Window-Dressing in German Interwar Balance Sheets

German accounting rules value assets and liabilities asymmetrically and thus lead to grossly distorted balance sheets. In the interwar debate on a reform of disclosure regulation, financial experts considered the (undisclosed) tax balance sheet, which had to be drawn up separately for the corporate tax assessment, as a paradigm for adequate financial disclosure. However, due to tax secrecy they were barred from analyzing tax documents. Using archival evidence, we analyze tax balance sheets from which the reliability of disclosed balance sheets of the interwar period can be assessed. It emerges that companies overstated their profits in the mid and late 1920s, but grossly understated them in the Nazi economy.

In March 1993 the German automobile concern Daimler-Benz disclosed a decision that immediately was considered as a milestone in German financial history. The company had decided to list its shares on the New York Stock Exchange (NYSE) and thus was the first German firm to accept the US-GAAP accounting standards. Although many other German firms would like to list their shares on NYSE as well, few have followed Daimler’s example so far. In contrast, senior executives of concerns like Bayer and Mannesmann publicly criticized Daimler for ‘bending’ to the Americans. The main reason for this attitude is that

‘German firms are obsessed with conservative accounting, and their standards allow managers to hide huge reserves on balance sheets without telling shareholders. [...] They fear greater disclosure and less conservative accounting will expose them to increased pressure from disgruntled investors. Most German managers still prefer the quiet life, even if that means giving New York a miss.’ (Economist, 1994: 83)

Hence financial analysts still have difficulties to assess the economic performance of German firms. This tradition of insufficient financial disclosure has affected German business historiography as well. Since German balance sheets are notorious for their unreliability, most authors shy away from financial issues.

This paper tries to show a way out of this dilemma, at least for the interwar period, and possibly for the 1950s and early 1960s as well. In the following section I summarize the arguments why the German disclosed balance sheet is an unreliable source. In the subsequent section I introduce the (undisclosed) tax balance sheet, a source not used by business or economic historians until very recently. The size of the gap between valuation in the disclosed and the tax balance sheets is shown by comparing the profitability of a sample of 106 industrial firms, with amazing results for the Nazi era. The last section concludes.

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