distinguished between different categories of mutual funds and split them into two categories with the median turnover rate serving as the dividing mark.24 Mutual funds with turnover rates above the median for the industry are classified as short-term-oriented investors. As previously mentioned, mutual funds are composed of families of funds with different objectives and investment strategies that are reflected in their turnover rates. Managers with high turnover strategies trade over their portfolio quickly in order to capture the potential changes in share price following implemented actions by portfolio companies – an investment strategy markedly different from longer term oriented mutual funds, whose assets are more passively managed. Fourth, hedge funds are classified as short-term-oriented investors. The raison d’eˆtre of hedge funds is to pursue flexible and aggressive strategies that entail above-normal risks in return for potentially high returns within short-term periods (Fung and Hsieh, 1997; Brown et al., 2001). Empirical studies on the investment decision-making process of hedge funds highlight the predominance of short-term trading strategies. The average holding period of hedge funds for significant holdings 23 Moreover, investments by UK/US short-term-oriented investors started to occur around 1997–8 for France and the early 2000s for Germany. These investors concentrated their investment allocation in their domestic markets before competition incentivized them to expand abroad. See Achleitner et al. (2010) and Dafsaliens (various years). 24 The median turnover rate of American mutual funds from 1997 to 2009 was 57 percent (see Investment Company Institute, various years).

72

Short-term Capital Mobility in France and Germany

(above 5 percent) in the United States varies between twelve and twenty months (see Brav et al., 2008). Gradante and Hennessee’s analysis of 793 American hedge funds totaling $137 billion in assets reveals an average portfolio turnover rate that varied between 237 and 305 percent from 2000 to 2003 – that is from about four to slightly more than five months (Gradante and Hennessee, 2003: 13).25 A final methodological note on the operationalization of potentially disrupting inwards capital flows in France and Germany. The aim is to uncover the presence of short-term impatient investors in the two countries. The focus of the inquiry is at the micro-level, that is, it deals with the impact of specific categories of investors on the process by which companies coordinate their activities and, thus, on the sustainability of nonliberal varieties of capitalism. Therefore, the selection of equity stakes with a minimum threshold of 5 percent as an indicator of short-term capital entails that the database of this book is unlikely to include index-related portfolio holdings resulting from a top-down investment strategy. Fund managers that focus on the macroeconomic features of countries tend to acquire small stakes in a large number of companies according to their market capitalization in order to reflect the macro characteristics of the economy rather than focusing on firmspecific features.26 The noninclusion of data that follows from a top-down strategy is not consequential for the argument presented in this book. The analysis of bottom-up investment strategies serves as a better guide to assess the impact of capital mobility on French and German varieties of capitalism. For one thing, membership of the Euro zone has seen significant convergence in the monetary policies of these two advanced capitalist economies – thereby limiting the insights of a comparison between them based on top-down investment strategies (Hancke´ and Soskice, 2003). Moreover, and perhaps more importantly, France and Germany have liberalized their trade regime via the completion of the EU internal market – as well as removing controls on capital flows. The consequence of the former is straightforward – namely the rise of foreign ownership. The liberalization of trade policy, however, is equally significant. Weaker product market competition previously generated concomitant economic rents that

25 The short-term holding strategy of hedge funds also reflects the financial expertise of fund managers that contrast with the technical expertise of private equity managers (Achleitner et al., 2010). For an analysis of the role of private equity funds across varieties of capitalist economies, see Batt and Applebaum (2010). 26 Moreover, institutional investors acquiring less than a 5 percent stake in a company are less likely to engage in shareholder activism, an important feature of the political nature of the conflict between firms and short-term-oriented funds (see Briggs, 2007).

73

Contingent Capital

could be reinvested in the firm to maintain long-term commitments with stakeholders – such as employees (Roe, 2001; see also Barker, 2010). The discretion exercised by management in reinvesting retained earnings – an aspect of the long-term interactions between different actors – is now threatened on two fronts: the size of economic rents has been affected by an open trade policy and management is no longer shielded from pressures for shareholder value maximization. The data in the presence of foreign institutional investors in France and Germany reveals a striking pattern of divergence. Short-term, impatient shareholders – namely hedge funds and mutual funds with above average turnover rates – have targeted France over Germany as an investment destination in a ratio of 2 to 1 (see Table A1 in the Appendix of this chapter). Out of the top sixty French firms by market capitalization, twenty-four of them recorded thirty-nine instances of investment over the 5 percent threshold by short-term-oriented institutional investors.27 Out of the top sixty German firms by market capitalization, only fifteen of them recorded nineteen instances of investment above the 5 percent threshold. However, the French attractiveness to short-term investors is substantially reduced when considering the investment allocation of mutual funds with below average turnover rates – that is, medium and long-term-oriented investors (see Table A2 in the Appendix of this chapter). For the top sixty French firms, thirty-two of them recorded fifty-nine instances of investment over the 5 percent threshold. The similar figures for Germany are twenty-six firms with forty-two investment stakes. The findings for long-term-oriented mutual funds suggest the presence of important organizational changes inside German companies – but not in ways that fit with the short-term horizon of impatient investors (see also Deeg, 2005a, 2010). I issue two final notes on the empirical measurements of capital flows in France and Germany by UK/US-based shareholder value-oriented institutional investors. The conclusion that French firms are more attractive to short-term-oriented investors receives further confirmation from a comparison of the price/earnings (P/E) ratio of companies. The P/ E ratio is an indicator of how cheap or expensive the shares of a company are. It is calculated by dividing the price per share by its earnings per share. The P/E ratio is a valuation of the firm’s share price compared to its per-share earnings. It shows how much shareholders are willing to pay per dollar of earnings. The overall higher P/E ratio of French firms indicates that investors must pay relatively more for a given level of 27 Because a firm can receive more than one investment from investors, the number of investments is invariably higher than the number of companies.

74

Short-term Capital Mobility in France and Germany Table 2.4. Price–Earnings Ratio, French and German Stocks

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

France, CAC 40

Germany, DAX 30

France, SBF 120

Germany, DAX 100

21.42 23.02 28.11 17.13 18.93 11.30 15.81 13.84 13.97 12.99 11.69

21.44 20.08 24.35 18.42 18.87 9.58 12.23 11.00 12.70 11.85 11.09

21.08 21.83 27.15 17.05 18.67 11.12 16.24 14.47 15.12 13.88 11.73

21.64 18.79 23.37 17.79 17.15 9.47 12.89 11.46 13.54 12.49 11.68

Source: DataStream.

earnings compared to the German market (see Table 2.4). In other words, the attractiveness of French firms for short-term, impatient capital cannot be attributed to low share price compared to per-share earnings. The higher P/E ratios of French firms also reflect the expectations of higher streams of earnings in the future. Finally, the investment allocation of UK/US-based funds in France and Germany highlights a specific relationship on the question of local fit. Economic sociologists, in particular, have provided significant insights into the likelihood of adoption of new institutions across different settings (Burt, 1982). The process of institutional adoption is driven by the presence of fit between the content of normatively appropriate practices between the new institution and those already in place (Strang and Macy, 2001). The extent to which a new institution is perceived to share important similarities with already established norms of legitimacy embodied in the local institutional framework increases the odds of its successful introduction. How does the issue of local fit translate into capital flows by Anglo-American institutional investors in France and Germany? The presence of significantly diverging institutional configurations in the organization of work in France and Germany highlights the importance of different adjustment strategies for the implementation of shareholder value-restructuring schemes (Rebe´rioux, 2002; Goyer, 2006a). The extent to which power is concentrated at the top of the managerial hierarchy constitutes a crucial factor that shaped the content and likely speed of corporate restructuring of portfolio companies (Clark and Wojcik, 2007: 15). Does the presence of institutional 75

Contingent Capital

differences in the organization of work in France and Germany matter for the investment allocation of UK/US-based funds? The answer to this question highlights the institutionally contextualized importance of the notion of local fit. The characteristics of targeted companies in French, Germany, and the United States share strong similarities across different groups of UK/US-based institutional investors.28 Passively managed mutual funds have targeted well-governed companies paying high dividends and with lower discrete spending in France, Germany, and the United States. The characteristics of targeted companies in the three countries do not exhibit significant differences on the issue of the investment allocation of passively managed mutual funds. Nevertheless, the relevance of the question of fit/local context manifests itself in three ways. First, hedge funds and actively managed mutual funds have sought to extract shareholder value by targeting two sets of French and American firms: financially profitable companies from which they can extract dividends; and undervalued companies implementing strategic/operational changes such as asset divesture refocus on core competencies and asset spinoff. This is not the case for Germany. The investment allocation of hedge funds in Germany highlights a preference for profitable companies with high stock prices. Second, the investment strategies of short-term investors have displayed a strong preference for the French market over that of Germany as revealed by Table A1 in the Appendix. The volume of the blockholding acquisitions by impatient shareholder value-oriented funds exhibit significant divergence between France and Germany. Their assessment of the content and likely speed of implementation of restructuring schemes, sometimes strongly induced by the undertaking of shareholder activism by these impatient financiers, contributes to the determination of the volume of the investment allocation across markets. Third, the commonalities regarding some of the characteristics of targeted companies in France and Germany do not extend to their performance after the arrival of short-term institutional investors. In France, domestic firms targeted by short-term funds, but not those targeted by passively managed mutual funds, exhibited an important increase in operational performance. In Germany, targeted companies did not experience any increase in operational performance whether targeted by short-term or long-term investors. This divergence in outcomes highlights the greater institutional fit inherent in 28 The following discussion draws from Goyer and Jung (2010). See also Brav et al. (2008) and Klein and Zur (2009).

76

Short-term Capital Mobility in France and Germany

the generalization of the empirical findings between France and the United States; but not between Germany and the United States. It also strongly suggests the importance of the distribution of authority inside companies (Rebe´rioux, 2002; Goyer, 2006a; see also Maurice et al., 1986; Hall and Soskice, 2001). Corporate governance is not simply about the attitudes of controlling executives regarding shareholder value as advanced by the law and economics perspective. The ability of corporate executives to implement reorganization schemes is also crucial for impatient investors. The decision to pursue strategies of shareholder value might remain an executive prerogative that is not solely dictated by actors on financial markets, but the implementation of such policies in France is greatly facilitated by the relatively weaker position of employees as compared to Germany.

77

APPENDIX

Table A1 French and German Companies in the Top 1,000 European Index, Market Capitalization on December 17, 2003 (Overall European Rank) (Number of Investments above the 5 Percent Threshold by Short-term-Oriented Funds) France 1. Total (5) 1998: Fidelity (MF) 2. BNP-Paribas (20) 3. Aventis (29) 4. Socie´te´ Ge´ne´rale (34) 5. Carrefour (39) 6. AXA (43) 7. L’Ore´al (50) 8. Sanofi-Synthe´labo (51) 9. Vivendi (52) 2004: Fidelity (MF) 10. France Telecom (53) 11. Danone (59) 12. LVMH (67) 13. Alcatel (73) 1997: Fidelity (MF) 2004: Fidelity (MF) 14. Suez (74) 15. Cre´dit Agricole (75) 16. Air Liquide (77) 17. Saint-Gobain (78) 18. Renault (87) 19. Schneider (92) 2000: Janus (MF) 20. Lafarge (95) 2002: Putnam (MF)

21. Accor (134) 2003: Putnam (MF) 22. Peugeot (138) 2006: Wellington (MF) 23. Lagarde`re (158) 2004: Highfields K Management (HF) 2006: Fidelity (MF)

78

Germany (1)

1. Siemens (16)

(1)

2. Deutsche Bank (24) 3. Deutsche Telekom (25) 4. Allianz (30) 5. E.ON (33) 6. Daimler-Chrysler (36) 7. SAP (38) 8. BASF (44) 9. Munich Re (57)

(2)

10. Bayer (65) 11. BMW (83) 12. RWE (100) 13. Volkswagen (104)

(1)

14. Schering (129) 15. Hypo Bank (130) 16. Commerzbank (131) 17. Thyssen Krupp (152) 18. Deutsche Post (153) 19. Infineon (165) 2003: Fidelity (MF) 20. Deutsche Borse (172) 2003: Fidelity (MF) 2004: Atticus Capital (HF) 2004: Children Investment (HF) 2006: Lone Pine Capital (HF) 21. Metro (178)

(1)

22. Continental (204)

(2)

23. Altana (211)

(1) (1)

(1) (4)

Short-term Capital Mobility in France and Germany 24. Bouygues (160) 1998: Schroeders (MF) 2001: Putnam (MF) 25. Pinault Printemps Redoute (161) 26. Arcelor (168) 27. Vivendi Environment (182) 2003: Putnam (MF) 28. Michelin (184) 2004: Wellington (MF) 29. Vinci (187) 30. CapGemini (190) 2008: Fidelity (MF) 31. Pernod Ricard (197) 2001: Fidelity (MF) 32. Essilor International (198)

(2)

24. Henkel (214)

(1)

25. Porsche (220) 26. Adidas-Salomon (223) 27. Linde (253)

(1)

28. T-Online (264)

(1)

29. Lufthansa (294) 30. MAN (306)

(1)

31. Beiersdorf (331)

(1)

32. DepfaBank (340) 1998: Janus (MF) 33. Puma (348) 2003: Fidelity (MF) 34. TUI (368)

(1)

35. Heidelberger Cement (382)

(1)

36. Fresenius (390) 2008: Fidelity (MF) 37. Merck (409) 2004: Fidelity (MF) 38. Hypo Real Estate Holding (439) 39. MG Technologies (462) 2008: Fidelity (MF) 40. Stada Arzneimit (487) 41. Celanese (498) 2003: Fidelity (MF)

33. Thomson (217) 34. Pechiney (231) 2002: Fidelity (MF) 35. Publicis (236) 2001: Putnam (MF) 36. TF1 (247) 2001: Putnam (MF) 37. Casino (265) 38. Unibail (294) 39. Christian Dior (287) 40. Sodexho (327) 41. Valeo (329) 2007: Pardus (HF) 2008: Goldman Sachs (HF) 42. Thales (342) 43. Dassault Syste`mes (346) 2004: Fidelity (MF) 44. Wanadoo (347) 45. Autoroutes Sud France (353) 46. Business Objects (374) 2001: Fidelity (MF)

(2)

(1)

(4)

2004: Fidelity (MF) 2005: SAC Investments (HF) 2007: Tudor (HF) 47. Eurotunnel (378) (2) 2002: Oppenheimer Funds (MF) 2009: Goldman Sachs Aero 1 (HF) 48. Technip-Coflexip (381) (2) 1997: Fidelity (MF) 2000: Putnam (MF)

(1) (1)

42. Celesio (523) 43. MLP (547) 2006: Fidelity (MF) 44. Pro Siebensat (552) 45. Wella (558) 46. Epcos (565) 2007: Odey Asset Management (HF)

(1) (1)

(1)

(1)

(1)

(1)

47. Suedzucker (572)

48. Hannover Ruck (577)

continued

79

Contingent Capital Table A1 Continued France

Germany

49. CNP Assurances (411)

49. Medion (597) 2004: Fidelity (MF) 50. IKB DT Industriebank (603) 51. Douglas (608) 52. Singulus Technologies (621)

(1)

53. BilfingerBerger (632) 2005: Fidelity (MF) 54. Karstadtquelle (643) 55. Kali&Salz (658) 2004: Fidelity (MF)

(1)

50. Sagem (418) 51. Air France (430) 52. Atos (434) 1998: Fidelity (MF) 1998: Janus (MF) 2006: Centaurus Capital (HF) 2007: Pardus Capital (HF) 53. Hermes (436) 54. Genica (438) 55. Neopost (446) 1999: Egerton Capital (HF) 1999: Fidelity (MF) 2008: Fidelity (MF) 56. Havas (457) 1999: Putnam (MF) 2003: Fidelity (MF) 57. Imerys (469)

(4)

(3)

(2)

56. Frankfurt Airport (714)

57. HeidelbergerDruckmaschinen (723) 2004: Fidelity (MF) 2007: Centaurus Capital (HF) 58. AAreal Bank (737) 2006: Fidelity (MF) 59. IVG Immobilien (776) 60. Hugo Boss (785)

58. Natexis Bank (471) 59. BIC (490) 60. Zodiac (509)

(1)

(2)

(1)

Table A2 French and German Companies in the Top 1,000 European Index, Market Capitalization on December 17, 2003 (Overall European Rank) (Number of Investments above the 5 Percent Threshold by Long-term-Oriented Mutual Funds) (Ownership Structure at the Time of the Investment) France 1. Total (5) 2. BNP-Paribas (20) 1997: Templeton 3. Aventis (29) 1997: Templeton 4. Socie´te´ Ge´ne´rale (34) 5. Carrefour (39) 6. AXA (43) 7. L’ Ore´al (50) 8. Sanofi-Synthe´labo (51) 9. Vivendi (52) 2004: South East Asset Mgt 2007: Capital Group

80

Germany (1) (1)

(2)

1. Siemens (16) 2. Deutsche Bank (24) 2008: Alliance Bernstein 3. Deutsche Telekom (25) 4. Allianz (30) 5. E.ON (33) 6. Daimler-Chrysler (36) 7. SAP (38) 8. BASF (44) 2008: Alliance Bernstein 9. Munich Re (57) 2008: Alliance Bernstein

(1)

(1) (1)

Short-term Capital Mobility in France and Germany 10. France Telecom (53) 11. Danone (59) 12. LVMH (67) 13. Alcatel (73) 2002: Brandes Investment 2008: T Rowe Price 14. Suez (74) 15. Cre´dit Agricole (75)

(2)

16. Air Liquide (77) 17. Saint-Gobain (78) 18. Renault (87) 1997: Templeton 2006: Capital Group 2008: Alliance Bernstein 19. Schneider (92) 2005: Capital Group

(3)

(1)

10. Bayer (65) 2005: Capital Group 11. BMW (83) 12. RWE (100) 2007: Capital Group 13. Volkswagen (104) 2004: Brandes 2004: Capital Group 14. Schering (129) 15. Hypo Bank (130) 2004: Capital Group 16. Commerzbank (131) 2006: Capital Group 17. Thyssen Krupp (152) 18. Deutsche Post (153)

(1)

(4)

(1)

20. Lafarge (95) 2008: Dodge &Cox 21. Accor (134) 2004: Templeton 2005: Capital Group 2009: Longleaf Partners 22. Peugeot (138)

(1) (3)

19. Infineon (165) 2003: Capital Group 2006: Brandes 2006: Dodge & Cox 2007: Templeton 20. Deutsche Borse (172) 2004: Capital Group 21. Metro (178)

23. Lagarde`re (158) 1997: Templeton 2008: Alliance Bernstein 24. Bouygues (160) 2005: Capital Group 25. Pinault Printemps Redoute (161) 26. Arcelor (168)

(2)

22. Continental (204) 2004: Capital Group 23. Altana (211)

(1)

24. Henkel (214)

27. VivendiEnvironment (182) 2005: Capital Group

(1)

28. Michelin (184) 2000: Templeton 2006: Capital Group 2008: Alliance Bernstein 29. Vinci (187)

(3)

30. CapGemini (190) 2006: Goldman Sachs (MF)

(1)

25. Porsche (220) 26. Adidas-Salomon (223) 2000: Templeton 2007: Invesco 2009: Capital Group 27. Linde (253) 2006: Capital Group 2009: MA Financial Services 28. T-Online (264)

29. Lufthansa (294) 2008: Alliance Bernstein 30. MAN (306) 2008: Equitable Holdings

(1) (2)

(1) (1)

(1)

(3)

(2)

(1) (1) continued

81

Contingent Capital Table A2 Continued France 31. Pernod Ricard (197) 2000: Silchester 2009: Capital Group 32. Essilor International (198) 2001: Amvescap-UK 33. Thomson (217) 2006: Brandes 2006: Templeton 2007: Dodge & Cox 34. Pechiney (231) 1997: Templeton 35. Publicis (236) 2004: Harris Associates 36. TF1 (247) 1997: Sanford Bernstein (MF) 2007: Harris Associates 37. Casino (265)

Germany (2)

31. Beiersdorf (331)

(1)

32. Depfa Bank (340)

(3)

33. Puma (348)

(1)

(1)

34. TUI (368) 2008: Alliance Benstein 2008: Neuberger Berman 35. Heidelberger Cement (382)

(2)

36. Fresenius (390)

38. Unibail (294) 1997: Templeton 2003: Wellington Mgt 39. Christian Dior (287)

(2)

40. Sodexo (327) 2007: Arnhold Bleichroeders 41. Valeo (329) 2001: Templeton 2005: Brandes 42. Thales (342) 2006: Capital Group 43. Dassault Syste`mes (346)

(1)

37. Merck (409) 2002: Tweedy Browne 2004: Capital Group 2009: MA Financial Services 38. Hypo Real Estate Holding (439) 2005: Capital Group 2008: Orbis Funds 39. MG Technologies (462) 2003: Capital Group 40. Stada Arzneimit (487)

(2)

41. Celanese (498)

(1)

42. Celesio (523)

(1)

43. MLP (547) 2006: Harris Associates 44. Pro Siebensat (552)

44. Wanadoo (347) 2002: Goldman Sachs (MF) 45. Autoroutes Sud France (353) 46. Business Objects (374) 2005: MA Financial Services (MF)

47. Eurotunnel (378) 2009: Franklin (MF) 2009: M&G (MF) 48. Technip-Coflexip (381) 2004: Oppenheimer Funds 2006: Capital Group 2006: Trademarks NWQ 2007: Causeway Fund 2008: Alliance Bernstein

82

(2)

45. Wella (558) 46. Epcos (565) 2002: Capital Group 2006: Dodge & Cox 2008: Alliance Bernstein 47. Suedzucker (572)

(5)

48. Hannover Ruck (577)

(1)

(2)

(3)

(2)

(1)

(1)

(3)

Short-term Capital Mobility in France and Germany 49. CNP Assurances (411)

50. Sagem (418) 51. Air France (430) 2008: Alliance Bernstein 2008: Capital Research 52. Atos (434) 53. Hermes (436) 54. Gecina (438) 55. Neopost (446) 2003: Harris Associates 2006: Jupiter (UK) 2007: Arnhold Bleichroeders 56. Havas (457) 57. Imerys (469) 2007: M&G 58. Natexis Bank (471) 1997: Sanford Bernstein (MF) 59. BIC (490) 2001: Templeton 2002: Oppenheimer Funds 2002: Amvescap (UK) 2002: Silchester (UK) 2007: Arnhold Bleichroeders 60. Zodiac (509)

(2)

(3)

(1)

(1) (5)

49. Medion (597) 2004: Jupiter (UK) 2007: Orbis Investment 50. IKB DT Industriebank (603) 51. Douglas (608)

52. Singulus Technologies (621) 53. Bilfinger Berger (632) 2006: Schroeders UK 54. Karstadtquelle (643) 55. Kali & Salz (K&S) (658) 2006: M&G 2007: Capital Group 2007: Franklin Mutual 56. Frankfurt Airport (714) 2006: Capital Group 57. Heidelberger Druckmaschinen (723) 2004: Brandes 58. AAreal Bank (737) 2004: Capital Group 59. IVG Immobilien (776)

(2)

(3)

(1) (1)

(1)

60. Hugo Boss (785)

83

3 Law and Economics and Capital Mobility across Advanced Capitalist Economies

What institutional arrangements best account for the willingness of short-term investors to acquire important equity stakes in listed companies? The law and economics perspective emphasizes the importance of legal protection for minority investors. Noncontrolling shareholders need assurance that they will get a return on their investment before parting with financial assets (Shleifer and Vishny, 1997). After all, and unlike creditors, noncontrolling shareholders are not promised any payments in return for their acquisition of equity capital in the firm. They have no claim to the specific assets of the firm either in the event of bankruptcy or during normal times. The willingness of minority shareholders to acquire equity stakes in companies is contingent upon the extent to which they are protected from shareholder value-destroying actions of controlling executives. The role of institutionally based legal arrangements – and their enforcement – is critical to this process (LaPorta et al., 2000). Which institutions best protect noncontrolling shareholders? The law and economics perspective highlights the presence of different types of agency costs which all contribute to destroy shareholder value but for which different legal– institutional solutions should prevail (Coffee, 2005).1 The nature of agency costs differs across national and increasingly within national systems of corporate governance. The fundamental issue in economies characterized by the dominance of firms with ownership diffusion is to alleviate the divergence of interests between noncontrolling shareholders and powerful managers. Unchecked executives can pursue a

1

84

For a critical analytical overview, see Roe (2005).

Law and Economics and Capital Mobility

panoply of shareholder value-destroying policies ranging from actions that enable them to profit personally – embezzlement, misappropriations of resources – to empire building or shirking. The set of institutions most effective in this context are those aiming directly at curbing managerial opportunism – financial disclosure, fiduciary duties of care and loyalty, composition and structure of the board of directors, and managerial remuneration (see e.g. Gourevitch and Shinn, 2005: 42–7). In economies characterized by ownership concentration, in contrast, institutions designed to minimize problems of managerial opportunism are not as crucial since the controlling shareholder possesses both incentive and means to monitor and discipline corporate executives. Instead, the nature of agency costs takes the form of a divergence of interests between the large owner and the noncontrolling shareholders – the former potentially abusing his power and using corporate resources for his own advantage (Shleifer and Vishny, 1997). The control over corporate policies by a large shareholder is valuable since the former can transfer value and receive benefits that are not shared with the latter. Examples of these private benefits associated with control are numerous (Dyck and Zingales, 2004). For instance, the information acquired by the dominant shareholder from the operations of the firm might provide him or her with potential opportunities in other areas. The controlling shareholder can use knowledge from a company to exploit opportunities in other areas. Another example of private benefits lies in the ability of the large owner to fix transfer prices at below market levels between a company and its subsidiaries – the classic case of the pyramidal form prevalent in many continental European countries.2 The set of institutions most effective in this context are those that impose a duty of care and loyalty on the controlling shareholder as well as limiting deviations from the one-share-one-vote principle. The maintenance of a controlling stake is less expensive in countries where deviations from the one-share-one-vote principle are prevalent, since large shareholders can maintain control while raising additional funds through equity issues (Nenova, 2003; Dyck and Zingales, 2004: 28; Enriques and Volpin, 2007: 126). What are the predictions of the law and economics perspective regarding the investment strategies of short-term-oriented investors in France 2 See Enriques and Volpin (2007). For example, let us assume a large shareholder owning 60 percent of firm A which itself owns 50 percent of firm B. Moreover, let us further assume that firm B itself owns 100 percent of another listed company – namely firm C. The incentives of the large shareholder of firm A – in a context characterized by the underdevelopment of legal protection or minority investors – lies in forcing firm B to buy (sell) assets at over (below) market price to firm C.

85

Contingent Capital

and Germany? Legal–institutional arrangements that work well in lessening the negative impact associated with one type of agency costs might not be effective in another setting. For the law and economics perspective, French and German companies with diffused ownership should constitute the primary targets of Anglo-American institutional investors rather than corporations with ownership concentration. Three arguments have been presented from a legal perspective. First, the systems of corporate law in France and Germany provide less protection to minority shareholders in situations of self-dealing by the controlling shareholder in comparison to those involving managerial opportunism. Second, companies characterized by ownership diffusion should constitute the primary targets of institutional investors since legal reforms enacted in the two countries in recent years were aimed at strengthening the influence of shareholders over the strategic direction of companies. Legal reforms in the two countries have increased the number of issues for which shareholder approval is needed. Would these reforms translate into shareholder value? The answer to this question is contextually bounded. Increasing the number of issues for which shareholder approval is required is unlikely to result in shareholder value-friendly policies in the presence of a controlling owner. Minority shareholder empowerment resulting from greater voice over strategic decisions of the firm is more likely to be effective in the absence of a controlling owner. Third, the involvement of short-term investors in the strategy of the firm in the form of shareholder activism is more likely to generate a desired outcome in the absence of a controlling owner. I proceed to review these three sets of arguments and then present the data on the ownership structure of targeted, and nontargeted, companies.

3.1 Corporate Law and the Protection of Minority Shareholders What institutional arrangements matter most for the willingness of shortterm institutional investors to acquire an important equity stake in French and German listed companies and how could we measure it? The development of the securities markets and the transformation of ownership structure of listed companies have been critical issues for law and economics scholars. The critical precondition for the development of deep and liquid securities markets requires the presence of a system of corporate law that is protective of the rights of dispersed shareholders (LaPorta et al., 2000). The willingness of minority investors to provide equity capital is contingent upon the extent to which their investments are protected from 86

Law and Economics and Capital Mobility

expropriation by managers or controlling investors. Therefore, the differences in the extent to which different situations are subject to stringent legal protection should matter from a legal perspective. The key issue is that legal arrangements of corporate law in France and Germany are better at protecting the interests of noncontrolling shareholders from the value-destroying actions of managers, as compared to wealth-diverting moves by the controlling shareholder.3 Managerial opportunism is significantly constrained by legal–institutional arrangements in the two countries. First, listed companies have had to use international accounting standards since January 2005 following the implementation of a new EU directive. This regulation was introduced in the wake of the bulk of large German firms, and about a third of French blue-chip companies, already reporting their results to IAS or US-GAAP practices by the late 1990s (Goyer, 2006b: 88). Second, the fiduciary duties of care are strongly enshrined in the two economies. The principle of the duty of care stipulates that directors and top executives are responsible individually or as a group to shareholders for violations of laws applicable to corporations and for errors committed in the course of management. The actions of corporate officials that would impair the interests of shareholders – or that would favor the interests of some shareholders at the expense of others – constitute a breach of the duty of care (Birk, 1998: 65–6; Schmidt, 1999: 283). Third, the concept of the duty of loyalty in French commercial law stipulates that the interested party must inform the board of the nature of the conflict of interest associated with a potential transaction in three broad areas: the attribution of specific advantages by the firm to oneself, any positions occupied by an official in other companies, and the financial structure between the firm and its subsidiaries in the event of a merger (Schmidt, 1999: 30–3). Fourth, the duty of loyalty in German law stipulates that directors and executives cannot accept commissions on behalf of the company and cannot use for their own benefit opportunities that would be beneficial for the corporation (Birk, 1998: 66). The duty of loyalty requires that corporate officials refrain from using information acquired in their official capacity for their own personal gains outside the activities of the corporation – that is, the doctrine of corporate opportunities. Fifth, these two advanced capitalist economies are characterized by the high level of the quality of commercial contract

3 See Cools (2004) and Enriques and Volpin (2007) for analytical overviews. For in-depth analyses of French and German corporate law, see Tunc (1982), Birk (1998), Schmidt (1999), Conac et al. (2007a), Hansmann and Kraakman (2004), Hertig and Kanda (2004), and Rock et al. (2004).

87

Contingent Capital

enforcement (Roe, 2002: 262). In other words, the presence of legal arrangements designed to prevent managerial abuses is backed up by a judicial system of well-functioning courts. The main shortcoming of institutional legal arrangements in France and Germany is that they are substantially less effective at tackling potential problems of self-dealing by the controlling shareholder. The legal systems of these two countries are plagued by different sets of issues as well as similar problems. The point is not to characterize the system of corporate law of these two countries as being significantly deficient. In fact, corporate law in these two countries is quite good and the quality of contract enforcement is excellent (Tunc, 1982; Roe, 2002; Conac et al., 2007a). The issue is to identify points of weakness of the legal systems that put noncontrolling shareholders at risk and, moreover, to highlight the fact that these problems revolve around the opportunistic behavior of the controlling owner. I discuss, respectively, questions related to French corporate law, German corporate law, and common issues related to both economies. The French system of corporate law suffers from several issues that expose noncontrolling shareholders to the opportunism of large owners. First, the doctrine of corporate opportunities does not exist in corporate law, with the implication that large shareholders can exploit information acquired in the running of the corporation for their own gain (Zingales, 1998: 45). Second, the French corporate sector is characterized by its heavy reliance on unequal voting rights and other deviations from the one-share-one-vote principle that were abolished in Germany under the 1998 Kontrag law (Goyer, 2006b: 89). French corporate law allows firms to award double voting rights to shareholders who have held their shares for at least two years. The justification for this deviation from the one-share-one-vote principle is to encourage long-term shareholding; but its effect has been to deter takeovers (Hansmann and Kraakman, 2004: 56). Moreover, the presence of unequal voting rights in France makes it easier for a large shareholder to maintain control with a minimum of invested capital (see e.g. Nenova, 2003). Third, French corporate law is underdeveloped regarding the question of concealed distributions to shareholders (Conac et al., 2007a: 502–3). German corporate law, in contrast, identifies transactions that constitute self-dealing between the dominant shareholder and the corporation. In particular, transactions between the corporation and a shareholder (any shareholder) that occur on unfavorable terms to the former are said to constitute de facto distribution to that shareholder. No such emphasis has taken place in French corporate law. Fourth, liability suits have proven to be an ineffective legal mechanism to remedy the effects of 88

Law and Economics and Capital Mobility

the expropriating actions of the controlling owner (ibid.). French corporate law is excellent on paper. Individual shareholders are able to sue subservient directors on behalf of the corporation. However, derivative suits have been fairly rare in great part due to the ban on contingency fees that has proven to be a hurdle to shareholder litigation. Fifth, limited preemptive rights in France imply that minority shareholders face greater risk of share dilution in the form of new equity issuance by the controlling owner. The notion of preemptive rights refers to a legal strategy of protection whereby existing shareholders are able to purchase new shares prorate before any shares are offered to either outsiders or other existing shareholders who want to increase their stake. The aim is to limit the ability of the controlling owner to increase his or her stake at substantially below market prices. The shortcomings of French corporate law are that the preemptive rights of minority shareholders are limited to those enshrined in company charters and that preemptive rights can be waived for a period up to two years without specification of their use – subject to supermajority approval (Pistor et al., 2003: 684; Rock et al., 2004: 147–8). In Germany, in contrast, preemptive rights are mandatory – that is, not limited to provisions of the charter – and are waived by a super majority approval (75 percent of voting rights present at a shareholder meeting) only if the allocation of new shares can be specified in advance (Pistor et al., 2003: 688). As regards the German case, the main issue is that the duty of loyalty is extremely encompassing and also applies to noncontrolling shareholders (Birk, 1998: 65–6; Hertig and Kanda, 2004: 128). German corporate law requires that directors and executives take into consideration the interests of all parties (shareholders, employees, creditors, and business partners) participating in the running of the corporation – thereby militating against some forms of shareholder value. German courts have often supported the decisions of corporate officials (and of large shareholders) to override the demands of minority investors on the basis they would have negatively affected the position of employees and threatened the existence of the corporation. Second, the approval of important (i.e., nonroutine) transactions differs in French and German corporate law (Conac et al., 2007a: 498–500; Hertig and Kanda, 2004: 121–3). In both countries, noncurrent transactions between a firm and an interested party – such as a large shareholder – must be approved by the board of directors. In France, moreover, these important related party transactions must also be ratified by the annual shareholder meeting and corporate law allows minority shareholders to request the appointment of a statutory auditor to investigate such transactions. 89

Contingent Capital

Important related party transactions do not, however, require shareholder approval in Germany and the appointment of a statutory auditor has been limited in practice. Finally, enforcement mechanisms against controlling shareholders’ self-dealing have been limited in scope in both France and Germany. Enforcement practices of courts have traditionally focused on cases dealing with bankruptcy flowing from the actions of the dominant shareholder (Hertig and Kanda, 2004: 126; Conac et al., 2007b). Courts in the two countries have been less active in penalizing related party transactions in conflict-of-interest situations that do not threaten the existence of the corporation. Court decisions favorable to plaintiffs are heavily concentrated in cases of insolvent companies. This shortcoming is important since legal provisions against the self-dealing actions of the dominant shareholder are significantly less influential without appropriate enforcement mechanisms. In the French case, few suits have been brought forward against large companies listed on the primary segment of the Paris Bourse. Moreover, courts have been reluctant to secondguess managerial decisions, thereby following the equivalent of the American Business Judgment rule (Cools, 2004: 31; Conac et al., 2007b: 45–6). In fact, French courts have limited their intervention to situations where the dominant shareholder pursued actions expressly prohibited by corporate law; they have also stayed away from cases of poor managerial policies that negatively affected shareholder value. In the German case, courts have focused on the violation of procedural rules by the controlling shareholder concerning issues of self-dealing (Conac et al., 2007b: 56). As in France, judges have been reluctant to challenge the legitimacy of the controlling shareholder to make corporate decisions – no matter if minority shareholders found them displeasing (ibid.: 61–2). The loophole in the ability of corporate law in France and Germany to protect minority shareholders against the actions of managers versus those of the controlling owner constitutes an important issue from the law and economics perspective. The interests of shareholder valueoriented, short-term-oriented institutional investors – hedge and actively managed mutual funds – can differ substantially from that of a dominant shareholder. The main issue is that the benefits and costs of holding controlling stakes – which entail a reduction in diversification risks – vary across advanced capitalist economies and are driven by the degree of legal protection for minority investors from the law and economics perspective. In countries with lower protection of shareholder rights, investors can prevent a violation of their rights by acquiring a controlling stake in a company (defensive move) and by taking 90

Law and Economics and Capital Mobility

advantage of their control over the strategy of the firm to extract private benefits of control (offensive action) (Goergen and Renneboog, 2003). The presence of ownership (or voting) concentration is valuable since the large owner controls corporate decisions (Shleifer and Vishny, 1997; Zingales, 1998). In turn, control over the corporate strategy of the firm is valuable per se since large owners receive private benefits of control that are not shared with other shareholders. The notion of the private benefits of control refers to the aggregate value a controlling owner can extract from the company at the expense of minority shareholders.4 It has long been observed that shareholders do not receive benefits in proportion to their equity stake in a corporation – that is, their control rights are greater than their cash flow rights. Instead, large owners receive a disproportionate amount of corporate benefits.5 Prospective buyers, in the context of extensive private benefits of control, do not pay prorate value for the stock if they lack confidence in the willingness of dominant owners to pursue friendly shareholder value strategies, and, if the discount is deep enough, concentrated ownership persists since the latter decide not to sell.6 The issue is critical since the dominant shareholder faces tradeoffs in countries with lower degrees of legal protection for minority investors – reaping the economic benefits of higher share prices through shareholder valueenhancing policies but at the cost of giving up the private benefits of control. The empirical evidence also points to the reluctance of blockholders wishing to raise equity finance from the public at large to step in and provide legal protection and other safeguard mechanisms for

4 The key readings on the notion of the private benefits of control are Barclay and Holderness (1989), Zingales (1998), and Nenova (2003). 5 What are the private benefits of control? The academic literature has identified several types of private benefits of control. First, the position of dominance of a large owner might allow him to increase his stake in the company through dilutive share issues and minority freeze-outs. Second, private benefits result from the synergy benefits realized by the controlling shareholder. The information acquired by the dominant shareholder from the operations of the firm might provide him with potential opportunities in other areas. The controlling shareholder can use knowledge from the company he owns to exploit opportunities in other firms. Third, the controlling shareholder can use his dominant position over the control of the strategy of the firm to transfer assets at below market prices to other firms in which he also holds a controlling stake. Fourth, the dominant shareholder can reduce his tax burden by transferring profits – through the form of transfer pricing on nonmarket terms – from highly profitable firms that he controls to ones that are losing money but that he also controls. Fifth, the controlling owner can treat himself preferably by paying special dividends only to certain categories of shareholders – most likely himself. The value associated with all of these opportunities constitutes a private benefit of control since minority shareholders do not reap the gains associated with these opportunities. For a full discussion, see Zingales (1998), Johnson et al. (2000), and Dyck and Zingales (2004). 6 See Roe (2003: 161–7).

91

Contingent Capital Table 3.1. French Firms with Deviations to One-Share-One-Vote Principle (in %) Exceptions to one-share-one-vote rule

Unequal voting rights

France top 40

France top 120

1996

1999

2001

1996

1999

75

68

58

32

68

Source: Davis Global Advisors, Leading Corporate Governance Indicators, various years.

minority shareholders.7 Finally, the maintenance of a controlling stake in a company is less expensive in countries where deviations to the oneshare-one-vote principle are prevalent. Large owners can maintain their control over the firm while raising additional equity from the greater public through unequal voting rights and nonvoting shares.8 This is particularly relevant in the French case whereby a large number of bluechip companies rely on deviations from the one-share-one-vote principle as a protective mechanism against takeover (see Table 3.1).

3.2 Legal Protection of Shareholders: A Contextualized Perspective The international diversification of assets by Anglo-American institutional investors has contributed to the “globalization” of corporate governance. Shareholder value-oriented institutional investors from the United Kingdom and the United States, especially hedge funds and actively managed mutual funds, have pushed for competitive returns set in absolute terms (hedge funds) or against third-party benchmarks (mutual funds) (see e.g. Clark and Wojcik, 2007). The arrival of UK and US-based institutional investors in continental Europe has brought new sets of expectations that stand at odds with the traditional mode of governance of firms. Moreover, the strategy of international expansion of Anglo-American institutional investors has also generated an industry of best corporate governance practices – most notably in the form of codes. Institutional investment organizations have published lists 7

Gourevitch and Shinn (2005: 97). Unequal voting rights and nonvoting shares constitute two mechanisms by which large shareholders can create a gap between their ownership stake and their voting power. The use of unequal voting rights by an important number of continental European companies is characterized by granting investors who kept their shares for a predetermined period of time with extra voting power. For example, French corporate law allows companies to give double voting rights to shareholders that have kept their shares for a period of two years. One of the intentions of this bylaw is to reduce the voting power of short-term investors such as hedge/ mutual funds. 8

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Law and Economics and Capital Mobility

of guidelines of what are considered essential strategies to unlock shareholder value.9 Among these best practices are boards of directors composed of nonexecutive/independent directors; sub-board committees (audit, nomination, and remuneration) dominated by independent directors; voting rights characterized by the one-share-one-vote principle; extensive range of issues for which shareholder approval is needed; heightened financial transparency that enables shareholders to evaluate the situation of listed companies; and extensive pay disclosure of executives that is comprised of a significant variable components. The presence of these institutional arrangements is seen as a necessary condition for the delivery of shareholder value.10 Would the implementation of the above best practices result in heightened shareholder value in France and Germany? The above description of shareholder value-enhancing practices carries a cumulative assumption, namely the more the better. The adoption of these best practices is seen as contributing – although perhaps to different degrees – to the development of the prominence of shareholder value. In other words, the links between these practices and shareholder value is positive even though some of the former might have greater impact on the latter. This cumulative assumption, however, neglects the importance of contexts. The question is not simply that some of the above practices contribute unequally to the delivery of shareholder value, but that they could impact negatively contingent upon the context in which they are embedded. The first analytical, and insightful, treatment of this question was Mark Roe’s analysis of Codetermined boards in Germany.11 Boards of directors have largely failed to serve as a mechanism to defend the interests of minority shareholders in Germany. Their composition is not conducive to such an enterprise: half of the boards are composed of employee representatives, the other half elected by large shareholders. Moreover, the introduction of Codetermination has led to an increase in the size of boards – thereby rendering them ineffective to serve as a monitoring device. Nonetheless, Roe warns against the introduction of independent directors serving alongside employee representatives. The key issue is that the empowerment of boards of directors in Germany, in the form of the greater presence of independent directors, might run counter to the interests of minority shareholders. Empowering boards of directors would also empower their employee-half against

9 Representative instances are the set of annual reports published by Davis Global Advisors and the country corporate governance codes published by CalPERS. 10 See e.g. Davis et al. (2006). 11 See Roe (1999).

93

Contingent Capital

atomistic independent directors comprising the other half. Thus, Roe suggests that it might be better for minority shareholders to live with substandard board governance. After all, important decisions are often taken in sub-board committees where employee representatives are absent. The implication of Roe’s insights for the current analysis of the investment allocation of short-term-oriented investors is that legal reforms to enhance the power of shareholders will produce different consequences according to the context in which they are embedded. The impact of the legal empowerment of shareholders in France and Germany is shaped by the ownership structure of companies (Mayer, 2001, Cools, 2004; Hansmann and Kraakman, 2004; see also Enriques and Volpin, 2007). The allocation of decision-making powers in continental Europe, especially in France, is concentrated in the hands of shareholders as opposed to the greater role played by the board of directors under Delaware’s corporate law (Cools, 2004: 44; Bebchuk, 2006). Is this allocation of power in shareholders conducive to the implementation of shareholder value? It is contingent and depends on whether ownership is dispersed or concentrated. Two instances illustrate this point. First, the power of shareholders to remove directors is strongly enshrined in French corporate law (Hansmann and Kraakman, 2004: 37). Directors can be removed without cause by simple majority either at the annual general meeting or at any other shareholder meetings. Sitting directors can be removed before they have served their entire term. German corporate law, in contrast, makes it more prohibitively difficult to remove directors before the end of their mandate: the assent of threequarters of voting shares is required, justification must be provided, and Codetermination parity must be restored in the event of the removal of an employee representative (ibid.: 38). French corporate law is shareholder-friendly regarding the question of the removal of directors. But does this friendliness on paper translate into shareholder value? The answer to this question is contingent upon the ownership structure of listed companies. In the presence of ownership concentration, shareholder-friendly corporate law results in the provision of substantial authority to the controlling shareholder in the strategic direction of the company (ibid.: 60). Therefore, the friendliness of French corporate law is more likely to translate into shareholder value in the absence of a controlling owner – that is, under ownership diffusion. Second, the power of banks in German corporate governance has been reduced through legal reforms of voting proxy. Prior to the 1998 Kontrag law, German banks were often able to exercise significant voting power in listed companies via their role as custodian of shares since 94

Law and Economics and Capital Mobility

small investors did not generally instruct banks on their voting preferences. German banks – especially Deutsche Bank, Commerzbank, and Dresdner Bank – often ended up dominating shareholder meetings (Edwards and Fischer, 1994). With the 1998 Kontrag law, however, banks are unable to use voting rights attached to shares that they do not own unless they have been authorized to do so. This situation contrasts with the previous period during which banks were able to vote shares held in their custodian role unless specifically instructed by shareholders not to do so. The reform of the proxy voting power of banks in Germany is potentially beneficial to minority shareholders but only in a specific context. The Kontrag law has reduced the power of banks – a category of shareholders who are almost invariably allied with management and large owners (see e.g. Deeg, 1999; Gourevitch and Shinn, 2005: 164–7). On the other hand, however, the controlling owner is unaffected by the proxy voting of banks since he is obviously likely to instruct them how to vote if shares are held in a bearer form – or simply vote the shares himself. The system of proxy voting is more likely to generate problems of collective action for small, dispersed shareholders than for the controlling owner. Thus, the reform of the proxy voting of banks is more likely to translate into shareholder value in the context of ownership diffusion. The implication from the discussion in this section, and in the previous one, is that short-term-oriented institutional investors should target firms with ownership diffusion from the perspective of the legal protection of minority shareholders – although for different reasons. The argument presented in the previous section highlighted the shortcomings in French and German corporate law. Minority shareholders face two types of issues that are invariably mutually exclusive: managerial opportunism and the extraction of private benefits of control by the controlling owner (Coffee, 2005). The systems of corporate law of these two advanced capitalist economies are better geared toward dealing with the former problem than that of controlling self-dealing transactions by the controlling owner. The argument presented in this section, in contrast, emphasizes the importance of contexts associated with the process of legal reforms designed to empower shareholders (Enriques and Volpin, 2007). The same reform will engender different consequences for shareholder value since its potential benefits are contingent upon the presence of ownership diffusion. Empowering the large controlling owner is unlikely to translate into shareholder value.

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Contingent Capital

3.3 Shareholder Activism and the Legal Protection of Minority Shareholders The presence of ownership concentration raises an additional problem – namely the effectiveness of shareholder activism. The engagement of short-term investors in the affairs of portfolio is less likely to produce expected results if the large controlling owner can easily outvote them. Shareholder activism has increased in prominence in recent years – first in Anglo-American economies and then in continental Europe.12 The increased importance of shareholder activism stands in sharp contrast to tactics used in the past. Institutional investors have traditionally refrained from monitoring companies in an active fashion. Shareholder activism is potentially plagued by a problem of collective action (Rock, 1991). The stake of an individual institutional investor organization based in the United Kingdom and the United States – even that of the biggest funds – is significantly smaller than large owners in continental European systems of corporate governance despite the fact that collectively institutional investors effectively control domestic corporations (Davis and Kim, 2007). An individual fund bears all the costs of activism, such as mounting a proxy campaign, while receiving only a pro rata of the gains associated with better firm performance. As a result, AngloAmerican institutional investors have traditionally followed the Wall Street Walk – selling their stocks if dissatisfied with the performance of portfolio companies. Nonetheless, shareholder activism has increased in importance in the last two decades – even if limited to a minority of institutional investors’ organizations (Monks and Minow, 1995: 134; Kahan and Rock, 2007: 1046). For one thing, the Wall Street Walk has become less feasible for funds with concentrated equity stakes in listed companies (Gilson and Kraakman, 1991). The very act of selling an important stake is likely to influence the price of the stock. Significant increases in the stock price must be secured before short-term investors unload their concentrated stake. Moreover, the rise of shareholder activism has been significantly driven by a new category of investors – namely, but not exclusively, hedge funds (Kahan and Rock, 2007). Managers of hedge funds face significant incentives to engage in shareholder activism: their compensation is heavily performance-related in contrast to that of managers at passively managed mutual funds and pension funds; they face no conflict of interest in the form of managing the company’s funds of 12 See Gilson and Kraakman (1991), Pound (1993), Black and Coffee (1994), Monks and Minow (1995), Morin (1998), Zanglein (1998), Gourevitch (2006) for reviews.

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potentially portfolio corporations as is the case for their mutual funds counterparts.13 As a result, hedge funds do sometimes select a company that would be a good candidate for shareholder activism and then acquire a significant stake and become active. This form of activism contrasts with that of other institutional investors who are generally ex post, namely shareholder engagement in a portfolio company whose performance has degraded (ibid.: 1069). Shareholder activism, even if limited to a small number of institutional investors, can constitute a powerful force in corporate governance. Short-term investors who seek to engage in shareholder activism should target firms with ownership diffusion. In the presence of ownership concentration, the controlling owner can effectively outvote the efforts of institutional investors pressuring for the implementation of policies designed to boost the stock market capitalization of the firm. The implication is that the unlocking of shareholder value through activism from foreign investors is unlikely to happen in the presence of a large, controlling shareholder who can resist their efforts to introduce reorganizations though his voting power. Thus, the promise of shareholder activism constitutes the third factor accounting for the greater attractiveness of companies with ownership diffusion from the law and economics perspective.14 Finally, and closely connected to the above argument about shareholder activism, the size of the free float of a listed company also plays a role in the investment decisions of short-term-oriented funds. Free float is the proportion of shares not held by strategic shareholders and that are not stock with sales restrictions. It constitutes an indicator of the degree of ownership concentration of the company, a lower free float indicating a higher degree of concentration. Why is the free float relevant to the investment decisions of investors? Recent studies have revealed the importance of home bias in the investment decisions of American and British funds despite the disappearance of barriers to international capital mobility across countries and the potential gains associated with greater diversification (Chan et al., 2005; Kho et al., 2009). The domestic bias reflects the extent to which investors overweight the home market in their holdings. In other words, the share of

13 Although the conflicts of interest of American mutual funds are not present in continental Europe (see Morin, 1998; Davis and Kim, 2007: 554). 14 Moreover, the circulation of information is primarily internal in settings characterized by ownership concentration and the absence of adequate legal protection against the actions of controlling shareholders. Minority investors face greater uncertainties regarding the true value of the corporation as compared to better-placed shareholders with access to private information (see Clark and Wojcik, 2007: 98).

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the home market in their holdings is larger than the home market’s share of total world market capitalization. The absolute increases in outflows by Anglo-American funds in foreign equities have been smaller than the growth of the market capitalization of foreign markets. Initial hypotheses on this Anglo-American home bias centered on differences in legal rights for minority investors around the world and on the lack of availability of large blue-chip companies. However, these hypotheses are incomplete for two reasons. First, the domestic bias is not limited to American and British investors, but to institutional investors in large emerging economies and in every advanced capitalist economy (Chan et al., 2005: 1501–11). Second, the domestic bias of American and British institutional investors is affected by the fact that the bulk of foreign companies’ shares are held by insiders and is thus not readily available to outside investors.15 The degree of free float is often used as a rule of thumb by institutional investors. If the free float percentage is low, hedge and mutual funds will drive up the price per share when they attempt to acquire a significant number of stocks. The implication is that the investments of hedge and mutual funds in France and Germany could be driven by differences in degrees of free float.

3.4 Ownership Structure and the Investment Allocation of Short-term Investors: Empirical Evidence What is the empirical evidence on the links between ownership structure and the investment strategies of short-term-oriented funds? The classification of the structure of corporate ownership of companies builds on prior research in order to heighten comparability. Investigations focusing on the impact of management-controlled firms – that is, characterized by the absence of a large single or a group of friendly shareholders – use a cutoff point of 5 percent as a measure of ownership dispersion.16 Studies on the impact of large owners with substantial control over the strategic direction of the firm employ an equity stake of 20 percent or more as an indicator of ownership concentration.17 Finally, firms in which the largest shareholder – or group of friendly

15 For instance, the percentage of shares of American and British public traded companies that were owned by insiders in 2004 was, respectively, only 12.2 and 12.3 percent. The similar figure for the OECD zone was 38.4 percent (see Kho et al., 2009). 16 Whittington and Mayer (2000, 193). 17 Gourevitch and Shinn (2005: 17), Enriques and Volpin (2007: 118).

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owners – controls between 5 and 20 percent of the corporation are labeled medium concentration. Data on the ownership structure of large French and German companies casts serious doubts on the ability of the law and economics perspective to account for the disparities in the investment allocation of short-term investors. First, targeted firms with ownership concentration (X = 0, Y = 1) constitute an important segment of the dependent variable of this book (see Table A1 in Appendix of this chapter). The distribution of the thirty-nine instances of investments above the 5 percent threshold in French firms is as follows: thirteen in ownership concentration, fifteen in medium concentration, and eleven in ownership diffusion. The corresponding figures for the nineteen instances of targeted investments in German companies are ten, two, and seven. In other words, the presence of ownership diffusion (X = 1, Y = 1) constitutes a minority of cases of targeted investment allocation by short-term investors. Second, the data on the ownership structure of companies that were not targeted by short-term institutional investors (Y = 0) also highlights the shortcomings of the law and economics perspective (see Table A2 in Appendix of this chapter). The analysis of the characteristics of these firms is important for avoiding problems of case selection bias – namely that the ownership structure of French and German companies is overall characterized by ownership concentration – or that have experienced movements toward diffusion only recently. The selection of the data on the ownership structure of nontargeted companies is taken from two dates – December 17, 2003, and December 17, 2007 – in order to capture the potential longitudinal evolution in their shareholder base. The data on the ownership structure of nontargeted French firms is the following: forty-eight in ownership concentration, seventeen in medium concentration, and only two in ownership diffusion. The presence of ownership diffusion is almost always associated with a targeted investment stake with the implication that growing dispersion of ownership in France could attract even more funds from short-term oriented investors. Data from the German case, however, highlights the context sensitivity of the previous statement. The data on the ownership structure of nontargeted German firms is fifty-one for ownership concentration, eleven for medium concentration, and twenty-two for ownership diffusion. In other words, the relationship between ownership diffusion (X = 1) and being targeted by short-term investors (Y = 1) varies between France and Germany.

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Table A1 Ownership Structure of Companies Targeted by Short-Term-Oriented Funds (Ownership Structure at the Time of the Investment) France 1. Total (5) 1997: Fidelity (MF) Ownership structure: high concentration 2. Vivendi (52) 2004: Fidelity (MF) Ownership structure: dispersed

Germany (1)

(1)

3. Alcatel (73) (2) 1997: Fidelity (MF) Ownership structure: medium concentration 2004: Fidelity (MF) Ownership structure: medium concentration 4. Schneider (92) (1) 2000: Janus (MF) Ownership structure: high concentration 5. Lafarge (95) (1) 2002: Putnam Ownership structure: medium concentration 6. Accor (134) (1) 2003: Putnam (MF) Ownership structure: medium concentration 7. Peugeot (138) (1) 2006: Wellington (MF) Ownership structure: high concentration 8. Lagarde`re (158) (2) 2004: Highfields K Management (HF)

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1. Infineon (165) 2003: Fidelity (MF) Ownership structure: medium concentration 2. Deutsche Borse (172) 2003: Fidelity (MF) Ownership structure: dispersed 2004: Atticus Capital (HF) Ownership structure: dispersed 2004: Children Investment (HF) Ownership structure: dispersed 2006: Lone Pine Capital (HF) Ownership structure: dispersed 3. DepfaBank (340) 1998: Janus (MF) Ownership structure: high concentration

(1)

4. Puma (348) 2003: Fidelity (MF) Ownership structure: dispersed

(1)

5. Fresenius (390) 2008: Fidelity (MF) Ownership structure: high concentration 6. Merck (409) 2004: Fidelity (MF) Ownership structure: high concentration 7. MG Technologies (462) 2008: Fidelity (MF) Ownership structure: high concentration 8. Celanese (498) 2003: Fidelity (MF)

(1)

(4)

(1)

(1)

(1)

(1)

Law and Economics and Capital Mobility Ownership structure: medium concentration 2006: Fidelity (MF) Ownership structure: medium concentration 9. Bouygues (160) 1998: Schroeders (MF) Ownership structure: high concentration 2001: Putnam (MF) Ownership structure: high concentration 10. Vivendi Environment (182) 2003: Putnam (MF) Ownership structure: high concentration 11. Michelin (184) 2004: Wellington (MF) Ownership structure: medium concentration 12. CapGemini (190) 2008: Fidelity (MF) Ownership structure: medium concentration 13. Pernod Ricard (197) 2001: Fidelity (MF) Ownership structure: high concentration 14. Pechiney (231) 2002: Fidelity (MF) Ownership structure: high concentration

15. Publicis (236) 2001: Putnam (MF) Ownership structure: high concentration 16. TF1 (247) 2001: Putnam (MF) Ownership structure: high concentration 17. Valeo (329) 2007: Pardus (HF) Ownership structure: medium concentration 2008: Goldman Sachs (HF) Ownership structure: medium concentration 18. Dassault Syste`mes (346) 2004: Fidelity (MF) Ownership structure: high concentration

Ownership structure: high concentration

(2)

9. MLP (547) 2006: Fidelity (MF) Ownership structure: high concentration

(1)

(1)

10. Epcos (565) (1) 2007: Odey Asset Management (HF) Ownership structure: dispersed

(1)

11. Medion (597) 2004: Fidelity (MF) Ownership structure: high concentration 12. BilfingerBerger(632) 2005: Fidelity (MF) Ownership structure: dispersed

(1)

(1)

(1)

(1)

(1)

(1)

13. Kali&Salz (658) (1) 2004: Fidelity (MF) Ownership structure: medium concentration 14. HeidelbergerDruckmaschinen (723) (2) 2004: Fidelity (MF) Ownership structure: high concentration 2007: Centaurus Capital (HF) Ownership structure: high concentration 15. AAreal Bank (737) (1) 2006: Fidelity (MF) Ownership structure: high concentration

(1)

(2)

(1)

continued

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Contingent Capital Table A1 Continued France 19. Business Objects (374) 2001: Fidelity (MF) Ownership structure: dispersed 2004: Fidelity (MF) Ownership structure: dispersed 2005: SAC Investments (HF) Ownership structure: dispersed 2007: Tudor (HF) Ownership structure: dispersed 20. Eurotunnel (378) 2002: Oppenheimer Funds (MF) Ownership structure: dispersed 2009: Goldman Sachs Aero 1 (HF) Ownership structure: dispersed 21. Technip-Coflexip (381) 1997: Fidelity (MF) Ownership structure: high concentration 2000: Putnam (MF) Ownership structure: high concentration 22. Atos (434) 1998: Fidelity (MF) Ownership structure: medium concentration 1998: Janus (MF) Ownership structure: medium concentration 2006: Centaurus Capital (HF) Ownership structure: dispersed 2007: Pardus Capital (HF) Ownership structure: dispersed 23. Neopost (446) 1999: Egerton Capital (HF) Ownership structure: medium concentration 1999: Fidelity (MF) Ownership structure: medium concentration 2008: Fidelity (MF) Ownership structure: dispersed 24. Havas (457) 1999: Putnam (MF) Ownership structure: medium concentration 2003: Fidelity (MF) Ownership structure: dispersed High concentration: 13 Medium concentration: 15 Dispersed: 11 Total: 39

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Germany (4)

(2)

(2)

(4)

(3)

(2)

High concentration: 10 Medium concentration: 2 Dispersed: 7 Total: 19

Law and Economics and Capital Mobility Table A2 Ownership Structure of Companies Not Targeted by Short-TermOriented Funds (Ownership Structure in 2003 and 2007) France

Germany

1. BNP-Paribas (20) 2003: Medium concentration 2007: Medium concentration 2. Aventis (29) 2003: Medium concentration 2007: N/A 3. Societe Generale (34) 2003: Medium concentration 2007: Medium concentration 4. Carrefour (39) 2003: High concentration 2007: High concentration 5. AXA (43) 2003: High concentration 2007: High concentration 6. L’ Oreal (50) 2003: High concentration 2007: High concentration 7. Sanofi-Synthelabo (51) 2003: High concentration 2007: High concentration 8. France Telecom (53) 2003: High concentration 2007: High concentration 9. Danone (59) 2003: Medium concentration 2007: Medium concentration 10. LVMH (67) 2003: High concentration 2007: High concentration 11. Suez (74) 2003: High concentration 2007: High concentration 12. Credit Agricole (75) 2003: High concentration 2007: High concentration 13. Air Liquide (77) 2003: Dispersed 2007: Medium concentration 14. Saint-Gobain (78) 2003: Medium concentration 2007: Medium concentration 15. Renault (87) 2003: High concentration 2007: High concentration 16. Pinault Printemps Redoute (161) 2003: High concentration 2007: High concentration 17. Arcelor (168)

1. Siemens (16) 2003: Dispersed 2007: Dispersed 2. Deutsche Bank (24) 2003: Dispersed 2007: Dispersed 3. Deutsche Telekom (25) 2003: High concentration 2007: High concentration 4. Allianz (30) 2003: Medium concentration 2007: Dispersed 5. E.ON (33) 2003: Dispersed 2007: Dispersed 6. Daimler-Chrysler (36) 2003: Medium concentration 2007: N/A 7. SAP (38) 2003: High concentration 2007: High concentration 8. BASF (44) 2003: Dispersed 2007: Dispersed 9. Munich Re (57) 2003: Medium concentration 2007: Dispersed 10. Bayer (65) 2003: Dispersed 2007: Dispersed 11. BMW (83) 2003: High concentration 2007: High concentration 12. RWE (100) 2003: Medium concentration 2007: Medium concentration 13. Volkswagen (104) 2003: High concentration 2007: High concentration 14. Schering (129) 2003: Medium concentration 2007: N/A 15. Hypo Bank (130) 2003: Medium concentration 2007: N/A 16. Commerzbank (131) 2003: Medium concentration 2007: Dispersed 17. Thyssen Krupp (152) continued

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Contingent Capital Table A2 Continued France

Germany

2003: Medium concentration 2007: N/A 18. Vinci (187) 2003: Medium concentration 2007: Medium concentration 19. Essilor International (198) 2003: Medium concentration 2007: Medium concentration 20. Thomson (217) 2003: Medium concentration 2007: Medium concentration 21. Casino (265) 2003: High concentration 2007: High concentration 22. Unibail (294) 2003: High concentration 2007: Dispersed 23. Christian DIOR (287) 2003: High concentration 2007: High concentration 24. Sodexo (327) 2003: High concentration 2007: High concentration 25. Thales (342) 2003: High concentration 2007: High concentration 26. Wanadoo (347) 2003: High concentration 2007: N/A 27. Autoroutes Sud France (353) 2003: High concentration 2007: N/A 28. CNP Assurances (411) 2003: High concentration 2007: High concentration 29. Sagem (418) 2003: High concentration 2007: N/A 30. Air France (430) 2003: High concentration 2007: High concentration 31. Hermes (436) 2003: High concentration 2007: High concentration 32. Gecina (438) 2003: High concentration 2007: High concentration 33. Imerys (469) 2003: High concentration 2007: High concentration 34. Natexis Bank (471)

2003: High concentration 2007: High concentration 18. Deutsche Post (153) 2003: High concentration 2007: High concentration 19. Metro (178) 2003: High concentration 2007: High concentration 20. Continental (204) 2003: Medium concentration 2007: High concentration 21. Altana (211) 2003: High concentration 2007: High concentration 22. Henkel (214) 2003: High concentration 2007: High concentration 23. Porsche (220) 2003: High concentration 2007: High concentration 24. Adidas-Salomon (223) 2003: Dispersed 2007: Dispersed 25. Linde (253) 2003: High concentration 2007: High concentration 26. T-Online (264) 2003: High concentration 2007: N/A 27. Lufthansa (294) 2003: Medium concentration 2997: Dispersed 28. MAN (306) 2003: High concentration 2007: High concentration 29. Beiersdorf (331) 2003: High concentration 2007: High concentration 30. TUI (368) 2003: High concentration 2007: High concentration 31. Heidelberger Cement (382) 2003: High concentration 2007: High concentration 32. Hypo Real Estate Holding (439) 2003: Dispersed 2007: Dispersed 33. Stada Arzneimit (487) 2003: Dispersed 2007: Dispersed 34. Celesio (523)

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Law and Economics and Capital Mobility 2003: High concentration 2007: High concentration 35. BIC (490) 2003: High concentration 2007: High concentration 36. Zodiac (509) 2003: High concentration 2007: High concentration

High concentration: 48 Medium concentration: 17 Dispersed: 2

2003: High concentration 2007: High concentration 35. Pro Siebensat (552) 2003: High concentration 2007: N/A 36. Wella (558) 2003: High concentration 2007: N/A 37. Suedzucker (572) 2003: High concentration 2007: High concentration 38. Hannover Ruck (577) 2003: High concentration 2007: High concentration 39. IKB DT Industriebank (603) 2003: High concentration 2007: High concentration 40. Douglas (608) 2003: Medium concentration 2007: High concentration 41. Singulus Technologies (621) 2003: Dispersed 2007: Dispersed 42. Karstadtquelle (643) 2003: High concentration 2007: High concentration 43. Frankfurt Airport (714) 2003: High concentration 2007: High concentration 44. IVG Immobilien (776) 2003: High concentration 2007: High concentration 45. Hugo Boss (785) 2003: High concentration 2007: High concentration High concentration: 51 Medium concentration: 11 Dispersed: 22

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4 Complex Causation and Contextualized Capitalisms

This study of the investment allocation of short-term investors in France and Germany is embedded in important choices of research methodology regarding the nature of causation in social sciences. The analysis of short-term capital movements in two countries constitutes an ideal testing ground for the issue of complexity in research methods, but also faces the typical problem of the comparison of observed cases limited in both their diversity and in relation to the number of potential explanatory variables and, moreover, with many of the relevant variables for the research question of this book covarying – although not in a symmetrical fashion. Making inferences about causal relationships, that is, the question of how to assess that a variable (x) exerts a causal effect on another (y), constitutes the central pillar of research methodology. After all, “events do not just happen; they happen under certain conditions” (Caramani, 2009: 41). The importance of the logic of inference cuts across academic disciplines. Research methodology at its core embodies a “set of logically based procedures for systematically testing against empirical evidence alternative (or competing) hypotheses about causal connections between phenomena” (ibid.: 3). For many scholars, these sets of procedures associated with the logic of inference have united qualitative-oriented research methods with quantitative-based approaches. For instance, King, Keohane, and Verba emphasize the overarching importance of the logic of inference since “differences between the quantitative and qualitative traditions are only stylistic and are methodologically and substantially unimportant. All good research can be understood – and is indeed best understood – to derive from the same underlying logic of inference” (King et al., 1994: 4). The two research approaches strive to meet the requirements associated with the logic of inference. 106

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Nonetheless, and despite the insights inherent with a deeper integration associated with a joint analysis of qualitative and quantitative methods (see Braumoeller, 2003), important differences remain. Mahoney and his collaborators have identified two key distinguishing features (Mahoney and Villegas, 2007; Mahoney, 2008; Mahoney and Terrie, 2008). First, the conception of causation differs across the two methodological approaches. The aim of qualitative-based methods is to explain adequately each of the historical events (y) under consideration. SmallN qualitative studies are built around the notion of a causes-of-effects approach in order to provide a comprehensive and complete account of important and specific outcomes. The objective is to highlight how a variable (x) exerted a causal effect on numerically limited outcomes (y) for each of the sets of cases under consideration; the generalization of the average and typical effect of a variable (x) on outcomes (y) is not the issue. The identification of the specific values taken by an independent variable that generates an outcome of interest is paramount. Quantitative-oriented approaches, in contrast, seek to estimate the average causal effects of the independent variables of interest. Large-N studies are built around the notion of effects-of-causes approach whereby the aim is to estimate and generalize the average impact of independent variables across a large number of cases. Second, the research techniques and tools of causal analysis differ across the two methodological approaches. Qualitative studies rely on the notion of necessary/sufficient conditions to assess the causal importance of a limited number of hypothesized independent variables. By contrast, the use of regression techniques designed to test competing theories stands prominently in quantitativeoriented studies. These two differences between qualitative and quantitative approaches are not stylistic; they entail profound implications for the logic of inference for research methods in social sciences. The issue of complexity illustrates quite well the profound implications associated with the two approaches. This study of the investment allocation of short-term capital in France and Germany reflects the importance of causal complexity. There are many factors that account for the disparities in the investment allocation of short-term capital in France and Germany. I concentrate on the insights provided by the Varieties of Capitalism (VoC) perspective (organization of work) and the law and economics approach (protection of minority shareholders). The investment allocation of short-term investors reflects the importance of the combination of intersecting conditions. Qualitative research methods highlight how different factors combine in different ways to produce at times similar outcomes (equifinality), 107

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and interact at other times to generate a specific outcome that would not occur without the presence of all of these interacting factors (conjunctural causation). The study of causal complexity in social sciences has long been the province of qualitative-oriented approaches but recent developments in quantitative-based studies have broken this monopoly. Many statistical techniques and regression analysis designs are able to capture interaction effects that flow from combinatorial causal effects (Jackson, 1996; Gordon and Smith, 2004; Braumoeller and Kirpichevsky, 2005). Nonetheless, it would be erroneous to conclude that differences between qualitative and quantitative approaches have evaporated. As mentioned above, the conceptualization of causation remains different. The goal of quantitative approaches remains the assessment of the typical effects of specified independent variables rather than the provision of a comprehensive account of important outcomes. Moreover, and flowing from the previous point, statistical analyses still conceptualize causes as being additive with the implication that the effect of an intersection of variables is similar across all other contexts. Finally, quantitative approaches assume unit homogeneity in the sense that a change in the value of the independent variable is assumed to result in a change in the value of the dependent variable of the same magnitude across all other cases (see Hall, 2003: 381–3; Hall, 2010a: 5–9). The analysis of the causes and consequences associated with shortterm capital mobility in France and Germany is analyzed in this book within the specificities of qualitative research methods with the aim of providing a comprehensive account for the disparities in investment allocation between the two countries. This choice is not capricious and, moreover, is not determined by the alleged superiority of one research method over the other. The use of qualitative methods in this book is based on ontological choices. As Hall (2003: 373–4) argues, “ontology refers to the character of the world as it actually is. . . . If a methodology consists of techniques for making observations about causal relations, an ontology consists of premises about the deep causal structures of the world from which analysis begins and without which theories about the social world would not make sense.” Thus, the burden is placed on this author to demonstrate why a qualitative approach is better suited to the research question of this study. In particular, an important contribution of this book is to show that independent variables that are part of an intersection of conditions are not simply causally relevant. The relative strengths of different effects of combinations will be presented – a task that is best suited for qualitative-oriented approaches.

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The rest of this chapter is organized in the following manner. First, I present the core elements of the institutional perspective presented in this book. Second, I highlight the strengths and limitations of Mills’ method of difference for the study of phenomena characterized by the importance of causal complexity. Third, I present the core features of the concepts of necessary/sufficient conditions and highlight their contribution to the analysis of the investment allocation of short-term investors in France and Germany. Fourth, I stress the importance of context and its associated notion of a hierarchically superior institutional variable as the ontological foundations of the role of complex causation in social sciences.

4.1 Institutions and Causal Complexity The presence of institutional diversity across advanced capitalist economies does matter (Whitley, 1999; Hall and Soskice, 2001). The specification of the importance of institutions highlights the centrality of interaction between different institutional spheres of the economy. The key analytical starting point is that the impact of a single institution should not be seen in isolation, but as part of a whole interactive process whose impact is contingent upon the overall institutional configuration in which it is embedded. In other words, the effects of an institution are contingent upon the specifics of its interaction with other institutions (Hall 1994). In particular, the VoC approach conceptualizes the political economy as a set of a highly interdependent arenas where the impact of institutional practices in one sphere – both on the behavior of firms and on economic performance – depends on the type of institutions present in other spheres (Hall and Franzese, 1998; Soskice, 1999). Policy reforms with a focus on a single institutional sphere will invariably produce unintended consequences. In turn, the interactive process between institutions leads to the formation of different patterns of institutional complementarities (Hall and Gingerich, 2009). The concept of institutional complementarities refers to a situation whereby specific institutional arrangements found in one sphere of the economy interact with those prevalent in other spheres and make them more effective than they would otherwise be on their own (Milgrom and Roberts, 1994, 1995). The above brief synopsis of the key fundamental pillars of the VoC approach highlights its close affinity with the groundbreaking work of Ragin (1987) on research methodology. Sensitivity to complex and historical specificities is strengthened by the role of institutions in the VoC perspective (Hall, 2010a). The concepts of institutional interaction 109

Contingent Capital

and institutional complementarities rightly stress the importance of explaining outcomes in terms of combinatorial causation and strongly suggest the perils associated with thinking about causation in terms of the average/mean effects of individual variables since the impact of a single institution is contingent upon its interaction with other institutions in a given setting. Nonetheless, the framework is incomplete to fully capture the hierarchical dimension of institutional interaction. As pointed out by Mahoney (2008: 428), works in comparative politics increasingly rely on the notion of complex interactions but often fail to precisely locate all relevant necessary/sufficient conditions. The concept of causal complexity, and its associated sets of necessary/sufficient conditions, comes in many forms (Braumoeller, 2003; Mahoney, 2008: 417–20). Therefore, the argument presented in this book builds on the core concepts of the institutionally based VoC with the aim of tackling two issues. The first is related to the hierarchical nature of institutions that are part of a process of causal complexity whereby outcomes are explained in terms of combinatorial conditions. As pointed out by Goldthorpe (1997: 7), case-oriented studies highlighting the interactive and combinatorial effects of institutions are able to demonstrate whether specific independent variables are causally relevant; but no assessment of the relative strengths of the different independent variables has been attempted. Second, the analysis of important social phenomenon is increasingly presented in terms of necessary/sufficient conditions but without seeking to account for the uneven distribution of what is a necessary/sufficient cause across settings (Mahoney, 1999a, 2004). For instance, the object of study in Skocpol (1979) consists in the identification of common causes that led to social revolts in France, Russia, and China. Through the implicit use of necessary/sufficient conditions (see Mahoney, 1999, for a review), she highlights the importance of state breakdown and peasant revolts as main causal factors across these three cases and dismisses the causal importance of relative deprivation and urban worker revolts. State breakdown and peasant revolts are important given their impact on important outcomes for the three countries with successful revolutions in Skochol’s analysis. The presence of uneven distribution of necessary/ sufficient conditions across institutional settings, in contrast, has not been at the forefront of qualitative research. I demonstrate in this study how empirical results that reveal how a causal variable is necessary/sufficient in one situation, but not in another, should not be interpreted as proof leading to rejection. The presence of uneven distribution of conditions across cases presents insights for assessing the importance of institutional 110

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diversity. For necessary conditions, institutional diversity strongly suggests that different sets of factors need to be present across settings in order to generate a similar outcome rather than seeking common causes across a number of limited cases. For sufficient conditions, the presence of similar values on the dependent variable across cases does not imply similar values on the independent variable. The introduction of a similar institutional reform across countries takes place across settings characterized by different institutional starting points – thereby highlighting the fact that what is sufficient in one country will not necessarily be so in another.1

4.2 Method of Difference A methodological component of the qualitative research design of this book is the method of difference. The assumption of the method of difference is that the phenomenon of interest is always present/absent when the hypothesized independent variable is also present/absent – with other competing independent variables always being absent/present. This investigative strategy is characterized by the comparison of cases with similar and constant background features on a first set of control variables combined with changing values taken by the dependent and independent variables.2 The method is based on an association between phenomena, that is, cause and effect, with the isolation of the effect of other causal variables. The method of difference is well suited to the presence of fairly uniform background characteristics between cases since it reduces the number of candidate causes. The study variables of this particular study are the differences in the investment portfolio allocation of hedge and actively managed mutual funds in France and Germany (DV) and the firm-level institutional arrangements of workplace organization (IV). The similarities of the background characteristics of these two cases are 1 The empirical data presented in this book points to the importance of this issue of sufficiency. The presence of ownership diffusion in France constitutes an almost-sufficient condition for being targeted by short-term-oriented institutional investors in contrast to the German case whereby several firms without a dominant shareholder have not received a targeted investment stake. The uneven distribution of this sufficient condition across France and Germany should not be interpreted as a justification to give up on this notion, but rather to specify how changes across these two countries entail the participation of different groups of actors. The growing diffusion of ownership might constitute an important development for the unlocking of shareholder value but whether it is sufficient is contingent upon the overall institutional settings of national systems of corporate governance. 2 For excellent analyses of the role of the method of difference in qualitative studies using a small number of cases, see Van Evera (1997: 23–4, 50–5) and Mahoney (1999).

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EU membership, adoption of the single currency, removal of capital controls, and the size of their respective economies. European Union and Eurozone membership control for competition, trade, and interest rate policies (Frieden, 1991, 2001; Wilks, 2005; Soskice, 2007); removal of capital controls serve to eliminate the role of policymakers in regulating capital flows (Goodman and Pauly, 1993; Abdelal, 2007); and the comparable size of the two economies is associated with a similar degree of exposure to foreign trade. The essence of the method of the difference is about the identification of invariant patterns of association (Mahoney, 2000b). The presence of variation on the dependent variable cannot be accounted for by stability (or incongruent variations) on the values taken by the alternative explanations, thereby enabling the researcher to investigate a congruent cross-case difference that causes the above variation. The method of difference performs a useful role by introducing parsimony to the qualitative analysis – the lack of covariance between the values taken by the dependent variable and the background alternative explanations allow for a process of elimination to operate (Savolainen, 1994). In other words, the process of elimination takes place through comparative matching techniques. The validity of the logical inference between the dependent and independent variables is strengthened by the elimination of similar background characteristics for the two cases. The method of difference is designed to eliminate potential sufficient causes (Mahoney and Villegas, 2007: 75).3 The method of difference, however, is plagued by four shortcomings that necessitate that its use in qualitative strategy be complemented with other tools. First, the method of difference is always open to the criticism that important explanatory variables were not included in the analysis. The negative consequences associated with this shortcoming are particularly important in situations of causal complexity characterized by the importance of interaction effects among variables (Hall, 2003: 382–4). The invariant pattern of association between X (independent variable) and Y (dependent variable), with other analyzed competing variables lacking covariance properties with the dependent variable, is likely to miss two potential, and important, scenarios: the impact of X on Y is contingent upon the presence of another independent variable (conjunctural causation), and that Y could also result from the isolated occurrence of another independent variable (substitutability). This shortcoming serves as a useful reminder that the methodological 3 The method of agreement, in contrast, is designed to eliminate potential necessary causes.

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insights of the method of difference are best captured when combined with a rich narrative analysis that provides a detailed and nuanced understanding of the dependent variable.4 Second, the method of difference has a deterministic understanding of causation (Lieberson, 1991). The deterministic character of the method of difference reflects the notion that the presence of a factor will necessarily lead to a specific outcome. The relationship between the independent and dependent variables is understood as one of necessary AND sufficient condition given the congruence between their changing values – with the rejection of alternative explanations characterized by constant values. The method of difference is not well suited to processes of complex causation (Tilly, 1984; Ragin, 1987: 36–42). The strategy of identifying invariant patterns of association provides a significant contribution to qualitative strategies of causal inference, namely by enabling the researcher to demonstrate that invariant alternative explanations cannot constitute sufficient (method of difference) or necessary (method of agreement) causes. The uniform case conditions on four key dimensions – EU membership, adoption of the single currency, removal of capital controls, and roughly equivalent exposure to trade – makes it highly unlikely that they could in themselves serve as key, and sole, causal variables. But this does not imply that the firm-level institutional arrangements of workplace organization (IV) constitute a necessary and/ or sufficient condition to account for the differences in the investment strategies of hedge funds and actively managed mutual funds in France and Germany (DV). The conceptualization of causation inherent in the formulation of the method of difference creates two problems: the dependent variable could be either present or absent in the event of a sufficient cause being absent, and the dependent variable could be either present or absent in the event of the necessary cause being present (Mahoney, 2000b: 392). The method of difference, therefore, needs to be complemented by an analysis of necessary and sufficient conditions. Third, the acknowledgment of complex causation is not enough to guarantee the validity of the strategy of causal inference associated with the method of difference. As previously mentioned, I argue that short-term, impatient institutional investors can pursue a top-down investment strategy whereby fund managers build their portfolio based on the analysis of macroeconomic factors associated with different countries or a bottom-up investment strategy whereby the characteristics of firms play a fundamental role in their decisions to buy and sell. 4 The pioneer works combining the method of difference and a rich narrative analysis remain those of Moore (1966) and Skocpol (1979).

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The acknowledgment of the multiplicity of investment strategies fits well with my argument, namely that that the firm-level institutional arrangements of workplace organization constitute the most significant variable to account for the variation in my dependent variable. I do not seek to account for all of the instances of investment by hedge and mutual funds; I aim at accounting for “most” of the variation.5 However, this concession is still insufficient since it gives rise to a double standard: how can I reject alternative explanations by arguing that they cannot fully explain the variation in the dependent variable while preserving my own independent variable (see Mahoney, 1999: 1170–5)? The attempt to explain the “most” in the variation in the dependent variable requires the presentation of an argument for distinguishing between the causal impacts of different independent variables. The three previous criticisms issued at the Mills’ methods are well known. I issue a fourth criticism that has not been previously appreciated. It builds on the importance of context – a central feature of the argument presented in this book. The notion of context further reduces the insights provided by the method of difference. As previously mentioned, the method of difference performs a useful function in eliminating potential sufficient causes even if it often fails to capture phenomena of causal complexity. However, this assertion is based on the notion of a single and stable context. The comparison across contexts is often associated with the presence of different types of relationships between variables (Goertz, 1994). Thus, a potential scenario is that different contexts are associated with different invariant patterns of association. The elimination of alternative competing independent variables that are displaying incongruent variations with the values taken by the dependent variable in one context might not be possible in another. Independent variables could display congruent variations in one context and incongruent variations in a second context. In other words, the process of elimination through comparative matching techniques does not automatically translate across contexts.

4.3 Necessary and Sufficient Conditions The use of necessary/sufficient conditions constitutes a research technique associated with small-N qualitative studies that are built around 5

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the notion of causes-of-effects causation in order to provide a comprehensive account of a limited number of cases (Mahoney, 2008; Mahoney and Terrie, 2008). They are appropriate to situations characterized by an understanding of causation based on the identification of specific values of variables that generate outcomes of interest (Braumoeller and Goertz, 2000; Mahoney, 2004: 82–5). Alongside this widespread interest in the use of necessary/sufficient conditions, a surge of publications has designed specific methodological tools for causal and descriptive inference that enable the researcher to test for necessary and sufficient conditions as well as to address their theoretical implications. These methodological techniques operate in two stages. First, the researcher seeks to establish whether a variable is a necessary or sufficient condition for an outcome to occur. Second, and in the presence of covariation between the tested variable and the outcome, the focus shifts to establishing whether the tested variable is trivially necessary or trivially sufficient. Triviality implies that the variable possesses little or no importance to account for the presence (or absence) of the dependent variable. Several techniques exist to tackle these issues. For instance, the use of “typological theory” constitutes an interesting technique for the provision of an assessment of whether variables are systematically matched in a pattern of correspondence consistent with necessary or sufficient causation.6 The process by which the researcher concludes that a variable is a necessary/sufficient condition for an outcome to occur is greatly facilitated if one clearly establishes its specific theoretical properties and empirical implications. Assume a 2  2 matrix with the different cells representing the different values (absent = 0; present = 1) taken by the dichotomous tested variable (X) and the dependent variable (Y). Necessary conditions are characterized by two features (Braumoeller and Goertz, 2000: 846–7; Caramani, 2009: 58–63). The first feature presents X as a necessary condition for Y if X is always present when Y occurs (cell IV of Figure 4.1). The presence of Y in the absence of X would seriously shatter the necessary character of the latter (cell III of Figure 4.1). The second feature conceptualizes X as a necessary condition for Y if Y does not occur in the absence of X (cell I in Figure 4.1). The absence of X as a necessary condition is sufficient for Y to be itself absent. In turn, the presentation of these two features generates three implications for the testing of necessary conditions (Braumoeller and Goertz, 2000). The first implication is that the number of cases

6

The concept of “typological theory” is taken from George and Bennett (2005).

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x

X=0

X=1

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Figure 4.1. Necessary and Sufficient Conditions

falling into the third cell (X = 0, Y = 1) should be close to zero for necessary conditions.7 The presence of many observations in cell III would constitute the most damaging evidence for the role of X as a necessary condition. The second implication is that the collection of observations from cell II (X = 1, Y = 0) is surplus to requirements from the perspective of testing for necessary conditions, thereby illustrating the mistake in the utilization of data from the four cells. The third implication, which follows from the previous two, stipulates that the bulk of the observations found in cells I and IV (X = 0, Y = 0; X = 1, Y = 1) would strongly contribute to the hypothesized relationship of necessity between X and Y.8 Sufficient conditions are also characterized by two features (Caramani, 2009: 56–8). The first feature presents X as a sufficient condition for Y if Y is always present when X is itself present (cell IV of Figure 4.1). The second feature conceptualizes X as a sufficient condition for Y if Y is never absent in the presence of X – that is, the lack of observations of cases in situations where X is present and Y is absent (cell II in Figure 4.1). In turn, the presentation of these two features also generates three implications for the testing of sufficient conditions. The first implication is that the number of cases falling into the second cell (X = 0, Y = 1) should be close 7 I use the more neutral term “should be” rather than “is” for describing the relationship between the presence of a value taken by X and the corresponding/resulting value taken by Y. Otherwise, the use of typology would be characterized by a strong element of determinism whereby the presence of a certain value taken by X must necessarily result in a specific value taken by Y (Lieberson, 1991). 8 However, this statement applies solely to a comparison between data found in cells I and IV versus observations found in cell III of Figure 4.1.

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to zero for sufficient conditions. The presence of many observations in cell II constitutes the most damaging evidence for the role of X as a sufficient condition. The second implication is that the collection of observations from cells I and III (X = 0, Y = 0; X = 0, Y = 1) is unnecessary from the perspective of testing for sufficient conditions, thereby also illustrating the mistake in the use of data from the four cells. The notion of sufficient condition implies in principle the presence of (potentially) different paths toward the generation of an outcome of interest that could be resulting from the presence of X – or from that of another variable. The third implication, which follows from the previous two, stipulates that the bulk of the observations found in cell IV (X = 1, Y = 1) as compared to cell II (X = 1; Y = 0) would strongly contribute to the hypothesized relationship of sufficiency between X and Y. Finally, the empirical evaluation of necessity/sufficiency requires an additional step – namely whether X is trivially necessary/sufficient. The concept of trivialness refers to the degree of importance of a necessary/ sufficient condition. It constitutes an empirical concept rather than a theoretical notion (Dion, 1998; Braumoeller and Goertz, 2000: 854; Goertz, 2006). As pointed out by Downs (1989: 234), there are potentially an infinite number of necessary/sufficient conditions for any phenomenon with its associated diverging rates of explanatory power. Trivialness refers to the inability of X to account for the values taken by Y, not to any suggestion that there is no logical connection between the two variables. Therefore, the notion of triviality is to be distinguished from the concept of irrelevancy whereby Y never occurs no matter the value taken by X. For necessary conditions, trivial conditions refer to low (or absence of) importance of a variable in two potential scenarios. The first one refers to the absence of variation in the independent variable for all values taken by the dependent variable. In all cases, Y = 0 and Y = 1, the value taken by the independent variable is constant. A trivial necessary condition is characterized as being constant (present) in all cases in the universe of analysis – both in the presence or absence of the dependent variable. In statistical terms, the independent variable does not vary. The second scenario refers to the absence of variation in the dependent variable. In all cases, X = 0 and X = 1, the value taken by the dependent variable remains unchanged. A trivial necessary condition is characterized by the stability of the value taken by the dependent variable in all cases in the universe of analysis – both in the presence or absence of the independent variable. In statistical terms, the dependent variable does not vary. Thus, the distribution of observations associated with a trivial necessary condition would fall in either two sets of cells: lack of variation in the independent variable or lack of variation in the 117

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X

0 Low

1 High

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100

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Figure 4.2. Trivially Necessary Conditions Source: Braumoeller and Goertz (2000: 855).

dependent variable (see Figure 4.2). In other words, the occurrence of a trivial necessary condition follows from the fact that the variable does not vary in statistical terms. Trivialness becomes more likely as the number of cases in either cell I or IV of Figure 4.1 (X = 0, Y = 0; X = 1, Y = 1) decreases toward zero. To put it differently, the absence of trivialness requires significant variation in both the distributions in the Y = 0 and Y = 1 rows (problem of the lack of variation in the independent variable) and in the X = 0 and X = 1 rows (problem of the lack of variation in the dependent variable).9 The above presentation of the techniques of necessary/sufficient conditions is important for the analysis of small-N studies where the understanding of causation is oriented around the presentation of a comprehensive account of the cases under consideration. They provide useful tools for the analysis of how variables operate in a limited number of settings. Moreover, they differ from an average impact understanding of causation since not all collected variables are relevant for the analysis of a limited number of cases.10 Nonetheless, three sets of criticism have been issued for the analysis of necessary/sufficient conditions. The first concern is that the use of necessary/sufficient conditions embedded in studies of causal complexity has not sought to tackle the relative

9 Finally, the notion of trivially sufficient conditions refers to the lack of variation in the independent variable in the sense that X never occurs (Goertz, 2006: 104). The interest of trivially sufficient condition refers to a situation of the world that is virtually impossible to attain. For instance, the literature on democratic peace states that if all countries were democracies then world peace would occur since democracies do not go to war against each other. This example suggests the importance of a (sufficient) condition that in practice is virtually impossible to reach but that often constitutes an important goal for policymakers. 10 For necessary conditions, observations collected from cell II of Figure 4.1 are unnecessary. For sufficient conditions, observations collected from cells I and III of Figure 4.1 are unnecessary. In large-N studies, in contrast, data from these cells is essential for assessing the average impact of a hypothesized independent variable.

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importance of the (institutional) variables (Goldthorpe, 1997). Necessary/sufficient causes are presented as being important since they are part of an intersection of conditions that generate a specific outcome, but such deserved acknowledgment of causal complexity should not obscure the fact that some (institutional) variables are more influential on outcomes than others. What is the relative weight of different necessary/sufficient causes? The importance of this issue partly lies in the fact that the process of institutional change in advanced capitalist economies in the last twenty years has exhibited significant divergence both across countries and across institutional spheres with changes in corporate governance often noted for being more impressive than institutional transformation in other areas (see Hoepner, 2001; Deeg, 2005a, ¨ rsch, 2007; Hall, 2007; Hall and Thelen, 2009). 2010; Jackson, 2005b; Bo The divergent trajectories of change in the last twenty years combined with the presence of strikingly different paths of conflict settlements across advanced capitalist economies entail that what is necessary and/ or sufficient in one setting will not be a causal variable in another (see Section 4.4). The second issue is that the use of necessary/sufficient conditions has generally been presented as not being appropriate for the study of causal complexity in social sciences due to their inferred deterministic character. Although more specifically focused on Mills’ method, but also applicable to the more general use of necessary/sufficient causes, Lieberson (1991) argues that necessary/sufficient conditions are based on a deterministic logic that does not fit well with the world of social sciences, especially that of small-N studies. His criticism is built upon three elements. In the first place, the deterministic character of sufficient/necessary conditions is reflected in the fact that the presence of a factor (X) conceptualized as necessary and/or sufficient will necessarily lead to the specified outcome (Y). The dependent variable must be generated (Y = 1) in the presence of an independent variable deemed as sufficient (X = 1); the dependent variable cannot be generated (Y = 0) in the absence of an independent variable deemed as necessary (X = 0). There is no room for deviations in this kind of relationship between variables.11 Secondly, and building from the previous point, the presence of a single deviation from the predicted theory leads to a serious problem for necessary/ sufficient causes. For instance, how should one interpret that validity of X as a necessary condition if we gather four observations in cell I, two observations in cell III, and four observations in cell IV of Figure 4.1? 11 In contrast, Lieberson (1985, 1991) prefers to use the notion of probabilistic causation whereby the presence of a factor (x) increases the likelihood of a specified outcome (y).

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For large-N-oriented scholars, the conclusion is simple: 80 percent of observations fit with the prediction of the theory regarding the relationship between X and Y. For small-N studies, in contrast, the situation is more complicated given that either one variable or an intersecting combination of variables causes a given outcome. How many deviations from the theory can be tolerated among a small number of cases? Thirdly, Lieberson (1991, 1997) also argues that small-N comparative analyses do not allow probabilistic thinking since they would require a much larger sample to have any meaningful results. Contrary to the argument presented by Gerring (2005), necessary/sufficient causes cannot be conceptualized as probability raiser, that is, increasing the likelihood of the occurrence of the dependent variable, since the impact of X (or non-X) remains the same before the event (potential) and after the event (actual). Moreover, causation can take place without any probabilistic implications – that is, X causes Y to happen but without increasing the probability of Y to occur (Menzies, 1996). Thus, necessary/sufficient causes do not possess the flexibility associated with a probabilistic understanding of causation whereby the presence of a given factor merely increases the likelihood of occurrence of the expected value on the dependent variable rather than necessarily leading to the specified outcome.12 The third issue raised as regards the use of necessary/sufficient conditions is that the acknowledgment of the importance of causal complexity does not provide enough analytical hints for the identification of the specific form of the process by which the impact of one variable depends on which others are present (Mahoney, 2008; Mahoney et al., 2009). This is an important question since numerous and diverging sets of necessary/sufficient conditions flow from the presence of different forms of causal complexity. Many different concepts are associated with different forms of causal complexity. A first form of causal

12 The argument presented in this book relies on the use of necessary/sufficient causes but without their alleged deterministic aspect. Some of the reasons for the compatibility of necessary/sufficient causes with probabilistic thinking have already been identified. For instance, Mahoney (2004: 84–5) has pointed out that many small-N analyses evaluate causes that are necessary or sufficient with some quantitative benchmark, such as occurs 90 percent of the time (see also Dion, 1998). In particular, the measurement of variables in a continuous rather than in a dichotomous fashion in fuzzy-set analysis enables the presentation of causes as necessary or sufficient with a small amount of “tolerable” measurement error (Ragin, 2000). The use of a modest number of cases (e.g., N = 15) can often lead to results that achieve standard levels of statistical confidence in fuzzy-set analysis. Moreover, the use of ordinal strategy of causal inference in small-N studies is based on an understanding of causation in probabilistic terms (Mahoney, 1999: 1160–4). The notion of causal inference is understood as the process of matching estimations of observed outcomes that can be attributed to a specific value on a hypothesized independent variable (Mahoney, 2000b: 407).

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complexity is that of conjunctural causation whereby only the combination of multiple conditions will produce a specific outcome: x1 and x2 produce Y. The impact of one institution or variable depends on the presence of others. Ragin (1987: 20) refers to conjunctural causation as cases where “an outcome results from the combinations of conditions.” Three implications follow from the presence of conjunctural causation: independent variables are necessary without ever being sufficient, multiple paths to the nonoccurrence of the dependent variable exist since only the combination of X1 and X2 has a causal impact, and a change in the value taken by one variable can have dramatic consequences since the absence of one factor is sufficient for the occurrence of a different value in the dependent variable (Braumoeller, 2003: 212). For the VoC literature, the process of conjunctural causation conceptualizes institutional arrangements as interacting to complement each other. As a result, the presence of stability or the occurrence of change in the broader institutional framework of countries cannot be inferred from change in any one institution.13 The VoC perspective highlights the pitfalls associated with piecemeal institutional change, given that the effects of a single institutional variable on the overall operation of the political economy vary with the presence of other institutions that are already in place. A second form of causal complexity is substitutability. This refers to multiple and independent paths to a common outcome: x1 or x2 produces Y (Braumoeller, 2003; Ragin, 2006). The concept of substitutability highlights the presence of multiple and independent causal paths. It resonates well with Merton’s concept of functional equivalency (Merton, 1968). Different institutional clusters can result in a similar outcome. Three implications follow from the presence of substitutability: key individual independent variables are always sufficient, but never necessary; multiple paths to the occurrence of the dependent variable exist since the presence of either (or both) x1 and x2 has a causal impact; and a change in the value taken by one of the independent variables does not necessarily entail dramatic consequences since the presence of one factor is sufficient for the occurrence of a different value on the dependent variable (Braumoeller, 2003: 218–19). The extent to which a change in one independent variable impacts on the dependent variable decreases as the value taken by the other independent variable increases (and vice versa) (ibid.: 211). For the VoC literature, the concept of substitutability calls for a greater theoretical sophistication between 13 For a full discussion of the macro effects of interaction between institutions in different spheres, see Hall and Franzese (1998).

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the character of coordination and the institutional framework that supports it (Hall, 2007; Hall and Thelen, 2009; see also Goyer, 2006a). Variation in the latter does not necessarily entail change in the former. Alongside these two dominant forms of causal complexity, an additional two have also featured prominently: INUS and SUIN causes. INUS causes refer to a form of causal complexity whereby the hypothesized independent variable which is an insufficient but necessary component of a condition which is itself unnecessary but sufficient for the outcome to be generated (Mackie, 1965: 246). In other words, the outcome can be generated by multiple paths (substitutability) whereby each is characterized by the presence of joint variables (conjunctural causation). SUIN causes refer to a sufficient but unnecessary part of a factor that is itself insufficient but necessary for an outcome to be generated (Mahoney et al., 2009). In this situation, the outcome is generated by the presence of a specific factor (necessary) that is itself composed of many alternative dimensions that can function as substitutes (sufficient). These different forms of causal complexity are united in that the impact of the independent variables on the dependent variable, though cumulative, is not additive across cases and contexts (Braumoeller, 2003: 212). Nonetheless, these different forms of complexity entail different implications for what constitute necessary and/or sufficient conditions across diverse situations. This is not a trivial issue given the nature of institutional change across advanced capitalist economies. Are we facing a situation best captured by the insights of Hall and Franzese (1998) whereby joint causes are necessary to produce an outcome? Alternatively, are we dealing with a situation where multiple institutional settings are compatible with a given mode of coordination (Hall, 2007; Hall and Thelen, 2009; see also Goyer, 2006a)? I now turn to a discussion of these three criticisms issued at the use of necessary/sufficient conditions. I argue that the notion of context as the hierarchically superior institutional variable can tackle these two key issues: the relative strength of institutional variables part of an intersection of conditions, and the uneven distribution of necessary/sufficient causes across advanced capitalist economies.

4.4 Context, Hierarchical Institutions, and the Use of Necessary/Sufficient Conditions Political, economic, and social life is complex in the sense that important outcomes are invariably produced by the interaction of conditions (Ragin, 1987). The interaction between several causal variables acts to 122

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form distinctive patterns of politics across space and time (Hall, 2010a). Nonetheless, different independent variables that are part of a pattern of causal complexity are not equally influential in generating the outcome of interest. In the spirit of Orwell’s Animal Farm, the relative strength of the different causal variables vary. There is an element of hierarchy among the institutional arrangements that contribute to the value taken by the dependent variable. The notion of the hierarchically superior causal variable presented in this study highlights two features. The first is that the hierarchically superior causal variable contributes to the value by the dependent variable. For the argument present in this book, the degree of power concentration in top management constitutes an important determinant of the investment allocation of short-termoriented institutional investors. Limited time horizons and highly incentivized remuneration packages for managers of hedge funds and actively managed mutual funds translate into preferences for firms governed by top executives able to implement in a quick fashion strategies of shareholder value. The second feature is that the hierarchically superior causal variable provides the context that shapes the relationship between other causal variables and the dependent variable. The hierarchically superior causal variable does not impact on the values taken by other causal variables. Rather, the hierarchically superior causal variable contributes to determine whether these other causal variables will generate the outcome of interest on the dependent variable (Goertz, 1994; see also Falleti and Lynch, 2009). The institutional arrangements of work organization identified by the VoC perspective (Hall and Soskice, 2001; see also Maurice et al., 1986; Sorge, 1991, 2005; Soskice, 1999; Whitley, 2003; Jacoby, 2005; Goyer, 2006a) serve as the context and, thus, impact on whether the presence of legal protection for minority shareholders influences the investment allocation of short-term-oriented institutional investors. The impact of legal protection for minority shareholders, as operationalized by an ownership structure characterized by ownership diffusion, translates into different outcomes in France and Germany: the quasi-totality of French firms characterized by ownership dispersion has been targeted by short-term investors; several German companies characterized by ownership dispersion have not been targeted by impatient investors. The absence of power concentration inside German firms implies that strategies of shareholder value are difficult to implement in a quick fashion even when management is highly incentivized to focus on share price appreciation and where securing private benefits of control does not constitute an option. In other words, the presence of concentration of power in top 123

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management is paramount for the magnitude effect of ownership diffusion to occur. Finally, it is also important to note that the notion of institutional hierarchy should not be conceptualized as a paradigm war between two theories made to be tested against each other. The point is to retain the notion of causal complexity while incorporating the importance of the relative strength of the different causal variables that are interacting with each other to generate the outcome of interest. The interaction between variables is essential for capturing the complexity inherent in important phenomena in social sciences; but interaction between variables does not necessarily mean that the value taken by one causal variable will impact on the corresponding value taken by another causal variable. Institutional hierarchy is reconciled with causal complexity. What are the origins of institutional hierarchy? Advanced capitalist economies are characterized by different settlements of conflict on major questions (Hall, 1984, 1986; see also Berger, 1979; Roe and Gilson, 1999). Different groups or coalitions have emerged triumphant across settings at historical junctures with the outcome that newly created institutions reflect the preferences of the winning groups rather than being functional responses to economic exigencies (Gourevitch, 1986). The cases of France and Germany are characterized by significant differences in the strategy of labor organizations in the first four postwar decades (Ross, 1982; Markovits and Allen, 1984). The political strategy of French trade unions has deprived employees from important means of influence over the strategic direction of companies as well as lessened the dependence of management on the bulk of the (blue-collar) workforce for the development of their innovative capabilities (Maurice et al., 1986; Howell, 1992). The strategy of German trade unions for the extension of political democracy to the shopfloor has been crucial in the distribution of legal rights that have provided employees with a strong foothold in the strategic direction of companies as well as strongly induced management toward strategies of incremental innovation that build on the competencies and skills of core employees (Thelen, 1991; Soskice, 1999; Muller-Jentsch, 2003). The presence of diversity in the settlements of major conflicts across countries, in turn, resulted in different institutional arrangements in corporate governance (Roe, 2000, 2003) and other spheres of the economy (Crouch, 1993; Swenson, 2002; Mares, 2003; Thelen, 2004; Sorge, 2005). Moreover, these institutional arrangements not only reflect specific historical instances of settlements of conflict but also shape future developments. The character of institutional arrangements often entails that they consolidate the power of political collations responsible for 124

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their introduction as well as outliving them (Hall, 2010a: 21–4). Two mechanisms are important in the process by which institutions consolidate the power of existing coalitions or outlive them. First, institutional arrangements distribute power across groups in an asymmetrical fashion (Berger, 1981; Hall, 1986; see also Moe, 2005). Unbalanced power relations resulting from the configuration of institutional arrangements is particularly marked at the level of the firm whereby cross-country differences in the coordination of activities is shaped by the presence of significant divergence in the distribution of authority (Maurice et al., 1986; Sorge, 1991, 2005; Soskice, 1999; Hall and Soskice, 2001). Second, differences in the settlements of conflict across advanced capitalist economies, and the resulting divergence in the constellation of institutional arrangements, entail that international and domestic developments do not translate into common pressures for firms and other actors in the economy (Thelen, 1993; see also Iversen, 1996). Different institutional starting points, and their associated unequally distributed sources of pressure, are particularly crucial in the context of two uneven patterns of change: hybridization whereby firms borrow from the features of other economic models in a process of piecemeal institutional change (Regini, 2000); and significant divergence related to changes across various spheres of the economy – institutional change being more prevalent in some spheres than in others (Hall and Thelen, 2009). The notion of a hierarchically superior institutional variable offers significant insights for the study of institutional change. The context in which the hierarchically superior institutional variable is embedded significantly contributes to make some types of changes more feasible than others. Moreover, it highlights the importance of assessing the character of change – namely whether it is radical or more incremental, even self-reinforcing. For instance, the analysis of the investment allocation of shareholder value-oriented institutional investors in France and Germany strongly suggests the importance of distinguishing between the character of coordination of activities by firms versus the institutional framework that supports them (Hall, 2007; Hall and Thelen, 2009; see also Goyer, 2006a). The arrival of patient UK/USbased institutional investors in Germany, often at the expense of longterm domestic shareholders, does not constitute a fundamental break. German companies have been rather successful in incorporating concerns about shareholder value in the context of the innovative competencies of the firm being built on the bulk of the workforce (Hoepner, 2001; Bo¨rsch, 2007; see also Herrigel, 2008b). The arrival of impatient investors, and the expansion of the market for corporate control, could have been more damaging for the process by which German 125

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companies coordinate their activities (see e.g. Callaghan and Hoepner, 2005). In a similar vein, the incursions of short-term-oriented institutional investors in France should not be interpreted as a change in the mode of coordination of companies. Their presence has indeed broken down the insulation from monitoring top corporate executives have previously been able to enjoy (Morin, 1998; Hancke´, 2002). Nonetheless, impatient investors appreciate the concentration of power in top French corporate executives since it facilitates the quick design and implementation of strategies of shareholder value (Rebe´rioux, 2002; Goyer, 2006a). The marginalization of employees in the process of adjustment of French companies provides management with a greater number of options to implement strategies of shareholder value. Moreover, the notion of a hierarchically superior institutional variable translates well into the analysis of change through the logic of necessary/sufficient conditions. As previously mentioned, ontology should be distinguished from techniques associated with research methods (Hall, 2003). The ontology of this study of the investment allocation of institutional investors highlights both the importance of complex causality and the influence of a hierarchically superior institutional variable on major outcomes. The concept of necessary conditions serves to reflect this ontology, given that some types of change are more feasible than others across settings. The panoply of institutional factors and the full range of patterns of mobilization needed to generate a given outcome are different across advanced capitalist economies. Specific causes are necessary to produce changes and given that these causes are unequally spread across countries, the occurrence of change will necessitate the presence of different institutional reforms. In other words, it takes a greater number of factors to come together in certain settings as opposed to others (see e.g. Pierson, 2000). What is necessary to bring about a specific outcome will differ across institutional settings. Necessary conditions are interesting in that they refer to the importance of a variable. Could the occurrence of new values on the dependent variable occur without the presence of a specific independent variable? The answer would be negative in the case of a necessary factor.14 Conversely, the concept of sufficient conditions also reflects the ontology of complex causality but through a different dynamic, namely

14 As pointed out by Goertz (2006), however, the relative importance of necessary conditions is part of a pattern of conjunctural causation which exhibits important differences. If x1 and x2 constitute two necessary conditions and that X1 is occurring rarely and x2 is always occurring, then x1 is relatively more important. The necessary factor that occurs less frequently in situations of conjunctural causation is relatively more important.

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by illustrating the diverging outcomes associated with the introduction of common reforms across institutional settings. The occurrence of a similar and piecemeal, as opposed to full-scale, institutional development across settings will result in different consequences since the range of additional institutional features that also need to be present for producing a given outcome are unequally distributed across countries. What is sufficient to bring about a specific outcome will differ across institutional settings. Sufficient conditions are interesting in that they provide for an assessment of institutional change associated with the introduction of market-oriented reforms. For instance, what are the consequences associated with the passage of minority shareholder friendly legal reforms? Would their implementation be sufficient to induce a fundamental break across non-liberal market economies? The notion of sufficient conditions is insightful since it enables a move beyond the equilibrium of institutions as barriers. As noted by Goertz (1994: 20–5), institutional arrangements could take the form of barriers against future developments. Their presence restricts the range of possible options. In other words, they prevent the translation of institutional change in other areas from having an impact on the dependent variable. This is an important aspect of institutions, but what happens when these institutions that serve as barriers are removed? For instance, the literature on corporate governance in Japan has previously emphasized the importance of the main banks, through their dual role as monitors and providers of external finance, as the overarching factor in accounting for the specificity of the Japanese model (see e.g. Sheard, 1989; Scharfstein et al., 1990; Aoki, 1994). However, the focus on the main bank system is significantly less useful for analyzing the current evolution of corporate governance in Japan in the post-context of the deregulation of the patterns of corporate finance and of the banking crisis of the 1990s. The concept of sufficient conditions captures well the dynamics associated with the implementation of market-enhancing measures – often reflecting the removal of institutions as barriers in non-liberal market economies. The system of corporate governance in France and Germany has undergone major changes in recent years. Measures to increase the degree of legal protection of minority shareholders have been introduced (Beyer and Hoepner, 2003; Cioffi and Hoepner, 2006; Enriques and Volpin, 2007; Tiberghien, 2007). Moreover, the ownership structure of blue-chip companies in the two countries has become more diffused but with important variations: the decline of cross shareholdings in France has been dramatic while the restructuring of corporate ownership in Germany was characterized by domestic companies selling to 127

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other German firms already part of a common network of directors and/ or owners (Culpepper, 2005; Davis et al., 2012). These changes are associated with different outcomes: French firms with ownership dispersion have been targeted by short-term investors, while many German companies without a significant owner have remained significantly less affected by the strategy of international diversification of impatient funds. The lack of a constant relationship between variables is not capricious but rather reflects the importance of context in which actors are embedded (Goertz, 1994). The growing presence of ownership diffusion in France occurred in an institutional setting characterized by the concentration of power in top management that, in turn, makes it easier to implement strategies of shareholder value that fit with the preferences of short-term investors. The same development in Germany, namely the rise of ownership diffusion, did not generate a change in the value taken by the dependent variable (blockholding acquisitions by short-term investors) of the same magnitude as in the French case. The coordination of activities in German companies is characterized by the involvement of many actors that, in turn, makes it more difficult to implement strategies of shareholder value that fit with the preferences of hedge funds and actively managed mutual funds. The presence of a specific value on the hierarchically superior causal variable (i.e., concentration of power in top management) is crucial for the assessment of the magnitude effect of the value taken by the other causal variable (i.e., ownership diffusion). The relationship between these two causal variables is not symmetrical; it is one of hierarchical interaction. Therefore, I issue two propositions within the language of necessary/sufficient conditions: (a) what is necessary in terms of a range of institutional reforms to result in a similar outcome differs between advanced capitalist economies, and (b) whether a similar institutional development across different economies is sufficient to produce a similar outcome is highly unlikely given the differences in the constellation of institutional arrangements.

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5 Coordination and Institutions: France and Germany Compared

5.1 Introduction What accounts for the attractiveness of the French market over that of Germany for short-term investors? How do the disparities in the investment allocation of UK/US-based funds translate into consequences for the two systems of corporate governance? Based on the importance of complex causation whereby outcomes are generated by a series of intersecting factors, I analyze the respective influence of two important aspects of institutional arrangements on the investment allocation of short-term-oriented institutional investors: legal rights of minority shareholders (law and economics) and the influence of the organization of work on the process by which companies coordinate their activities (varieties of capitalism). The assessment of the relative importance of different institutional variables is best served by the provision of a sharp distinction between two stages of the decision-making process of hedge funds and actively managed mutual funds. These two categories of short-term, impatient funds allocate capital with the expectation of a value increase of their investment through the growth in the price of the firm’s shares and/or the release of cash flows in the form of dividends – all within a short-term horizon. The first stage refers to the attitudes of top executives toward shareholder value. Corporations where management is not accountable and/or is not interested in implementing shareholder value strategies do not constitute a good fit with the investment strategies of impatient investors. In contrast, the predispositions of corporate executives for the pursuit of policies that increase the value of the firm’s price stocks and/or provide dividends thus constitute a key factor for short-term, impatient funds to commit their capital. The law and economics perspective 129

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emphasizes the importance of legal protection for noncontrolling, usually minority, shareholders. The willingness of short-term-oriented institutional investors to acquire an important equity stake in listed companies is contingent upon the extent to which their investments are secured from suboptimal shareholder value corporate strategies by managers and controlling shareholders (Shleifer and Vishny 1997; LaPorta et al., 2000). The rationale behind this argument stems from the fact that minority shareholders, who have limited strategic involvement in the conduct of the strategy of the firm, face a greater risk of expropriation and are often less likely to receive a substantial return on their investment in situations of lower degrees of legal protection for investor rights. However, the discussion in Chapter 3 highlighted the shortcomings of the law and economics perspective. The attitudes of corporate executives toward shareholder value, as viewed through the lens of shareholder protection and ownership structure, cannot account by themselves for the disparities in the investment allocation of impatient investors in France and Germany: the presence of ownership diffusion constitutes a quasi-sufficient for blockholding acquisitions in France but not in Germany.1 The attractiveness of the French market for hedge funds and actively managed mutual funds highlights the importance of institutional arrangements associated with the implementation of short-term-oriented, shareholder value-enhancing measures. The favorable predispositions of corporate executives toward shareholder value cannot be assumed to be faithfully and, equally important, quickly implemented. Institutions stand between the preferences of actors and outcomes (see e.g. Garrett and Lange, 1995). The second stage of the decision-making process of hedge funds and actively managed mutual funds is related to the ability of corporate executives to execute reorganization schemes. The nature of corporate restructuring is important for the investment decisions of impatient investors. Is the implementation of flexibility and strategic change a managerial prerogative that is unilaterally imposed or mutually negotiated with other actors in the firm? Crucial to this question is the issue of coordination. Advanced capitalist economies are distinguished by their specific configuration of interdependent institutions that impact on the mode of coordination of companies (Soskice, 1999; Hall and Soskice, 2001; Berger, 2006). In particular, institutional arrangements shape the process by which firms develop and sustain their innovative competences (Whitley, 2003; Sorge, 2005). The development 1 Moreover, an important percentage of target companies in the two countries was characterized by ownership concentration.

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of innovative capabilities can be achieved through the involvement of the bulk of employees in complex problem-solving activities, or reflects the importance of coordination characterized by vesting unilateral authority in top managers and senior staff in combination through reliance on external labor markets for the hiring of specialists (Maurice et al., 1986). Firm-level institutional arrangements across advanced capitalist economies provide actors with different degrees of opportunity to delay or block adjustment. The greater the number of actors involved in the decision-making process with full or partial veto powers, the slower the pattern of adjustment of companies – a situation that does not fit well with the preferences of short-term-oriented institutional investors. The presence of variation in the firm-level institutional arrangements of workplace organization constitute an important variable that better account for the greater propensity of hedge funds and actively managed mutual funds to target French-listed companies as compared to the legal perspective. The relationship between firm-level institutional arrangements and the process of strategic investment of short-term, impatient capital is the following. The overall aim associated with the investment decisions of short-term-driven hedge and mutual funds is to generate capital gains for their investment portfolio and/or force the release of cash flows in the form of dividends. The investment strategies of hedge funds and actively mutual funds differ from their long-term-oriented colleagues on three key issues. First, short-term-oriented fund managers are driven by heightened performance concerns. They possess marked incentives to surpass financial benchmarks (actively managed mutual funds) or reap as high as possible absolute returns (hedge funds), not just achieve targeted mandated minimum returns – the situation prevailing for pension funds.2 This focus on relative performance for actively managed mutual funds – and on absolute performance for hedge funds – flows from two factors. The first results from the competitive environment for the management of the equity investment business of pension funds and individual savers. Investors can shift their assets across many funds. The second factor is the importance of variable pay for fund managers. For mutual funds, managerial remuneration is based on the volume of assets under management and the returns on investment associated with the composition of the portfolio. The presence of high-profile league tables and the importance of variable pay entail that fund managers face both constraining scrutiny and enabling inducement to achieve as high as

2

See Brown et al. (1996) and Fung and Hsieh (1997) for overviews.

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possible returns (Chevalier and Ellison, 1997). For hedge funds, managerial compensation derives from the amount of assets under management and, to a substantial extent, from incentive fees. These incentive fees are paid only in the event of the returns on the portfolio exceeding preestablished benchmarks (Brown et al., 2001). Second, the structural characteristics of the hedge fund and the actively managed mutual fund industries compel managers to achieve high returns, not simply match an index. The criteria and processes by which short-term-oriented investors select companies for a targeted investment involve the acquisition of firm-specific information (Chevalier and Ellison, 1997; Brown et al., 2001). This situation stands in contrast to the composition of the stock portfolio for pension funds that is essentially based on an index strategy, and for passively managed mutual funds where lower management fees and avoidance of active trading constitute the cornerstone of their strategy. Active management of the equity portfolio produces results inferior to market indexing (Malkiel, 2003). As a result, short-term-oriented institutional investors focus on the acquisition of firm-specific knowledge needed to acquire a targeted investment in listed companies – in contrast to the lack of expertise of long-term funds on this question (Romano, 2001). Third, and following from the previous two features, the holding period for hedge funds and actively managed mutual funds is quite short. The average holding period of hedge funds for significant holdings (above 5 percent) in the United States varies between twelve and twenty months (see Brav et al., 2008). The corresponding median figure for mutual funds between 1997 and 2009 was about twenty-three months but with significant variation between actively and passively managed funds (see Investment Company Institute, various years). For instance, the average time a share is held for Fidelity (actively mutual funds) was 2.63 years in 1999 and is even shorter for stocks in its international portfolio (Bandru et al., 2001: 125; Morningstar, various years). For the data collected in this study on acquisitions over the 5 percent threshold, the holding period of the various European/international portfolios of Fidelity was always less than twenty-three months. The investment horizons of Brandes and Capital Group, the two most important passively managed mutual funds investing in France and Germany, were never inferior to 3.5/4 years. The investment horizons of Dodge & Cox, another important passively managed mutual fund, was at least five years (Morningstar, various years). Short-term-oriented fund managers face greater liquidity concerns given that financial assets under their management are redeemable on demand by investors and, moreover, often seek to profit from changes in the stock value of portfolio companies. 132

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What is the relationship between the preferences of short-term, impatient investors and the institutional arrangements of workplace organization of French and German firms? Why is France a privileged destination of investment for hedge funds and actively managed mutual funds? The presence of power concentration at the top of French firms – as embodied in the firm-level institutional arrangements of workplace organization – constitutes an important causal variable that mediates broader endogenous and exogenous developments. The legal rights of works councils and the operation of the boards of directors have failed to provide employees with significant influence over the strategy direction of companies. The coordination of activities in French firms is characterized by the vesting of unilateral authority in top managers and senior technical staff. The bulk of the workforce does not contribute to the development of the organizational capabilities of companies (Maurice et al., 1986; Culpepper, 1999, 2003). Firm-level institutional arrangements characterized by top managerial power concentration make it easier to quickly translate these preferences for shareholder value into practice (Rebe´rioux, 2002; Goyer, 2006a). French firms are relatively more attractive to hedge and actively managed mutual funds since the elaboration and implementation of restructuring schemes are management-led under the guidance of a small number of corporate officials. The relative absence of constraints on top management does not provide them with incentives to incorporate the bulk of the blue-collar, skilled employees in the strategic direction of companies. In turn, French firms distributed more dividends after being targeted by foreign institutional investors. Moreover, French companies who previously experienced relative inferior operating performance, as compared to nontargeted firms, also displayed continuous improvement after being targeted (Goyer and Jung, 2010). The investment strategies of short-term-oriented investors, in contrast, do not fit well with the institutional configuration of German companies. The process of coordination of activities of German firms is characterized by shared authority with the bulk of the workforce (Maurice et al., 1986; Soskice, 1999; Whitley, 2003). The legal rights of works councils and the legal provisions of boards of directors limit the autonomy of corporate executives. The development of the innovative capabilities of companies takes place on the basis of the long-term contribution of skilled employees through institutionalized career paths. The various stakeholders of German companies, especially employees, have a voice in corporate decision-making that, in turn, hinders rapid, nonnegotiated adjustment (Thelen, 1991; Muller-Jentsch, 1995). Firm-level institutional arrangements provide for early involvement of employees in the decision-making process (Bo¨rsch, 2007: 37–41). 133

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Nonetheless, an issue remains unresolved. The direction of causality in the analysis of the performance of targeted French companies is consistent with two scenarios. The first is that of shareholder activism occurring ex ante (Kahan and Rock, 2007). Shareholder value-oriented funds first proceed to determine whether a potential portfolio company would benefit from activism, then acquire a blockholding position, and then become active. The strategy is made possible by the concentration of power in top French corporate executives. The main issue is to convince the management to adopt shareholder value-oriented policies that fit with their investment strategy. The second scenario is that of the superior ability of fund managers to select portfolio companies (Gruber, 1996). Institutional investors pick firms who they assess are likely to adopt favorable corporate policies that will unlock shareholder value. They do not engage in shareholder activism. Causality goes from expected changes in firm policies to blockholding investments by institutional investors. Differences in the direction of causality entail important political implications. Under the shareholder activism scenario, the ability of institutional investors to shift funds across borders constitutes the most important development for the unlocking of shareholder value. The implementation of (short-term-oriented) restructuring schemes is imposed on recalcitrant executives who would not have implemented them without the presence of foreign activist funds. Under the second scenario, the process of adjustment of companies is driven by managerial preferences largely unaffected by developments in international finance. In fact, the presence of foreign institutional investors can be strategically used by corporate executives to present the implementation of changes in corporate policies as distasteful and unavoidable. The distinction between these two scenarios is difficult to perform in the French context since the absence of an equivalent to the 13F filings of the Securities and Exchange Commission (SEC) on investors’ intention on their blockholding stake is not available. The inability to distinguish between the shareholder activism versus the superior selection skills hypothesis does not constitute a major issue for the analysis of short-term capital flows for two reasons. First, the central research question of this project is to account for the presence of disparities in the investment allocation of short-term investors in France and Germany, not to explain the dynamics for every single instance of blockholding stakes in firms. The key distinguishing feature is the presence of significant variation in firm-level institutional arrangements between the two countries. Institutional differences highlight the range of available options for external investors seeking a return on their 134

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investment. The uncertainties of the French case (shareholder activism versus superior selection skills) are coupled with the presence of several alternative adjustment paths – as compared with the limited range of options available in Germany. Second, the counterfactuals of the French case illustrate the continuing exclusion of labor. What would have happened in the event of the nonarrival of institutional investors? Does the introduction of shortterm-oriented strategies of shareholder value result from the imposition of constraints on recalcitrant French managers? The transition period between the withdrawal of the state from many economic activities (approx. mid-1980s) and the arrival of foreign institutional investors (approx. mid- to late 1990s) provides interesting insights. The period corresponded to the overall absence of monitoring of corporate executives (Gourevitch and Shinn, 2005: 262–73). On the corporate governance side, corporate executives sought protection from unwanted takeover bids through cross-shareholdings (Morin, 1998). On the employment relations side, large French firms took advantage of the newly designed vocational track programs of post-secondary institutions in order to gain access to new skills but without compromising on the hierarchical relationships on the shop floor (Hancke´, 2002; Verdier, 2006). The range of preferences of French corporate executives is wide. Strategies of shareholder value constitute one interesting option whose introduction might not have happened, at least not in the same form, without the arrival of foreign institutional investors. However, the development of skills based on the certified skills of the bulk of the workforce, by contrast, has not been attempted by French companies. The remainder of this chapter is organized in the following manner. First, I identify the institutional arrangements of firm-level organization that are prominent in illustrating the concentration of power at the top of French companies and the constraints on managerial autonomy in Germany. I discuss four areas of firm-level organization – legal rights of firm-level works councils, skill certification and formation, segmentation of activities, and the autonomy of employees in problem-solving tasks. Second, I analyze the adjustment process of companies in the two countries in recent years. I make two points: I highlight how the introduction of new institutions has reinforced existing modes of coordination of French and German firms, and I demonstrate how existing institutions have shaped the process of adjustment of companies. The ultimate outcome is the presence of variations in the degree of fit between institutional arrangements of workplace organization and the strategies of different categories of institutional investors.

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5.2 Legal Rights of Employees Substantial cross-national differences in the institutional and organizational features of firm governance are shaped by the distribution of legal rights at the firm-level. This distribution ranges from information, consultation, codetermination, and unilateral worker control over various issues with substantial variation among advanced capitalist economies in regard to their presence and distribution. The distribution of legal rights presents management with constraints and opportunities in the elaboration and implementation of the strategy of the firm. The degree of power concentration inside companies is related to the extensiveness and comprehensiveness of the legal rights of actors – most notably employees. In some cases, legal rights provide employees with means to delay or block important strategic decisions of companies. The German case is characterized by the presence of extensive and comprehensive legal rights for employees that provide them with several (quasi) veto powers in some areas. These (quasi) veto powers are extremely important for labor since its legally protected position does not rely on implicit contracts (Thelen, 1991; Bo¨rsch, 2007). Interactions between actors in Germany is a long-term iterated game since employees do not have to take into consideration whether it is in the interests of management to include them in the decision-making process. These legally secured rights provide labor organizations with multiple opportunities to intervene since consensus is almost required for adjustment. By contrast, the French case is characterized by the presence of extensive (but not comprehensive) legal rights for employees that do not result in the provision of (quasi) veto power (ETUI, 2001). The legal rights of works councils in France provide for employee expression in the workplace, but not for effective voice (Desseigne, 1995). The outcome of the underdeveloped legally based veto rights of French employees is one where unilateral employer prerogative is widespread (Goyer and Hancke´, 2005). The overarching feature of the German system of employment relations is the detailed legal status of the actors and of their rights and responsibilities with the associated mandatory structures that provide for a strong foothold for employee involvement (Thelen, 1991; Gumbrell-McCormick and Hyman, 2006). The legally based veto points of German employees are embedded in the system of Codetermination that operates at two levels: the representation of employees on the board of directors and an extensive set of legal rights at the company level through the works councils. The 1976 law on Codetermination

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provides for equal representation of employees and shareholder-elected directors on the supervisory board. Employees and shareholder representatives each possess one vote – with the chairman appointed from the shareholder side casting the deciding ballot in the event of a tie. The major function of the supervisory board is to appoint, supervise, and replace members of the management board. The selection of managers requires a two-thirds majority, thereby ensuring a veto power for labor. Hard-line managers who are unable to get along with labor are virtually excluded from the board (Hopt, 1994: 207). The second aspect of Codetermination rights refers to an overall extensive system of labor participation in corporate affairs through the works councils. Workers in any enterprise (or plant) employing more than five employees are entitled by law to elect every three years works councillors to represent their rights at the firm-level. The legal rights of works councils are both comprehensive and extensive in that they provide a strong foothold for employees and limit exclusionary strategies on the part of management. Overall, the legal participation rights of works councils are strong in social matters, weaker over personal issues, and modest in economic and financial matters (Prigge, 1998: 1013). The legal veto rights of works councils on issues of job and bonus rates, overtime and the allocation of working hours, use of technical devices designed to monitor employees’ performance, or the introduction of new payment methods prevent German managers from acting unilaterally. In fact, the importance of works councils has substantially increased in recent years. The heightened volatility of markets and the need to adjust quickly has raised the prominence of firm-level works councils and reduced the importance of national unions. The greater flexibility of decentralization of collective bargaining has shifted the locus of collective bargaining, but has not resulted in unilateral managerial control over firm strategy. Works councils have become “co-managers” of the firm in the implementation of painful restructuring measures and the elaboration of new strategic business decisions (Muller-Jentsch, 2003; see also Herrigel, 2008b). These extensively and comprehensively defined legal rights of works councils have enabled them to project their influence regarding employment issues inherent in the implementation of restructuring schemes. Works councils have often strategically used their veto power in some areas through linkage to other issues where they have weaker Codetermination rights (Thelen, 1991; Muller-Jentsch, 1995). Works councilors have often refrained from exercising their legal rights in areas where they are strong in exchange for greater influence on questions covered only by information rights. In particular, works councils have been able 137

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to combine their consultation rights over dismissals – which can considerably delay restructuring schemes – with their veto rights over the hiring of new employees. Firm-level works councils possess full veto power over hiring, thereby constraining managerial ability to rely on outside experts. New jobs must be offered first to the current members of the workforce. The inability of German employers to rely on external labor markets in their restructuring strategy – that is, fire current workers, hire new ones – originated in a deal struck between the German labor movement and employers in the early 1980s. German employers were compensated for the closure of the external labor markets, as works councils took the lead in designing and implementing programs of internal flexibility in the firm (Streeck, 1984). In other words, the position of organized labor and the works councils in the training system has enabled them to impose significant constraints on hiring new employees when a company scales back its activities to a few core competencies: since new training programs have to be approved by an expert body in which organized labor holds half of the seats, they have de facto veto power over these programs. Moreover, works councils must approve the list of workers made redundant – which usually reflects seniority rights and social concerns. A potential outcome is that a confrontational management risks losing younger and skilled workers if it presses ahead with uncompensated, compulsory redundancies.3 The result is that management seeks to incorporate works councils in restructuring ¨ rsch, 2007: 111–15). Thus, schemes from the beginning (see e.g. Bo German managers are constrained on several fronts: skills are a prerequisite for jobs, companies must provide the relevant training to employees, the content of these programs must be certified by an outside body where labor possesses a veto, and the hiring of new employees with the requisite skills is subject to the approval of works councils.4 Works councils in France, in contrast, play a limited role, resulting from the nature of their composition and legal rights. The works councils are composed of fifteen elected councilors for companies with over 1,000 employees: one representative from each union organization

3 See Bertrand Benoit and Hugh Wiliamson, “Works councils help ease the pain of economic downturn,” Financial Times, August 14, 2001, p. 2. 4 Moreover, the strong position of works councils in Germany has led to the underdevelopment of Anglo-American HRM techniques (Marginson and Sisson, 1994). The role of the personnel department has been limited to the provision of information and to ensuring that companies are not in breach of regulations associated with national employment laws. Important issues governing shop floor organization involve works councils, not members of the personnel department.

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present in the firm, the CEO, and two members of management. The CEO controls the agenda of the meeting and has veto power over its direction – thereby contributing to its lack of credibility with employees (Gumbrell-McCormick and Hyman, 2006: 482). Moreover, the power and influence of the works councils in France remain limited since their legal rights are essentially of a consultative nature – the legislation on works councils assigns no veto rights that might encourage bargaining and serious discussion (Desseigne, 1995). French employees have no opportunity to link their information rights to other issues where they could block change. The information provided by management is often delivered late and is of little usefulness. The fulfillment of legal requirements imposed on management is characterized by formalism and has forced work councillors to sue management on numerous occasions. Finally, works councils possess limited information rights on the hiring of new staff – not full veto power that could prevent employers from replacing current workers with new employees. Relying on outside experts has, in fact, proven to be a privileged strategy of adjustment for French companies (Hancke´, 2002: 57–82; Palpacuer et al., 2007).5

5.3 Training and the Building of Firm Competencies The second set of key firm-level institutions is those related to the process of skill formation and certification of the workforce, that is, training. There are two central technical problems in the organization of the workplace in large firms (Marsden, 1999: 32–41). First, employers must proceed to align job demands with worker competencies. This process can be accomplished according to the attributes of the task or of the qualifications of the individual worker (Eyraud and Rozenblatt, 1994). Under the first scenario, employers choose the production techniques to which employees must adapt. The demands of the tasks determine the capabilities of employees. Under the second scenario, the distribution of jobs is allocated according to the already acquired skills of employees – that is, the qualifications of workers determine the definition of jobs. Second, employers must be able to monitor their workforce through the use of criteria for performing tasks in a variety

5 The position of firm-level works councils in France is further weakened by the absence of legal arrangements that would provide for Codetermined employee representation on the board of directors. The only legal provision is for two members of the works councils to take part in any meeting of the boards of directors but without voting rights (Deakin and Rebe´rioux, 2009: 131).

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of environments. This process can be accomplished according to a set of rules that delimits the scope of jobs in terms of certain attributes of the task themselves. Alternatively, this process can involve the identification of broad functions to be performed. The differences in the matching of jobs and worker competencies in France and Germany shape the ability of management to implement restructuring measures in a unilateral manner. The matching of jobs and employee competencies contributes to a specific distribution of authority within the firm. Moreover, it also results in diverging degrees of dependence of management on the skill of employees for the development of the innovative capabilities of the firm (Whitley, 2003). The German economy is organized around the presence of a majority of employees with certifiable skills as a strategy for firms to develop their capabilities in areas of incremental innovation. French companies, in contrast, build their competencies around top managers and technical specialists rather than investing in the improvement of the skills of the bulk of the workforce. The divergent method of coupling tasks and competencies in France and Germany is reflected at two stages. First, vocational training is prominent in Germany and relatively neglected in France for large companies reflecting the ability of the former to compete on the basis of incremental innovation in export markets (Culpepper, 2003). A substantially higher proportion of workers in Germany has undergone vocational training and has experienced higher retention rates at the end of their apprenticeship (Culpepper, 1999: 286, 301; Thelen and Busemeyer, 2008: 9–12).6 Moreover, industrial or regional chambers must certify the training programs of firms, and any change in the content of training certification – the modification of an existing certification or the introduction of a new one – requires the approval of a body of experts in which national industrial unions (not firm-level works councils) occupy half of the seats (Culpepper, 1999). The veto power of employees on the board of the industrial and regional training

6 These cross-national differences have been long-standing. In 1970, only 27.6 percent of active males had no basic vocational training compared to 79.7 percent in France (Maurice et al., 1984: 352). For the category of manual employees, 57.0 percent of German employees had completed a vocational training program compared to only 26.0 percent in France (ibid.: 354). By 1995, the average number of trainees for large German firms (over 500 employees) was six per 100 workers with a retention rate of 85 percent. The corresponding figure for large French companies was 2.2 per hundred workers in 1996 with a retention rate of 35 percent (Culpepper 1999: 286, 301). The French training system suffers from both quantitative and qualitative problems. In fact, the issue of training was itself ignored by the French unions until the mid-1980s and even encountered hostility from the biggest labor organization, namely the CGT (Sellier and Silvestre, 1986: 203).

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commissions prevents significant modification of the system and ensures a stable demand for certified employees.7 The comprehensiveness of this nationally certified and enforced vocational training has experienced some erosion in recent years in the context of large German firms seeking to develop more company-specific training programs. Nonetheless, employees still hold significant amounts of power due to the stakeholder nature of the vocational training (Thelen, 2004; Thelen and Busemeyer, 2008). Second, the different patterns by which competencies and jobs are matched in the two countries are also visible throughout the entire career of employees – and are not simply limited to vocational training. The qualifications of German employees determine the definition of jobs. The access to a majority of jobs in large firms is based upon the holding of a recognized diploma or qualification – most often acquired as part of a vocational or on the job training program. Moreover, vocational training has served as an effective conduit for bluecollar employees seeking promotion to the middle echelons of the managerial hierarchy (Soskice, 1994; Finegold and Wagner, 2002).8 Training remains the essential criteria for qualifications and is invariably a prerequisite for employment and promotion. As a result, the institutions of training constrain management on several fronts: skills are a prerequisite for jobs, management must provide the relevant training to employees, the content of these programs must be certified by an outside body where labor possesses a veto, and the hiring of new employees with the requisite skills is subject to the approval of works councils. Finally, it is also important to highlight the “efficiency” component of training in Germany. The involvement of business associations in setting skills standards ensures that member companies value the certifiable skills of their employees (Whitley, 2003: 682–7). As Culpepper (2003) points out, the resolution of the poaching problem – whereby employees are hired away by rival companies before the original firm is able to recoup the costs of its training investments – constitutes a critical, but not sole, issue associated with the institutionalization of a training system. The other critical issue – analytic uncertainty – refers to the usefulness of skills for firms competing in competitive markets. Will

7 In turn, works councils have been instrumental in setting training standards as well as overseeing the implementation of training programs inside the firm. 8 Mid-level managers and foremen must also undergo specific training in order to be appointed and promoted. The promotion process in German firms reflects the acquisition of the required technical expertise and completion of the relevant training. This process ensures that the authority of projects managers rests on technical competence and is not based on their access to higher levels of managerial authority.

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the certifiable skills acquired by employees allow them to contribute to the development of firm capabilities? It is one thing to induce (or compel) firms to invest in training despite the potential poaching problem, but it is quite another to ensure that the skills acquired by workers will improve the ability of firms to adjust and compete. The involvement of firms in the design of training programs, alongside the legal constraint on unilateral employer strategies as described above, provides substantial incentives for firms to develop collective competences with the participation of a majority of the workforce. The outcome is that the career of employees within firms is linked with skill improvement and upgrading (Sorge, 1991; Whitley, 2003). By contrast, the development of the core competencies of French firms is not based on the skills of the bulk of the workforce. The educational system remains the primary mechanism by which employees are assigned to skilled positions, with vocational and on-the-job training occupying an inferior status (Marsden, 1999: 121–38). This should not obscure the fact that an impressive series of legislative output on training programs has been adopted in France in the last twenty-five years. In particular, state officials have introduced compulsory taxes for vocational and on-the-job training in order to increase the skill level for the bulk of the workforce (Boyer, 1995: 35–43). The state-imposed training levies require companies to allocate a predetermined percentage of their wage bill for training purposes – thereby eliminating the underinvestment problem associated with poaching. Nonetheless, flows of funds on training have been concentrated on managerial staff (with already high levels of skill) and newly hired outside experts – not on the improvement of the general skills of the majority of employees as the tax levies do not specify how firms should allocate them (Culpepper, 2003: 57).9 The French case is characterized by the absence of any legal requirement to assign specific jobs to workers with certifiable skills. Employers 9 Another instance by which state officials in France have tried unsuccessfully to increase the prominence of training is the subsidy and tax credit programs for the hiring of young trainees since the mid-1980s. The basic feature of these programs is the provision to companies of generous subsidies (for usually a three-year period) covering a significant percentage of the salary of young workers. However, these programs have also failed to increase the general level of skills of blue-collar workers. The percentage of trainees retained by the firm after the expiration of the subsidies under this program was only 29 percent (Charpail and Zilberman, 1998: 50). This figure stands below that of the national retention rate for trainees in France which are substantially lower than those prevalent in Germany. Second, a majority of firms using these schemes have not invested substantial amounts of funds in the training of employees (Culpepper, 2003: 67). In other words, French employers do not use the subsidies provided by the state as a means to increase the skill level of the workforce, but merely as a strategy to lower labor costs as evidenced by low retention rates (ibid.: 66–75).

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have used their own criteria to define jobs. Attempts by state officials to impose the recognition of training (vocational or on-the-job) as a prerequisite for holding jobs have been successfully opposed by employers (Culpepper, 1999: 277–80; Marsden, 1999: 98). The absence of recognized training in France highlights the importance of skills externally acquired or produced by the firms themselves. In particular, large French firms have increasingly oriented their recruitment efforts toward university graduates from the newly created (late 1980s) vocational tracks (Hancke´, 2002; Verdier, 2006). Moreover, the provision of training and the promotion system are highly selective and contribute to further inequalities. The relationship between training and promotion is reversed in France. Management selects workers to be promoted and then provides them with the appropriate training (Marsden, 1999: 77). French firms provide in-house training for managers with high potential as well as for employees who usually have substantial experience in the firm (Falcoz, 2002; Culpepper, 2003: 57). The promotion system of French firms is a reflection of a change of status decided by top management rather than through the acquisition of technical expertise. Finally, boards of experts (business associations and employee committees) on training play a simple consultative role (Culpepper, 1999: 278). Works councils possess only information rights on the use of funds for training. At the firm-level, works councils possess only information rights as employers must specify how funds raised from tax levies will be spent. As regards the specifics of vocational training, moreover, it is the Ministry of Education that is largely responsible for the elaboration of the standards (CEDEFOP, 1994: 86–9). The lack of involvement of employers in the standardized system of skill formation entails that the qualifications associated with vocational training are not likely to be valued by firms – the analytical uncertainty problem not being solved. The irony of the French vocational training system is that it does not provide a guarantee of a skilled job despite being state certified.

5.4 Work Organization and the Segmentation of Activities The third major difference between the organization of the workplace in France and Germany concerns the extent to which activities are segmented, that is, the degree of managerial control over the organization of the production process, especially in regard to how employers rely on the bulk of the workforce in organizing and carrying out tasks (Whitley, 1999: 38–44). The segmentation of activities constitutes a source of 143

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constraint and incentives on the managerial ability to implement restructuring schemes. A segmented workforce reduces the dependence of management on specific groups of employees. At the same time, however, functionally isolated employees without an encompassing vision of the activities of the firm limit the ability of corporate executives to pursue strategies of incremental innovation where the autonomy and contribution of shop floor employees are essential. The French case is characterized by the segmentation of production activities and responsibilities between blue-collar employees and managers, and an emphasis on narrow and specialized skills for the former (Linhart, 1994: 57–64; Marsden, 1999: 131–2). Firms rely on the presence of rules that regulate the nature of the tasks to be accomplished – rather than the functions to be performed – to organize the production process (Maurice et al., 1986: 60–5; Marsden, 1999: 103–4). The initial rationale for this specific organization of the workplace in France is best accounted for by Crozier’s notion of the avoidance of face-to-face relationships and where individualism ranks high as a value (Crozier, 1963; see also Sorge, 1993). The French propensity for uncertainty avoidance, combined with the antagonistic nature of industrial relations, led firms in the first three postwar decades to adopt mechanisms designed to both prevent the involvement of employees in the conduct of the strategy of the firm as well as protect them from unpredictable and unwarranted intrusion. However, the advent of firm-level flexibility and the increasing importance of microprocessor technology in the late 1970s did raise the costs associated with the maintenance of this separation between elaboration and implementation of tasks. The need for companies to adapt quickly to a changing environment is best served by a different set of attitudes on the part of the workers.10 Employees must enter into a dialogue with management and different functional departments in order to achieve flexibility, quality, and speed. The avoidance of the face-to-face dialogue is no longer sustainable in this context. Greater participation by employees in the modification of their environment has taken place inside large French companies in the last twenty years (Linhart, 1994: 23–47; Hancke´, 2002). Employees have become more involved in problem solving and contribute in monitoring and evaluating performance, as more is expected of them from management (Linhart, 1993).11 They are

10 For an analysis of the implications of the concept of flexibility for workplace organization, see Streeck (1987). 11 Interestingly, the use of quality circles in France was the highest for the European Union by the late 1990s (Benders et al., 1999).

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given a greater choice of tasks by the management. Nonetheless, the separation between planning and execution is still predominant in France and the organization of work has not lost its key fordist component (Linhart, 1994: 48–64; Culpepper, 1999: 274–80; Sorge, 2005). Shop floor restructuring in the last fifteen years might have provided for greater employee involvement in monitoring and evaluating performance, but still does not allow for their influence over what tasks they perform and the conditions under which work takes place. Hierarchical relationships are still predominant inside French firms, despite the greater involvement of employees.12 As a result, the separation between planning and execution still limits the ability of blue-collar employees to participate in the conduct of the business strategy of the firm, since they possess a limited view of its operations. This limitation, in turn, contributes to the concentration of power at the top of the managerial hierarchy. The organization of work in Germany, on the other hand, is characterized by the application of rules to broad functions, rather than by trying to predict all contingencies on the shop floor through heavy reliance on explicit instructions (Maurice et al., 1986; Kristensen, 1997; Whitley, 2003). The predominance of employees with certifiable skills and the subsequent reliance of management on the bulk of the workforce as a strategy to develop the capabilities of the firm constitute critical factors that have bridged the gap between conception and implementation in Germany (Whitley, 2003: 669–79). The role of training is particularly important in this process, as employees are grouped according to the types of qualifications they possess and tasks are organized according to their skill requirements (Marsden, 1999: 32–41). The outcome is one in which the institutional arrangements of the workplace are characterized by blurred organizational boundaries and reduced segmentation, the delegation of control over the nature of work processes resulting in the involvement of employees in many tasks, and low reliance on formal rules in evaluating performance. In turn, the broad skills of German employees have been conducive to the development of flexible working time in order to better match staffing and order levels. The dual use of high internal functional flexibility combined with numerical flexibility in working time has resulted in a high level of job tenure for qualified employees (Auer and Cazes, 2000; Erlinghagen, 2008).

12 The dual nature of this development – change in practices of workplace organization combined with stability in power relationships – testifies to the importance of the distinction between institutional framework and the mode of coordination that follows from these institutions. See Hall (2007) and Hall and Thelen (2009) for an analysis of this crucial distinction.

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5.5 The Autonomy and Competencies of Workers in Problem-Solving Tasks The fourth firm-level institutional difference between France and Germany deals with the degree of autonomy for employees on the shop floor. I distinguish between the separation of task execution and implementation (covered in the previous section) from the extent to which workers exercise discretion over how tasks are performed and their ability to contribute to problem solving for two reasons. First, institutional arrangements in large firms might enable employees to have some influence over the standardization process, but still render them powerless to shape the conditions under which work takes place once job tasks are standardized. This is particularly the case for France where the greater involvement of employees has not been matched by a corresponding willingness of management to share authority (Linhart, 1994: 48–64; Sorge, 2005: 180–2). Second, the ability of employees to contribute to problem solving is not independent of the development of their organizational careers. For instance, the narrow skills of French employees limit their contribution to problem solving and the fulfillment of the organizational goals of the firm, despite greater managerial expectations. The autonomy and competencies of employees in problem-solving tasks in large firms exhibit a sharp contrast across these two advanced capitalist economies. The institutional arrangements of workplace organization in Germany provide for substantial autonomy in the definition of tasks and autonomy in their implementation (Maurice et al., 1986: 90–100; Sorge, 1991: 168–76; Kristensen, 1997). High levels of authority sharing and the involvement of workers beyond the managerial hierarchy in the elaboration of the strategy of the firm link the fate of employees to that of management (Whitley, 2003: 669–79). Skilled employees possess strong incentives to develop problem-solving capabilities. Nonetheless, the potential willingness of employees to invest in firm-specific, problem-solving capabilities raises a serious dilemma. The development of firm-specific knowledge by employees can take place at the expense of improving general skills that would be more useful in external labor markets. How are the potential negative consequences associated with this dilemma solved in the development of competencies in Germany? The capabilities of German employees are shaped in a profound manner by the content of their skills. The involvement of employer associations in the certification process ensures that skills are relevant to their

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strategic needs. In particular, the involvement of national union representatives in the certification process ensures that skills will be of general character and fit with broad job description. The degree of polyvalence of workers is high since the organization of the workplace favors the acquisition of broad based skills (Maurice et al., 1986: 69–73; Streeck, 1992: 36–40). The content of the skill certification of employees is not inexorably connected to a limited number of tasks.13 National unions, and IG Metall in particular, have been adamant in insisting that skills should be broad rather than narrowly task-connected. Finally, the use of job rotations enhances the degree of polyvalence of German employees, thereby increasing their ability to engage in problem-solving tasks (Maurice et al., 1986: 79–84; Streeck, 1992: 36–40). Job rotation allows companies to rely on employees with broad skills to tackle shifts in work demands (Marsden, 1999: 133). German employees are open to job rotations across departments and divisions since their career development is linked to their ability to contribute to the success of the firm (Whitley, 2003: 674). The institutional arrangements of workplace organization in France, by contrast, do not significantly contribute to the development of the problem-solving capabilities of employees. First, job demarcations are stricter. The segmentation of the activities of the firm between elaboration and execution and the narrow skills of French employees entail that they possess a limited view of the totality of the operations of the firm and rely on top management for coordination. Their ability to develop firm-specific, problem-solving capabilities is seriously limited since they have a limited view of the operations of the firm (Sorge, 1991: 168–76). Second, job rotations in French enterprises are lower than in Germany (Marsden, 1999: 130–1). The working life of employees tends to be

13 Therefore, it is important to note the difference between the firm-specific skills of employees versus the broad content of skill certification. Firm-specific skills refer to the fact that the accumulated human capital of employees would be difficult to transfer in its entirety to another firm. Firm-specific skills result from the accumulation of training, autonomy in the undertaking of initiatives regarding quality control and other aspects of the production process, team work with long-tenured fellow employees, interactions with suppliers, and developed knowledge of the activities of the firm. Acquired skills are not easily transferable. The broad content of skill certification, by contrast, refers to the adjustment mechanisms in the alignment of job demands with worker competencies. In the German organization of work, the qualifications of workers determine the definition of jobs but nevertheless require that skills can be redeployed to alternative uses in the light of market shifts (see e.g. Streeck, 1992). Rigid job classification systems might serve to protect workers against managerial intrusion but would constitute an impediment to competitive adjustment. The process of organizing tasks around the skills of employees is not sufficient. These skills must also be broad enough to be redeployed to other uses within the context of the organization of activities within the company. Broad skill certification provides for an excellent fit with the firm-specific nature of the skills of employees.

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associated with limited tasks, therefore leading to substantial segmentation of work roles and greater functional specialization. Therefore, the process of problem solving is management-led with the involvement of a few highly qualified technical specialists.

5.6 Firm-Level Institutional Arrangements and Paths of Adjustment The previous sections have highlighted the presence of long-standing, significant institutional differences in the distribution of authority inside French and German companies with important implications for the investment allocation of Anglo-American institutional investors. The process of adjustment of companies in the two countries to financial and product market pressures constitutes the topic of this section. The institutional arrangements of large French and German firms internally structure authority in different ways that, in turn, provide management with a different set of constraints and opportunities in the process by which companies adjust. The debate is not between stability versus change – but between different paths of adjustment that, in turn, reinforce the pattern of skill formation and distribution of authority in the two countries. I analyze the paths of adjustment in Germany and France, respectively.

5.6.1 Adjustments in Germany German companies have exhibited flexibility in adjusting to shifts in demand in world markets in the last fifteen years – although not in a manner that fits well with the preferences of short-term-oriented investors. Instead, the pattern of adjustment of German companies is characterized by the occurrence of important institutional change that has substantially increased the ability of German firms to successfully deal with capital and product market pressures but in a manner that builds on the strength of its pattern of skill formation and innovative capabilities in areas of incremental innovation (Hoepner, 2001; Vitols, 2004; ¨ rsch, 2007). The position of employees inside German Deeg, 2005a; Bo companies does constrain and limit the range of possible options for adjustment, but does not prevent, indeed it even facilitates, the implementation of specific restructuring schemes. In particular, works councils have become an important actor in the design and implementation of corporate restructuring schemes in a manner that preserves the

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development of the innovative capabilities of firms based on the bulk of the core, blue-collar employees. Four aspects of change in Germany are interesting for this analysis. First, the vocational training system has undergone important innovations that have preserved its relevance for employers (Finegold and Wagner, 2002; Bosch and Charest, 2008; Bosch, 2010a). The content of training schemes for existing occupations has been comprehensively updated to incorporate flexibility in work organization careers (e.g., high internal functional flexibility) with the introduction of new information technologies – all of this in the context of constantly broadbased skill profiles. Between 1996 and 2005, sixty-four new categories of occupations were created and major modifications to 189 occupations were introduced.14 As a result, about 74 percent of existing occupations in early 2006 had either been recently created or had undergone substantial modifications (Bosch, 2010a: 147). Moreover, the newly created/modified occupational categories have been built around new forms of work organization that are prevalent inside companies. For instance, electricians and fitters are no longer trained separately but work together in teams inside companies at an early stage of their apprenticeships. Another factor that accounts for the continuing relevance of vocational training is the increased competencies and qualifications of high school graduates pursuing an apprenticeship. Firms are increasingly recruiting from the intermediate (Realschule) and upper (Gymnasium) high school tracks at the expense of graduates from the lower secondary school track (Hauptschule). The share of trainees from the Hauptschule track has fallen from 80 to 37 percent between 1970 and 2005 and, moreover, is concentrated in the least attractive apprenticeships (ibid.: 142). The result is that the average apprentice is better educated which, in turn, has enabled companies to raise the standards for the theoretical components in many vocational occupations. Second, firm-level works councils have become heavily involved in the process of economic adjustment of companies (Muller-Jentsch, 2003). This increased participation has been the result of a proliferation of agreements between plant management and works councils over the past twenty years that deviate from agreements signed by nationally based unions. The bulk of these company-level pacts is dominated by specific types of trade-offs and compromises: employees concede on issues of production shifts, cost-savings measures on working time, 14 In particular, four newly created occupations have been introduced in the late 1990s in the areas of information technology and have proved highly popular with apprenticeships and now constitute a little over 15 percent of new training positions (Bosch, 2010a: 148).

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new types of work organization, and performance-related pay in exchange for investment agreements by the employer that guarantee production at specific sites and/or the provision of increased job security for core (i.e., skilled) workers (Rehder, 2003; Seifert and Massa-Wirth, 2005).15 The role of works councils has significantly expanded with these company-level pacts given their privileged position in the collection of information about work flow, inventory, and other dimensions of new forms of work organization (Herrigel, 2008b: 122). Third, German companies have pursued many strategies of widespread experimentation with alternative forms of work organization that often extend beyond what is permitted by the legal framework of the German system of industrial relations (Behrens and Jacoby, 2004; Herrigel, 2008b).16 Nonetheless, these experimentations with new forms of work organization are best characterized by a redefinition of stakeholder capitalism rather than a straightforward liberalization process since they involve the participation of core employees in their elaboration and implementation (Muller-Jentsch, 2003; Herrigel, 2008b). The legal institutional starting points of these experimentations are crucial since both employers and workers (works councils and unions) possess some forms of veto powers that can be used to block unilateral change (Behrens and Jacoby, 2004). Innovations in strategies of work organization constitute controlled experiments. The involvement of works councils in experimentations that stretch beyond the legal framework of German industrial relations has provided a unique opportunity to expand their knowledge of the operations of the firm through information exchange with suppliers and other stakeholders (Herrigel, 2008b: 120–6). As a result, firms have responded to the volatility of markets by redeploying the capabilities of employees to new uses – instead of relying on dismissals and other types of market-based adjustments. This adjustment process is possible because the skills of employees are broad enough to accomplish a wide range of tasks. Broad skills and blurred organizational boundaries provide employees with a 15 Interestingly enough, works councils have also supported shareholder value strategies designed to increase the market value of the firm in order to deter hostile takeovers – provided that these measures are not imposed unilaterally and do not threaten investment programs (Hoepner, 2001). 16 For instance, Volkswagen reached an important agreement with its works councils and IG Metall in allowing for the incorporation of suppliers in its plants despite legal restrictions (Herrigel, 2008b: 120–2). Legal provisions in German industrial relations technically prohibit this form of work integration in order to prevent companies from employing workers under different terms than those specified in the local collective bargaining agreement – which is inevitably the case with the incorporation of workers from suppliers. The aim associated with this new form of work organization is to maintain the competitive position of the firm in a context of shortened product cycles and pressures for cost reductions.

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fairly complete view of the operations of the firm (Whitley, 2003: 669–79). Training curricula and regulations are broadly defined to avoid overspecialization in narrow skill assignments, and the blurring of boundaries and responsibilities allows employees to switch between different functions. The skills of employees shape their ability to solve problems that, in turn, presents management with opportunities to reorganize the production process. Fourth, the process of adjustment of firms has also been facilitated by state policies in the sphere of industrial relations. Partial and piecemeal deregulation of the legal apparatus of the industrial relations system has provided firms with greater flexibility in the use of the workforce (Lehndorff et al., 2009; Palier and Thelen, 2010). The wholesale deregulation of labor markets has not taken place in Germany. Rules on dismissals for employees on standard, permanent contracts have not been modified and remain some of the most restrictive among advanced capitalist economies (OECD, 1999). Instead, the deregulation of labor markets targeted “nonstandard” employment relationships. Restrictions on fixed-term contracts were significantly eased in 1996 so that employers could offer contracts for up to two years without special justification (Ebbinghaus and Eichhorst, 2006). Moreover, part-time employment also experienced an important growth as a result of new and generous fiscal incentives for employers introduced by the SPD-Green coalition government in the late 1990s/ early 2000s (Caliendo and Wrohlich, 2006). By 2008, nonstandard employment (fixed-term and part-time jobs) accounted for a little over one-quarter of the working-age population in Germany (Schmid, 2010: 6).17 Moreover, the rise of nonstandard jobs was accompanied by reforms of the welfare state in the form of reduced employment benefits and duration – the Hartz IV reform. The adjustment process of German companies has been impressive but does not fit well with the preferences and tactics of short-term investors. Firm-level institutional arrangements of German firms still place serious constraints on the ability of managers to conduct the business strategy of the firm in a unilateral manner. The redeployment of the skills of core employees to new economic circumstances involves a process of experimentation to ensure that the certified skills are relevant to the production needs of companies. This learning-by-doing

17 The use of fixed-term contracts was more prevalent in large export-oriented manufacturing firms with the implication that the automatic termination of contracts provided companies with increased flexibility. The importance of part-time jobs, in contrast, was concentrated both in the less-unionized service sector and in the component of manufacturing that has been outsourced (Palier and Thelen, 2010: 127).

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strategy is unlikely to be accomplished as rapidly as external mechanisms of adjustment that rely on dismissals and other types of marketbased adjustment. This is particularly true in times of rapid product and technology change that require a radical transformation in skill content. The German system is plagued by important short-term rigidities. The introduction of a new product or technology invariably gives rise to jurisdictional disputes among various employees. The respective role to be performed by each of the skill category in the introduction of new products must be bargained out.18 The specific adjustment process of German companies in the last fifteen to twenty years has taken place in a manner consistent with the development of their innovative capabilities in areas of incremental innovation process and via the crucial contribution of the skills of core, ¨ rsch, 2007 ). Nonetheless, critics blue-collar employees (Deeg, 2005a; Bo have taken aim at the growing inequalities that have resulted from the content of this adjustment process. The charge is that the introduction of institutional change has led to the emergence of institutionalized dualism between better-protected, skilled employees and unskilled workers in peripheral areas – a process partly underwritten by state policy (Palier and Thelen, 2010; see also Lehndorff et al., 2009). The massive growth of company-level pacts has divided the labor movement into core and peripheral employees since the increased job security for skilled workers was matched with increased productivity – an exchange process not available for unskilled employees. Moreover, the stabilization of the working conditions for core, skilled employees was made possible by the general outsourcing of functions previously performed within large companies and through the emergence of a secondary labor markets dominated by nonstandard jobs. As a result, the favorable working conditions of core and skilled employees in dynamic segments are no longer disseminated throughout the wider economy. Adaptation to economic changes has been a negotiated process with employees as in the past, but the outcomes of these changes are no longer roughly similar across the whole economy.19 The occurrence of dualism is undeniable. The assessment of the causes of this process remains open to discussion. The most prominent interpretation highlights the disorganization of the German political economy whereby the increased importance of the interaction between

18 For instance, thirty-one new occupations were defined and ninety-seven were updated and modernized between 1996 and 1999. See Herrigel and Sabel (1999) for in-depth analysis. 19 Compare an earlier analysis of adjustments (Turner, 1991) with a current assessment of change (Palier and Thelen, 2010).

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works councils and companies has replaced an obligatory social order dominated by ideas of justice and social cohesion (Streeck, 2008). The changing preferences of the “business” class entail that the behavior of market players – firms and works councils in particular – is increasingly characterized by the predominance of voluntary, contracted, individual agreements aimed at firm competitiveness in its current economic context. This transformation of the German political landscape is perhaps best characterized by the replacement of Durkheimian institutions with binding social obligations with more Williamsonian-oriented institutions based on voluntary coordination (Bosch, 2010b: 207). An alternative interpretation stresses how the institutional changes that led to dualism in Germany have been introduced as a strategic move to preserve as much as possible, not undermine, existing institutional arrangements associated with ideas of justice and social cohesion (Palier and Thelen, 2010). The development of dualism in Germany has been associated with raising inequalities, but did not lead to an “Americanization” of its social model. Notwithstanding the Hartz reforms, social assistance for the unemployed in Germany remains relatively generous as compared to corresponding arrangements in liberal market economies. Changes in Germany have been negotiated and billed as necessary adjustments to preserve core economic activities in areas of incremental innovation and where employment tenure is higher and the building of innovative capabilities takes place with the bulk of the (core) workforce rather than with just a few top specialists. In other words, the sustainability of national models that emphasize the notion of social justice might not be possible without some types of institutional change (Thelen, 2004). Moreover, the adjustment process of German companies has enabled them to avoid the implementation of more radical restructuring schemes. The hypothetical absence of reforms could have led to the loss of competitiveness in markets with potential stronger counter-reactions. As pointed out by Gilson (1996: 332), “initial conditions may select the path, but the institutions that emerge in response are subject to powerful selection mechanisms. If the institutions created along the path cannot function effectively in comparison with those of competitors, they will not survive.” The choice is not between stability and transformation, but between different paths of change. The French case is interesting for the analysis of the emergence of dualism in Germany. Nonstandard employment relationships have also spread in French labor markets but have contributed to the further marginalization of employees from the strategic direction of companies and from the process by which innovative capabilities are developed. In contrast 153

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to their French counterparts, German companies have been able to achieve greater flexibility and have largely managed to avoid the arrival of short-term investors with their impatient attitude toward capital investment. The combination of the stability of core institutional arrangements of work organization with the specific content of their process of adjustment – innovations in vocational training system, spread of company-level pacts, experimentation with alternative forms of work organization, and deregulation of “nonstandard” employment relationships – has been attractive to medium/long-term investors but has not been sufficient to “please” short-term investors.

5.6.2 Adjustments in France The centralized and functionally differentiated work organization of large French firms militates against experimentation with skill redeployment. Instead, it entails faster patterns of reorganization that build on the separation between categories of workers. The importance of the failure of state officials to impose the recognition of training as a prerequisite for holding specific jobs becomes apparent in this context. Differences in skill formation between France and Germany are not simply a quantitative issue – that is, more workers possessing certified skills in the latter. The sharp segmentation of production activities and responsibilities between bluecollar employees and managers, a rigid system of rules, and the emphasis on narrow and specialized skills limit the ability of workers to participate in the conduct of the business strategy, thereby lessening the dependence of management on the skills of the bulk of the workforce.20 The adjustment process of large French firms has also experienced major institutional changes in the last fifteen years. Nonetheless, the presence of hierarchical relationships inside companies has remained intact. The influence of controlling corporate executives in the governance of firms has substantially increased. Three aspects of change are important. First, the introduction of just-in-time and other Japanese-inspired management techniques from the late 1980s onward have enabled French companies to achieve greater operational efficiency without compromising on managerial authority (Hancke´, 2002; Doeringer et al., 2003).21 High-performance management techniques in the Japanese context

20 Compare the similarities between Maurice et al. (1986: 59–90), Culpepper (1999), and Sorge (2005: 142–83). 21 See also Meardi et al. (2009) for an analysis of the transfer of work organization practices by American and German multinational companies in Eastern Europe.

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have been crucial for the incorporation of employees, as well as their empowerment, in the process by which firms develop their innovative capabilities through the use of self-managed production teams that, in turn, promote problem solving and continuous improvement in processes and product quality. The diffusion of Japanese-inspired management techniques has been widespread and profound inside large French companies (Lorenz, 2000). Nonetheless, the introduction of these business practices cannot be interpreted as a wholesale transfer of employment practices in France. For one thing, the greater emphasis on quality circles and just-in-time techniques has resulted in decentralization of decisionmaking at lower levels of firm hierarchy, that is, the shop floor, but without a similar decentralization at the top (Schmidt, 1996: 393–8). Major decisions still remain centralized in the hands of the CEO and his managerial team. The division between conception and execution remains valid despite the greater autonomy of shop floor teams to take initiatives that fit within the overall strategy decided elsewhere (Linhart, 1991, 1993). Moreover, the introduction of high-performance management techniques has been piecemeal inside French companies, thereby reflecting the lack of importance of broad-based skills for blue-collar employees. For instance, semiautonomous teams on the assembly line in manufacturing companies are not linked with other teams involved in the process of quality improvement (Doeringer et al., 2003: 275). Finally, the role of the position of the foreman – a central figure in the implementation of high-performance management techniques – is different in France. In Japan, as well as in Germany, the foreman is recruited within the firm and comes from the ranks of experienced blue-collar employees. The career progression of the foreman is characterized by extensive on-the-job experience as well as shared training with fellow production workers on the shop floor. In France, the foreman is recruited from the ranks of university graduates from vocationally oriented training courses and, thus, does not have any work experience (Verdier, 2006). The foreman is grouped with white-collar employees and performs a disciplinary authority function (Sorge, 1993: 75–9). The outcome is that the introduction of Japanese-inspired management techniques has been a tightly controlled process run by top management. Greater flexibility in the operations of companies has not been accompanied by the empowerment of blue-collar employees over the production process.22 22 Interestingly, the transfer of Japanese-inspired management practices in Germany has proven easier and has also been characterized by less piecemeal experiments as compared to

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Second, the weight of “nonstandard” forms of employment in the French economy has experienced an impressive upward swing (Blanchard and Landier, 2002; Blanchard and Tirole, 2003; Palier and Thelen, 2010). French policymakers have found it easier to reform at the “margins” by reducing the degree of legal protection and the financial costs associated with fixed-term contract and part-time employment. Strong resistance from trade unions to a general liberalization of the rules on dismissals has dissuaded policymakers from attempting to reduce the employment protection for employees on a permanent contract (Palier and Thelen, 2010: 131–2). The legal protective regime for employees on standard employment contracts still remains one of the strongest among advanced capitalist economies (OECD, 1999). Lengthy notification requirements and the obligation to present a “social plan” (stipulation of the measures taken by management to train employees) that must be approved by courts seriously limit the ability of French firms to adjust to short-term fluctuations via substantial reduction in the number of permanent employees. By contrast, severance payments and administrative costs associated with fixed-term contracts have been reduced, the length of fixed-term contracts has been raised to twentyfour months, and subsidies are now provided for the use of part-time employees in specific circumstances in order to reduce employment. The outcome is that the aggregate weight of atypical jobs increased in a continuous fashion from 3 percent of all employment in 1970, to 10 percent in 1990, and to slightly over 25 percent in 2007 (Malo et al., 2000: 251; Palier and Thelen, 2010: 130). In terms of flows, moreover, over 70 percent of new jobs fall into the category of nonstandard employment (Blanchard and Tirole, 2003: 18). Equally significant is the fact that the recourse to atypical jobs by French companies, an important element of flexibility for them, largely failed to reduce unemployment. Large firms have exhibited a preference toward letting go employees at the end of their fixed-term contracts and instead proceed to recruit new workers on a limited-term basis (ibid.: 20). Third, the adjustment process of large French firms has also been facilitated by the crumbling of the internal career path and the stable

France (Sako, 1994; Herrigel and Sabel, 1999). The broad-based skills of German employees defined around qualifications and competencies, an outcome of vocational and on-the-job training, share important similarities with the process of skill formation of shop floor employees in Japanese companies. A clear track career trajectory based around entry-level qualifications and further training serves to delegitimize the recourse to external labor markets in Germany. The foreman is selected among blue-collar employees and his authority is based on both his highly developed firm-specific skills as well as his ability to cooperate with fellow team members.

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employment relationship for white-collar managers (Falcoz, 2002). The labor markets for French white-collar employees are currently characterized by external hiring – as opposed to internal promotion – and by increased rates of employee turnover. This development has increased the flexibility of large companies in their adjustment process while reinforcing the concentration of power at the top of large French firms – therefore fitting perfectly with the investment strategies of short-termoriented investors. The dismantling of internal labor markets for white-collar employees highlights the importance of change in labor laws. Employment relations in France are governed by two sets of law on the regulation of dismissals: the constraining and expensive collective redundancies scheme and the more liberal personal motive plan. The first deals with the dismissals of ten employees within thirty days for firms with more than forty-nine employees. The legislation for this type of dismissal seriously limits the ability of managers to rely on dismissals as a strategy of adjustment. It is one of the most restrictive among advanced capitalist economies on several dimensions: delay to start of notice, procedural requirements, and definition of unfair dismissal (OECD, 1999). Moreover, severance payments for dismissed employees are relatively onerous: two-fifteenth of a month’s salary for each working year. The second regime on dismissal – personal motive plan – is far more liberal in regard to procedural requirements and is half as onerous: one-fifteenth of a month’s salary for each working year. An interesting development is the changing balance between these two mechanisms of layoffs. Personal motive for dismissals increased from 350,000 to 585,000 between 1995 and 2005, while job losses associated with the collective redundancies scheme dropped from 440,000 to 205,000 for the same period (Palpacuer et al., 2011). Moreover, employees dismissed for personal reasons tend to be older white-collar workers with substantially above-average income and qualifications. The ability of French firms to rely on the dismissal of white-collar employees reflects the increasing use of contracts with numerous flexibility clauses that are characterized by criteria of individual accountability and obligation of means (Falcoz, 2002). The crumbling of the internal labor markets for managers has enabled large French firms to achieve a greater degree of flexibility – but without having to become dependent on blue-collar employees. The occurrence of change in large French companies has thus solidified the concentration of power at the top.

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6.1 The Argument Revisited The rise of global financial markets in the last twenty years has been impressive (Garrett, 2000). Crucial to this development has been the removal of controls on the movements of capital across borders (Goodman and Pauly, 1993). Contrary to conventional accounts, European policymakers were instrumental in the design and promotion of the liberal rules of international finance (Abdelal, 2007). Their aim was the promotion of a rule-based process of globalization in contrast to the ad hoc piecemeal steps of American authorities. The irony is that it is the free mobility of capital across borders which has made possible the implementation of a strategy of international diversification by shareholder value-oriented institutional investors. The arrival of UK/US-based funds constitutes a relatively new phenomenon in France and Germany. The ownership structure of large, listed companies in the two countries was characterized by an overall absence of hedge funds and mutual funds from liberal market economies as blockholders prior to the mid- to late 1990s (see Achleitner et al., 2010; Dafsaliens, various years). Previous analyses of the process of cross-border portfolio investments by shareholder value-oriented institutional investors have provided subtle and significant insights by highlighting the importance of the political process by which new actors with very different interests and incentives enter into an economy whose institutional characteristics and values are very different from that of the country of origin (Fiss and Zajac, 2004; Ahmadjian and Robbins, 2005). Nonetheless, no analysis of the political dimensions and implications associated with the arrival of foreign institutional investors in France and Germany can take place without considerations of the specificities of their historical and institutional contexts. For one thing, the two

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economies had experienced significant liberalizing measures by the late 1990s (Djelic and Zarlowski, 2005; Streeck, 2008). Among the most significant of these liberalizing policies were the removal of capital controls, deregulation of the previously bank-based financial sector, and adhesion to a common European monetary system. For Roe (2003: 150–3), these measures testify political movements toward the right in France and Germany. Nonetheless, politics defined as a conflict of interest between foreign investors and domestic firms constitutes a too broad category to assess the consequences associated with the arrival of shareholder valueoriented funds. In many aspects, the evolution of corporate governance in France and Germany in the last ten years has been a rather uneventful transformation – albeit with sharp differences in the identity and volume of foreign capital in the two countries. Large companies attracted institutional investors that have contributed to the stability of work organization: short-term funds are unlikely candidates to challenge the hierarchical organization of work inside French companies since it facilitates the introduction of unilaterally designed restructuring schemes; the investment horizons of long-term funds are compatible with the involvement of the bulk of the (core) workforce in the development of the innovative capabilities of German firms. Instead, politics is better conceptualized as an important variable that shaped the institutional building of workplace organizaton in the two countries. The settlements of conflict specific to France and Germany resulted in significant differences in the distribution of authority inside companies that, in turn, has provided for different degrees of fit with the preferences and strategies of institutional investors. The institutional arrangements associated with the organization of the workplace in France and Germany are important, but have remained unconnected and uninfluential regarding other developments in the two economies. Most notably, institutional arrangements of workplace organization cannot account for the process of legal reforms of the rights of minority shareholders – a process driven by an entirely different set of motivations (see Cioffi and Hoepner, 2006; Tiberghien, 2007). In other words, the influence of politics on the settlement of conflict in the area of workplace organization does not impact on the values taken by the other causal variable in this study, namely the legal protection of minority shareholders. Nonetheless, the institutional arrangements of workplace organization mediate the relationship between legal reforms that has resulted in increased protection for minority shareholders and the strategy of blockholding acquisitions by UK/US-based institutional investors. Politics is part of a 159

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process of complex causation that significantly contributes to outcomes, but that does not impact on the values taken by each single causal variable. Therefore, the important factor was that these two economies were institutionally organized in sharply different ways before the arrival of institutional investors as a result of specific terms of settlements of political conflict. The issue is not limited to the fact that they have proceeded forward in the implementation of liberalizing measures that might prove to be more shareholder friendly (see Sections 2.1 and 2.2 in Chapter 2), but encompasses the fact that the institutional configuration at the firm-level provides for a different panoply of adjustment strategies. The impact associated with new developments, such as increased legal protection for minority shareholders, is contingent upon the prevailing hierarchization of institutions. The presence of concentration of power in top management is crucial for the magnitude effect of these important new developments to occur. I emphasize how the choices made by labor organizations in the two countries constituted a crucial element that translated into different structures of authority at the firm-level. In Germany, labor organizations sought to extend control at the shop floor via the Codetermination system in addition to having other goals such as Keynesian demand management, economic planning, and nationalization. The focus on achieving full participation in economic decision-making at the firm-level proved to be significant especially in the context of other goals being unreachable. Institutional arrangements of large German companies stand in the way of controlling executives attempting to implement adjustment strategies in a unilateral fashion. Significant constraints on managerial autonomy, in turn, make it difficult to implement short-term-oriented strategies of shareholder value. In France, the political maximalist strategy of trade unions took place during a period of important state intervention in the economy and served to compensate for their firm-level weaknesses. The refusal to participate in the strategic management of companies on the part of trade unions enabled controlling executives (managers or large blockholders) to concentrate power at the top of the hierarchy. In turn, the greater concentration of power inside French companies provides for a better fit with the preferences of short-term investors by making it easier to implement specific strategies of shareholder value. The paradox is that a political economy organized around more powerful corporate executives has proven more welcoming to blockholder acquisitions and the shareholder mantra since governing executives have more power to implement this new governance principle. 160

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The presence of significant disparities in the investment allocation of shareholder value-oriented institutional investors in France and Germany also highlights the relatively “managed” evolution of the two systems of corporate governance. The provision of a distinction between different categories of institutional investors serves to illustrate their different goals and strategies with implications for the consequences associated with foreign ownership. The coordination of activities and the development of innovative capabilities differ sharply between French and German companies (Maurice et al., 1986; Sorge, 1991, 2005; Culpepper, 2003; Whitley, 2003). In France, the coordination of activities inside large companies is characterized by the vesting of unilateral authority in top managers, but not in the bulk of the workforce. The hierarchical patterns of differentiation and the concentration of power inside French companies reflect both organizational politics and the mode of coordination by which they develop their competitive competences. The arrival of short-term institutional investors, while potentially proving a source of disturbance for corporate executives seeking to capture private benefits of control, has further contributed to the exclusion of the bulk of the workforce from the governance of companies. The concentration of power at the top of the hierarchy inside French firms is valued by short-term institutional investors since it makes it easier to reorganize the strategy of the firm in a relative speedy fashion – a key aspect of the preferences of this category of funds given its short-time horizon (Rebe´rioux, 2002; Goyer, 2006a). In Germany, the coordination of activities inside large companies is characterized by high levels of authority sharing with the bulk of the core workforce. The development of innovative capabilities takes place on the basis of the long-term contribution of skilled employees through institutionalized career paths. The relative absence of short-term-oriented institutional investors coupled with the growing strength of medium to long-term funds with their demands for financial transparency and a long-term horizon constitutes a stabilizing factor for the institutional arrangements of the workplace organization of German companies. Employees as well as minority shareholders benefit from the provision of greater financial transparency and from the imposition of constraints on managerial opportunism (Hoepner, 2001). The implication from the above analysis is that the character of coordination of activities at the firm-level must be seen as analytically separate from the institutional framework that supports it (Soskice, 1999; Hall and Soskice, 2001). Changes in the latter do not need to result in the modification of the former (Hall, 2007; Hall and Thelen, 2009). The total absence of institutional change does not constitute a necessary 161

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condition for the sustainability of national varieties of capitalism – and for their corresponding systems of corporate governance (Thelen, 2004). The key issue for this study is whether the presence of institutional change in the form of the transformation of the ownership structure of companies with the arrival of UK/US-based institutional investors sustains or threatens the mode of coordination of companies. The globalization of financial markets and the greater mobility of capital across borders have not undermined the domestic institutions of work organization in France and Germany, a key institutional feature of these two models of capitalism. Moreover, the above-noted disparities in the investment allocation of institutional investors in France and Germany provide the methodological foundations to illustrate the impact of future developments in the two countries. My thesis is definitively context-specific but is not contingent upon the absence of change in the future. The point is not about having a better crystal ball, but about succeeding in embedding the argument in a process of causal complexity whereby the occurrence of change on the dependent variable, and the manner in which change is taking place, can be assessed and characterized. The focus on the institutional arrangements of workplace organization in France and Germany should not be interpreted as an advocacy that a single institutional variable can account for the differences in the investment allocation of UK/US-based institutional investors. The argument presented in this book is embedded in a process of complex causation where outcomes result from intersections of conditions (see Ragin, 1987). The importance of causal complexity highlights the crucial role of the ontological foundations in social sciences, namely that important political and social outcomes have more than a single cause (Hall, 2003, 2010a). Two institutional variables serve as important contributors to the dependent variable: the legal protection of minority shareholders and the arrangements of workplace organization that shape the process of coordination of activities. Nonetheless, I seek to build on but also move beyond the importance of the combinatorial effects of institutional variables. The presentation of the notion of context as hierarchy serves to provide an assessment of the relative strengths of the different independent variables that are part of a phenomenon of complex causation (see e.g. Goldthorpe, 1997; Goertz, 2006). The aim is to highlight how one element of a pattern of complex causation offers greater, but not exclusive, insights for capturing the values taken by the dependent variable.1 The notion of context as

1

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See also the discussion of the concept of concomitant variation in Chapter 1.

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hierarchy illustrates the relative explanatory strength of institutional variables: the hierarchically superior causal variable contributes to the value by the dependent variable; the hierarchically superior causal variable also shapes the relationship between other causal variables and the dependent variable (Goertz, 1994; see also Falleti and Lynch, 2009). The notion of context as hierarchy was also operationalized in the form of necessary/sufficient conditions but with a departure from existing research. Important social phenomena are increasingly presented in terms of necessary/sufficient conditions but without seeking to account for the uneven distribution of what is a necessary/sufficient cause across settings (Mahoney, 2004). The fact that what is necessary/sufficient in one setting is not necessarily so in another should not be interpreted as a lack of a constant relationship between variables but rather as a reflection of the importance of the context in which actors are embedded (Goertz, 1994). The uneven distribution of necessary/sufficient conditions across settings illustrates the presence of significant institutional differences in terms of what needs to be undertaken in order to produce change. The panoply of institutional factors and the full range of patterns of mobilization that are needed to generate a given outcome are different across advanced capitalist economies (Hall, 2010a). Necessary and sufficient conditions play a different role in this process. Necessary conditions are interesting in two ways. They can, for example, highlight the importance of a variable in its absence (Braumoeller and Goertz, 2000). Could the occurrence of new values on the dependent variable occur without the presence of a specific independent variable? The answer would be negative in the case of a necessary factor. Moreover, the concept of necessary conditions illustrates how institutional arrangements can act as barriers against future developments by restricting the range of options if not present (Goertz, 1994: 20–5). The contribution of sufficient conditions, in contrast, deals with potential scenarios when institutional barriers are removed. The notion of sufficient conditions is insightful since it enables a move beyond the equilibrium of institutions as barriers. Sufficient conditions are geared toward future developments. What happens in the presence of institutional change? Would the removal of institutions as barriers be sufficient to generate a specific outcome? If the answer is positive, then the removal of institutional barriers should be interpreted as the last stumbling block to the dependent variable taking a specific value. A negative answer, on the other hand, illustrates the difficulties associated with the introduction of change into any pattern of complex causation (Hall, 2010a). The concept of sufficient conditions illustrates how an embedded argument in solid 163

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research methodology is resistant to the advent of change in the “real” world of political economy. The discussion of necessary/sufficient conditions was illustrated through the concept of the ownership structure of companies in Chapter 3. The rationale was the following. From the law and economics perspective, the systems of corporate law and protection of minority shareholders in France and Germany are better placed to deal with agency costs arising from the self-serving behavior of managers in situations of ownership diffusion as compared to the focus on private benefits of control by the controlling shareholder in concentrated ownership settings. The expectation is that Anglo-American institutional investors are likely to primarily target companies without a controlling shareholder. Companies with ownership diffusion are thus more likely to prove more attractive. However, the data presented in Chapter 3 cast serious doubts on this prediction of the law and economics perspective. In the first place, a substantial number of companies with ownership concentration in the two countries have been targeted by institutional investors – thereby highlighting the limited character of ownership structure as a necessary condition. Secondly, the presence of ownership diffusion, the ideal scenario for the law and economics perspective, generated different outcomes in France and Germany. The quasi-totality of French firms with ownership diffusion has been targeted by foreign institutional investors while several German companies with ownership diffusion have not been targeted. The presence of ownership diffusion constitutes a sufficient condition in France, but not in Germany. Why is this outcome important? As previously mentioned, the set of legal reforms in relation to minority shareholders in France and Germany was unconnected to issues related to the organization of work. For instance, legal reforms in Germany were aimed at reducing the power of banks in corporate governance and were embedded in a broader electoral strategy of economic modernization of the SPD whereby the interests of middle-class voters could be reconciled with the traditional working-class electoral base (Cioffi and Hoepner, 2006). Nonetheless, the impact of these legal reforms (independent variable) on inward capital flows (dependent variable) are mediated by the context in which they are embedded, namely the organization of work that prevents the unilateral implementation of strategies of adjustment in Germany. The impressive set of legal reforms designed to further protect the legal rights of minority investors in Germany is not, then, sufficient to make domestic firms attractive to short-term investors.

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Thus, the role of politics is important but circumscribed in a specific manner. Politics was influential in shaping the institutional content of work organization of large companies in France and Germany that, in turn, contributed in a hierarchical manner to the value taken by the dependent variable in this study. However, the influence of politics over the formation of the hierarchically superior causal variable, that is, the institutional context, also highlights its limits. The impact of political developments in other areas, such as the pro-minority shareholder legal reforms, remains limited precisely to the prior constitution of the hierarchically superior causal variable. Politics is part of a process of complex causation where several causal variables are at work but where the institutional context mediates the relationship between other causal variables and the dependent variable. In other words, the influence of politics over the institutional content of one causal variable is more important than political developments in other institutional spheres.

6.2 Varieties of Capitalism and the 2008 Financial Crisis History never stands still. The financial crisis of 2008 and the ensuing economic downturn, first felt as a banking crisis, presents challenges for the analysis of diversity across capitalist economies. The worldwide economic downturn has revived interest in the inherent instabilities of capitalism, most notably the tensions between the constantly selfdriven expansions of market relations with capitalism’s own need for consumers (Crouch, 2009). Moreover, the widespread diffusion of the economic downturn suggests that commonalities across and interdependencies between national models of capitalism could prove more important than their differences (Streeck, 2008; 2010). The rather “uneventful” evolution of French and German corporate governance in regard to the implementation of strategies of shareholder value contrasts with the depth of the current crisis as a challenge to institutional diversity. The world of international finance is experiencing a potentially deeper transformation. The economic downturn is an ongoing process which strongly militates against the presentation of definitive theories and predictions. Instead, I would suggest that two key concepts presented in this book are insightful for the analysis of the crisis: the interactive dimensions of complex causation, and the distinction between the dominant character of coordination within varieties of capitalism and the institutional framework supporting it. A first concept is that the origins of the financial crisis are best understood through a process of interaction and 165

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complex causation with strong variation across national settings. The presence of a combination of conditions is required in order to generate a specific outcome. The implication is that the intersection of many conditions is context-specific and unlikely to be present in all settings. The financial crisis and the ensuing economic downturn have impacted economies in different ways. For instance, the subprime housing crisis in the United States highlights the importance of the interaction of different factors at both macro- and micro-levels: the excesses of overleveraged households, lax supervision and regulation of the financial system, loose monetary policies, structures of incentives and compensation tied to short-term profits and excessive risk taking, a favorable borrowing context that witnessed large flows of cross-border funds in the United States, and the ability of banks to proceed to funnel the mortgages to Wall Street institutions where they were turned into complex financial products (securitization) and sold to less-informed foreign investors often unable to properly assess the risks inherent in the original transactions (Coffee, 2006; Soskice, 2007; Shiller, 2008; Gourevitch, 2010; Roubini and Mihm, 2010: 13–37; Soskice and Iversen, 2010). As previously argued, the impact of a single policy should not be seen in isolation since its impact varies according to the national institutional configuration in which it is embedded (Hall, 1994). This is particularly evident in the behavior of homeowners in the United States who viewed their dwelling as an investment whose value was assumed to be constantly rising (Davis, 2009: 1–30). Through debt restructuring designed to take advantage of the tax deductibility of mortgages, homeowners come to rely on increases in house prices that were increasingly unconnected to their employment income to fund consumer spending (see also Crouch, 2009). They were able to undertake vast amounts of risks through leveraged instruments but without any corresponding undertaking of the full consequences and responsibilities of their actions. The subprime housing crisis illustrates the fact that that easiness of access to mortgages does not of itself account for the depth of the crisis but rather that the “portfolio investment” behavior of American homeowners reinforced the financial problems. The second key concept is that the responses of national governments to the financial and economic crisis requires an analytical distinction between the dominant character of coordination within varieties of capitalism and the institutional framework supporting it. The presence of interdependencies between national economies (Streeck, 2010) and the crucial role of institutional investors in the propagation of economic shocks (Kaminsky et al., 2003) would point 166

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to the irrelevance of the origins of the crisis. The economic downturn has spread across advanced capitalist economies and, moreover, has generated a flurry of responses by national governments whether or not initially hit by the problems of financial institutions (Posch et al., 2009). Moreover, the exports of coordinated market economies have been negatively affected by the economic recession in other countries.2 The economic interdependencies between capitalist economies could suggest that the study of commonalities is becoming more important than that of diversity. Nonetheless, the reaction of national governments to the financial crisis has been sharply divergent (Hall, 2009; Soskice, 2009). The Keynesian state has made a comeback but the content of policy stimulus differs. The key issue is whether the specific contours of Keynesian demand management policies impact on the dominant process by which firms coordinate their activities within varieties of capitalism. The dual challenges of promoting economic growth and employment while reducing budget deficits generated different responses by different national governments. These policies are driven by differences in the configurations of political institutions, the free floating or fixed character of exchange rates, reliance on exports or domestic consumption to maintain growth, diverging institutional starting points in skill formation, and political narratives by which governments have justified the implementation of austerity and expansionary measures (Berger, 2009; Hall, 2010b). In Germany, the specific content of Keynesian demand management highlights the importance of the firm-specific character of skills (Hall, 2009, 2010b). The focus of initial demand package stimulus was on the preservation of existing, highly skilled jobs. A key element of the rescue package was the award of subsidies to companies for covering the costs of retaining employees who were put on a part-time schedule. Preventing job losses for those with firm-specific skills is important, given the credibility of commitment associated with the provision of skills that are limited to specific settings. Not only would dismissed employees find it hard to find employment given the nontransferable character of their

2 Although it is not surprising that export-oriented economies have been hard hit in the short-term from an international decline in consumer demand, the key question is whether these economies will retain the manufacturing capabilities and their competitive advantage in areas of incremental innovation (see Berger, 2009). Will the policy responses by policymakers in those economies contribute to the sustainability (or reproduction in different forms) of the institutional framework that sustains the mode of coordination of economic activities at the firm-level and the process by which firms develop their innovative capabilities?

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skills, but the willingness of future cohorts of workers to invest in firmspecific skills could be negatively affected (see e.g. Estevez-Abe et al., 2001). By contrast, the content of Keynesian demand management in liberal market economies highlights the importance of consumer demand to restore growth (OECD, 2009). Tax cuts and public spending on infrastructure have been prominent aspects of the attempts by policymakers to generate growth. The content of policy responses in liberal market economies is ironic given the previous reliance on indebtedness for the stimulation of aggregate demand. Privatized Keynesianism in the United Kingdom and the United States was designed as an economic and political strategy to secure political consent for deregulatory policies by enabling people with median or below-median salaries to keep on consuming despite their stagnant character of their real income (Crouch, 2009). Governments promoted access to housing, favored the import of cheap consumer goods from low-income countries, and supported the expansion of credit through the deregulation of the financial sector (Hall, 2010b). Privatized Keynesianism, however, proved economically difficult to sustain given the limits to indebtedness. Politically, the idea of debt to sustain consumption has unfortunately proven more resilient.

6.3 Concluding Remarks No self-respecting economist, political scientist, or sociologist today ignores the importance of institutions. Along with this heightened interest in institutional arrangements, and in the presence of diversity found across advanced capitalist economies, social scientists have become deeply interested in processes of change (Hall, 2007; Streeck, 2008; Hall and Thelen, 2009). Analyses that would capture differences between countries at one point in time, but that otherwise fail to comprehend the impact associated with processes of institutional transformation, are of limited use in an era of widespread change. This study of cross-border capital movements in France and Germany is closely concerned with this interest in institutional change. An important aspect of the evolution of corporate governance in the two countries is the transformation of the ownership structure of large, listed companies. Foreign institutional investors, especially UK/US-based shareholder value-oriented funds, have become important equity holders in French and German corporations. However, the rise in importance of foreign financial capital in the two countries does not in any way negate the crucial importance of institutional diversity between different 168

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systems of corporate governance. I conclude with three broad remarks regarding the role of institutions, and the importance of institutional change, which form the core insights of this study. First, the process of interaction between institutions remains crucial for the study of capitalist diversity even under conditions of institutional change (Hall and Gingerich, 2009). The impact of a single institution is shaped by the specifics of its interaction with other institutions according to the institutional configuration in which it is embedded (Hall, 1994; Hall and Franzese, 1998). There are two scenarios of institutional interaction (Valdivielso del Real, 2009). The first one is that of stable institutions mediating the impact associated with new developments. Variations in institutional frameworks across advanced capitalist economies result in divergent responses to changes in the world economy – an analysis made as early as the mid-1970s (see Katzenstein, 1977). The second scenario is characterized by the interaction between stable institutions and other institutional arrangements that have themselves been undergoing a transformation resulting from the presence of an external stimulus. The analysis of piecemeal institutional developments, that is, change in the value of some but not all institutions, is well accommodated by the Varieties of Capitalism perspective. The impact of piecemeal institutional change is characterized by variations between advanced capitalist economies given the presence of divergent institutional starting points (Thelen, 1993; Locke and Thelen, 1995; see also Kogut et al., 2002). These scenarios of institutional interaction entail that even similarly designed, and thus apparently similar, institutional reforms will lead to sharply distinct consequences because of diverging institutional interaction effects (Hall and Thelen, 2009: 23). For instance, legal reforms to improve the position of minority shareholders in the two countries (Cioffi and Hoepner, 2006; Tiberghien, 2007) have provided foreign investors with different incentives. The existing concentration of power in top management in France suggests that the underdeveloped legal rights for minority shareholders constituted the last stumbling block for the acquisition of blockholding positions in French firms. The impressive legal reforms undertaken by German policymakers, by contrast, have failed to convince short-term investors of the attractiveness of German companies for their short-term strategies (see e.g. Deeg, 2005a). Thus, the responses of firms and advanced capitalist economies to economic shocks are driven by existing institutional interaction effects. In other words, the direction of change is institutionally conditioned (Hall, 2007). Second, institutional frameworks limit the range of available adjustment strategies to firms and other actors when confronted by external 169

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stimuli in two ways. The first is that institutions act as a barrier to change by precluding certain adjustment trajectories (Goertz, 1994: 20–5). The presence of specific institutional arrangements acts as a (quasi) veto power over the undertaking of specific tasks. In other words, the removal of specific institutional arrangements constitutes a necessary condition for increasing the range of possible options. The second is that institutional frameworks preclude particular adjustment paths because they rely on the presence of other institutions. Institutions are often the targets of the strategic behavior of actors given their influence over important outcomes (Calvert, 1995; see also Gourevitch, 1999). Institutions are not simply a matrix of incentives and constraints to which actors adjust passively (Whittington, 1988; Morgan, 2005; O’Sullivan, 2007; see also Hancke´ and Goyer 2005). Actors can learn to operate within specific institutional frameworks with the implication that similar institutions can lead to different outcomes. Nonetheless, the behavior of actors seeking to capture institutions is conditioned by the presence of not one but a number of institutions (Hall, 2005; Hall and Thelen, 2009: 11–15). A prior analytical step is therefore to investigate the range of adjustment strategies associated with institutional frameworks. For instance, the presence of short-term investors in France cannot provide an assessment of the relative importance of shareholder activism versus that of the superior selection ability of fund managers, but the fact that this debate is possible for the French case reflects the importance of the context-specific institutional arrangements of workplace organization. The undertaking of shareholder activism in Germany would be riddled with an additional problem, namely the ability of firm-level works councils and employees to resist change even if management adopts the shareholder value maximization mantra. Third, the occurrence of institutional change may be limited to one subsector of the economy without spilling over into others for two reasons. The first is that institutional change takes place outside the hierarchically superior causal variable, with the consequence that the effects associated with the new institution on the dependent variable is strongly mediated. The hierarchically superior causal variable impacts on the relationship between the new institutions in other spheres of the economy and the value taken by the dependent variable. The above example of the legal reforms of the rights of minority shareholders in France and Germany illustrates this dynamic. The presence of differences in the organization of work in the two countries strongly influences whether the process of legal reforms will be sufficient to convince foreign shareholders to acquire blockholding positions in French and German companies. The second reason is that the occurrence of 170

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institutional change on the hierarchically superior causal variable does not necessarily result in radical change. The impact of institutional transformation on the hierarchically superior causal variable requires an analytical distinction between the character of coordination from the institutions that support it (Hall, 2007; Hall and Thelen, 2009). The presence of many institutional changes in the organization of work in France and Germany (see Section 5.6 in Chapter 5) has left unchanged the specific content of the capacities for strategic coordination in the two countries. Power remains concentrated in top management in France, yet corporate executives in Germany face significant constraints on their ability to implement restructuring schemes in a unilateral fashion. The occurrence of institutional change in both France and Germany has been profound. The interesting issue is not whether shareholder value (in the form of blockholding acquisitions) is compatible with the French and German political economy, but how and under what conditions. The methodological debate regarding the impact of important developments in the world economy is not about stability versus change, but about how domestic features of national economies interact with external developments to result in different types of change. Therefore, varieties of capitalism are alive and well and playing in Greenwich (CT), Paris, and Wolfsburg. Where did I hear that before?

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Index

Achleitner, A.-K. 1, 72 n., 73 n., 158 actively-managed mutual funds 16, 66, 71, 90, 128 decision-making process 129, 130 financial returns 68 firms attractive to 133 hedge funds share common features with 69 holding period for 132 incentives 64, 123 investment allocation 2, 74 investment strategies 67, 113 relative performance for 131 structural characteristics 132 time horizons 2, 62–3, 69 top portfolio companies for 67 advanced university degrees 56, 58, 59 agency costs 10–11, 164 institutions aimed at reducing 11 lessening 37 minimization of 17 types of 11, 12, 84, 86 Aguilera, R. 12, 15 n., 56, 57 n. Allen, C. 16, 22 n., 28, 29, 30, 124 Amable, B. 7, 47 Anglo-American institutional investors 54, 96 acquisition of concentrated equity stakes 51 differences between categories of 61–9 international diversification 53, 54, 92 international expansion 20, 92 investment allocation 40, 55, 56 large-scale portfolio investments 61 local fit and capital flows by 75 minority shareholders targeted by 42, 44 preferences/strategies of 48 primary investment targets 71, 86, 164 settings previously insulated from 1 Annuaire des Socie´te´s 71 n. Aoki, M. 127 Applebaum, E. 73 n. apprenticeships 140, 149 arbitrage 63

Austria 22 n. Bandru, D. 63, 132 bankruptcy 84, 90 Barclay, M. 91 n. Barker, R. 74 Batt, R. 73 n. Bauer, M. 56, 57 n., 58 Bennett, A. 115 n. Benoit, B. 138 n. Berger, S. 2, 3, 5, 6, 18, 21, 35, 45, 124, 125, 130, 167 Bertin-Mourot, B. 56, 57 n., 58 Bessiere, V. 61 Beyer, J. 40, 127 Birk, R. 87, 89 Black, B. 96 n. Blanchard, O. 40, 156 blockholding acquisitions 39, 43, 60, 134 concentrated 63 impatient shareholder value-oriented funds 76 last stumbling block for 163, 169 ownership diffusion a quasi-sufficient for 9, 37, 123, 130 blue-chip companies 87, 92 attractiveness of 2 large, lack of availability of 98 leading index for continental Europe 54 ownership structure more diffused 127 blue-collar workforce 124, 145–53, 157 responsibilities 139–48, 154 skills 16, 133, 142 n., 146–48, 152, 155, 156 n. vocational training and promotion 141 bonds 55, 63 deregulated market 52 Boolean algebra 6 n., 7 n. Bornstein, S. 29 Bo¨rsch, A. 16 n., 35, 40 n., 42, 55, 70, 119, 125, 133, 136, 138, 148, 152 Bosch, G. 149, 153 Boyer, R. 2 n., 31, 47, 142

199

Index Brandes 132 Braumoeller, B. 33, 39, 44 n., 107, 108, 110, 115, 117, 118, 121, 122, 163 Brav, A. 2, 34 n., 67, 73, 76 n., 132 Britain 14, 22 n. devaluation of the pound (1992) 63 n. pension funds 66 trade unions 29 Brown, K. 65 n., 68, 131 n. Brown, S. 65, 67, 72, 132 budget deficits 27, 167 Bundesbank 29, 30 Busemeyer, M. 40 n., 140, 141 business associations 28, 141, 143 California Teachers (retirement systems) 63, 68 Callaghan, H. 126 Campbell, J. 4, 7 n., 8, 70 Canada 71 n. capital controls: removal of 5, 40, 52, 73, 112, 113, 158, 159 restoration of 53 capital flows: authority over the direction of 53 cross-border 52 empirical measurements of 70–74 inward 73, 164 local fit and 75 outward 51 removal of control on 5, 73 role of policymakers in regulating 112 Capital Group 132 capital mobility 1 law and economics and 84–105 removal/disappearance of barriers to 20 short-term 51–83 uneven across borders 15 Caramani, D. 106, 115, 116 cash flows 91 large 34 n. release in the form of dividends 129, 131 return on investment 54 causal complexity, see complex causation causal inference 33, 36 n., 42, 43, 106 ordinal strategy in small-N studies 120 n. qualitative strategies of 113 specific methodological tools for 115 causal variables 7, 33, 111, 119 analysis of complexity and hierarchy between 39 crucial 133 hierarchically superior 7–8, 9, 10, 38, 41, 42, 49, 123, 128, 163, 165, 170, 171

200

hypothesized 9, 42, 47–8 interaction between 122–3 multiple 34, 46 n. necessary/sufficient 110 relationship between dependent variables and 123, 163, 165 relative strength of 123, 124 some matter more than others at specific points in time 32 causation/causality 6, 8, 20, 134 causes-of-effects 107, 115 combinatorial 110 conceptualization of 33, 108 conjunctural 33, 44, 45, 108, 112, 121, 122, 126 n. heterodox-probabilistic understanding of 36 n., 37 n., 38, 46 probabilistic 45, 119 n., 120 see also complex causation CEDEFOP (European Centre for the Development of Vocational Training) 143 central banks 52 control over the actions of 24 deflationary bias within 30 CEOs (chief executive officers) 58 n., 139 educational background 59–60 tenure of 59 CFDT (French trade union) 23, 26 CGT (French trade union) 23, 25, 26, 140 n. Chalban-Delmas, J. 23 n. Chan, K. 97, 98 Charest, J. 149 Charpail, C. 142 n. China 110 Cioffi, J. 38, 40, 46, 127, 159, 164, 169 civil service 24, 57–8, 59, 64 Clark, G. 2, 71, 75, 92, 97 n. class conflict 14, 22 n. Clifford, C. 39 Clift, B. 16 n., 25, 61 coalition formation 14, 18 n., 46 n. linking with institutions 17 coalitions 16, 18, 124–5 preferences of actors embedded in 19 three-actors model 17 codetermination 14, 15, 28, 30, 93, 136–7, 139 n. control at shop floor via 160 latest development in 32 Coffee, J. 1, 9, 11, 84, 95, 96 n. Cohen, B. 29, 51, 52, 55 Cohen, E. 58

Index collective bargaining 150 n. autonomy in 29 decentralization of 137 institutionalized (late 1960s) 22 n. substitute for 27 collective redundancies scheme 157 Commerzbank 95 Commission des Ope´rations de Bourse 65 n., 66 common causes 110, 111 communists 23, 25, 26 competitiveness 17, 28 lack of 27 complex causation 21, 41, 43, 44, 50, 129, 160 contextualized capitalisms and 106–28 difficulties associated with introduction of change into 163 forms of 33, 120–1, 122 importance of 4, 33, 34, 39, 41, 107, 109, 120, 162 institutions/institutional hierarchy and 35, 38, 49, 109–10, 124, 162 investment allocation of short-term investors embedded in 36 law and economics perspective in 37 multiple and conjunctural causes in 33–5 origins of financial crisis best understood through interaction and 165–6 politics in 45, 165 potential sufficient conditions in 48 n. qualitative, case study-oriented research research well suited to analysis of 32–3 Conac, P.-H. 87 n., 88, 89, 90 Conference Board 53, 62 conflict settlement 15, 124, 159 differences in 7, 119, 125 historical specificities of 21–32 location-specific 5–6, 8 politics reflected in 10, 33 specific content by which negotiated 15, 16 see also class conflict consensus political systems 17, 19 consumption 31, 167, 168 context 5, 7, 8, 9, 10, 20, 44 contextualized capitalisms 21, 106–28 Cools, S. 87 n., 90, 94 Cornelius, P. 53 corporate law 12, 37, 42, 50 protection of minority shareholders 86–92, 164 removal of directors 94 shortcomings in 95 courts 88, 89, 90, 156

covariance 43, 112, 115 creditworthiness 55 cross-shareholdings 54, 59 decline in 61 friendly 52 n. protection from unwanted takeover bids through 135 Crouch, C. 5, 16, 47, 124, 165, 166, 168 Cuervo-Cazurra, A. 56 n. Culpepper, P. 2 n., 4, 5, 13, 18, 28, 34, 35, 40 n., 46, 49, 60 n., 128, 133, 140, 141, 142, 143, 145, 154 n., 161 currency 112, 113 recipient-country risks and restrictions 53 transactions/trading 51, 52 Dafsaliens 1, 72 n., 158 Davis, G. 1, 11, 56, 61, 96, 97 n., 128, 166 DB (defined-benefits) schemes 62, 64 DC (defined-contribution) schemes 62 Deakin, S. 18, 40 n., 139 n. debt credit 24 debt-equity ratio 52 n. decision-making process: allocation of powers 94 decentralization at lower levels 155 early involvement of employees in 133 incorporation of employees in 32 management-led 2–3 number of actors involved in 131 participation in 6, 22, 28–9, 160 stages of 129, 130 strategic 136, 137 see also investment decisions Deeg, R. 4, 7 n., 8, 21, 41, 47, 70, 74, 95, 119, 148, 152, 169 Del Guercio, D. 62 n., 64, 66 Delaware 94 demand management 160, 167, 168 dependent variables 6 n., 7, 8, 9, 10, 19, 33, 36, 38, 39, 40, 41, 42, 43, 44 n., 45, 48, 49, 99, 108, 115, 119, 126, 127, 128, 164, 170 detailed and nuanced understanding of 113 impact of independent variables on 33, 122 likelihood of the occurrence of 120 market-enhancing developments impact on 46 necessary and sufficient condition between independent and 113, 121 occurrence of change on 162

201

Index dependent variables (cont.) presence or absence of 117 relationship between causal variables and 123, 163, 165 validity of logical inference between independent and 112 variation in 112, 114, 117–18 deregulation 40, 51, 52, 127, 154, 159 partial and piecemeal 151 political consent for policies 168 Deutsche Bank 95 Deutsche Bo¨rse 67 devaluation 63 n. Dion, D. 117, 120 n. disclosure 70–1, 85, 93 disinflation 28 dismissals 150, 151, 156, 157 divergence of interests 10, 11, 84, 85 dividends 2, 12, 67, 133 cash flows in the form of 129, 131 high 34 n., 66, 76 special 91 n. Dodge & Cox 132 Doeringer, P. 154, 155 dollar convertibility 52 Dresdner Bank 95 Durkheimian institutions 153 duty of care 85, 87 Dyck, A. 85, 91 n. Ecole Polytechnique 24, 57, 58 n. economic planning 160 state-orchestrated 29 economic stagnation 24 employment relations 18, 19, 40, 41, 135, 136 nonstandard 151, 153, 154 EMS (European Monetary System) 27, 52, 159 ENA (Ecole Nationale d’Administration) 24, 57, 58 Enriques, L. 37, 40 n., 46, 85, 87 n., 94, 95, 98 n., 127 equity-based finance 32 EU (European Union) 22, 144 n. directives 70–1, 87 financial regulation 67 n. internal market 73 single currency 53, 112, 113 Euro Stoxx indices 54, 71 exchange-rate stability 15, 53 exchange rates 25, 69 fixed 51, 167 explanatory variables 106, 112 exports 15 n., 51, 140, 151 n. negatively affected 167

202

Falleti, T. 8, 42, 44, 123, 163 FDP (German Free Democratic Party) 30 n. feedback loops 19 n., 20 Fidelity 63, 65, 69–70, 132 fiduciary duties 85, 87 Fifth Republic (France) 25 financial crisis 1, 50 varieties of capitalism and 165–8 financial markets 52, 77 broad access through low management fees 63 concern to avoid surprising with unexpected bad news 54 global 158, 162 key first-order condition for 13 liberalization of 52 picking firms currently undervalued on 68 Financial Times 138 n. Finnemore, M. 53 n. firm-level institutions 30, 34, 35, 36, 37, 111, 113, 114, 131–48 constraints imposed on management 3, 16, 22, 28, 29, 133, 135, 136, 148, 151, 160, 161, 171 importance of 9 see also institutional arrangements firm-specific knowledge 66, 132, 146 first-past-the-post, see majoritarian political system fiscal policy 24, 29 Fiss, P. 15, 32, 55, 56–7, 158 Florida State (public pension fund) 63 Fordism 31 foreign exchange 51, 53 see also exchange rates Franks, J. 52 n. Franzese, R. 19 n., 30, 33, 46, 109, 121 n., 122, 169 Frieden, J. 45, 51, 52, 53, 112 Fung, W. 53, 62, 69, 72, 131 n. fuzzy-set approach 6 n., 120 n. Gallie, D. 2 n. Garrett, G. 17, 31, 51, 130, 158 GDP (gross domestic product) 54, 69 worldwide 51 George, A. 115 n. Gerring, J. 36 n., 120 Gilson, R. 4, 6, 12, 21, 96, 124, 153 Gingerich, D. 19 n., 48, 109, 169 Glynn, A. 51 Goertz, G. 7, 8, 20, 33, 42, 43, 44 n., 48 n., 114, 115, 117, 118, 123, 126 n., 127, 128, 162, 163, 170

Index Goetzmann, W. 65 Goldthorpe, J. 7, 35, 110, 119, 162 Gourevitch, P. 1, 3, 4, 5, 6, 7, 12, 13–14, 16, 17, 18, 19, 20, 21, 29, 34, 54, 61, 69, 85, 92 n., 95, 96 n., 98 n., 124, 135, 166, 170 Goyer, M. 2 n., 4, 8, 9, 15–16, 22, 34, 36, 40, 42, 46, 55, 61, 69, 70, 75, 76 n., 77, 87, 88, 122, 123, 125, 126, 133, 136, 161 Gradante, C. 73 Grandes Ecoles 57, 59 Grands Corps 57, 58 Greve, H. 56 Gumbrell-McCormick, R. 136, 139 Gymnasium 149 Hall, P. 2, 3, 4, 6, 7, 8, 18, 19 n., 21, 23, 24, 27, 29, 30, 33, 34, 35, 42, 44, 45, 46, 47 n., 48, 70, 77, 108, 109, 112, 119, 121 n., 122, 123, 124, 125, 126, 130, 145 n., 161, 162, 163, 166, 167, 168, 169, 170, 171 Hancke´, B. 2 n., 15–16, 22, 35, 58, 73, 126, 135, 136, 139, 143, 144, 154 Hansmann, H. 87 n., 88, 94 Hartz reforms 151, 153 Hawkins, J. 62 n., 66 Haxhi, I. 56 n. hedge funds 1, 2, 16, 67, 70, 71, 128, 158 actively-managed mutual funds share common features with 69 attractiveness of market for 130 average holding period 72–3, 132 decision-making process 72, 129, 130 highly incentivized remuneration packages 123 holding period for 132 incentives faced by 64 investment allocation 2 investment strategies 3 shareholder value 76 short-term-driven investment decisions 131 structural characteristics 132 time horizons 63, 123 turnover rates 72–3 Hendry, J. 54 Hennessee, L. 73 Herrigel, G. 12, 32, 58, 125, 137, 150, 152 n., 156 n. Hertig, G. 87 n., 89, 90 heterodox-probabilistic terms 36 n., 37 n., 38, 46

Hoepner, M. 15, 16, 21, 32, 38, 40, 41, 42, 46, 47, 54 n., 60 n., 119, 125, 126, 127, 128, 148, 150 n., 159, 161, 164, 169 Holderness, C. 91 n. Hoppenstedt Aktienfu¨hrer 60, 71 n. Hopt, K. 137 Howell, C. 3, 16, 22 n., 23, 27, 124 Hsieh, D. 53, 62, 69, 72, 131 n. Hyman, R. 5, 136, 139 IAS (International Accounting Standards) 87 IG Metall 147, 150 n. imports 51 incentive fees 67, 132 incentives 2, 11, 43, 85, 133, 142, 158, 166, 169, 170 compensation 68 financial 63, 64, 65, 66, 131 fiscal 151 labor organizations 24 limiting 16, 30 managerial 16, 61, 69, 144 political 61 remuneration 61, 123 shareholder 34 skilled employees 146 workers to become union members 27 independent variables 19, 36 n., 108, 123, 126, 164 absence/lack of variation in 117, 118 average causal effects of 107 causal impacts of 114 critical 35 hypothesized 7–8, 9, 34, 41, 43, 107, 111, 120 n., 122 impact on dependent variables 33, 122 necessary and sufficient condition between dependent and 113 necessary without ever being sufficient 121 validity of logical inference between dependent and 112 whether causally relevant 109, 110 industrial relations 20, 26, 150 antagonistic nature of 144 legal apparatus of 151 politicization of 23, 25 state autonomy in 27 inferences: descriptive 115 faulty 49 logical 7, 106, 107, 112 theoretical 61 see also causal inference

203

Index inflation 24, 29, 52 Inspection des Finances 58 institutional arrangements 2, 3, 10, 12, 22, 56, 109, 111, 113, 114 characterized by top managerial power in France 133 differences between 146 diversity in 5, 7, 13 identified by VoC 9, 19n., 36, 123 paths of adjustment and 35, 148–57 shareholder value and 93 variation in 131, 134 see also legal-institutional arrangements institutional change 46, 47, 49, 119, 121, 127, 148, 152, 153, 163, 168, 171 full-scale 5 importance of 169 impressive 8 incremental 4, 5 limited to one subsector of the economy 170 major 154 piecemeal 5, 19 n., 121, 125, 169 total absence of 8, 161–2 institutional complementarities 19 n., 41, 46, 48, 49, 109, 110 reembedding of the concept 45, 47 institutional diversity 5, 15, 49, 109, 111 crucial importance between different systems 168–9 current crisis as challenge to 165 politics and 10–21 institutional investors, see Anglo-American institutional investors; hedge funds; insurance sector; money managers; mutual funds; pension funds institutional variables 18 n., 21, 121 causal effects of 7 combinatorial effects of 162 hierarchical character of 5, 6, 32–41, 42, 44, 46 n., 109, 122, 125, 126, 129 relative explanatory strength of 163 relative importance of 118–19 insurance sector 58 n., 59 interest rates 28, 52, 112 international diversification 53, 54, 92, 128, 158 international expansion 20, 92 international finance 158, 165 developments in 51–5, 61, 134 international trade 51 INUS conditions 33, 122 invariant patterns of association 43, 112, 113, 114

204

Investment Act (US 1940) 72 Investment Company Institute 62, 72 n., 132 investment decisions 30, 70, 72, 131 free float and 97 importance of home bias in 97 nature of corporate restructuring important for 130 specific guidelines on 62 n. strategic 72 Italy 29 Iversen, T. 166 Jackson, G. 15 n., 32, 56, 57 n., 119 Jackson, J. 108 Japan 13, 52 n., 56, 71 n., 127 high-performance management techniques 154–5 informal arrangements and social norms 14 skill formation of shop floor employees 156 n. Johnson, S. 91 n. Jung, D. K. 76 n., 133 just-in-time technique 154, 155 Kahan, M. 67, 96, 134 Kanda, H. 87 n., 89, 90 Katzenstein, P. 4, 7, 169 Keohane, R. 106 Kepel, G. 6, 21 Keynesian policies 31, 160, 167, 168 Kho, B.-C. 97, 98 n. Kim, E. H. 96, 97 n. Kim, H. 57 King, G. 44 n., 106 Kirpichevsky, Y. 33, 108 Kogut, B. 6, 7 n., 45, 53, 56, 59, 60 n., 61, 169 Kontrag Law (Germany 1998) 88, 94, 95 Kraakman, R. 87 n., 88, 94, 96 Krempel, L. 54 n., 60 n., 128 labor market rigidities 15 labor markets 23, 24, 25 deregulation of 40, 151 external 59, 131, 138, 146, 156 n. internal 59, 157 nonstandard employment relationships 151, 153 potential changes in regulation of 41 secondary 152 white-collar employees 157 labor organizations 21, 22, 23, 24, 25, 28–9, 45, 124, 136, 140 n., 160 see also trade unions; works councils

Index Landier, A. 40, 156 Lange, P. 17, 23, 25, 27, 29, 31, 51, 130 LaPorta, R. 9, 11, 12, 34, 37, 84, 86, 130 law and economics perspective 13, 34, 35, 36, 41, 43, 77, 107, 129 and capital mobility 81–105 essential feature for 42 focus of early studies 11 hierarchically inferior position of 40 ideal scenario for 45, 164 most important and determining factor for 9 relationship between investment allocation of short-term investors and 37 shortcomings associated with 12, 130 supposed superior explanatory power of 48 VoC versus 39 layoffs 13, 157 left-wing political parties 23 legal-institutional arrangements 9, 11, 12, 84, 86, 87 Lehndorff, S. 151, 152 Levy, J. 16, 23, 25, 26, 28 liberal market economies 18–19, 127, 153, 158 Keynesian demand management in 168 liberalization 15, 16, 20, 150 financial 52, 68 fixed-term contracts 40 rules on dismissals 156 trade policy 73 Lieberson, S. 6, 33, 35, 36 n., 113, 116 n., 119, 120 Linhart, D. 25, 144, 145, 146, 155 liquidity concerns 61, 63, 69, 132 Locke, R. 2, 6, 45, 169 Lukauskas, A. 52 n. Lynch, J. 8, 42, 44, 123, 163 McDonald, I. 65 Mackie, J. 6, 8, 33, 42, 122 macroeconomic factors 69, 113 Macy, M. 56 n., 75 Mahoney, J. 4, 6, 33, 35, 36 n., 38, 44 n., 107, 110, 111 n., 112, 113, 114, 115, 120, 122, 163 majoritarian political system 18, 19 Malo, M. 156 managerial autonomy 10, 37 constraints on 22, 28, 135, 160 managerial opportunism 13, 86, 95 constrained 87, 161 institutions aiming directly at curbing 85

lessening agency costs driven by 37 Marginson, P. 138 n. market capitalization 17, 68, 73, 98 largest/top sixty firms by 71, 74 sharp drop in 54 strategies/policies designed to boost 2, 70, 97 Markovits, A. 16, 22 n., 28, 29, 30, 124 Marsden, D. 139, 142, 143, 144, 145, 147 Marxist theory 25, 26 mass production 31 Maurice, M. 2 n., 16, 22, 34, 35, 46, 58, 77, 123, 124, 125, 131, 133, 140 n., 144, 145, 146, 147, 154 n., 161 Mayer, C. 24, 52 n. Mayer, M. 57 n., 98 n. Meardi, G. 154 n. Merton, R. K. 4, 44, 121 method of difference 109, 111–14, 119 mid-level variables 3–4, 35 Milgrom, P. 41, 109 Mill, J. S. 109, 114, 119 minimum wage 27 n. minority shareholders 18, 94, 161, 165 control at the expense of 11, 34, 50, 91 interests of 14, 19, 93 legal reforms to improve the position of 169 willingness to acquire equity stakes 84 see also protection of minority shareholders; rights of minority shareholders Minow, N. 64, 67, 96 mode of accumulation 6, 25 state-centered 26 mode of production 21, 31 monetary policy 24, 28 absence of autonomy 51 employment-friendly 29 loose 166 significant convergence in 73 money managers 62, 63 Monks, R. 64, 67, 96 Moody’s 55 Moore, B. 113 n. Morin, F. 16 n., 25, 52 n., 54 n., 60 n., 96 n., 97 n., 126, 135 Mundell-Fleming conditions 51 mutual funds 98, 114, 158 assets under management 53, 62 compensation of managers 64, 65 conflicts of interest 97 n. investment allocation 74 investment strategies of 3 long-term-oriented 74

205

Index mutual funds (cont.) managerial remuneration 131 performance of 62, 64–5 regulatory constraints 70, 72 short-term-driven investment decisions 131 mutual funds turnover rates 72 n., 74 see also actively-managed mutual funds; passively-managed mutual funds National-Socialist Party (Germany) 29 necessary conditions 37 n., 44 n., 45, 93, 111, 119, 126, 163 limited character of ownership structure as 164 removal of specific institutional arrangements constitutes 170 testing of 115–17 trivial 117, 118 necessary and sufficient conditions 6, 7, 8, 33, 36 n., 110, 113, 114–22, 163, 164 qualitative studies rely on 107 Nenova, T. 85, 88, 91 n. Nguyen-Dang, B. 58 n. OECD 39, 151, 156, 157, 168 on-the-job training 141, 142, 143, 156 n. O’Sullivan, M. 16, 18, 42, 52, 170 ownership diffusion 11, 14, 50, 111 n., 130 companies targeted by short-term investors 9, 20, 36 n., 37, 42, 44, 45, 48, 86, 95, 97, 99, 164 dominance of firms with 84 emergence of 10 growing 20, 43, 45, 48, 128 magnitude effect of 38, 43, 124, 128 move toward 41 self-serving behavior of managers in 164 settings characterized by 37 n., 45, 54, 85, 86, 97 n., 99, 123 spread of 40 Palier, B. 40, 151, 152, 153, 156 Palpacuer, F. 40 n., 139, 157 Paris Bourse 90 passively-managed mutual funds 62, 63, 66, 68, 72, 76, 96, 132 P/E (price-earnings) ratio 74–5 pension funds 17, 49–50, 68, 69, 96, 131, 132 defined-benefits schemes 62, 64, 67 growing recourse to indexing 66 term horizons 63 Piore, M. 21, 31 Pistor, K. 89 politics 25, 45, 123, 159–60, 165

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and institutional diversity 10–22 structured across spaces and over time 46 n. Pozen, R. 62, 67 preference aggregation 18 preference formation 2, 17, 18 n. preferences 14 n., 16, 19, 20, 22, 35–6, 39, 48, 49, 52 n., 123, 124, 128, 130, 131, 133, 148, 151, 159, 161 changing 153 constant 4 defined 67 managerial 134 national 53 nonfinancial corporations for bank borrowing 52 n. political 51 translation into policy 17 voting 95 wide range of 135 widely diverging 61 Prigge, S. 30 n., 137 privatization 20 probability 36 n., 65 n., 120 see also heterodox-probabilistic terms problem-solving 144 autonomy of employees in 135, 146–8 involvement employees in complex activities 131 productivity 31, 152 proportional representation, see consensus political systems protection of minority shareholders 3, 13, 35, 36 n., 37 n., 38, 40, 42, 95, 107, 130 corporate law and 86–92, 164 impact of 123 increased 127, 160 investment allocation of short-term investors 9 shareholder activism and 96–8 public policy 17–18 qualitative analyses 33, 106, 107, 108, 140 n. introducing parsimony to 112 see also small-N studies quality circles 144 n., 155 quantitative analyses 6, 7, 32–3, 34, 106, 107, 108, 120 n., 140 n. Quantum Fund 63 n. Ragin, C. 4, 6, 7 n., 8, 33, 35, 43, 44, 46, 109, 113, 120 n., 121, 122, 162

Index Rajan, R. 12 rating agencies 55 real interest rates 28, 52 real wages 31 Realschule 149 Rebe´rioux, A. 9, 22, 40 n., 42, 75, 77, 126, 133, 139 n., 161 rediscounting policies 24 reflationary policies 27 regression analysis 33, 108 returns on investment 131 shareholders need assurance they will get 11, 84 Rigamonti, E. 54 n., 60 n. rights of minority shareholders 12, 13, 34, 37, 40, 41, 46, 129, 159, 164 legal reforms of 170 underdeveloped 169 Roberts, J. 41, 54, 65, 109 Rock, E. 67, 87 n., 89, 96, 134 Roe, M. 5 n., 6, 12, 13–14, 15, 19, 21, 37, 74, 84 n., 88, 91 n., 93–4, 124, 159 Ross, G. 23, 24, 25, 26, 27, 29, 124 Rueschemeyer, D. 44 n. Russia 110 Sabel, C. 31, 152 n., 156 n. Saint-Etienne, C. 25 Sanders, G. 56 n., 57 SAP (Swedish Social Democratic Party) 31 Scandinavian countries 22 n. see also Sweden Scharfstein, D. 127 Schmid, G. 151 Schmidt, D. 37, 87 Schmidt, V. 22, 57, 155 SEC (US Securities and Exchange Commission) 134 Securities Laws 71 Sellier, F. 16, 24, 25, 26, 27, 28, 140 n. settlements of conflict, see conflict settlement shareholder activism 17, 61, 66, 76, 86, institutional investors unlikely to engage in 73 n., 134 protection of minority shareholders 96–8 superior selection skills versus 135, 170 shareholder value 12, 21, 32, 71, 84, 86, 92, 95, 158, 159, 161, 171 attitudes of top executives toward 129, 130 value creating 1, 55 destroying policies 85 funds have sought to extract 76 maximization 74, 170

militating against some forms of 89 necessary condition for delivery of 93 poor managerial policies that negatively affected 90 preferences for 133 rise of short-term version of 41 specific corporate policies that enhance 67 unlocking of 97, 111 n., 134 shareholder value strategies 93, 150 n. alternative 13 decision to pursue 77 friendly 91 implementing 2, 9, 17, 22, 34, 35, 39, 42, 43, 126, 128, 129, 160, 165 introduction of 16, 37, 43 short-term-oriented 135, 160 shunned 15 suboptimal 130 unbridled, harder for corporate executives to pursue 13 Sheard, P. 127 Shinn, J. 1, 12, 13, 16, 17, 18, 19, 20, 34, 54, 85, 92 n., 95, 98 n., 135 Shleifer, A. 9, 11, 34, 84, 85, 91, 130 Silvestre, J.-J. 16, 24, 25, 26, 27, 28, 140 n. Sisson, K. 138 n. skill formation 18, 20, 40, 41, 139, 143, 148, 156 n. differences in 154 diverging institutional starting points in 167 Skocpol, T. 110, 113 n. small-N studies 6, 107, 114–15, 118, 119, 120 social background 58 social capital 57 development of 56, 58 social norms 14, 53 n., 56 social revolts 110 socialist parties 23, 26, 27, 29 incorporating into democratic liberal frame 6 sociological features 15 n., 55–61, 75 Sorge, A. 2 n., 4, 16, 22, 31 n., 34, 35, 40 n., 45, 46, 123, 124, 125, 130, 142, 144, 145, 146, 147, 154 n., 155, 161 Soros, G. 63 n. Soskice, D. 2 n., 3, 18, 28, 34, 45, 46, 47 n., 58, 73, 77, 109, 112, 123, 124, 125, 130, 133, 141, 161, 166, 167 Soviet Union 29 SPD (German Social Democratic Party) 151, 164

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Index Standard & Poor’s 55 State Street (subcustodian firm) 72 statistical techniques 33, 108 Steinmo, S. 4, 44 stock markets: companies entering and leaving 71 integration of 52, 53, 55, 61 mobility of capital across 70 see also market capitalization Strang, D. 56 n., 75 Streeck, W. 5, 15, 22, 31, 32, 138, 144 n., 147, 153, 159, 165, 166, 168 strikes 23, 30 substitutability 33, 112, 121, 122 sufficient conditions 44, 48–9, 114–22 see also necessary and sufficient conditions Sweden 31

see also on-the-job training; vocational training Tricornot, A. 54 Tunc, A. 87 n., 88 Tuschke, A. 56 n., 57

takeover bids deterring 88, 150 n. protection from 61, 92, 135 unwanted 54, 135 Terrie, L. 33, 107, 115 Thelen, K. 2, 4, 6, 7, 8, 16, 19 n., 22, 28, 30, 31, 32, 35, 40, 44, 45, 46, 70, 119, 122, 124, 125, 133, 136, 137, 140, 141, 145 n., 151, 152, 153, 156, 161, 162, 168, 169, 170, 171 Third Republic (France 1870–1940) 24 Tiberghien, Y. 38, 40, 46, 127, 159, 169 Tirole, J. 156 Tkac, P. 62 n., 64 trade integration 15 trade unions: commitment to securing decision-making participation 6 conservative policymakers attempt to circumvent and weaken 30 ideologies of 22, 26, 27, 28 mass mobilization by 23, 24 political maximalist strategy of 27, 124, 160 resistance to general liberalization of rules on dismissals 156 state-centered strategy of 29 see also CFDT; CGT; collective bargaining; IG Metall training 25, 27, 56, 138, 145 and building of firm competencies 139–43 commitments to 19 n. curricula and regulations broadly defined 151 firm-specific skills result from accumulation of 147 n.

Valdivielso del Real, R. 169 Van Ees, H. 56 n. Van Evera, S. 111 n. Vanguard 63 Verba, S. 106 Villegas, C. 33, 107, 112 Vishny, R. 9, 11, 34, 84, 85, 91, 130 VoC (varieties of capitalism) 2, 10, 13, 34, 35, 37–8, 40, 41, 42, 45, 48, 50, 107, 109, 110, 121, 129 behavior of funds differs across 71 critics of 47 differences in 18 financial crisis and 165–8 impact of capital mobility on 70, 73 important insight of 19 n. institutional arrangements identified by 9, 36, 123 law and economics approach versus 39 meaning and extent of convergence across 5 nonliberal 73 sustainability of 73, 162 vocational training 28, 140, 155, 156 n. compulsory taxes for 142 continuing relevance of 149 training innovations in 149, 154 nationally certified and enforced 141 qualifications associated with 143 see also CEDEFOP Volpin, P. 37, 40 n., 46, 85, 87 n., 94, 95, 98 n., 127 voting rights 93, 95, 139 n. double 88, 92 n. preemptive 89 unequal 61, 88, 92

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Union de la Gauche 23 United Kingdom, see Britain United States 29, 76, 77 hedge fund average holding period 72–3, 132 importance of the CFO 56 investment allocation 39 n. pension funds 66 subprime housing crisis 166 University of Tokyo 56 US-GAAP (US Generally Accepted Accounting Principles) 87

Index Walker, G. 56, 59, 60 n. Watson, M. 67 Weimar 29 welfare state policies/reforms 15, 151 Whitley, R. 2 n., 3, 16, 35, 40 n., 46, 57 n., 109, 123, 130, 133, 140, 141, 142, 143, 145, 146, 147, 151, 161 Whittington, R. 57 n., 98 n. Williams, C. 12 Williamson, H. 138 n. Windolf, P. 55, 56, 57, 58, 59 Woidtke, T. 64, 66 n. Wojcik, D. 2, 71, 75, 92, 97 n. working class 21 support for left-wing political parties 23 traditional electoral base 164

Works Constitution Act (Germany 1952) 30 works councils 16, 27, 31, 32, 140, 141, 143, 148–9 ability to resist change 170 elections for 26 n., 137 interaction between companies and 152–3 legal rights of 30, 133, 135, 136, 137 power and influence 138, 139 role significantly expanded 150 Woywode, M. 2 n. Zajac, E. 15, 32, 55, 56–7, 158 Zilberman, S. 142 n. Zingales, L. 11, 12, 85, 88, 91 Zysman, J. 24, 52 n.

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