Is competition good for corporate performance? An analysis on German and Italian firms

 1. Introduction 
Over the last decade, Total Factor Productivity (TFP) growth in many continental 
European countries such as Italy and Germany has been weak, especially in 
comparison with the United States. Productivity growth is important for a number of 
reasons; not only it improves firms value but it has also remarkable public policy 
implications. For example, the recent rally of oil prices coupled with exceptional rises 
in food prices is putting under strong pressure price stability in the EMU. In order to 
increase wages avoiding a price-wages spiral, productivity growth must be boosted. 
Moreover, weakening productivity performances should worry us. Taking into 
account the projected demographic challenges, future living standards will 
necessarily depend on high productivity growth. Understanding the determinants of 
TFP growth may provide useful insights on how such countries can be put back in 
track. 
In this paper, I will try to investigate the impact of corporate governance, financial 
pressure and product market competition on Total Factor Productivity growth at firm 
level for Italian and German manufacturing firms. Very broadly, corporate 
governance is the set of mechanism, both institutional and market based, than 
induce those who make decisions regarding how the company will be operated to 
make decision that maximize the value of the company to its shareholders. For the 
purpose of this study, I focus more on the ownership structure of the firm rather than 
more ‘internal’ aspects such as board composition. That is, corporate governance is 
interpreted as the combination of the firm’s ownership concentration and its capital 
structure (in particular the role played by banks as major creditors). Given this 
definition, it is natural to consider also the interactions between corporate 
governance, product market competition and financial pressure. One difference with 
respect to previous works done in this area is that I will also try to see whether there 
is any difference in TFP growth between firms that are owned by domestic or foreign 
shareholders. The analysis will be based on a sample of very large manufacturing 
firm operating in Italy and Germany for the period 1998-2006. The data has been 
retrieved from Amadeus, a database developed by Bureau Van Dijk. 
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Why are corporate governance, financial pressure and product market competition 
so important? There is some theoretical foundation that competition improves 
corporate performance by reducing lack of effort by managers (Nickell (1996) and 
Köke and Renneboog (2003) provide useful reviews). Financial pressure may also 
act as an incentive for managers to perform well. When levels of debt are high, the 
likelihood of bankruptcy increases and managers will increase they effort to avoid this 
bad outcome. In addition, poor financial performance often prompts restructuring 
plans aiming at boosting firm productivity. (Franks et al., 2001) Finally, strong 
ownership puts management under more pressure than widely dispersed ownership. 
Usually, strong owners are more active in the corporate decisions, collect more 
information and are more interested in avoiding rent extraction by managers. Denis 
and McConnell (2003) provide an extensive review of interaction between corporate 
governance and firms’ performance for economies other than the US. 
While there is a lot of literature on the impact of corporate governance and product 
market competition on productivity in market-based economies (such as the UK or 
the US), studies on bank-based economies are somewhat lacking. Germany and 
Italy are both bank-based economies, even if for different reasons. For what 
concerns Germany,  its corporate landscape is not only characterized by large 
controlling share blocks, but also by the strong presence of large banks. Usually 
banks are major creditors with long-term lending relationships backed up by direct 
and indirect share ownership, implying the possibility of exerting important control 
rights. For these reasons, Germany is often referred to as a “bank-oriented” 
corporate governance system (Köke and Renneboog, 2003). On the other hand, a 
large part of Italian firms’ debt is represented by bank-debt, although in general 
Italian firms do not rely too much on third-party capital. There are several reasons for 
this phenomenon, the most important one being the Italian peculiar productive 
structure, characterized by small and medium enterprises, often controlled by strong 
shareholders. This implies that most firms have difficulties in accessing the capital 
market, both because of their dimension or their governance structure. Finally, I use 
the German sample also to have a meaningful comparison with previous studies 
(Lehmann (2000), Januszewski (2001), Köke and Renneboog (2003)). 
In addition, Italy and Germany had different reactions against the competitive 
pressures due to globalization. Italy is an export-oriented economy. In the past, the 
manufacturing sector enjoyed high productivity growth contributing to a brilliant 
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export performance and a strong price competitiveness. However, after joining the 
EMU and with the continuous dismantling of trading barriers, the engine of growth 
has stalled. Italian problems following the globalization shock have been particularly 
strong because of its production structure, heavily based on traditional low skill 
product. More surprisingly, according to Faini and Sapir (2005), the Italian 
comparative disadvantage has been reinforced by shifting its relative specialization 
even further towards these low skill sector
1
. Indeed, it seems that countries that have 
better coped with globalization are those that changed their production structure, 
moving towards area less subject to low-cost competition, such as high tech goods 
and services. Germany, like Italy, has been somewhat slow in changing its 
production structure characterized by strong manufacturing activities. Nonetheless, 
the results are completely different; Germany managed to maintain a strong 
international competitiveness in terms of both quality and price and it did so through 
productivity improvements. Hence, the increase in competitive pressure prompted 
two different reactions; Italy choose to move toward sectors in which there is greater 
pricing power
2
, while Germany tried to preserve its competitive advantages by 
improving its production processes. 
This study exploit differences between these two bank based economies in order 
to investigate the  impact of corporate governance, product market competition and 
financial pressure on TFP growth. To my knowledge, there is no study which applies 
this line of research to Italian firms
3
 nor other European countries, excluding 
Germany. I also address endogeneity problems by using a differenced GMM 
methodology as suggested by Arellano and Bond (1991). In addition, I try to apply 
the Levinsohn and Petrin (2003) methodology to check for robustness of the results. 
                                                 
1
 According to Lanza and Quintieri (2007) one source of Italian problems is that the country did not 
adjusted to the new economic conditions, maintaining the same production structure of the “economic 
miracle” period. 
2
 In the period 2000-2005 the quantity of exported good remained constant while the price of 
exports rose; this trend is supported by the increase occurred in this period in the value of Italian 
exports. http://www.istat.it/comest/ 
3
 See Bianchi and Bianco (2006) and Bianchi and Bianco (2007) for descriptive studies on the role 
of banks in non financial firms and the patterns of corporate control in the last 15 years in Italian firms. 
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 The main results of this paper are: 
1. Losses and greater financial pressure (as measured by ratio of bank debt to 
total debt) has positive effect on TFP growth both for German and Italian firms 
2. A smaller degree of product market competition reduces TFP growth for 
German Firms. On the contrary, a smaller degree of product market 
competition increases TFP growth for Italian Firms.  
3. In High Tech firms, increased competition boosts productivity growth. In Low 
Tech firms, greater production rents are associated with greater productivity 
growth. 
4. Strong corporate control in German firms acts as a substitute of competition. In 
Italy, strong foreign ownership has a positive effect on productivity growth.  
The rest of this paper is organized as follows. In section 2 I review the existing 
theoretical and empirical literature on the relationship between product market 
competition, corporate governance and firm performance. In section 3 I describe 
the firm-level data used in the empirical analysis and how the main variables have 
been retrieved. In section 4 I present the estimation methodology that is used in 
this paper, based on the generalized method of moments estimator introduced by 
Arellano and Bond (1991). I also go over the Levhinson and Petrin (2003) 
methodology which is used for a second set of regressions. In section 5 I comment 
on the estimation results. Finally, section 6 contains some concluding remarks. 
 
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