Interests of Incumbents. There are several reasons why the legal and institutional impediments
for a stronger stock market (with more IPOs and venture capital financing) were not overcome—
irrespective of whether this would have been optimal or not. First, there may have been
ideological reasons. German politicians are quite proud of the “soziale Marktwirtschaft” (social
market economy) and may be reluctant to implement changes that are considered to be socially
unjust (e.g., giving up codetermination, admitting hostile takeovers, giving external financiers
more rights). Second, politicians may have benefited from not changing the system: extracting
rents from state-owned corporations or private firms (such as lucrative jobs for politicians and
support for political projects) is easier if there is less competition (profits are higher and it is
easier to deal with a few large private firms) and if the rights of minority shareholders are weak.
Third, politicians, with a view to their re-election chances may try to avoid negative publicity
from pressure groups. In addition, there are several ways in which incumbents may have
benefited from a system where (i) it is difficult for new firms to receive financing for risky
projects, (ii) transparency and disclosure are low and (iii) cross holdings make hostile takeovers
difficult. (See Rajan and Zingales, 2001.) All three effects reduce competition and external
pressure for structural change: Unions, acting in the interest of members (i.e., employees), benefit
by extracting higher wages as well as social benefits and protecting the jobs of current
employees; managers and owners of existing firms may benefit from being able to extract higher
private benefits of control. Of course, interests of the different incumbents are not always aligned.
Nevertheless, they may form coalitions against those who would benefit from changing the
system, e.g., outside shareholders, entrepreneurs seeking funding or the unemployed. For
example, managers and controlling shareholders may prefer less influence by the unions, but both
are natural allies against external investors and the potential threat of a takeover (Hellwig, 2000).
Pagano and Volpin (2000) developed a model in which controlling shareholders want low
investor protection to extract larger benefits of control and to gain political support from workers
by granting them more job security. If social benefits and job security are important, workers’
benefits are tightly linked to the well-being of the firm. Perotti and von Thadden (2002) argue
that workers and creditors prefer less risk and form coalitions to support bank over equity
financing and benefit from low transparency.
A thorough discussion of the interests of the different groups and their influence on the
political decision making process in Germany is beyond the scope of this paper. The idea that
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