Codetermination as an interlocking system

Codetermination is an interrelated set of institutions which consists of five major elements (Table 19.1). At the plant level, it involves the representation of workers in works councils.

Table 19.1 Codetermination as an interlocking system

discussions with respect to such issues as hours, time and form of payment, and the hiring and firing of individual workers. They need to agree on eco­nomic matters that concern them existentially, in particular if a plant is to be closed. In such a case, a social plan needs to be implemented. Obviously, the works councils have no say over what is being produced, what the prices are, what kinds of investment are being made, and so on.

Next to the works councils, codetermination provides for the representa­tion of labour representatives on the supervisory boards of corporations. The supervisory boards appoint management and supervise management activi­ties. Under different codetermination acts, workers have either one-third or one-half of the seats of the supervisory board. In the supervisory boards, the long-term investment plans of companies are determined. Third, codetermination may involve the appointment of one member of the manag­ing board of the company, who is in charge of personnel affairs and has the special trust of the labour representatives on the board. In this, and only in this sense, labour can participate in the managing of some corporations, but the personnel director will always be in the minority. Under German cor­porate law, the board acts jointly.

The system has become the centre of political disagreement with respect to efforts at forming the type of a European Company ‘Societas Europea' (SE). The German Company Board representation would have to somehow fit in with the structure of the European Union.

The acts establishing codetermination in Germany were passed by the German federal parliament in 1951, 1952, 1965 and 1976. The 1976 act, for instance, which generalized the codetermination model that had originally in its strong form been limited to the so-called ‘mountain' industries (mining and steel), carried a majority in parliament of more than 90 per cent. In the context of European Union harmonization attempts of corporate law, Ger­many is trying to introduce codetermination as an element into European corporate law; this is being resisted by some other European Union members. The reason for Germany's stance in this matter is the fact that codetermination is part of the German consensus and departing from it is not supported by any one of the stronger political movements in the country.

From a law and economics point of view, the question remains why Ger­many opted for this peculiar form of company organization, which is at substantial variance with the classical model of the business firm. The answer to this question has to be given in two parts: the first needs to address the issue of why codetermination was introduced in the first place; the second needs to address the issue of why codetermination is being clung to as a generally desired form of corporate organization.

In 1949, Germany still lay in ruins. The reconstruction effort had not really taken off, because the institutional prerequisites (stable money, stable legisla­tive framework, labour harmony, a supporting tax system and consistent economic policy) were not yet quite in place. Codetermination was one aspect of this package of implementing the institutional prerequisites for the reconstruction of post-Second World War Germany. Since the physical plants had been largely destroyed or were still subject to dismantling, productive capital was actually embodied in human capital. The human capital, of course, needed to be won over in any investment decision. It is for this reason that human capital was systematically introduced into the organized forms of capital representation in the corporation. Only in this way did it seem poss­ible to reinvest unpaid wages and dividends into the company. In 1951 and 1952, pursuant to the government programme, West Germany introduced the system of codetermination as we now know it. It was chosen in preference to a number of different organizational alternatives which would all have been much less compatible with the functioning of a market economy.

In 1965, with the reform of the act on joint-stock companies, codetermin­ation was again expanded into sectors not hitherto covered. It was further expanded in 1976. It is difficult to conceive of an interest group-driven scenario of parliamentary legislative decision making that could explain the consistency of the record and the large supporting majorities.

Codetermination as a model cannot be superimposed on any country. Leg­islators keen on copying Germany’s legislation should carefully consider Bohm’s (1951) argument in order to find out whether the conditions that prevailed in Germany and made codetermination a worthwhile legislative experiment would prevail in the candidate country as well. Otherwise, Bohm’s warning of a collusion of capital and labour against the consumer might well be heeded with profit.

In reviewing the parliamentary debate in 1951, one is surprised to note how little time was spent in hammering out the details of the legislation. Indeed, much of the relevant knowledge was probably shared by the members of parliament, but it was going to take almost 30 years before, in 1979, the German Constitutional Court emphasized the extent to which the different institutions making up the German codetermination system are interdepend­ent, even interlocking.¹ The system makes sense only because its five different pillars support each other: taking one element away can result in serious shortcomings. The five elements have been listed in Table 19.1, and their interdependence will be discussed in turn in the sequence of the numbers indicated.

The works councils are the oldest element. They were introduced during the First World War originally in the ammunition industry in order to allow work­ers, who threatened to strike, to participate in decisions about the organization of their working environment, schedules and the like.

1. The works councils relate to the institutions of collective bargaining in terms of the division of tasks. All those aspects works councils deal with are, in principle, not subject to collective bargaining. For instance, collective bargaining will set the base wage. Works councils will dis­cuss with management when and how the wage is paid. This division of the task is extremely important since works councils, in order to be effective, have to be able to reach their goals by convincing manage­ment of the superiority of their proposed solution in the interest of the entire company. Works councils participate in decision making in the sense that they cannot be ignored: rarely can they take decisions on their own. Only in one case (when the firm is to be liquidated) can works councils, by withholding their agreement to the social plan, impose serious damage on the firm’s owner. The institution of collec­tive bargaining, on the other hand, by definition uses powerful sanctions on either side. The workers can strike, the companies can lock them out. In both cases, serious losses can be imposed. Unions may not be able to strike because they may not be able to pay the striking workers their compensation, which typically they are understood to do. This division of tasks is extremely important, in particular as we compare the German situation with the American one. In the United States, collective bargaining will also cover work rules, a practice which can result in very formalistic agreements about which disputes are likely to arise. On the other hand, union leaders used to collective bargaining may find it difficult to cooperate in company boards when given the chance, as in the case of Eastern Airlines (under the chairmanship of Frank Bormann).

2. The works councils are often the recruiting ground for the labour mem­ber in the supervisory board of German cooperations. It is here we realize that the two-tier system is a precondition for the possibility of codetermination. If the works councils were to send representatives into the managing board, they would end up negotiating with themselves. Incidentally, the labour directors mentioned above were always re­cruited from the outside in order to avoid such a conflict. By being able to rely on the works councils, the supervisory boards have a second channel of information at their disposal, the first one being management which, as they also have to control it, may be withholding information that could be damaging. It is for this reason that the system of codetermination can strengthen owners’ rights in the firm, at the ex­pense of managers. In this sense, codetermination is one conceivable answer to the problem involving the division between ownership and corporate control.

3. Bonding is a device to protect sensitive investments in specific assets. When highly specific human capital is deployed in the production pro­cess, the owners may be interested in seeking protection against the loss that can occur if inappropriate management decisions are being taken. The works councils can provide such protection, on the one hand through the day-to-day consultation with management, on the other hand through their links with the supervisory board. Here both labour and capital can seek to protect the value of the investment by monitoring management that, through its operation, determines the marginal productivity of both capital and labour.

4. In Germany (as in the United States) local communities depend for their tax revenue on the profitability and presence of corporations within their jurisdiction. There exists a symmetry in the interest of the local commu­nities and the employees of corporations, who typically are tied to these communities by virtue of their home ownership, family and other ties, and generally their roots. German workers tend to be much less mobile than their American counterparts. Thus, the works councils also act in the interest of the local communities from which they come in guarding the presence of the corporation at its current location. This, by the way, does not prevent codetermined firms from making sometimes large invest­ments overseas, if these investments are perceived by labour representatives as implicitly enhancing the stability of their own jobs.

5. By virtue of the division of tasks between the system of collective bargaining, on the one hand, where employers’ associations and the trade unions negotiate the base wage, and the system of works councils, on the other, where the day-to-day operation of the working routines is being discussed, the works councils are relieved of those issues which necessarily would result in acrimonious disputes. Thus the two systems support each other.

6. Since labour representatives sit on the boards of corporations, the unions possess much more detailed information about specific companies than their American counterparts. They are therefore unlikely to overshoot in their bargaining, and are more inclined to take a long view and maxi­mize lifetime earnings rather than per annum wages.

7. The first German post-Second World War parliament gave the hair-thin majority of the governing coalition ‘an overwhelming majority’, a very important demonstration of a consensus living in the post-Second World War West German democracy. The families of the workers typically being tied to the location, title needs to be given to all these stakeholders. Unions make these investments, because the investment they make in wage concessions can be guarded through the codetermination struc­tures.

8. Very often, trade unions also guard the interests of the corporation in the towns where they operate. They thereby help in creating a business environment that is hospitable to the corporate activities.

9. The two-tier board can function effectively because, through the works councils, information can be gathered in a systematic manner. The board is able to collect information which sometimes is not even avail­able to management.

10. Since the supervisory board and the managing board are separate, the managing board is free to bargain with the unions, who are not repre­sented there. A single-tier system would not allow for this separation of interests.

11. The two-tier system, again, helps in safeguarding investments against excessive demands from either side. This is true for both labour and capital.

12. Although, through the corporate city tax (Gewerbesteuer), the Ger­man city is in fact a stakeholder in its corporations, and although the city is expected to furnish services from basics to schools, sometimes even theatres and symphony orchestras, no attempt seems to have been made to repeat the features of the Hesse Organization Act and grant the city seats on the supervisory board. The instrument that is used is typically a plain contract. This is a public contract, but many communities preferred to contract privately through development boards (Entwicklungsgesellschaften).

13. Since bonding of investments is one of the key strategies used under codetermination, the works councils chairmen have a specific role that is far beyond that of a shop steward, for instance, in the British system. They are selected, not for their aggressive negotiation skills, impressive confrontational methods or rhetoric, but rather for guaran­teeing smooth working relationships and an avenue for resolving the many conflicts that necessarily develop when people have to work together, certainly if highly committed and highly skilled people are involved.

14. Also collective bargaining is conducted differently when bonding of investments is a part of the set of strategies. Tactics need to be more subtle, not only in view of strike funds, but also in view of the human capital investments at stake.

15. Bonding is an attractive alternative strategy because the supervisory board allows for keeping an eye on the specific investments made.

16. Since bonding strategies are available, cities, in turn, are able to make long-term commitments, which after all they have to finance out of tax revenues. These investments can go far beyond what is usually prac­tised in the United States by, for instance, a county development board. For example, establishing schools, theatres, public swimming pools and the like requires not only the initial investment, but also the continued commitment to cover the sometimes substantial operating costs.

17. Cities, through the works councils, often have an avenue by which they can put their priorities on company board agendas and demand firm decision making as well. This is important when issues of city planning and work organization overlap (as with bus schedules). Short communi­cation lines can substantially cut transaction costs.

18. When a strike is being called, the mayor holds his breath. The city can lose twice, not only because of the reduced income and therefore likely increased level of entitlements that need to be paid out - in Germany the entitlements have to be paid by the cities, not by the state or the federal government - but also because depressed corporate revenues mean depressed corporate tax revenues, putting the city budget into a squeeze. It is obvious that through various channels a moderating influence is present.

19. Most cities in Germany operate a bank, the so-called Sparkasse. This is a leftover from traditional cameralist policies. These banking institu­tions also get involved, as they can in Germany, with locally operating companies, since commercial and investment banking can be done through one and the same institution in the German banking system. In this way, the city can exert influence through the supervisory board if, as is customary, the major local banks and firms take seats on this board. The city mayor, in turn, typically appoints the bank manager. Often, the city also relies to a not insignificant extent on the bank revenues for its own budgetary requirements.

20. Since the interests of the city and the workers (its citizens) overlap to a large extent or are even fully parallel, the city where the company is operating is also interested in keeping the strategy of bonding invest­ments viable. It tries to create an environment that makes the strategy attractive.

In this (as well as in many another unmentioned) way, the five pillars of codetermination support the entire structure in an interlocking fashion. Re­moving any one of them will lead to multifarious consequences, and these consequences are very difficult to predict beforehand. Codetermination cre­ates a specific actor in the labour market that is strongly committed to human capital formation and to the location where the works are sited. This is a different position from that of the typical American or multinational corpora­tion, which tends not to maintain close ties to any specific location. The consequence is that codetermination tends to open up a different arena where, next to labour market exchange, decisions can be taken. These decisions refer to shaping the production function, not to the formation of wages. The latter distinction also points to the reason why codetermination has to be the result of legislative decision making and cannot conceivably be the outcome of collective bargaining. It is not a bargain, it is rather a constitution in which production functions can be shaped.