Organizational design in the banking industry -

A comparative institutional analysis of the German

cooperative banking group∗

Marco Weiss†

July, 16th, 2004

Abstract

Different institutional designs often have evolved over time for the perfor-

mance of the same economic or social activity. In the provision of financial

services such different institutional arrangements can be found as well. This

paper examines the strategy, organization and corporate governance of the

cooperative banking group in Germany. By contrasting the different config-

urations of the organizational design parameters with that in the Deutsche

Bank AG - a model more in line with standard economic theory about profit-

maximizing firms - the systemic features of both business models are described.

It is shown that both models constitute consistent systems. The performance

and ability to adapt to changes of these two different organizational designs

is analyzed at the end of the paper.

JEL Classification: G21, L22, P13, P51

Keywords: economics of organization, corporate governance, banking, coopera-

tives, comparative institutional analysis, organizational design

∗I thank my colleagues at the Wilhelm Merton-Chair at the Johann Wolfgang Goethe-University

Frankfurt/Main for comments. I especially thank Mathias Beers of norisbank AG for a discussion

of these ideas.†Address for correspondence: Wilhelm Merton-Chair for International Banking and Finance;

Johann Wolfgang Goethe-University, Frankfurt/Main; http://www.finance.uni-frankfurt.de;

Phone: ++49(0)69 798-28268; M@il: weiss@finance.uni-frankfurt.de

1 Introduction

Different institutional and organizational designs often have evolved over time for

the performance of the same economic or social activity. In the provision of financial

services such different institutional arrangements can be found as well. By applying

the methodology of a comparative institutional analysis1 crucial differences between

different economic systems can be established. This paper follows this path by

comparing a publicly listed bank like the Deutsche Bank AG with the cooperative

banks in Germany. It is striking that the biggest German bank, Deutsche Bank, has

had total assets of �804 billion at the end of 2003 whereas the credit cooperatives

with their central banks and other special finance companies in their group have had

an aggregated, non-consolidated total assets of approximately �988 billion. This is

due to the fact that the cooperative banking group is not a single legal entity but is

formed by about 1.400 independent banks. This is not the only difference. Also in

respect to their strategy, their organizational structure, their owners and corporate

governance and last but not least the understanding why they are in business at

all, both institutional designs differ remarkably.2 This paper compares the different

structures and processes that make up the different institutional arrangements and

answers the question whether one banking group is more efficient than the other or

if both institutions have their advantages but also disadvantages.

Related literature A lot of work on German cooperative banks is done at a

specialized chair at the university of Munster. Theurl and Kring (2002), for exam-

ple, describe the governance structures of various banks operating in the German

cooperative banking group. For selected institutions on all levels of the German

cooperative banking group they list the formal and informal arrangements that

shape the governance of the institution in question and the governance of the whole

net of institutions. Especially the use of different legal bye-laws allows for a fine-

tuned governance of each individual entity, but also for a delicate set of checks and

balances in the whole group.

Greve (2002) has a similar approach to analyzing the German cooperative bank-

ing group. By applying the insights from the new institutional economics literature

he shows that the cooperative form is an efficient institution when asymmetric in-

formation about the creditworthiness of clients prevail. By the same argument,

he shows that the formation of a cooperative banking group with central banking

institutions is an effective response to deal with that uncertainty. The imminent1See Aoki (2001).2They are also changing over time and adapt to new challenges and opportunities as the whole

German financial system and banking industry change. This paper analyzes a snapshot of both

institutional arrangements at the time around 2002.

1

hold-up problem that any specific investment of small cooperative banks towards

the monopoly of the central bank causes can be dealt with through the assignment

of the ownership of the central bank towards the local credit cooperatives. Greve

(2002) sees the principle of membership and the identity of members and customers

as the core competence of the credit cooperatives.

This article goes beyond this narrow focus on governance aspects in the German

cooperative banking group. By contrasting the cooperative banking group as one

organizational design for performing an economic activity with another design - the

Deutsche Bank as a firm more in line with traditional economic theory - it analyzes

whether both ways to produce and distribute financial services are efficient and

consistent systems. The governance of cooperatives can only be one element in

such a corporate system. Of equal importance are the strategy pursued and the

purpose fulfilled by such an economic system as well as the allocation of power in

the system conveyed either at a micro-level by the organizational structure or at

the macro-level by the corporate governance.

Deutsche Bank AG Deutsche Bank AG was founded in 1870 in Berlin ”to trans-

act banking business of all kinds, in particular to promote and facilitate trade rela-

tions between Germany, other European countries and overseas markets”3. Spread-

ing out from these headquarters it has opened branches in all important German

cities as well as in the major capitals abroad. Over the years it has grown to the

market leader in Germany in many areas of banking and asset management and

has become a respectable bank with global ambitions. Today the bank has approx-

imately 503.000 different shareholders with the bulk (82%) of its shares held by

institutional investors. In more than 1500 branches the bank serves more than 13

million customers in personal and private banking, mainly in Germany and the EU.

Additionally, many institutional investors rely on Deutsche Bank to have their assets

managed. In the last years Deutsche Bank made considerable efforts to build up an

investment banking division by acquiring first the London-based Morgan Grenfell

and later the US-bank Bankers Trust. At the end of 2003, the bank employs 67.682

people of which more than half work outside Germany. The corporate culture of

Deutsche Bank is geared towards performance and leadership plays a strong role

in the group: both issues are manifested in the banks former slogan ’Leading to

results’ and the current one of ’A passion to perform’.

The cooperative banks ”In terms of the number of people, co-operatives are the

largest economic organization in Germany with approximately 20 million members.

Co-operative banks represent the largest group of co-operative companies with 153http://www.deutsche-bank.de.

2

million members and 200,000 employees.”4 The cooperative banks rest on the idea

of Friedrich Wilhelm Raiffeisen that what the individual cannot achieve, may be-

come possible for the many. In 1850 Hermann Schulze-Delitzsch founded the first

Volksbank in Saxony. He later described this experience in a publication which led

to the autonomous foundation of many local banks based on these principles. The

credit cooperatives grew locally and the top tier was established later, only when the

need for these institutions emerged.5 At the end of 2003, there were 1.393 indepen-

dent cooperative banks (Kreditgenossenschaften) with an average volume of total

assets of �406,5 million. They are supported by two central banks (DZ Bank, the

product of a merger of DG Bank and GZ Bank in September 2001 and WGZ-Bank),

two mortgage banks (DG Hyp and Munchner Hypothekenbank), Germany’s biggest

building society with a market share of 25% (Bausparkasse Schwabisch Hall), one

insurance company (R+V), the third-biggest German investment funds managers

(Union Investment, DIFA and DEVIF together in the Union-Fonds-Holding AG)

and several special finance companies for leasing (VR Leasing), factoring and other

financial services, e.g. the BAG Bankaktiengesellschaft in Hamm for problem loans.

This Finanzverbund is completed by four companies performing IT services (e.g.

Fiducia) and by the seven regional associations (Genossenschaftsverband) that per-

form consulting and auditing services for their members. The credit cooperatives

are organized in the Bundesverband der Volks- und Raiffeisenbanken (BVR).

Altogether, the cooperative banks and their top-tier institutions have around

15.000 branches and offices in Germany (down from 17.500 in 2000) serving 30 mil-

lion customers. With a market share of roughly 18% of client deposits in Germany

in April 2004 the credit cooperatives and their two central banks were second only

to the savings banks - also a group of independent banks structured in a similar

fashion as the cooperative banking group. The four biggest private banks together

(among them Deutsche Bank) had a share of 14,4% in deposits. In loans to private

households and corporations the big four had a market share of 12,7% compared to

16,1% of the cooperative banking group.6

Table 1 gives the key figures for both banking groups for the last three years.

Methodology The goals of this paper are the description of the different organi-

zational designs that the two banking groups have chosen as their business model

and the analysis whether one organizational design is superior to the other in terms

of economic performance. The emphasis is put on the cooperative banking group as

the business model less in line with standard economic theory. The publicly listed4http://www.dzbank.de.5See Aschhoff and Henningsen (1996) for a more detailed history of the cooperative banks in

Germany.6Figures and calculations are from Deutsche Bundesbank (2004).

3

Deutsche Bank Cooperative Banking Group

2001 2002 2003 2001 2002 2003

Total assets1 918.222 758.355 803.614 903.000 909.000 890.000

Income

before tax1 1.803 3.549 2.756 0,37%2 0,47%2 n.a.

Number of

- customers 12.000.000 12.500.000 13.000.000 30.000.000 30.000.000 30.000.000

- shareholders 523.059 512.519 503.000 15.154.624 15.184.846 15.281.857

- employees 94.782 77.442 67.682 170.000 170.000 175.000

- branches 2.099 1.711 1.576 16.707 15.866 14.979

ain million �bof total assets of primary banks

Table 1: Key facts and figures for the banking groups

Deutsche Bank is used as a reference point and benchmark since in this business

model performance measures like profit are much more pronounced as prescribed

by economists.

The methodology used for this comparative institutional analysis is that of sys-

tems theory. A system consists of various elements that have certain characteristics

with each other. One such characteristic can be a complementary relationship be-

tween two elements. Mathematically, this amounts to a positive cross derivative

or a supermodular relation between these two elements.7 From the viewpoint of

economics, this characteristic leads to the fact that increasing one element also

increases the benefit from increasing the other as well. If many elements form a

complementary relationship with each other, the right configuration of all is im-

portant for the proper functioning of the whole system. Such a system that makes

use of the complementarity between its various modules is a consistent system.

No small deviation in the configuration of any single element can lead to a better

performance of the whole system but may even impair the success of the system

by making it inconsistent. When these complementary relationships prevail among

the elements, the coordinated configuration becomes necessary. This is the issue of

organizational design.

The first authors using this mathematical approach in the realm of economics

were Milgrom and Roberts (1990). They showed how the Japanese system of man-

ufacturing applied by Toyota was indeed a system with the main parameters con-

figured in a consistent way. In the area of banking, Aoki and Patrick (1994) applied

this thinking to describe the Japanese banking system. The various contributors

towards Krahnen and Schmidt (2004) use this methodology to describe the merits

of the German financial system. A comparison between different financial systems7See Topkis (1998) for the mathematics of complementary and supermodularity.

4

in Europe is provided by Schmidt, Hackethal, and Tyrell (2002). For the use of this

methodology in the context of corporations as systems, see Roberts (2004). The

organizational design of consistent systems is nearly always a bimodal distribution

with two distinct configurations. In this article the two systems in question are the

organizational designs of Deutsche Bank and the cooperative banking group. Such

consistent systems are local optima: Any incremental variation in only one element

will lead to an inferior performance of the system as a whole.

The idea of combining the framework of comparative institutional analysis with

this systems thinking can provide an answer whether on consistent system is better

than the other, i.e. does a global optimum exist? In the context of this article this

translates into the question whether the organizational design of either Deutsche

Bank or the cooperative banking group is more efficient.

Structure of the paper Section 2 analyzes in depth the question which strategy

these organizations pursue and how this strategy is reflected in the respective orga-

nizational structure - either internally in one bank or over the external boundaries

of many smaller divisions. The issue of corporate governance of the two organiza-

tional designs is dealt with in section 3; here the question of how control is allocated

and how leadership is exercised is analyzed. In both sections, a short description of

the benchmark of Deutsche Bank is given before concentrating on the configuration

of the elements in the organizational design of the cooperative banking group. Sec-

tion 4 then evaluates in which situations the one or the other arrangement has an

advantage or whether one organizational design must be seen as grossly inefficient.

2 Strategy and organizational structure

2.1 Deutsche Bank

Strategy and business understanding The Deutsche Bank is structured as a

virtual holding company with two business groups: a ’Corporate and Investment

Bank’ and ’Private Client and Asset Management’. The strategy that Deutsche

pursues with this concept is customer-focused with both business groups closely

connected to create substantial revenue and cost synergies.8 With the new con-

cept however, the responsibility for IT infrastructure was decentralized to the two

business groups ”to enable product and client-related IT developments to be imple-

mented faster and more efficiently”9. From the remaining parts of the virtual hold-

ing structure Corporate Center and Corporate Investments perform crucial tasks

like planning, control and managing of the industrial holdings and venture capital8Deutsche Bank (2004).9Deutsche Bank (2001, p. 8).

5

activities while DB Services is open to attract business volume in scale intensive

activities from other banks as well.

Structure of the bank Deutsche Bank’s structure is rather centralized with im-

portant strategic and operational decisions being made in its corporate or divisional

headquarters in Frankfurt or - in the case of investment banking - in the more im-

portant markets like London and New York. Deutsche Bank pursues a strategy with

global ambitions. Having acquired Morgan Grenfell and Bankers Trust it directs

many resources into the investment banking business with its potentially higher

margins. In the annual rankings of the investment banking business Deutsche Bank

has climbed in recent years into the bulge bracket and looks well-positioned to cater

for the biggest clients on a worldwide basis. Unlike some of its Wall Street-rivals it

is backed by a huge balance sheet that allows intermediate financing of a client for

the short- and medium-term whenever the market conditions do not allow for an

immediate issue of securities in the capital markets.

Human resource policy and career paths Human capital at Deutsche Bank is

well qualified to meet the goal set by the overall strategic direction: more than half

of all employees are graduates from universities. The responsibility for training and

acquisition of necessary skills is left mainly to the individual, but certain executive

development programs together with Ashridge Management College and Duke Uni-

versity exist with Deutsche Bank sponsoring some of the expenses. Deutsche Bank

states on its website: ”A new view of career is gaining importance: development of

one’s own capabilities, expanding the basis of one’s knowledge and gaining prestige

for one’s abilities, knowledge, and personality.”10 This emphasizes the acquisition of

rather general than bank-specific knowledge and puts weight on the employability

of its human resources.11

Consistent with the relatively high degree of decision-making power, the human

resource policy is shaped by equity-based compensation elements like the DB Share

Scheme and DB Global Share Plan for top managers. The value of such compensa-

tion is subject to change due to market conditions or dismal performance: In 2003,

the bank released �20 million to earnings related to amounts previously accrued for

such options.12 This puts risk on employees which in turn leads to a self-selection of

people applying to work with Deutsche Bank. Employees in general are encouraged

to buy shares of Deutsche Bank by a special scheme with 65% of them participat-

ing in it worldwide in 2000. Even at the retail level, pay-for-performance schemes10http://www.deutsche-bank.de.11See Ghoshal, Moran, and Bartlett (2001) for the concept of employability.12See Deutsche Bank (2004, p. 83 - 91) for the use of these various equity-based compensation

elements.

6

were introduced for tariff employees at around this time.13 The idea behind this

strong emphasis on variable pay elements and high empowerment is to encourage

innovation in products and processes.

Although there are established career paths within Deutsche Bank and an up-

or-out rule at least in the investment banking division, it does not operate a strict

internal labor market. Too much emphasis on growth by acquisitions and many

restructurings prohibit the effective use of it. A further sign that Deutsche Bank

is not committed to such an internal labor market, is the appointment of the new

speaker of the board, Josef Ackermann, who joined Deutsche Bank only in 1996

after he was thwarted at Credit Suisse.14 Economic theory predicts that in such

an environment implicit contracts about future promotions are no good instrument

to give incentives to employees and management. Incentive effects must therefore

be provided by pay-for-performance and stock options as mentioned above and is

consistent with the emphasis on employability.

2.2 The cooperative banks

Strategy and business understanding The strategy for the cooperative bank-

ing group as a whole is ’made’ or coordinated by their association, the Bundesver-

band der Volks- und Raiffeisenbanken (BVR - Federal Association of German Co-

operative Banks).15 The new strategy ’Concentrating Forces’ was overwhelmingly

endorsed by 97% of the members of the BVR on their 2001 general meeting. Seven

special projects16 were started that deal with particular problems. Teams with

people from many Finanzverbund-organizations were built. In all teams the repre-

sentatives of the local banks are the biggest group. The responsibilities for these

projects and the coordination is undertaken by either the BVR, the regional asso-

ciations, the central banks or the IT-services - wherever the greatest competence

is.

The understanding why the cooperative banks are in business is stated by on of

the largest credit cooperative on its website thus: ”The cooperative form rests on a

special principle. For us as a cooperative bank the pursuit of profit in a shareholder-

value sense is not everything. More important is the economic advancement of our

members. [...] Our responsibility against our members does not only include the

payment of an attractive dividend. It also involves a strong orientation towards our

business area and the accompanying of our target group - the entrepreneurial and

private middle class.”17

13See Deutsche Bank (2001).14See Economist (2002) for a portrait of Josef Ackermann.15Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001, p. 5).16See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001, p. 10).17http://www.frankfurter-volksbank.de.

7

On the top-level, the DZ Bank describes its role as follows: ”[I]t is the cen-

tral clearing bank, liquidity manager and service provider for the local co-operative

banking sector. As a group it also covers business involving investments, mort-

gage banks, savings and loans as well as leasing, factoring, insurance and financing

for equity capital and projects. These services are provided by specialists in the

subsidiaries in Germany and abroad.”18

Both statements have in common that profitability is only seen as a necessity to

stay in business. The more important goal lies in fostering the interest of their mem-

bers and helping their clients - or from the perspective of the central institutions,

the local credit cooperatives - to succeed.

Structure of the group In its annual report the BVR gives the following state-

ment about the structure of the Finanzverbund: ”The ideal of the cooperative

banking group is and will be the legally and economically autonomous Volksbank

or Raiffeisenbank in its local community. The cooperative banking group is no con-

cern and it will not become one in the future. The autonomy of the BVR members

and its agents remains untouched.”19

The structure of the German cooperative banking group is very decentralized.

At the end of 2003 there were 1.393 Volks- and Raiffeisenbanks, the local credit

cooperatives, that are independent legal entities. Their 15 million members are

the ultimate owners of the whole cooperative banking group since the shares of

the central banks are held by the primary banks. The majority of the special

financial institutions are in turn controlled by the central banks and the local credit

cooperatives together or are subsidiaries of the central institutions.

The role of the local credit cooperatives is to promote the business and welfare of

its members by offering them the best products. They have the local knowledge to

make the right decisions for this goal and to give the best advice for its customers.

Therefore the marketing of financial products is in the realm of the local cooperative

banks. They specialize in serving the customer in the best way.

The role of the central banks in the organization is that of an agent to the small

autonomous units that make up the Finanzverbund. ”According to its statutes,

DZ Bank’s traditional mandate is to promote the German co-operative system. It

supports its partner banks in times of high credit demand or of excess liquidity,

and provides them with the whole multitude of products and banking services,

because it would be inefficient to let every local credit co-operative develop these

individually.”20 The DZ Bank sees its main tasks as to perform the central bank

function for the 1.131 Volksbanken and Raiffeisenbanken in their area and to carry18http://www.dzbank.de.19Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001, p. 9).20http://www.dzbank.de.

8

out the all the commercial bank functions in Germany and abroad for them and

their clients when necessary.

The role of the special financing institutions then is to build up the expertise in

various areas of financial services. They develop new products like mutual funds,

insurances and special finance like factoring and leasing and concentrate on the

efficient execution of the related tasks. It is here where the special knowledge about

products and the legal and tax environment resides. These special organizations act

as a center-of-competence within the Finanzverbund and their number is growing

as recent foundations and outsourcing of various activities shows.

Human resource policy and career paths Most employees in the local credit

cooperatives are from that particular region and know their customers not only

as such but also meet them regularly in their social lives. Unlike the employees

from the Deutsche Bank who often are ’imported’ from another branch and have

many incentives to leave for another job after a few years, the employees in the credit

cooperatives show a greater loyalty to their bank. Meaningful relationships between

customers and their bankers can develop better and often endure many generations.

The cooperative banks rely less on university graduates but emphasize more the

apprenticeship system with subsequent training done within the Finanzverbund by

the Akademie Deutscher Genossenschaften (ADG) or provided by external sources

on a level below that of universities. This fits well to the internal labor market that

the Finanzverbund operates for the directors of the local banks, their central banks

and their association. The current president of the BVR for instance has worked in

the DG Bank and institutions that previously merged with it before being appointed

for the top job at the BVR. The Bankaktiengesellschaft AG in Hamm, a center-

of-competence for bad loans, as another example dispatched several employees in

2000 to work on a temporary basis as executives in the top management of other

banks.21

Systemic features in the strategy and organizational structure of the

cooperative banking group The deconstruction of the value chain that today

is so popular among many big industrial groups has been in place in the cooperative

banking group for more than the last century. The unbundling of activities allows

to concentrate on how best to achieve the economies that underlie the respective

business. In the case of marketing these economies are mostly one of scope. Value for

customers is best created by selling the most appropriate good to them. The dense

branch network and the fact that the local cooperative banks and their employees

are firmly rooted in the local community allows them to gather the necessary specific21See BAG Bankaktiengesellschaft (2001, p. 12).

9

information that make the realization of these economies of scope possible. By

concentrating on the ’production’ of financial services and the related back-office

activities the central banks and the special finance institutions achieve economies

of scale. They step in whenever the local banks are either too small for the efficient

production of financial services or are restrained by the limited geographic reach of

each bank.

The research and development activities and the production activities are or-

ganized in the central banks and the special financial institutions. By pooling the

best human resources in center-of-competences it becomes possible to create a com-

petitive edge for the local credit cooperatives and for the other institutions within

the Verbund. Innovation and entrepreneurship is probably enhanced by the decen-

tralized structure of the Verbund with formal delegation of decision rights to the

managers at the local banks and branches. With trial and error it is possible to

adapt to changes and to find the solution that suits each particular change in the

best way. The role how innovation is handled in the Verbund can be shown with

the example of the recently founded VR Kreditwerk AG, a joint venture between

the DG Hyp AG and Bausparkasse Schwabisch Hall AG which specializes in the

provision of back office work that is related to all aspects of real estate financ-

ing. Kreditwerk states on its website that the ’open architecture’ of the Kreditwerk

makes it possible for other cooperative mortgage banks and all interested credit

cooperatives to participate in this innovative service concept.22

3 Corporate governance

3.1 Deutsche Bank

In the corporate governance of the Deutsche Bank four stakeholders are explicitly

acknowledged: ”Deutsche Bank regards its shareholders, customers, staff and so-

ciety as its four key stakeholders with equal status and with whom it engages in

dialogue and partnership. Maintaining a balance among this quartet of interests

is, for us, a demanding and compelling challenge. Part of our corporate identity is

to create lasting added value for all four interest groups.”23 As in any capitalistic

corporation formal control rights rest ultimately with the shareholders who provide

the equity capital necessary for the banks operations. They can exercise their rights

in the annual general meeting. In 2003, about 39% of the registered shares made

use of these rights in the AGM of Deutsche Bank.

The shareholders elect their representatives into the Supervisory Board, the22http://www.vr-kreditwerk.de.23Deutsche Bank (2001, p. 12).

10

Aufsichtsrat. Together with the representatives of the employees according to the

German codetermination law they jointly control the Board of Managing Directors -

or Vorstand - made up of four people as per June 2004 who are ultimately responsible

for the decisions taken in the bank. It is supplemented by the Group Executive

Committee that has eleven members and includes the managing directors as well as

the business heads of the group divisions. It reviews the development of the various

businesses, discusses strategy and prepares recommendations for final decision by

the Board of Managing Directors. The Deutsche Bank Vorstand exercises strong

leadership in a relatively small board compared to other German boards: The

spokesman Josef Ackermann has claimed a more CEO-like role for him. As in the

internal hierarchy there are clear responsibilities defined for specific tasks.

The stakeholder group of customers can rely on a competitive banking market

in Germany. The power for Deutsche Bank to extract rents from them is thus

limited. Besides its representatives in the supervisory board, the staff has broad

decision-making power assigned by various elements of the organizational structure

and can thus safeguard its investments which are of rather general nature due to

the employability concept pursued by Deutsche Bank.24

The distribution of power between these four stakeholders is of interest: There

remains the question if Deutsche Bank ultimately is a company run in the interests

of its shareholders. They have stated on their website in 2002: ”A bank’s growth

depends on its shareholders’ willingness to provide sufficient capital. Shareholders,

however, will only do that if they receive a return that corresponds at least to the

usual capital market yield. Only then will Deutsche Bank shares remain an at-

tractive investment for private and institutional investors.”25 Nothing is said about

maximizing shareholder-value; instead it is implied that the shareholders get the

’usual capital market yield’. That is quite a long way from their role as residual

claimant prescribed to them by the economic theory.

3.2 The cooperative banks

With more than 15 million members the cooperative banking group has one of

the most dispersed share-holdings in the world.26 Like a capitalist firm the Volks-

banken and Raiffeisenbanken delegate functions and responsibility to people, who

are competent and which enjoy the confidence of the members. The members select

a supervisory board. This selects the executive board of the bank.27 Executive24On the substitutability of power conveyed through the corporate governance and power con-

veyed through the organizational structure see Schmidt and Weiss (2003).25Deutsche Bank (2001, p. 12).26See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001, p. 55).27See Theurl and Kring (2002, 8 - 11) for more information on cooperatives governance.

11

board and supervisory board are responsible towards the yearly members or repre-

sentatives meeting for their activities. Thus the responsible persons are checked in

a democratic way. Each member is equal: It has one voice, regardless of the number

of shares. The democratic cooperative form functions by the system of checks and

reconciliation of interests.28

However, this democratic element has its drawbacks as well. Because unlike

an incorporated bank the equity base of credit cooperatives is variable: Capital in

the cooperative banks can be redeemed by its members. That makes the cooper-

ative vulnerable to withdrawals of their capital base which determines its growth

possibilities. There is therefore a strong incentive for the management to retain

its earnings and thus secure the opportunity for future growth.29 This tendency is

further strengthened by the fact that the member share is redeemed at its nominal

value. This lack of a secondary market leaves any accumulated surplus with the

cooperative. The result is a rather unattractive financial claim that does not pro-

vide any strong incentives to actually use the formal power the general meeting of

members has.

This fact is enhanced by the allocation of decision rights between the members of

the cooperative. Regardless of the capital that one supplies she has only one vote in

the general assembly. The resulting feature of a credit cooperative is therefore a very

autonomous management that is not subjected to external control by the capital

markets nor internal control by the general meeting.30 Is this an inefficient outcome

or are there other checks and balances in place to keep the power of managerial

discretion small?

This is indeed the case: The acquisition of information about the behavior of the

management is comparatively cheap. The members and shareholders of the bank

live close to their bank and the managers share the social life in the town or region

where the members reside. Any excesses and too much fringe benefits by the man-

agement can be seen rather immediately by the members and put into the regional

context and standards. Furthermore, the members perform different functions: they

are not only the providers of equity capital but they are also the depositors and

the borrowers of the bank. As shareholders they would go for more risk than they

would prefer in their role as depositors. By bundling together these three functions

into one, the agency conflict between shareholders and debtors is minimized. The

remaining agency problem between these members and the management is taken

care of by the fact that credit cooperative banks are firmly rooted in a limited area.28See http://www.bvr.de.29As Pleister describes, ”there is a rule of thumb when it comes to the distribution of the

economic results: a third is used for the internal strengthening, a third is used for the equity

capital and another third is assigned to customers/members. See Pleister (2001, p. 20).30For more on the issue of control in cooperatives see Krahnen and Schmidt (1994, p. 55 - 60).

12

That makes it easier to gather the necessary information to perform some control

- be it in the form of peer pressure between the borrowers and depositors or by

the members and their management - and puts some limits on the possibilities for

excessive growth. Other elements at work in restricting the discretion of the local

management is firstly the existence of an internal labor market that rewards the

building of an reputation and secondly the pressure that is put on by the BVR to

merge the local credit cooperatives to form bigger, more efficient units. Here again,

only the best managers will remain in the driving seat with the value for their social

life.

The corporate governance in the top tier institutions suffers from another agency

conflict. Here, the owners are the primary credit cooperatives that are represented

by their managers who are ultimately responsible to their cooperatives’ members.

As described earlier, they do not have strong incentives to perform in the interest

of their owners, so one might conclude that the control mechanism that is to be

applied in the top institutions like the central banks is weak as well. Looking at the

financial history of the DG Bank, the former top institute, one can see that here a

lack of control correlates with poor results. After being embroiled in an financial

scandal about securities lending in the late 1980s and a string of bad loans in the

mid-90s the bank was merged with the GZ Bank, itself the product of a recent

merger between two of the second-tier banks, to the new DZ Bank.

4 Evaluation

4.1 Performance: the narrow view

In 2000, the net income before tax that Deutsche Bank made was �4.949 million.

The credit cooperatives generated an annual profit of 0,20% of the average total

assets31, which amounts to �1.070 million. This wide discrepancy might lead one

to the easy and obvious conclusion that the credit cooperatives are a grossly ineffi-

cient way to organize modern financial services and should be seen as the inferior

organizational design. There are two caveats necessary however: Firstly, a sizeable

amount of the profit of Deutsche Bank is due to a bumper year in investment bank-

ing. The Global Corporates and Institutions division accounts in this year for a

profit of roughly 60%. In 2002, the latest year for which profit figures can be cal-

culated for the credit cooperatives, the �3.549 million by Deutsche Bank compare

with �2.632 million (0,47% of total assets) for the primary cooperatives.

Secondly, the profit made by the central banks and the special financial institu-

tions in the cooperative banking group is only included in the figure as far as it was31See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001, p. 53).

13

distributed in form of dividends towards the local credit cooperatives. Since there

are no consolidated accounts for the group as a whole the part of the profits that

was retained by these top-tier institutions is not included. When comparing the

institutional settings from a welfare point-of-view that easy and obvious conclusion

must be further challenged. The question arises how the creation of value can be

measured in a meaningful way. The profit figures given by the financial data are

based on the assumption that value is created solely for shareholders which even in

the case of Deutsche Bank is probably not true as mentioned before. Accounting

rules prescribe that e.g. personnel expenses are seen as costs. Other value created

might not even show up in the accounts, for example the ’lost’ revenue for a bank

that does not charge a fee for basic payment services for its customers - a practice

that many cooperative banks approve. These figures also exclude the value appro-

priated by the state: the cooperative banks in Germany paid four times as much

taxes as the big four private banks taken together.32

4.2 Where are the two systems different?

The role of leadership Certainly, differences are great when the role of leader-

ship is taken into consideration. At Deutsche Bank, the role that the board and the

new CEO-like spokesman play in setting the strategic direction is very large. Their

power evolves out of the strong emphasis on a centralized hierarchy as well as on

their human capital and the ability to succeed the selection process to make it to

the top. Capacity restraints play an important aspect why many decision rights are

delegated to lower levels like the newly created Group Executive Committee either

with or without formal authority.33

In the Finanzverbund on the other hand the leadership is not clearly allocated.

Power is spread deliberately and by design more widely across the whole Verbund.

Decision control and decision management is separated in the sense of Fama and

Jensen (1983): The BVR proposes and manages new strategies while the leaders of

the individual cooperative banks agree on the general direction and implement the

necessary changes to progress in this new direction. The managers of the individual

retail bank however obtain a wide degree of freedom and can choose whether to use

the products on offer in the Finanzverbund: Only around 60% of the retail banks

offer their clients products tailored by the building society Schwabisch Hall34, a

situation unimaginable in the Deutsche Bank.32Pleister (2001, p. 14).33See Aghion and Tirole (1997) for a distinction between real and formal authority and the

ramifications that delegation of control rights provides.34See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2002, p. 72).

14

Flexibility and adaptability Another potential weakness of the spreading of

power is the lack of rapid adaptability. Whenever urgent decisions have to be taken

and whenever coordinated action is necessary, the system used by Deutsche Bank

is probably better suited. An example for this is provided by the time it took

the Finanzverbund to agree on a common platform for e-banking. The VR-Net

was rather late compared to the pioneering role that Deutsche Bank played with

establishing the Bank 24 in 1995. The founding of a company to coordinate the

internet activities of the Verbund took place as late as July 2001 with the first

banking activities beginning in April 2002.35 However, as this particular example

shows, it can sometimes also be of advantage not to jump immediately on the

bandwagon of the latest management fads and to waste money and other resources

in ill-fated business ideas as many ventures have done during the stock market

bubble of the late 1990s.

Before this central solution was implemented many primary banks, especially

the bigger ones in the major cities with more sophisticated customers built online-

banking on their own. This experimentation led to a duplication of effort and money

on the one hand, but on the other hand the different investments undertaken by

many institutions led to innovative ideas of which the best were implemented in the

common standard. The case of VR-Net shows that the balance between autonomous

innovation and coordinated investments is rather tricky. In this example, a more

centralized and coordinated approach - either by direction as in the case of Deutsche

Bank or by evolving, but binding, standards as is the case in the innovation process

of open source communities - would have been better. Today, not every big primary

bank like e.g. the Berliner Volksbank that established online-banking on their own

before, has yet switched to the common solution with a single appearance provided

by VR-Net. At the end of 2002, only 347 cooperative banks have licensed the

technology provided.36

The role of bench-marking to establish the best practice within the Finanzver-

bund is consequently a sensible topic. In one project of the BVR, Bundeseinheitliche

Geschaftsprozesse (common business processes), this is undertaken with the objec-

tive to structure the whole Finanzverbund more efficiently and to gather data for

controlling.37

The human resource strategies Human resources are one of the crucial success

factors in banking. Deutsche Bank relies heavily on graduates from universities and

on the knowledge and ideas they bring with them. The turnover rate at particular35See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2002, p. 80).36See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2003, p. 79 - 80).37See Bundesverband der Deutschen Volks- und Raiffeisenbanken (2002, p. 29 - 33) for more

details on this project.

15

jobs is relatively high and people are evaluated by their results. In the investment

banking sector there is an active labor market with many possibilities for individuals

and whole teams switching their employers. This active market allows them to

command much of the rent that is generated by their scarce human capital. In the

cooperative banking sector the emphasis is more on people who join the bank after

leaving school and get trained internally in the bank. There is much less emphasis

on establishing connections with universities for recruiting. All in all, Deutsche

Bank relies more on the market for labor than the cooperative banks which operate

an internal labor market.

The product strategy Deutsche Bank has made intensive efforts to establish

itself as one of the banks in the bulge-bracket of investment banking. In this seg-

ment, human and social capital is the important resource that underpins the basis

for a competitive advantage. For many activities - like advising in mergers and

acquisitions - banks do not need much financial capital. This fact allows the invest-

ment bankers to capture a big slice of the economic value that is added by their

work. Hence the way Deutsche Bank treats its employees with regard to measuring

the contribution of the individual or the team towards performance and the way

those people are rewarded with bonuses and generous stock option packets fits this

product strategy.

The cooperative banks perform more the traditional tasks of commercial banking

which relies more on financial capital relative to human capital. The measurement

and especially the rewards structure is consistent with this market strategy and

the overall objective: the banks in the Finanzverbund emphasize more the value-

generated for customers. The use of stock options is not possible since even the

banks that are registered as an Aktiengesellschaft do not have their shares listed

at an stock exchange. Even if the market for those shares were liquid enough to

support the provision of incentives to employees by the means of stock options the

cooperative banks would probably not make much use of it: too much inequality in

the remuneration of employees would contradict the objective of pooling individual

strengths for the benefit of the group.

4.3 Complementarities between strategy, organization and

corporate governance

We therefore can distinguish between two different organizational designs - systems

that are characterized by complementarities between its elements and by consistency

in the way these elements are configured. As described above Deutsche Bank’s strat-

egy can be described as global with a tendency to shift resources from commercial

16

and retail banking to its investment banking division. In this business line, human

capital is relatively more important than financial capital. The global ambition and

reach allows it to implement career paths and a corporate culture that exactly uses

this strategy to attract and retain this scarce human capital. Much emphasis is put

on the performance of the individual or on the team and leadership plays a very

strong role: consistently, both themes are manifested in its former slogan ’Leading to

results’. The complementarities provided by rewarding empowered employees with

scarce human and social capital (especially in the investment banking division) with

bonuses and stock options are used. The measurement of performance, especially

in financial terms, is very elaborate. In the corporate governance, Deutsche Bank

explicitly recognizes that besides the shareholders who are rewarded with an ad-

equate return on their capital there are other stakeholders like those employees.

Especially when taking into account how much of the value generation depends on

the employees in investment banking the recognition of their stake and the rewards

of their investment seems appropriate, in particular when comparing them to pure

investment banks run in the Anglo-Saxon tradition which are often organized as

partnerships.

The Finanzverbund and the system it establishes is also characterized by com-

plementarities and consistency. By establishing individual legal and economic enti-

ties with formal decision-rights based in the local community and not some faraway

headquarters the Volks- and Raiffeisenbanken place a credible commitment to act in

the interest of the local community and the customers. A bad decision by the man-

agement spells the demise of the entire bank and not only a branch. Its strategy of

customer focus is strengthened by this regional principle. Placing the decision rights

that effect the whole group into the formally rather weak hands of the president of

their federal association and the board members of their central institutions allows

the credit cooperative system to achieve a distinct set of checks and balances in their

corporate governance that is also enhancing the value of their strategy of value cre-

ation for their local customers. The measurement of performance is rather subdued,

no consolidated accounts are prepared and the collection and publication of data

takes some time. Although there are some efforts to introduce bench-marking and

actively compare the different cooperative banks, the negligence of more sophis-

ticated financial performance measurement is consistent with the configuration of

other important elements. Too much focus on narrow financial performance would

run counter to the broad value maximization strategy and the autonomy of the local

credit cooperatives.

The mutually reinforcing elements of both systems are summarized in table 2.

17

Deutsche Bank Cooperative Banking Group

Decision-making centralized, top-down decentralized, bottom-up

Leadership strong and central dispersed

Personnel policy external recruiting ’internal’ labor market

Salaries/wages matching market, deferred elements,

more variable more fixed

Performance measure-

ment

strong financial performance

measurement

lack of overall performance mea-

surement

Corporate objective financial performance broad value maximization

Key stakeholder in cor-

porate governance

quartet of stakeholders diverse roles of members

Table 2: Systemic features of the two banking groups

4.4 Performance: the broader view

In times of rapid change the integrated system of the Deutsche Bank has many

advantages: The central leadership has the autonomy to give a direction and to

coordinate the necessary changes. This is especially important when there are

complementarities between the elements of the organizational design as was shown.

In this case it is a competitive advantage not to rely on consensus as the example

of the establishment of online-banking has shown. Here the possibility to make

a big leap instead of small steps38 was valuable. On the other side, in times of

relative stability the autonomous system of the cooperative banking group can show

its advantages. The formal delegation of decision rights is a plus when analyzed

from an economic perspective. Motivation and the incentive to invest in customer

relationships and the specific information that goes along with it is not subdued

as in the integrated approach.39 The slow growth and the small steps that the

Finanzverbund undertakes is also due to the fact that it is limited in its international

expansion by the existence of cooperative banking groups in other countries. The

agreement on alliances between these seems to be the only option in the mid-term for

an international expansion. The possibility simply to buy its way into new markets

and products as Deutsche Bank has done with the acquisition of e.g. Bankers Trust

does not seem viable.40

Both models must hence be seen as consistent systems to perform financial

services and when analyzing which is the more efficient one has to define in which

circumstances and over what span of time. Taking into account that both ways of

organizing the generation of financial services can look back on a history of more

than 130 years both institutional and organizational designs should be considered38See Milgrom and Roberts (1995) for this distinction.39See Aghion and Tirole (1997).40Growth by acquisition, however, has been undertaken when the norisbank has been bought

from HypoVereinsbank in October 2003.

18

as systems that are able to perform the economic functions of banks rather well.

This conclusion is further strengthened by the geographical spread of both business

models: the capitalist system of Deutsche Bank is also followed successfully by

other global financial institutions and widely studied in the economic literature.

The cooperative idea on the other hand has spread to probably every country on

earth in some form. The relatively better performance of one system over the other

depends on the pace with which innovations take place and institutions have to

evolve over time. As this pace varies the fortunes of each particular system can be

reversed.

References

Aghion, P., and J. Tirole (1997): “Formal and real authority in organizations,”

Journal of Political Economy, 105(1), 1–29.

Aoki, M. (2001): Toward a Comparative Institutional Analysis. MIT Press, Cam-

bridge.

Aoki, M., and H. Patrick (1994): The Japanese Main Bank System: Its relevance

for developing and transforming economies. Oxford University Press, Oxford.

Aschhoff, G., and E. Henningsen (1996): The German cooperative System -

Its history, structure and strength. Fritz Knapp Verlag, Frankfurt/Main.

BAG Bankaktiengesellschaft (2001): Konzernabschluß 2000. Hamm.

Bundesverband der Deutschen Volks- und Raiffeisenbanken (2001):

Jahresbericht 2000. Berlin/Bonn.

(2002): Wir bundeln Krafte - Jahresbericht 2001. Berlin/Bonn.

(2003): Wir bundeln Krafte - Jahresbericht 2002. Berlin/Bonn.

Deutsche Bank (2001): Results 2000 - Annual Report. Frankfurt/Main.

(2004): Annual Review 2003. Frankfurt/Main.

Deutsche Bundesbank (2004): “Statistisches Beiheft,” Bankenstatistik.

Economist (2002): “Face value - The great Swiss hope,” The Economist,

363(8273), 74.

Fama, E. F., and M. C. Jensen (1983): “Separation of Ownership and Control,”

Journal of Law and Economics, 26, 301 – 326.

19

Ghoshal, S., P. Moran, and C. A. Bartlett (2001): “Employment Security,

Employability and Sustainable Competitive Advantage,” in Strategy, Organiza-

tion and the Changing Nature of Work, ed. by J. Gual, and J. Ricart, chap. 4,

pp. 79 – 110. Edward Elgar Publishing, Cheltenham.

Greve, R. (2002): “The German cooperative banking group as a strategic network:

function and performance,” Arbeitspapiere des Instituts fur Genossenschaftswe-

sen der Universitat Munster.

Krahnen, J. P., and R. H. Schmidt (1994): Development Finance as Institution

Building. Westview Press, Boulder.

(2004): The German Financial System. Oxford University Press, Oxford.

Milgrom, P., and J. Roberts (1990): “The Economics of Modern Manufactur-

ing: Technology, Strategy and Organization,” American Economic Review, 80(3),

511 – 528.

(1995): “Continuous Adjustment and Fundamental Change in Business

Strategy and Organization,” in Trends in Business Organization: Do Participa-

tion and Cooperation increase Competitiveness?, ed. by H. Siebert, pp. 231 – 258.

J.C.B. Mohr (Paul Siebeck), Tubingen.

Pleister, C. e. (2001): Genossenschaften zwischen Idee und Markt. Campus,

Frankfurt/Main.

Roberts, J. (2004): The Modern Firm - Organizational Design for Performance

and Growth. Oxford University Press, Oxford.

Schmidt, R. H., A. Hackethal, and M. Tyrell (2002): “The convergence of

financial systems in Europe,” Schmalenbach Business Review, Special issue(1), 7

– 53.

Schmidt, R. H., and M. Weiss (2003): “Shareholder vs. Stakeholder: Okonomis-

che Fragestellungen,” in Handbuch Corporate Governance, ed. by P. Hommelhoff,

K. J. Hopt, and A. von Werder, pp. 107 – 127. Verlag Dr. Otto Schmidt, Koln.

Theurl, T., and T. Kring (2002): “Governance Strukturen im genossen-

schaftlichen Finanzverbund: Anforderungen und Konsequenzen ihrer Ausgestal-

tung,” Arbeitspapiere des Instituts fur Genossenschaftswesen der Universitat

Munster.

Topkis, D. M. (1998): Supermodularity and Complementarity. Princeton Univer-

sity Press, Princeton, N.J.

20