Did the German stakeholder model fail in Wirecard and Volkswagen?

When asked recently why “the German stakeholder model failed so spectacularly in Wirecard and Volkswagen", my immediate reaction was “it was not the German stakeholder model that failed". What we are looking at in Wirecard and Volkswagen are familiar governance shortcomings, seen in corporate scandals such as Enron, Theranos or Greensill.
In a policy briefing for the European Parliament we highlighted for Wirecard how each traditional corporate governance actor failed in ways we have seen in similar scandals. This goes to the company’s internal control system, its supervisory board, its external audit, the oversight bodies for financial reporting and auditing and, last but not least, the market supervisor BaFin. Another feature Wirecard shares with Enron, for instance, is the role of less traditional outside actors. Whistleblowers and the press were key in uncovering both scandals (compare Dyck/Morse/Zingales JoF 65 (2010) 2213). The portion of the system that failed, the actors that helped bring misbehavior to light, their interdependencies and struggles would have looked very similar in most jurisdictions.  

We might understand the German model as addressing employees as a core group of stakeholders. We would then be asking about the role of co-determination on boards.

My second reaction to the question was “maybe we have to talk about what we would call the German stakeholder model?". As a more general term, it denotes a form of management discretion. Along with, and in addition to shareholder value, boards may consider stakeholder concerns. Much of this broad understanding of the stakeholder model is today reflected in discussions on corporate purpose, sustainability and ESG. More specifically, we might understand the German model as addressing employees as a core group of stakeholders. We would then be asking about the role of co-determination on boards. It entails employee representatives on (supervisory) boards – in addition to representation through trade unions and work councils.

Volkswagen is a story of aggressive market expansion at all costs combined with a hierarchical corporate culture and a tightly knit shareholder base of family members and state ownership.

It is probably safe to say that the more general version of the German stakeholder value model has little to do with a corporate scandal along the lines of Wirecard or Volkswagen. This is not to deny a familiar critique of a stakeholder, rather than a shareholder focus. There is a certain risk that management might use its discretion to disguise opportunistic tunnelling as doing good things for stakeholders. However, neither Wirecard nor Volkswagen fall into that category. Volkswagen is a story of aggressive market expansion at all costs combined with a hierarchical corporate culture and a tightly knit shareholder base of family members and state ownership. Wirecard was a fraudulent venture very early on, involving large-scale accounting manipulations. Its playbook was focused on a convincing equity story and its meteoric rise fueled by the rapid growth of its market capitalization. Neither scandal involves a focus on stakeholder interests.

Co-determined companies fare better on corporate disclosure and accounting, but endogeneity issues make this a complex endeavor.

A more interesting question is whether we can frame co-determination on boards as an instrument in the toolbox of corporate governance. Historically, it was not conceived as such. Its proponents advertised co-determination as a form of extending democracy and inclusion from the political process to spaces of value-creation in the corporate world. Co-determination, so they suggested, provides an institutional framework for settling conflicts between employees and management. By contrast, the modern focus on principal-agent conflicts between shareholders and management was not the reason to introduce co-determination. Empirical work today suggests that co-determined companies fare better on corporate disclosure and accounting, but endogeneity issues make this a complex endeavor.

Conceptually, employee representatives can be just as entrenched as management. Their human capital is invested in one company, not a portfolio. Hence, their incentives will not necessarily align with shareholders, especially if management promises to keep their jobs secure. Behavioral work on corporate scandals suggests a possible coalition along these lines: Fraudulent managers can be motivated by a feeling of duty towards “their“ employees. In Wirecard, co-determination played no role for a simple reason. The corporation successfully circumvented co-determination. Its board members were appointed by shareholders only. Volkswagen, by contrast, is of course fully co-determined. However, given the company’s shareholder base, an (informal) coalition between executive board members, family and state majority shareholders, their representatives on the board and, lastly, employee representatives seems likely. Dispersed and small-stake shareholders were the ones on the losing end.

A lesson both corporate scandals hold is the role of non-traditional actors which have so far not been a focus of corporate governance research.

Summing up, it is not the German stakeholder model which failed in Wirecard and Volkswagen. It was never intended as a monitoring tool for principal-agent conflicts. A lesson both corporate scandals hold is the role of non-traditional actors which have so far not been a focus of corporate governance research. This goes to whistleblowers and the press (in Wirecard) as well as non-financial supervisory agencies (in Volkswagen). Future research will have to explore their incentives. Future lawmakers will have to enable their actions, bringing together areas of the law as diverse as corporate, employment, press and privacy.