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K. Subramanian

IT IS a legacy of Hitler era. Yet, the Germans are proud of it. They will unite and resist all efforts by foreigners to take it over. This is the story of Volkswagen (VW).

VW has been under repeated attacks from several quarters. The latest is from the European Commission (EC). On March 19, 2003, it requested the German Government to justify some of the provisions of Volkswagen Law 1960 (VW-Law) which are viewed by EC as violative of EC laws. If no satisfactory response is received within two months, the EC could ask for amendments to the VW-Law.

The German Government has asserted that the VW-Law is compatible with European law and does not violate free flow of capital in the internal market. In Germany, VW is a highly emotive issue and is embedded in the economic and social fabric of Lower Saxony.

The German Chancellor, Mr Gerhard Schroeder, himself made a shocking volte-face in European Parliament (EP) in July, when the ambitious Directive on Takoever Bids came up for vote. Work on the Directive had gone on for twelve years with the support of the German Government until zero hour.

By April 2001, the German Government decided to retract. There was an unusual alliance between Christian Democrats and Social Democrats to kill the Directive. It was Volkswagen uber alles! In reality, the clash is more between the Anglo-US model of "shareholder capitalism" and the European or, more importantly, German model of "Rhineland capitalism."

When Volkswagen was created, it was state-owned and managed by the Labour Front. It had a mission to provide jobs to the German people, to create German products and restore national pride.

After the withdrawal of allied forces in 1949, VW came under state control again. In 1960, it was converted into a stock corporation (AG) when the conservative Adenauer government put through the earliest privatisation programme in Europe. Around 60 per cent of its shares were offered to the public, with a preference for employees. The balance (40 per cent) was allotted Equally to the State of Lower Saxony and the German Federal Government.

This ownership pattern has not changed since then except for the divestiture of Federal equity in the 1980s. VW-Law safeguarded the ownership.

VW-Law has special provisions on the management of the company. While German Company Law provides for equal representation on boards for shareholders and the labour, VW-Law guarantees two seats each to the State of Lower Saxony and to the Federal Government. Strategic decisions such as on new plants, relocation, etc., cannot be taken without a two-third majority on the board.

The EC has faulted these provisions. It is unhappy with the requirement to appoint public directors in derogation of German Company Law. It objects to the special powers to the Supervisory Board, which would favour the employees at the cost of shareholders. The EC's zeal for financial reforms across the EU ignores the path taken by Germany. There is no single path or set of institutions leading to economic development.

Economic historians and institutional theorists explain how countries take differing paths or adapt institutions suited to their genius and environment. German companies share certain common features, like the following: (i) the dominant role played by banks and the complex system of cross-holding; (ii) industrial co-determination; and (iii) the production-oriented and company-centred management. These features intermesh and operate organically.

German companies do not rely on the stock market to raise funds. Retained earnings and internal funds meet substantially the needs of German companies. For instance, as on December 31, 2002, VW had equity of Euro 1.09 billion; it held a capital reserve of Euro 4.5 billion; and its revenue reserves and accumulated profits together added up to Euro 19.10 billion.

The intrinsic value of VW shares bears no relationship to its market quote and VW becomes an attractive company for takeover by other companies and investment banks.

While tapping external resources, there is greater reliance on banks estimated at 65 per cent. High reliance on banks leads to extreme concentration with networks of cross-holdings and interdependency. Though concentration and interlocking of shares prevent takoeovers, they generate pressures for financial reforms when scandals surface, as in the late 1980s. The banks' links with supervisory boards run deep. Supervisory boards control management and co-ordinate broader issues with a wider vision. Co-determination is unique to the German corporate system. Under the Co-Determination Act of 1976, `labour' gets an equal share on company boards.

Studies indicate that co-determination has served German national interests well. Some of the labour nominees of I.G. Metall have served on the VW board for long years and provided continuity. Though there is a dissenting view on the role of labour in supervisory boards, in the German context, it is not practicable to do away with it.

German management is company-centred and production-oriented. Engineers, or `techniks', are preferred, while in the US/UK there is a distinct preference for finance, accounts and marketing geeks. This approach ensures devotion to product development and stability in operations.

Management could concentrate on new projects or frontier technologies without fear of `loss' and takeover by outsiders. Contrast this with the situation in the US or UK, where, as Robin Blackburn would describe: "The practices of `financial engineering' allowed investment bankers, takeover specialists and a new breed of CEOs to see corporations as more or less accidental bundles of activities that could be split up and recombined, assets that could be spun off and securitised, staff that could be downsized and internal supplies that could be outsourced — all to release value and shed costs."

Volkswagen inherited certain typical German features. In corporate governance its record was unique. There are several studies on the company. Prof Ulrich Jurgens has done a seminal case study on Volkswagen for the Social Science Research Centre, Berlin.

Within a few years of its operations, VW turned into a global company. Its operations now extend to countries in Europe, Latin America, South Africa and China. In the highly competitive European market, its share is 20 per cent. In China, where it began its operations in 1985, it has a 90 per cent share of the market. While the subject cannot be dealt with exhaustively, a few episodes are highlighted, which mark VW as sui generis from other multinational companies. Its strategies and responses to crises defy accepted wisdom on MNC operations.

VW did not adopt a policy of `downsizing and distributing' its assets or operations in Germany or elsewhere. It has not been a footloose company and has rarely undertaken disinvestment.

As a policy, VW has not outsourced components. On the contrary, it exports components from Germany to other locations abroad. This is unusual when tested against standard theory, which suggests that MNCs locate component manufactures in countries with cheap labour and assemble them back home or in third countries. In the 1980s the company adopted a model that is described as the "strategy of diversified quality production." High value models are introduced with higher unit prices, running counter to conventional precept of cutting prices to increase sale volumes. This model suited Germany, which has very high wage levels and strong unions. It suited, equally, the interests of capital and labour.

In 1993, VW met with a major crisis due to recession, necessitating reduction of 30,000 jobs over the next two years. A shareholder-driven company would cut jobs to cut costs, but not VW. It had to safeguard the interests of labour too. It decided to cut working hours with a proportionate cut in wages.

The management, in its turn, bore similar cuts in salaries though it had to work longer hours. These may read like fables when we study the record many of US/UK companies in distress. VW cares for all stakeholders and is close to German hearts. They will not allow VW to be taken over by others.

We turn to the EC demand on VW-Law. Though the EC has sent the directive, it is unlikely that it will drive it to the logical end. The EC had worse problems relating to its Growth and Stability Pact, the lynchpin of economic union and single currency, last year. Ultimately, pragmatism prevailed and it settled for flexibility.

VU-Law is related to the `golden share' issue. Italy, France, Spain, Portugal and Denmark privatised state companies but retained controlling interest. In June 2002, the European Court of Justice ruled against `golden shares' and decreed that they be allowed only in special circumstances.

As the Economist (June 27, 2002) predicted, European governments are not likely to give up control over state companies unless the stock market turns healthy and there is political will to give up control over privatised state entities. The directive on VW-Law, which is of the same category, is unlikely to be enforced in the present atmosphere. The debate will, however, go on for long years.

There was a time when, in the early 1990s, Germany wanted to reform its financial sector and get integrated with the EU and also globally. It undertook modest reforms through new legislation and supported the work on the 13th Directive. The work had to be aborted abruptly. It became clear that harmonisation was not practicable in the short or medium term.

Germany had the shocking experience in 2000 of the hostile takeover of Mannesmann, a 109-year-old steel tubes major, by a fledgling UK company, Vodafone. Mannesmann was an old economy company that had turned `new economy' by expanding into the telecom sector and indulging in acquisitions and mergers of its own.

Its shares were widely held, unlike the stock of an average German company locked up in cross-holdings. Foreigners — individual or institutional Anglo-American investors — held 60 per cent of its shares. German banks, the universal banks, did not have major holdings in it. So the company became highly vulnerable.

More shockingly, the supervisory co-determination failed to take preventive measures. Once the bid was made, the directors could not prevent shareholders from tendering shares. This was because the German Law, as it stood then — the Control and Transparency Act of 1998 — did not authorise takeover devices such as `poison pills', common in the US.

Mr Schroeder intervened and warned about the consequences of a hostile bid. The battle was lost. The blow to German pride was that the head office of the oldest German company was shifted to the UK.

Germany retracted from reforms and modified its earlier laws. The Vodafone wound being still raw, Germany is unlikely to weaken national control over other companies. It will defend Volkswagen to the last ditch.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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