Employee Participation in Corporate Governance and Corporate Social Responsibility

My forthcoming book chapter, Employee Participation in Corporate Governance and Corporate Social Responsibility, which I recently posted on SSRN, looks at the interaction of employee participation systems (including German codetermination) on corporate social responsibility (CSR).

A large number of countries around Europe, mostly in the center and north, require some form of employee participation on the board of directors or supervisory board. The most prominent case is of course Germany, which has required half of the seats of the supervisory board of the largest firms to be taken by employees or union representatives in the largest corporations. Over the decades, employee participation systems have been a major point of controversy in European corporate governance and an obstacle to EU company law harmonization. While employee participation systems lost their allure in the “convergence in corporate governance” period of the 1990s and 2000s, the idea made a significant gain in 2013 when France introduced a requirement for the largest firms to have employee representatives on the board. Even the UK is now considering the addition of employee representatives to boards.

The term “Corporate Social Responsibility” (CSR) can be understood in a variety of ways. Based on the nexus of contracts theory of the firm, the chapter develops a distinction between “internal” and “external” CSR. Internal CSR relates to practices of the firm regarding groups with which it is in a long-term contractual relationship such as employees (sometimes called its stakeholders), whose specific investment in the relationship may generate an interest in the firm’s long term profitability akin to that of shareholders. External CSR addresses externalities produced by the firm, such as effects on the environment or consumers.

Based on this distinction, this chapter seeks to make two points. First, scholars have sometimes suggested that informal CSR (typically associated with US corporate governance) and formal stakeholder representation (such as German codetermination) are often substitutes. The CSR literature rarely engages with debates about corporate ownership structures in international comparison and their implications for employees. In an ownership structure with powerful blockholders, mere informal labor-related CSR would likely not signal a sufficient level of commitment to workers to foster human capital development. Informal practices should rather be seen as an aspect of the balancing act of boards in a dispersed ownership firm. Formal representation of employees, by contrast, is a necessary counterweight to the power of large blockholders in concentrated ownership corporations.

Second, distinguishing between internal and external CSR highlights a possible tradeoff between the two. Employees, as the main example for beneficiaries of internal CSR, can at times benefit from a corporation not being a good corporate citizen regarding external CSR. For example, employees’ jobs and career prospects may at times be enhanced if the corporation is profitable due to its disregard of the environment. The ongoing Volkswagen (VW) emissions scandal provides a timely illustration. The scandal, now that it has emerged, has become very expensive for VW. VW is notable for the structure of its supervisory board. Being subject to German codetermination, half of its board members are union and employee representatives. As VW still retains special appointment rights for the state of Lower Saxony under its articles of incorporation, the “shareholder bench” of the firm’s supervisory board still comprises two political officials next to representatives of the major shareholder groups. Nevertheless, this did not result in better external CSR. The scandal highlights that internal CSR are not necessarily linked. VW inflicted serious harm on its customers and possibly the environment, and a number of observers have blamed codetermination and the strong role of labor as a contributing factor. The point is not, however, that codetermination necessarily undermines effective oversight by the board, as critics of corporate governance have argued for decades. It is rather that workers, like shareholders, typically benefit when the company does well, and are often harmed when the company does not do well. Consequently, as long as VW successfully pursued an expansive strategy to which the emission cheating contributed, its employees probably benefited just as much as or even more so than shareholders did, resulting in high income, professional success and more secure jobs. VW managed to strengthen its position in the market and even increase its market share relative to its competitors. The reputational or long-term reasons that are considered a “good business case” for CSR have similar effects on shareholders and employees. Thus, whether a firm is a good “corporate citizen” does not depend so much on whether board members are elected by shareholders or employees, but rather on the effectiveness of legal compliance systems.

The full paper is available for download here.

Martin Gelter is an Associate Professor of Law at Fordham University.