Banks on Board

As part of a series of related papers, the authors examine the conceptual foundations of German and American corporate governance, specifically highlighting the role of banks' relationships to corporations and the stock market. This paper focuses on how the regulatory and macroeconomic environments of the two countries helped shape how banks, especially money-centred bankers, actually interacted with their clients. Prior to 1914, despite many regulatory obstacles, American banks wielded more power over U.S. corporations than the legendary German ones because they had more "opportunities" for intervention. The U.S. suffered larger booms and busts ("panics" and bankruptcies), had more foreign investment, as well as saw more corporate consolidation than in Germany. By contrast, German companies seemed to have less need for active bank management and largely maintained their distance from activist banks, although German banks could potentially wield great power through board membership and proxy voting. Additionally, German regulators and investors turned more readily to banks to bolster controls on equity and debt capital markets to dampen dangerous speculation of "productive assets." They encouraged banks to play a crucial intermediary role in solving the agency problem in firms and correcting the perceived weaknesses of financial markets—unlike U.S. regulators. Germans also expected banks to save companies from financial distress, but these occasions were more rare in Germany than in the United States. Surprisingly, the debates in Germany and the U.S. about the role of banks had many common features, yet the two countries increasingly found alternative solutions to classic corporate governance dilemmas. Whereas American regulators tended to suspect banks' insider relationship with companies and stock markets, and then endeavored to destroy this "money trust," German regulators turned to banks as institutional stabilizers to tame market turbulence and speculation. Over time, they bolstered rather than undermined banks' special relationship to firms and capital markets. Key institutional choices set the stage for a much greater divergence during the interwar period.