No need for governance? The impact of corporate governance on valuation, performance and survival of German banks during the 1870s

Abstract

We describe the legal rules underlying corporate governance of banks in Germany during the 1870s as well as the rules of governance fixed in corporate charters collected from a sample of 202 charters for the year 1872. Governance standards were – on average – below the legal default. In particular, voting rights as well as monitoring rights of shareholders were restricted. Most governance provisions did not affect the level of Tobin's Q in 1872, the change of the market-to-book ratio during 1873, and the probability of firm survival until 1880. Yet large banks having adopted a ‘one share–one vote’ provision and large banks having a governmental concession had a higher Tobin's Q, whereas the reverse holds for small banks. Moreover, the probability of firm survival was larger if small shareholders had voting rights or if shareholders could elect the supervisory board.

Keywords:

• financial history
• Germany pre-1913
• corporate governance
• law and finance

Acknowledgements

I would like to thank Christian Bayer, Thorsten Lübbers, participants of the 2008 Annual Conference of the Economic History Society, and two anonymous referees for many helpful comments. Brian Cooper substantially improved the writing. Financial support of Deutsche Forschungsgemeinschaft is gratefully acknowledged. All remaining shortcomings are in the sole responsibility of the author.

Notes

1. Guinnane, Harris, Lamoreaux, and Rosenthal (2007) provide a general overview about different legal forms of enterprises and their economic relevance during the nineteenth century in the US, the UK, France and Germany.

2. A similar decline in pay–performance sensitivity was already reported by Burhop (2004a), but without giving it a structural interpretation.

3. Microeconomic models supporting this hypothesis were, for example, developed by Durnev and Kim (2005) as well as Doidge, Karolyi, and Stultz (2007). A macroeconomic model showing a positive relationship between protection of property rights and Tobin's Q was developed by Albuquerue and Wang (2008).

4. See Burhop (2004b) for a comprehensive history of banking during the 1870s.

5. Shleifer and Vishny (1997), Tirole (2001) and Tirole (2006, pp. 15–65) give a general overview of corporate governance problems and mechanisms to solve them.

6. General discussions of the German system of corporate governance from an economic and business historical perspective, mostly with a focus on the period between 1880 and 1913, are Kocka (1981), Pohl (1981) and Fohlin (2005, 2007). Important legal historical studies are Grossfeld (1979) and Reich (1979) and Hopt (1980). See Hecht (1874), Warschauer (1902) and Passow (1922) for contemporary accounts of the German corporate law and its relation to economic development.

7. See Koch (1863) for the law and its interpretation.

8. For example, the small city states Hamburg and Bremen never limited incorporation; Saxony implemented free incorporation in 1861; Prussia followed in 1870 (Hopt, 1980).

9. Moreover, firms with weak governance rules might have a higher probability of bankruptcy since executives perform riskier projects. This higher bankruptcy probability also reduces the discounted value of future profits and should thus be reflected in the current level of the firm value.

10. Thus, the market for shares was ‘undemocratic’ in Germany as early as 1872. The face value of a share in Germany compares, for example, to the typical face value of a share in Britain of £1 (about 20 Marks) in 1900 (Hannah, 2007, p. 407).

11. 3.6 shares were necessary to attend the general meeting.

12. From an international perspective, similar voting restrictions were common in Europe during the late nineteenth century, see Hannah (2007).

13. It is important to note that almost no corporation allowed the transfer of votes to persons who were not shareholders of the corporation. In particular, this regulation restricted the depository voting rights of banks.

14. For example, Gugler and Yurtoglu (2003) show that payout ratios and ‘one share–one vote’ rules are negatively related in modern Germany and argue that payout ratios and changes in payout ratios are indicators of the severity of the principal–agent problem.

15. Accounting rules were relatively standardised during the early 1870s. Almost all banks prescribed a valuation of assets and liabilities according to the legal default rules. Nevertheless, some banks had more conservative accounting rules by prescribing that it was not allowed to value assets higher than the purchase price.

16. For the remaining 28 banks, payments to the reserve had priority.

17. Comparative figures for the nineteenth century are nearly unavailable. Hannah (2007) suggests that directors of British railway companies owned, on average, about 2% of the shares.

18. We define the following newspapers as national: Preußischer Staatsanzeiger, Berliner Börsenzeitung, Norddeutsche Allgemeine Zeitung, Frankfurter Zeitung.

19. This implies that bankers could only become members of the supervisory board if they personally owned shares of the corporation. The 1884 corporate law reform contained a rule that non-shareholders could become members of the supervisory board. Under the 1870 legislation, a substantial investment was necessary. The average bank had a nominal share capital of 6,970,000 Marks, 2.4% of that capital had to be owned by the – on average – 9.9 members of the supervisory board. This implies that the average member of the supervisory board had to own shares with a nominal value of about 17,000 Marks. Accounting for the average share price of about 140% of the face value, this implies an average investment of 40 times the annual income of a worker.

20. At the end of 1872, the market value of 25 shares was 9750 Marks, about 15 times the annual per capita income.

21. The monetary unification of Germany after 1871 and the foundation of the Reichsbank in 1876 most likely influenced the performance of banks of issue. We collected balance sheet data and stock price data for the end-of-year 1872, therefore banks incorporated after that date were excluded.

22. This is calculated as exp(2.864/0.174) and exp(36.88/2.49).