The position of banks in the (West) German economy is often cited, particularly by British authors, as a reason for its strong performance. Banks' representation on company boards may remove informational asymmetries that might otherwise lead to credit rationing and onerous lending terms, while their control of voting rights may reduce the transactions costs of ensuring that managers act in accordance with shareholders' preferences.

In Discussion Paper No. 497, Research Fellow Jeremy Edwards and Klaus Fischer examine the constituent parts of this argument using data for 1970-85. Bank loans were the largest source of external finance for investment by German producers, but they played no greater role for the economy as a whole than in the UK. Stock corporations (AGs) the only enterprises that must have supervisory boards financed much of their investment internally and hardly used bank borrowing. This was more important for the producing enterprises sector as a whole, however, which suggests that enterprises without supervisory boards borrowed more from banks.

German banks clearly have considerable control of equity voting rights and positions on large AGs' supervisory boards. For AGs that are widely held, small shareholders cannot afford to devote resources to monitoring and evaluating management performance, and the `proxy voting' system gives banks a decisive influence on the outcomes of shareholders' meetings. This in turn motivates them to monitor managements, but they may not use this influence in shareholders' interests. Bank representation on supervisory boards is significant, but not dominant, and these boards are not sufficiently integrated into AGs' strategic planning processes to assess whether particular management decisions are good or bad. Moreover, large German firms hold fewer board meetings than their counterparts elsewhere, which also suggests that they supervise managements less closely.

Edwards and Fischer argue that the `big three' German banks Deutsche Bank, Dresdner Bank and Commerzbank may have the wrong incentives to act as agents for shareholders: they have significant direct equity holdings in some large AGs, but for others their control of equity voting rights stems almost entirely from proxy votes, so their interests may differ from the shareholders'. Even for AGs in which they do have significant direct equity holdings, banks' managements may not be solely concerned with maximizing their returns. If agency problems give the managements of AGs scope to pursue their own interests at their shareholders' expense, then managements of banks which are themselves AGs may have scope to pursue their own interests, and imposing discipline on others to maximize the profits from the banks' direct equity holdings may not be their first priority. They are certainly not subject to control at their own shareholders' meetings, at which proxy voting gives them effective self-control.