German Konzern

Created By :
Raden Satrio Wibowo (12010114130127)

DIPONEGORO UNIVERSITY
1. Introduction
Business groups play an important role in many developed and developing countries.
Participation in business groups allows firms to reduce transaction costs, overcome market
imperfections and increase performance by using economies of scale and scope (Alchian 1969,
Williamson 1975, Chang and Choi 1988, Stein 1997, Hulle 1998, Khanna 2000, Khanna and Pelepu
2000). Specifically, recent studies have shown that investment by firms affiliated with business
groups is less sensitive to cash flow than investment by their stand-alone counterparts (e.g.,
Hoshi et al 1991, Perotti and Gelfer 2001). This finding is often interpreted as showing that
business groups have internal capital markets that alleviate external capital market imperfections
such as asymmetric information or transaction costs.
The key question is whether this result applies universally because the scope and extent
of wedges between external and internal financing depend on financial institutions. Indeed,
cross-country studies (e.g., Hall et al 1998, Bond et al 2003) report that the link between
investment and liquidity appears to be weaker in a bank-based financial system than in the Anglo-
American financial system. The main reason is considered to be the close ties between banks and
their client firms in bank-based systems. In close relationships information asymmetries are
weakened. This mitigates adverse selection and moral hazard, and thus relaxes financial
constraints (e.g. Peterson and Rajan 1995). Accordingly, as an internal capital market is
considered to be an alternative mechanism for providing insurance against the risk of being
financially constrained, it might be expected that participation in business groups is less
beneficial in a bank-based system like the German one. However, available evidence on the
difference in the investment-liquidity relationship between business group firms and firms
outside business groups in developed countries is limited to Anglo-American and Japanese
business models and, to the best of our knowledge, little is known about the sensitivity in the
continental business model. In fact, Morck et al. (2005, p. 672) observe that the lack of results
may be due to the lack of empirical attempts using developed country data.
This paper fills the gap and compares the investment sensitivity to cash flows of business
group firms with that of stand-alone firms in Germany. We thereby concentrate on the most
common type of German business group the Konzern, which is group of affiliated companies
consolidated under the unified leadership of a ruling company.
Previous research on the continental business model and its implications for investment
do not consider the effects of participating in business groups. They either focus on the periods
of early capitalism (e.g., Fohlin 1998, Becht and Ramirez 2003) or analyze the sensitivity of
investment to cash flow for modern German firms without paying special attention to their
affiliations (Audretsch and Elston 2002, Behr 2005, and Bond et al. 2003). Obviously, we do not
have micro-level data for other countries and hence cannot verify whether our claims hold for
the other continental European countries. However, the German business model of interaction
between firms and the financial sector is prominent in Europe and, to a significant extent,
captures the key ingredients of the financial system in continental Europe (see e.g. Rommens,
Cuyvers and Deloof 2007). Consequently, similar results could be expected to hold for other
countries and we hope that future work will shed more light on whether our conclusions apply
more broadly.
We use a unique large sample of German firms that is part of the balance sheet database
of Bundesbank, the German central bank. The sample contains annual characteristics of about
125,000 firms from 1988 to 2000. This dataset is particularly interesting as it includes a broader
sample of firms than is generally considered in studies of listed firms. Specifically, our sample
includes many small firms for which financial friction could be much more important than for
large firms in the bank-based financial system where banks have significant amount of
information about their business clients. Hence, unlike some previous studies based on listed
firms, we find important and meaningful variation in financial friction and can detect whether a
bank-based system can alleviate the friction for firms where this friction is particularly acute or
whether affiliation with a business group is better at reducing the adverse effects associated with
the financial friction.
By employing the econometric framework developed in Bond and Meghir (1994), we
find that the financial situation of small firms is affected by their affiliation status. If they belong
to a Konzern, the magnitude of investment sensitivity to cash flow is reduced. In contrast, there
 is no clear evidence that medium-sized and large companies participating in Konzerns have a
different investment response compared to that of their stand-alone counterparts. The
membership in Konzerns does not seem to provide a better remedy for financial friction than is
already available for this type of firm from house-banks or the German capital market.
3
The rest of the paper is organized as follows. The next section briefly describes the
German Konzern. Section 3 presents the Bundesbank dataset. Section 4 introduces the empirical
strategy. Section 5 discusses our empirical results. We conclude in Section 6.

2. The German Konzern

A Konzern is the most common type of business group in Germany. Companies
participating in a Konzern are coordinated by a single decision-making center and sometimes
bound together by cross equity holdings. The German Stock Companies Act defines a Konzern
(group) and the corporations that build it (group companies) in two alternative ways: (1) If one
dominant and one or more dependent companies are consolidated under the unified leadership
of the ruling company, they form a group and the individual companies are group companies. if
legally independent companies are bound together under a single management without one
company being dependent on the other, they form a group and the individual companies are
group companies.
Basically, Konzerns (groups) can be divided into two types. One type consists of a large
numbers of either vertically or horizontally related business divisions. The other type includes
seemingly unrelated lines of business. The latter is often referred to as a holding company or a
conglomerate. Horizontally or vertically integrated Konzerns are usually supposed to realize
synergy effects and/or block competitors in the same or in the up-stream and down-stream
markets. In many cases the Konzern includes financial firms. Banks and insurance firms either
serve to internalize profits that are created by the needs for financial services of non-financial
group members or they directly support internal capital allocation, or both. For example, the well
known Volkswagen Konzern includes the vehicle-producing divisions Volkswagen, koda,
Bentley, Bugatti, AUDI, SEAT, Lamborghini, Volkswagen Nutzfahrzeuge Scania, Volkswagen
Marine Bootsmotoren. In addition, attached to it are the financial firms Volkswagen Bank,
Volkswagen Leasing and Volkswagen Insurance Service.
The second common type of Konzern, the conglomerate or holding company, often has a
non-producing parent company that simply owns the subordinated companies. It holds usually
controlling shares in their seemingly unrelated subsidiaries and thus has enough influence to
direct the actions of the subsidiaries managements and boards. One of the best-known German
conglomerates is the Siemens AG. Typically, internal capital markets are controlled by the parent
company and, as with the first type, cross subsidization usually occurs between divisions. This is
often considered as being part of an implicit insurance contract against financial constraints and
is one of the important rationales behind building the architecture of a Konzern.
A concern (German: Konzern) is a type of business group common in Europe, particularly
in Germany. It results from the merger of several legally independent companies into a single
economic entity under unified management.
A concern consists of a controlling enterprise and one or more controlled enterprises. The
relationship between the controlling and controlled enterprises is based on the actual
commercial and management relationships, unlike parent and subsidiary companies which are
related by share ownership and voting rights.
Outside of professionals, the term Group, also mistakenly within the meaning of large
companies regardless of its corporate structure is understood.
The Group concept is one of anti-trust relevance: the so-called Group privilege, the
privilege of the consolidated Group companies involved, means that in itself, prohibition included
practices did not violate German or European Commission (EC) anti-trust law. On the other hand,
the Group concept in Banking Act in the formation of borrower unit and particularly of the large
credit limits of paramount importance.

Types of Concern
The Stock Corporation Act 1965 (Germany) ("the Act"), defines the Concern as: "one
dominant and one or more dependent companies under the unified leadership of the ruling
company together".
 The Act only applies to German stock corporations (which are analogous to public
company in the United States and the Commonwealth) and not to German limited liability
corporations (which are analogous to non-publicly traded companies in the United States and
the Commonwealth), which are regulated under the Limited Liability Company Act of 1892
(Germany).
The Act defines three different kinds of concern: the contractual concern, the factual
concern, and the flat concern.

Contractual Concern
In this form of concern, the controlling enterprise and controlled enterprise enter into a
control agreement - wherein the controlling enterprise can obtain management powers over the
controlled enterprise, sometimes amounting to complete control - and/or a profit transfer
agreement. These powers may be used in a way that is detrimental to the subsidiary, provided
that they are in the interests of the concern and do not damage the legal separateness of the
subsidiary.
In return, the controlling enterprise is liable to compensate the controlled enterprise for
all deficits of the controlled enterprise during the term of the agreement.

Factual Concern
In this form of concern, the controlling enterprise exerts a controlling influence on the
controlled enterprise, but there is no formal control or profit transfer agreement. If one company
owns a majority in another company, then the first company is deemed to exert a controlling
influence. The parent company is then liable for any damage which results from the interference
of the parent company in the subsidiary, which is judged on a case-by-case basis. This kind of
concern is more difficult to establish and so is more common.

Flat Concern
In this version, there is no parent company, instead a number of legally separate
companies are subject to common direction.
Other forms of Concern
To apply the law of concern to concerns involving German limited liability companies, the
German courts have created the qualified de facto concern, beginning in the 1970s. This form of
concern applies only in parent subsidiary relationships. If the parent is shown to have a long
standing and pervasive control over the affairs of the subsidiary, then there is a presumption that
the parent was not acting in the best interests of the subsidiary. If the parent is unable to displace
this presumption, then the parent is liable for all the obligations of the subsidiary.

This type of concern was limited by the German Federal Supreme Court in 2002 to only apply
where the control is such that the subsidiary will inevitably collapse or become insolvent, on the
basis that the parent has abused the separate legal personality of the subsidiary.