At a CEPR lunchtime meeting on 21 June, Colin Mayer presented the results of an examination and comparison of the patterns of corporate finance in Germany and the UK. Colin Mayer is the Price Waterhouse Professor of Corporate Finance at the City University Business School and Co-Director of CEPR's research programme in Applied Microeconomics. His talk was based on CEPR Discussion Paper No. 433, written jointly with Ian Alexander and entitled `Banks and Securities Markets: Corporate Financing in Germany and the UK'. The meeting was held as part of the Centre's `International Study of the Financing of Industry', funded by the Anglo-German Foundation, the Bank of England, the Commission of the European Communities, the Esmée Fairbairn Charitable Trust, the Japan Foundation, Lloyds Bank and the Nuffield Foundation. The views expressed by Professor Mayer were his own, however, and not those of any of these funding organizations, nor of CEPR.

Mayer compared the financing of industry in Germany and the UK, noting first that the breakdown of sources of corporate finance for the two countries at the aggregate level is remarkably similar. The majority of external finance in both countries is raised from banks, and there is no evidence that bank finance has in aggregate been greater in Germany than in the UK. The greatest difference in the composition of corporate finance between the two countries over the period 1970-85 was that retentions accounted for 74.2% of the total flow of funds to non-financial corporations in the UK, while the corresponding figure for Germany was 67.1%.

Mayer noted, however, that there are marked differences in the financing of large corporations in the two countries. He focused on the largest 115 companies quoted on each national stock exchange, from which he removed the banks and other financial institutions and then constructed equivalent series for sources and uses of funds. Large UK corporations were found to raise a greater proportion of their finance externally than their German counterparts: indeed, over the period 1982-8, German large firms raised 89.6% of their gross finance from retentions, while the corresponding figure for the UK was only 58.2%. This was not because UK firms invested any more of such funds in physical assets, but rather because they paid out greater proportions of their profits as dividends. Moreover, this difference in dividend pay-out ratios was on an increasing trend in the 1980s. In 1987 this ratio reached a peak of 28.1% in the UK, while the figure for Germany was a mere 6.5%. Mayer argued that it is because the proportion of dividends of large corporations distributed as dividends in the UK is so much larger than in Germany that more external finance is required to fund any given level of expenditure on investment.

Mayer noted that while large UK firms raise more new equity finance than German large firms, they also spend more of it on takeover activity. Netting off these purchases reveals that the funding shortfall is met through more long-term lending to UK than to German firms, so that the predicted advantage of German over UK bank finance does not apply. Instead, the main difference in the funding of large companies in both countries is in equity, not debt finance.

Mayer rejected conventional explanations of this difference, based on taxation differentials or presumed asymmetries of information between managers and shareholders. First, Germany has an exceptionally high rate of taxation on retentions which, if anything, should cause distributions by German firms to be proportionately higher. Second, it is scarcely plausible for UK managers to be signalling more buoyant future prospects than their German counterparts.

Mayer argued instead that the differences between the two countries' financial systems are best explained by theories of `control': hostile takeovers are virtually unknown in Germany but commonplace in the UK. The presence of a well developed market for corporate control induces UK firms to maintain higher dividend distributions in order to avert the danger of being taken over.

Control theories are also relevant to medium-sized firms, which raise appreciably more new equity finance from stock markets in the UK than in Germany. For example, medium-sized electrical engineering firms in the UK were found to raise 35.1% of their finance in the form of new equity over the period 1982-8, whereas the corresponding German figure was a mere 1.9%. This greater use of equity finance in the UK is mirrored in a higher level of bank lending in Germany, particularly in the form of long-term loans.

Mayer noted that the importance of long-term bank finance to medium-sized German firms is supported by data on the maturity of German bank lending to firms and the self-employed, which show that the proportion of such bank lending with a maturity of more than four years rose from 45.3% in 1970 to 52.4% in 1985. German banks exert a greater influence over the development of their corporate customers, and maintain tight control over both equity and bond markets.

In summary, large German firms enjoy a substantial degree of autonomy in the conduct of their affairs, and this has allowed them to retain a higher proportion of their self-generated funds than the corresponding UK firms. The German banking system is quite restrictive, however, in the control that it exerts over smaller corporations. This has encouraged more long-term bank lending to medium-sized firms, but at the expense of restricting their access to equity markets.