Neo-institutional theory and institutional change : executive share options in Germany

This study focuses on one element of corporate governance, Executive Stock Options (ESOs) in Germany. The fact that ESOs are purely an Anglo-American innovation, and are now getting adopted in Germany; a country whose corporate governance system is so much different from that of the UKlUSA, makes this study more interesting. Several studies on executive compensation have used agency theory as a theoretical lens. On the contrary, this study employs neo-institutional theory, a theoretical lens that embraces socio-economic factors within the firm's institutional and market environment. In general, early institutional theory was associated with path dependence and inertia. In international corporate governance, it has been used as an explanation for the continued divergence of national systems in certain contexts. However, recent developments in neo-institutional theory, under a combination of the New Institutional Sociology strand and the Old Institutional Economics strand identify the circumstances in which change is likely to occur, and this theory is developed to produce hypotheses in relation to governance changes. The adoption in Germany of the US practice of rewarding executives with stock options is chosen as a governance institution suitable for empirical testing. Results show significant hypothesized associations between firms' ESO adoption and institutional variables such as the presence of US investors, declared shareholder value commitments, dispersed share ownership and large block-holdings. Profits seem to act as an enabling resource for ESO adoption, rather than low profits creating a crisis and a greater willingness to adopt ESO changes. This study adds theoretical development in the study of corporate governance, especially to the debate on governance convergence. Indeed, German corporate governance is far from converging on the American system, and as shown in this study, changes in the German system suggest a 'hybrid' of firm corporate governance. With a lot of institutional changes taking place in transition economies (e.g. China and Eastern Europe), the European Union, and developing countries, this study has great relevance for policy makers and firm-level strategy.