June 11, 2004
From the desk of Jane Galt:Who guards the stakeholders?
A couple of interesting comments on my recent post on stakeholder capitalism.
From our beloved Contributor A:
Euro-weenie-lover that I am, allow me to note that Germany's "Mitbestimmung" system, in which labor holds seats on executive boards and helps make decisions, was the envy of the world for decades before Germany went into the toilet in recent years. Not only was labor unrest minimal, but (West) Germany's economy enjoyed fantastic growth rates.Now it turns out Germany needs, more than anything, massive labor-market reform to make it easier to fire people. But still and all, it's worth remembering that stakeholder systems have shown promise in the past, not just in theory but in many years of practice.
I think this is an excellent point, to the extent that the German economy, and Japan's to a lesser extent, does indeed look a lot like "stakeholder" firms writ large. I would question, though, how much the "stakeholder" model was the cause of Germany and Japan's growth, rather than merely enabled by it.
I'm not saying definitively that it wasn't a driver of growth; I can certainly tell a story where cooperative workers help drive new processes and profits, to the greater good of all. But I can also tell a perhaps more plausible story where the workers rent seek to the detriment of everyone else, aided, as they are in Germany, by the fact that workers have more votes than any other groups, and thus are likely to have the government weighing in on their side.
Scott says "so what if they do?":
. . . extrapolating from Europe in general, the companies which do have a high labor ownership contingent probably do innovate somewhat less, produce fewer new jobs, and bring less sharholder returns. Like Europe, the worker-owners of these companies may value job security and other benefits over high growth. Job security, if you are an employee/owner, may pay enough dividends to make up for the lower overall return on your stock in the company.. . .
So what? (Not that Jane particularly makes a value judgment for or against stakeholder capitalism).
If the pareto efficient frontier for a company to indeed maximize all stakeholder value (employee, customer, sharholder) includes, say, less growth but more job security than one maximizing sharholder value alone, that would not intrinsically be a bad thing (unless you are short term sharholder with immediate growth needs).
The question though, is whether the stakeholder system does actually maximise wealth for the group as a whole. Labour's share of management could be small, and still have a disproportionate effect, because shareholders are a fragmented group, and big money managers would often rather sell than interfere with internal politics. One can easily envision scenarios in which labour manages to destroy a fair amount of overall wealth in the process of rent-seeking.
Meanwhile, Jonathan points out that such studies often suffer from sample bias, since the companies that have a substantial labour presence on the board often had big problems to start with:
such studies usually have an overriding flaw. Companies which cede a lot of control to labor are generally firms which are in some sort of difficulty, so it isn't surprising to see them do less well on average. Statistically, it's damn hard to find a data set which controls for this sort of backward causality. And, to respond to the point above, it really isn't clear why firms in which labor has a strong ownership stake should do worse. Holding constant mangement skill (another almost impossible statistical task) it's hard to argue that making the shareholders more informed about their company (which they are if they work there)makes the company perform worse. indeed, if you believed that, why would you encourage (force) management to hold shares? We generally think people perform better if they have more of a stake in the outcome. Labor already has a large stake irrespective of share ownership, but it is an empirical question whether or not they would do better with a shareholding interest as well.
We should separate out ownership from control. Southwest airlines, which has profit sharing but not (as I understand it) labour board members, does better than either airlines which have no profit sharing, or airlines in which labour has half the board seats (as several tried in the 1990's. And still went bankrupt). Firms in which employees have a stake in the profits probably do perform better than others. But firms in which employees get to vote on the board, especially when you have one or more unions directing those votes, might well underperform other firms, as the employees use this power to funnel assets away from the company and shareholders, and into the pockets of the union, or the employee themselves. (One should always remember that, just as corporate executives do not always place their shareholders' needs in front of their owns, so union leaders often operate things to the benefit of the union and its executives, rather than the union members.) Posted by Jane Galt at June 11, 2004 3:21 PM | TrackBack | Technorati inbound links
I can't help it. My...what a big link we have here...
Having helped design compensation programs for small to medium sized businesses, my experience is that whether employee ownership is a good or a bad thing depends on a number of factors. With a high turnover, young, relatively uneducated workforce, employee ownership does little to encourage a sense of ownership by the employees. They aren't going to be there long enough to benefit from an increase in the business's value. If there are several unions, each union will share the "profit" from any increased labor productivity with the other unions. Far better for each union to maximize compensation for that union's members -- you don't have to share the value won at the negotiating table like you have to share profits. Such factors TEND to make employee ownership far less beneficial to the entire organization than the theory says they should be.
A dollar saved in expense may only increase profits by 15 cents -- which may only result in 2 or three cents of value to the members of a particular union. On the other hand, a dollar increase in salary would only "cost" union members 2 or 3 cents in profit. Which would you rather have your union focus on, increasing your salary (which increases your worth by 98 cents for every dollar) or reducing expenses (which only increases your net worth 2 cents for every dollar saved)? You wouldn't pass up a dollar of savings (if it did not come out of your pocket), but that's not where your focus would be. In short, employee ownership tends to work better in theory than in practice.
David...why do you say that a dollar saved in expense might only increase profits by 15 cents? A dollar saved in expense will increase pretax profits by *exactly* one dollar, and after-tax profits by something like 65 cents (with the exact number depending on the corporation's tax rate).
Oops. Typing too fast. David Foster, is of course, correct. Saving a dollar drops directly to the bottom line (on a before tax basis). Still, the main point is that saving a dollar produces less benefit to union members than does increasing compensation. Unless the union owns 100% the company, trying to increase union comp will produce far more benefit (from union member's perspective) than will trying to save money or increase sales.
Part of the problem is that a corporation is tough to look at in isolation. In the case where the value is maximized to the shareholders do we count in the cost to society if employees get laid off? This cost isn't being borne by the shareholders, but it is being borne by someone. So should costs to society count when the stakeholder maximizing company is compared to the shareholder maximizing company? If we don't count the unemployed then we are comparing two things that aren't the same, the one company contains extra workers. If we do count the unemployment costs where do we stop? At just the unemployment? Do we add in the lost benefits?
I don't have any answers, but I do think that the answer to the question of which one is more efficient depends on what you are measuring. It's not as simple as A = A.
Hmm...no excellent point for me...I will try harder.
Jane, I think you discount job security in the "wealth" component in your maximization (with a z) formula. While a shareholder may measure wealth in monetary terms, a stakeholder might measure in several different ways: overall benefits package, type of work, ability to accrue monetary gains, vacation, job security etc.
Furthermore, while shareholders may by and large be a fragmented group, the market as a whole (at least here in the states) puts a huge emphasis on short term p&l and q/q growth. While a separate issue from labor constraints on governance, the effect of shareholder expectations likely leads to equally problematic scenarios (such as our recent spate of corporate governance shenanigans - pressure to smoothly inflate profits leads to some bizarre, unethical, and illegal behavior not in the long term best interests of shareholders, stakeholders, or the company).
All that having been said, should there be a place for labor on the board? I don't know. But I think there should be more corporate commitment to their own employees, though not sure how to create that.
Jay - You are right, it's not a simple comparison to make. Another consideration to take into account, besides the societal costs of unemployment, is the cost of trapping capital in a dead or dying industry. If a shareholder focus leads to a more productive use of capital than does a stakeholder focus, society might be better off in the long run even if at the cost of slightly higher short-term unemployment.
Scott, I'm not saying that it's impossible that such a situation could maximise wealth; I'm just saying that I can also imagine scenarios in which there's a great deal of wealth destruction in order to transfer relatively small gains, monetary or otherwise, to employees. In the case of the airlines, it didn't even deliver much job security.
Overall, I have mixed emotions about job security. On the one hand, it's pretty clearly very valuable to employees, and as big a fan as I am of creative destruction, I have a hard time telling a 55-year old steelworker to start over. As people live longer, I think this is going to be a bigger and bigger issue for our society.
On the other hand, there seems to be a pretty clear tradeoff between security and innovation (I don't think it's any surprise that the worst periods of American industry, when we were producing expensive crap no one wanted to buy, coincided with the greatest period of job security). Over time, it also seems to result in a lot of value claiming for the in-group at the expense of less well off consumers and potential workers--the steelworkers make north of $100K, and some burger-flipper in Tuscaloosa has to pay $500 more for his car.
I think a lot of it is situational. Southwest is the most unionized major airline, yet remains on time and profitable, in part because it treats its workers relatively well, and because its unions usually seem to understand that what's good for the goose is goood for the gander. (For example, after 9-11, Southwest didn't lay anyone off, at a time when other airlines were hemmoraghing employees like mad. Similarly, the compromise worked out at AA went up in smoke, after news of the golden parachutes for the big guys came out. The Southwest action builds employee trust and loyalty, the AA way destroys it.)
As for the German model, it worked fairly well for a while, but is breaking down. In the past, the unions generally worked things out with the company, without needing to resort to strikes. When strikes were called, they were usually well-planned, designed to minimize impact on the public, but still put pressure on the target corporation. But the last autoworker strike (a year ago?) broke this pattern. The union misgauged public opinion, and the result was a disaster. Public support of unions dropped, and no major union objectives were achieved.
In my most humble opinion, much of this comes down less to mathematical calculations, and more to human ones. If labor and management trust and protect each other, and work to mutual benefit, things can run quite smoothly. If they scratch and claw and distrust each other fiercely, then the relationship will be contentious, and the road ahead bumpy.
Jane,
OK - I don't know that you and I differ considerably on this front. I don't know what makes the most sense either. I think profit-sharing might be the best incentive in a well-performing, growing company which is not seeking to replace its labor force with lower cost employees. However, if creative destruction is to be encouraged (and it appears that it should), a safety net - oops, I just cursed on this board didn't I ;) - might be appropriate for helping out those who got destroyed. Having been laid off at one point, I know that we give up something substantial when we lose job security. It is not clear to me if the winnings from creative destruction make up for that loss on an individual basis (thus a need for the safety net).
W. Edward Deming said "the most important things we need to manage can't be measured." Trying to determine whether employee stakeholding improves an enterprise is a challenging exercise.
Observing the problems that entrenched corporate incumbents create is less difficult. It's James Cramer's view that Americans rent stocks rather than own them. This means there is no check on corporate officers, and that they can command vast sums for mediocre performance. Corporate governance is broken in this regard, and can't be fixed short of allowing shareholders to vote deficient CEO's out of office. As things stand today, good moral values on the part of the CEO are all that prevent corporations from being looted by officers.
Jane, why are you using the British spelling of "labor"?
Yes, Jayne, why?
What ever happened to Lincoln Welders, the exemplar of ESOP when I was schooling?
Here in Palo Alto, we had a local paper go into ESOP, and they sold out to a National very soon.
During my time as a CPA, I got to see how 115 small-to-medium size companies operated.
The most successful companies gave incentives to their employees based upon profit, employee output, or sales. The more people in the company who get incentives, the more successful the company.
The most profitable company I have ever seen had incentives for almost every job in the company. Even the receptionist got a salary plus $.50 for every phone call she answered.
Jane: "...as big a fan as I am of creative destruction, I have a hard time telling a 55-year old steelworker to start over. As people live longer, I think this is going to be a bigger and bigger issue for our society."
Exactly the type of question that has led me, at age 50, to take a chunk of my retirement now and return to school to study economics and public policy. The answer to various problems may be "The baby boom generation must remain in the workforce longer," but it is not at all clear that the US workplace is prepared to provide that answer.
I'm able to take this time because of a combination of hard work, good planning, and even better luck. However, I expect that looking for a job in a new field at about age 55 will be an "interesting" experience. A more typical person my age -- with a mortgage, one or two kids still in college, short on retirement savings -- would find it extraordinarily difficult, I think, to take an entry-level position in a new field.
Jane, it's worth an essay or two.
There is nothing about a unionized work force that requires union representation on the board. I don't believe that Southwest's employees' unions have such representation. Southwest employees do have a direct stake in increasing profits, however, and a management team which has fostered trust from the start of the firm. Southwest is interesting also in that they operate very consistently in a highly cyclical industry. Whether such profit sharing works best in such cyclical industries, or whether it may work better in other types of industries may be a an interesting avenue of inquiry.
As a financial quant I am almost compelled to wonder how much of this argument can be put into a risk-return framework. Here the trade-off is between higher expected compensation and greater job security. I do not think the whole issue can be neatly put into this framework, but I do think that the framework may, nevertheless, provide some insights.
Another aspect of this argument is the general hiring environment in the industry. How quickly can a laid-off worker find new work? An extreme example is the case of Silicon Valley in the 1980's and 1990's. In this case laid-off workers would just cross the street and start working for another firm. These workers also favored an extreme compensation structure, in that they wanted a large part of their compensation to be paid in stock and stock options. I wonder if there is some sort of correlation between the ease of finding a new job and the kind of compensation desired by employees. Other factors are certainly important in the Silicon Valley example and may, in fact, dominate the factor that I mentioned.
Finally, I would like to mention an often overlooked inefficency in large corporations. In most such corporations the management is very hierarchical, often by necessity. Higher levels of management get higher pay. This fact means that the most efficient method for an employee to make more money is to move up the management hierarchy, leading to office politics. The problem here is that devoting work and effort to office politics can become a more efficient manner of increasing one's compensation than working for the company as a whole. Furthermore, the results of the effort to climb the corporate ladder can have little or no value for the company, but the resources devoted to the effort are taken from other, more worthy, projects. For example, given a choice between putting people on a project likely to help the company alot and a less worthy project that makes a rival look bad, often a manager will choose the less worthy project for political reasons. I know of one case where millions of dollars were spent on such a useless project that was designed to make other managers look bad. Fortunately, the senior vice president who was responsible was fired, but if things had gone a bit differently the result could have been a promotion. So the question is: can some kind of stakeholder program reduce these inefficiences? Note that this problem even extends to non-management employees who must allocate their time between different projects.
On a personal level being fired seems like a disaster -- something that
we would go to great lengths to avoid. But is it a bad thing on the
national level?
Jay and Scott each make posts above where they implicitly assume that
it is a bad thing for society -- that we could move forward if we
would make it less likely that people would be fired.
But:
From 2001 to 2002, the number of people who lost their jobs in the US
fell 9.6%.
Were these good times?
And:
"Total U.S. private-sector jobs increased by 17.8 million between 1993 and 2002.
To produce that healthy net increase, a breath-taking total of 327.7 million
jobs were added, while 309.9 million jobs were lost. In other words, for every
one new net private-sector job created during that period, 18.4 gross job
additions had to offset 17.4 gross job losses."
( See http://www.freetrade.org/pubs/briefs/tbp-019es.html )
To Mark:
I didn't really say it was bad that people were fired, I said that there was a cost associated with it.
To David:
You have a good point,from the standpoint of society as a whole it is a bad thing to have capital going into a dead end.
I hope this can add to the discussion. It's an article about the "talkers" vs. the "doers" by Thomas Sowell.
Utopia can never be attained. We can only strive to do the "right" thing in our eyes. But then there will be the talkers there to criticize what was done. :) :) :)
Another group of warriors for capital against the needs of labor. Karl Marx popped up last time capital trounced labor. Wonder what will pop up this time?
There is more to life than "productivity" and "efficiency."
Yeah, there's more to life than money, too. Productivity and efficiency do not come into play when I go to church, but also my job doesn't come into play either. I'm not sure this is relevant.
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