Codetermination is a system of shared corporate governance between workers and shareholders. While such a system has long been a staple of the European business world, it has been generally ignored by U.S. corporate governance scholars. When it has made an appearance, it has largely served as a foil for shareholder primacy and an example of corporate deviance.

Over the last 15 years, however, an expanding body of empirical research on codetermination has shown surprisingly positive results about the system’s efficiency, resilience, and benefits to stakeholders. Rather than experiencing the failures predicted by the law-and-economics view of shareholder primacy, codetermination has actually fared better than its alternatives, particularly in response to the global financial crisis of 2008. At a time when corporate leaders, politicians, and academics are rethinking the shareholder primacy model, it’s past time for scholars to review the new research and reexamine their prior assumptions. We hope to start this conversation with our new article, Codetermination in Theory and Practice.

The most well-known (and best studied) example of codetermination is in Germany, but many other European countries have their own varieties. As a broader principle, the term encompasses other methods of worker-management cooperation, such as works councils or interest arbitration. Here, though, we’re referring to worker representation on corporate boards. In Germany, the precise degree of employee representation depends upon factors like the type of industry and the number of employees; representation ranges from companies where workers elect one-third of the board members to those where workers have full parity with shareholders.

It’s worth noting that much of the scholarship evaluating the system has centered on its role in promoting broader goals such as social cohesion and fairness. That is, codetermination is viewed less in terms of an economic system than as one designed to promote a well-functioning democracy and help prevent social division. And, on this broad level, it is thought to be quite successful.[1]

Its success on the social level has carried over to the boardroom, where the relationship between shareholder and employee representatives on the supervisory boards has been relatively harmonious, fostered in part by the legal requirement that they put the interests of the corporation over those of their respective constituents. The relationships at the supervisory board level are a far cry from the law-and-economics predictions of inter-board squabbling, dysfunction, and firm-destroying voting cycles.

A number of recent studies on the more narrow, economic effects of codetermination have also been positive. While the consensus has shifted back and forth a bit over the last four decades, the last 15 years have seen a number of new studies with an almost uniformly positive assessment of the effect of codetermination on measures of keen interest to shareholders: productivity, profitability, and capital market valuation. Indeed, one of the stronger results came out of a 2020 study by Simon Jäger, Benjamin Schoefer, and Jörg Heining, which concluded that, if anything, “board-level codetermination raises capital formation.”[2] The shift toward more capital-intensive production may be the result of worker involvement in investment decisions, the fact that worker representatives may have longer-term views than shareholders or executives, or shared governance’s facilitation of cooperation between firms and their employees. Shareholders, on this account, may be better off investing in firms where employees have a stronger governance role.

A number of studies have also explored the effects of codetermination on the interests of other corporate constituents. One would expect that employees would gain most from more direct board representation,  and they do, in fact, appear to be better off by their own measures. Those measures, though, aren’t limited to the size of their paychecks. Instead, most studies appear to show that employees at codetermined firms enjoyed more job security and were better protected against layoffs. The job security was largely a product of a negotiated system called Kurzarbeit, which temporarily reduces the working hours (and salaries) of many of the employees during industry downturns. This security, though, came at the price of significantly lower wages. One recent study by E. Han Kim, Ernst Maug, and Christoph Scheider showed employees paid a premium equal to 3.3 percent of their wages for this employment insurance (a  tradeoff that had no effect on shareholders one way or the other).[3] The Kurzarbeit system was also a key factor in Germany’s ability to recover from the 2008 global financial crisis more quickly and more completely than other countries without strong systems of employee representation, including the United States.

Employee representation turns out to benefit other corporate constituents as well. A recent study by Chen Lin, Thomas Schmid, and Yuhai Xuan found that protecting the interests of the firm’s employees can (unintentionally) help protect the interests of the banks.[4] This is because “both stakeholders are interested in the long-term survival and stability of the firm.”  More specifically, the study found that codetermination was associated with favorable financing conditions, lower costs of debt, longer debt maturities, and fewer covenants. Codetermined firms were also found to have entered into fewer (and better) M&A deals, have more stable cash flows, and have less exposure to idiosyncratic risk.

Codetermination provides greater societal benefits as well. A recent study by Robert Scholz and Sigurt Vitols found that the strength of codetermination was positively related to substantive (as opposed to merely symbolic) corporate social responsibility policies.[5] Substantive CSR measures were defined as those that required an expenditure or investment in company resources and included setting concrete goals on emission reductions, the presence of job security, and the publication of a separate CSR report (or section in its annual report).

In sum, this wave of new economic research suggests that employee representation on corporate boards benefits employees, creditors, and the broader community through the pursuit of meaningful CSR measures. With the security of having a say in governance, employees are willing to trade off wages for job security in a way that avoids “hold-up” issues. Their representation also seems to help other corporate constituents through a variety of mechanisms, including the promotion of greater information flow within the firm and alignment on broader issues, such as the long-term health and stability of the firm. The results of these recent studies are quite clear: Codetermination benefits a wide range of corporate constituents at little or no cost to shareholders.

Codetermination systems vary in scope and scale, and the introduction of codetermination into any existing system of corporate law is bound to be complicated. But this set of empirical evidence on the practice of codetermination should get the attention of those involved in corporate governance. It is time for U.S. corporate law academics to take codetermination seriously and consider it as a viable alternative to shareholder primacy.

ENDNOTES

[1] See Jens Dammans & Horst G. M. Eidenmueller, Codetermination and the Democratic State, Illinois L. Rev. (forthcoming 2021) (available at SSRN: https://papers.ssrn.com/sol3/papers.cfm
?abstract_id=3680769#.

[2] Simon Jäger, Benjamin Schoefer & Jörg Heining, Labor in the Boardroom (Oct. 10, 2020) (unpublished manuscript), available at http://economics.mit.edu/files/17273.

[3] E. Han Kim, Ernst Maug & Christoph Scheider, Labor Representation in Governance as an Insurance Mechanism, 2018 Rev. Fin. 1251.

[4] Chen Lin, Thomas Schmid & Yuhai Xuan, Employee Representation and Financial Leverage, 127 J. Fin. Econ. 303 (2018).

[5] Robert Scholz & Sigurt Vitols, Board-level Codetermination: A Driving Force for Corporate Social Responsibility in German Companies?, 25 Eur. J. Indus. Rels. 233 (2019).

This post comes to us from Grant Hayden, a professor at SMU-Dedman School of Law, and Matthew Bodie, Callis Family Professor at Saint Louis University School of Law. It is based on their recent article , Codetermination in Theory and Practice, in the Florida Law Review and available here.