Germany’s banks are under fire. The calls to relax what one insider describes as the banks’ ‘stranglehold on German industry’ are becoming louder and more frequent. The banks, of course, have got used to such pressure over the years, but this time round their critics feel buoyed by international support.
Indeed, to a lesser extent, similar scenarios are being played out elsewhere in Europe, particularly in Spain and Italy. Powerful domestic banking networks are facing sharp criticism for being both substantial lenders to major businesses and significant investors in those same companies.
The principal cause of the demand for change in Germany is the pervasive nature of German ‘universal’ banking, in which the larger banks act as lenders, deposit-takers, shareholders, stockbrokers and corporate financiers, with companies more or less obliged to put all their eggs in one basket. Where conflicts of interest arise, as between being a lender and an investment adviser, there is concern that they are too often resolved in the banks’ favor.
The merger of the steel interests of Krupp Hoesch and Thyssen has highlighted banks’ strengths and influence. Earlier this year, Krupp Hoesch launched a hostile takeover bid for competitor Thyssen. Following criticism, particularly from the IG Metall trade union and from Thyssen-friendly political groups, the bid was withdrawn. Incongruously, a few days later the Thyssen board approved a friendly merger.
What incensed the bid’s opponents were the roles played in the campaign by Deutsche Bank and Dresdner Bank, which had advised Krupp Hoesch while holding supervisory board positions at both companies. It was also reported that Deutsche Morgan Grenfell had organized British and American roadshow presentations to promote Thyssen stock, allegedly giving the bank’s officers access to Thyssen’s books and cash positions. A spokesman for Deutsche Bank emphatically denies any impropriety and says that no confidential figures were revealed or used. In any event, claims the bank, the Krupp Hoesch merger instructions were only received after the Thyssen roadshows had ended.
Essential Support
The merger battle added fuel to the growing unease in Germany and elsewhere on the continent about the extent to which banks can dictate companies’ actions. It spurred an increase in the calls for the German universal banks to be obliged to reduce their industrial stock holdings and to be restricted in the number of supervisory board appointments their representatives could hold.
Dennis Phillips of Commerzbank’s Frankfurt office dismisses such demands. ‘The universal banks are not going to reduce their holdings in the near future. In any case, most of the industrial companies’ stocks are held as relatively short-term investments.’ He argues that bank support is essential for most such companies.
Many other bankers and some industrialists agree with Phillips. The past year has seen at least two instances where huge commercial enterprises were saved only because the large banks invested heavily. Both the metals and chemicals conglomerate Metallgesellschaft and the engineering combine Kloeckner-Humboldt-Deutz (where Deutsche Bank is now a big minority shareholder) likely would have failed in the absence of bank support.
There are strong indications, however, that the big banks are turning to investment banking in a move to reduce reliance on increasingly more risky commercial lending.
Hilmar Kopper, recently retired chairman of Deutsche Bank, believes the bank is doing the right thing in devoting resources to its investment banking activities, concentrated at Deutsche Morgan Grenfell, even though these have proved expensive. Repairing the damage after the recent misuse of clients’ money at Morgan Grenfell Asset Management, the bank’s UK fund management subsidiary, may eventually cost as much as DM1.2 bn.
‘Everything has to be questioned constantly,’ says Kopper. ‘The bank’s activities have to be looked at and very intensive questions asked about the future.’ He is pleased that there is now a balance between the income earned from fee-based and non-lending activities and the profits from traditional lending business.
The bank is still not a big player in global terms, and Kopper recognizes that any real growth will come outside Germany through corporate banking elsewhere in Europe, the US and the Far East. Equally, he acknowledges that changes in the German banking environment will come rapidly, particularly in retail banking and among the regional banks. Such changes will make life more difficult for the universal banks, he contends.
Currently, merger talks are going on between Bankgesellschaft Berlin (BGB) and Norddeutsche Landesbank, both with public-sector majority shareowners. The new group would have combined balance sheet assets of DM550 bn, putting it in the top echelon of German banking.
Despite strenuous efforts by pressure groups, the German government has set its face against any attempt to limit the banks’ holdings in industrial companies, and proposed legislation has been watered down significantly.
Initially there were plans to force banks to reduce their industrial shareholdings and to prohibit proxy voting by the banks. It was also proposed to oblige the banks to separate their investment activities from their lending business. Government and banking officials dismissed those proposals as unworkable and counter-productive.
The draft legislation does limit to ten the number of supervisory board seats that can be held by bankers, but most of the other provisions address relatively tame tidying-up issues.
Although the government has avoided the imposition on the banks of enforced industrial shareholding levels, most banks are recognizing that it is in their own best interests to reduce their holdings voluntarily – and to be seen to do so.
Commerzbank, for example, retains substantial share stakes in a number of companies – ranging from 28.5 percent in Alno, through 13.8 percent in Heidelberger Druckmaschinen, to 5.8 percent in Thyssen – but has reduced or disposed of its investments in several companies.
In 1996, the Thyssen stake, for instance, was reduced from 18.1 percent, and the bank has sold its holdings in Friatec, Kuhnle Kopp & Kausch, Linotype-Hell and Schweizer Electronic. The bank’s shareholdings rose overall, though, to DM2.15 bn, largely fueled by the purchase of a 4.99 percent stake in Security Capital Group, an American real estate company. Further non-German share purchases are expected.
A similar strategy has been revealed by Deutsche Bank, where new chairman Rolf Breuer says that the bank is reducing its domestic industrial holdings and concentrating on building up stakes in foreign businesses.
These domestic shareholding reductions will not, however, address one of the major concerns of the critics: the exercising of proxy votes by the banks. Typically, German shareholders deposit proxy votes and bearer form shares with their banks, which then exercise those votes according to their own criteria. The banks’ spokesmen say that, wherever possible, they always act in accordance with the wishes of the individual shareholders. But if those wishes are not made known, then the banks are authorized to vote the shares as they see fit.
Holdings Questioned
Analysts have expressed doubts about the efficacy of the banks’ investment strategies, with many holdings showing poor returns. Allied to this, continental European companies are showing a widening interest in national and international equity markets and many are turning their backs on bank financing as a major source of capital.
German bankers, in particular, reject this type of analysis. Commerzbank’s Phillips says that German banks lend proportionately up to four times as much as their UK counterparts. ‘This is because the German banks have a much closer relationship with their company clients, through supervisory board membership for instance, and know more clearly what is going on in a company,’ he claims.
Word from the Top
Managements want to stick with such comparatively easy access to bank credit, Phillips says. In any case, in his view it is difficult to persuade medium-sized companies to go to the stock markets for capital, partly because of the greater level of disclosure required and increased public scrutiny and analysis.
Overshadowing these issues is the larger one of the ways in which German, Spanish and Italian companies, for example, are being managed.
The scale and frequency of the corporate disasters, scandals and mishaps that have marked the past decade, and the almost incessant unveiling of yet more examples of financial shenanigans, have focused politicians’ and legislators’ attention much more sharply on the broader matter of corporate governance.
Even where best practice behavior has been developed and codified, there is a deep-seated reluctance to endorse and follow those requirements.
The Krupp Hoesch and Thyssen affair focused attention on one aspect of German corporate activity.
The country’s 1995 voluntary takeover code (under which a buyer of more than 50 percent of a target’s shares must bid for the remaining shares) has been rejected by many of Germany’s larger companies – including, for example, Hoechst, BMW and Volkswagen – and by the majority of its smaller listed companies.
Rolf Passow of BVI (the German association of investment funds) says that more companies must accept the code or the government will step in with statutory requirements. Commenting that only a third of quoted German companies have adopted the code, he said the situation was ‘thoroughly unsatisfactory’ and he wants the conditions strengthened to protect the interests of minority shareholders.
Behavioral Problems
Similar instances abound in other countries, where company boards and their senior shareholders (almost invariably including large domestic banks) have neglected to adopt good behavior guidelines or are, at best, only paying lip service to those they have adopted. And there is increasing concern in continental Europe about the behavior and practices of company managements and directors.
Recent research in the UK by Manifest, an institutional share-voting advisor, has shown that companies with poor corporate governance records tend to underperform in terms of total shareholder returns (share price and dividends). Manifest also found that the boards of poorly performing companies seemed reluctant to implement recommended corporate governance best practice guidelines.
This message is being clearly received elsewhere in Europe and there is mounting evidence that investors (and lenders) are no longer prepared just to sit back and take the rough with the smooth.
In Italy, for instance, institutions and private investors are beginning to make their voices heard and their voting power felt. The development of pension and mutual funds has strengthened demands for better corporate governance and more attention to shareholder value.
The real problem is the nature of Italy’s big private companies, which are largely family concerns with successive layers of holding companies, often separately quoted, through which the dynastic control of the groups are exercized.
Tommaso Padoa-Schioppa, newly appointed head of Consob, the Italian stock market watchdog, has pledged himself to reform the worst excesses and abuses. Padoa-Schioppa believes that the way forward is to tighten disclosure requirements and standards and improve regulatory control.
Italy’s privatization program over the next three to five years will be Europe’s largest and considerable attention will be focused on the degree of transparency and control imposed on the financial markets.
Consob commissioner, Salvatore Bragantini, sees the future in clear terms: ‘Either we develop an open market or our industrial prospects are doomed.’
The industrial families and the banks have, in effect, created mutual help arrangements, through friendly shareholder consortia and labyrinthine cross-shareholdings. Although there is considerable lip service being paid by the bigger companies to the notions of shareholder value, transparency and better corporate governance, very few have shown any willingness to become ‘conventional’ or true public companies.
One Italian analyst says that the time has come for fundamental change. ‘Investors are reacting strongly to what they see as a lack of responsiveness to shareholders’ concerns and worries. If companies will not introduce corporate governance controls voluntarily, then the shareholders will force the point.’ Aligned with this view is a widening disenchantment with the role of the banks, which have failed to play a convincing part in either persuading or forcing managements to adopt and honor corporate governance guidelines. In addition, the virtually unfettered lending practices of the banks have been severely criticized, particularly following the debilitating difficulties faced by many Italian companies when the economy went into recession in 1992.
Symptomatic of the changing environment is the failed merger between the textile interests of the Marzotto family and the industrial businesses of the Gemina group. The Milan investment bank, Mediobanca, was called in to resolve difficulties arising from the Marzotto family’s line of succession. Three years earlier Mediobanca had tried to merge Gemina with Ferruzzi-Montedison, and saw the Marzotto approach as an answer to Gemina’s problems.
The deal failed, largely because of misgivings over the lock-in clauses in the shareholder syndicate’s pact. Under the clauses the shareholders would have stuck together and resisted any unwelcome future bid approach. The Marzotto family pulled out of the deal and the financial markets took their revenge on Mediobanca.
Italian business is beginning, albeit slowly and somewhat tepidly, to turn away from such friendly deals between shareholders, from which it is argued no-one benefits but the original, often family-connected, shareholders. Pressure is mounting to oblige Italian companies to adopt UK-type corporate governance rules and guidelines. And the banks are right at the top of the target list for reform.
Family Ties
In Spain, where corporate affairs are marked by strong family linkages, intermingled shareholdings and the overwhelming presence of the banks as investors and lenders, there are significant moves toward breeding a better corporate culture.
The national stock exchange regulator, Juan Fernandez-Armesto, is determined to enforce codes of conduct on Spain’s companies, particularly the newly-privatized enterprises. Fernandez-Armesto is drawing up a set of guidelines to improve transparency, especially in those companies controlled by the domestic banks, and he is calling for the separation of the banks’ corporate finance and investment management activities. As one leading fund manager observes: ‘Spain’s banks have excessive control in the boardrooms. Many listed companies have the big domestic banks as large minority shareholders, and the scope for conflicts of interest is huge.’
An eight-member commission is drawing up a series of corporate governance recommendations, modeled on the Cadbury guidelines in the UK. Among other things, there will be a call for boards of directors to be smaller and to have a larger representation of non-executive directors.
At the heart of the whole corporate governance debate in many continental European countries is the question of the dominance of domestic banks. ‘The banks wield too much power and have too much influence,’ says one German supervisory board member. ‘They should be forced to reduce their industrial holdings.’
The issue of corporate governance and the part that the big banks play in company affairs is now firmly at the top of Europe’s financial markets agenda.
