Employee-Owned Enterprises–A Dream With Little Promise of Reforming Capitalism

An article in the Guardian today suggests that there are indeed alternatives to capitalism, and cites the example of cooperative ownership in one region of Spain. http://www.guardian.co.uk/commentisfree/2012/jun/24/alternative-capitalism-mondragon The article, however, focuses on only one aspect of capitalism – the nature of ownership – and only indirectly gets at the more fundamental principles of a free market determining supply, demand, wages, and profits.  Nevertheless it is an interesting look – once again – at the worker-owned model of capitalist enterprise.  The author first sets out the premise:

Modern societies have mostly chosen a capitalist organization of production. In capitalism, private owners establish enterprises and select their directors who decide what, how and where to produce and what to do with the net revenues from selling the output. This small handful of people makes all those economic decisions for the majority of people – who do most of the actual productive work. The majority must accept and live with the results of all the directorial decisions made by the major shareholders and the boards of directors they select. This latter also select their own replacements. Capitalism thus entails and reproduces a highly undemocratic organization of production inside enterprises.

And then offers the solution, based on the Spanish experience:

MC is composed of many co-operative enterprises grouped into four areas: industry, finance, retail and knowledge. In each enterprise, the co-op members (averaging 80-85% of all workers per enterprise) collectively own and direct the enterprise. Through an annual general assembly the workers choose and employ a managing director and retain the power to make all the basic decisions of the enterprise (what, how and where to produce and what to do with the profits).

The idea that traditional capitalism is failing and needs to be replaced by a more ‘progressive’ form of enterprise has gained currency in the last few years, precipitated by the financial and economic crises that have hit the United States and Western Europe.  At a recent conference convened by the Rosa Luxembourg Foundation (11/11), the premise was articulated by one of the organizers:

Rick Wolff argued that in the current capitalist crisis social transformation through the formation of cooperatives is inevitable: “The idea of workers self-directed enterprises is that the workers displace and replace the capitalists with themselves. This has to be the next step in the process of transformation.” As capitalist enterprises consistently fail and do not provide workers with economic security, new forms of cooperative worker ownership are an inevitable outcome.

Attempts to create worker-owner enterprises are not new and too many to mention here. The definition of such enterprises covers a wide range of possibilities – everything from state ownership (i.e. the state is the people) to ESOP profit-sharing programs, to small-scale stock option programs for employees.  Of the top 100 ‘employee-owned’ companies cited by the National Center for Employee Ownership, over 90 percent are included because they have a profit-sharing plan. I recently worked for a firm which had begun an ESOP program (on the Top 100 list), and in no way did I have a say in executive management decisions which were the exclusive domain of the CEO and CFO and the Board of Directors. Ownership has always meant investment.  For workers to ‘own’ a company, they must invest their own resources in it, thereby sharing in profits and losses. 

There have, of course, been successes, such as the one cited in the Guardian article; but many of the firms on the Center’s list are either relatively small or are in low-volatility industries (supermarkets figure prominently on the list as do health care companies.  No IT or other tech companies were on the list. No one denies the competitive nature of the basic food industry, but they do operate in a market of inflexible demand and are often semi-monopolies in many cities.  As far as health care is concerned, everybody gets sick.

The failures, however, are worth mentioning. One observer of the airline industry (Louis Proyect) noted that worker ownership did little to stave off the race to the bottom in what was once a well-paying industry with excellent benefits. Louis Uchitelle wrote in a NY Times piece (7/96) that worker ownership was no obstacle to the kind of downsizing that [occurred in other industries]. Uchitelle reported:

Take Kiwi Airlines, founded in 1992 by former Eastern Airlines pilots. It is 57 percent owned today by its 1,200 employees. But to cut costs, 60 owner-workers were laid off in January, many of them clerks whose jobs had been automated. “If we had done these layoffs earlier, there would have been revolution,” said Robert Kulat, a Kiwi spokesman. “We still had this concept of a happy family and of employees being bigger than the company. But big losses changed that. And people realized that to remain alive, to keep their own jobs, they had to change too.”

Perhaps more relevant Uchitelle claimed that a strong union allowed United Airlines, another worker-owned firm, to avoid downsizing but only four years later economic reality caught up with the company, as the January 14, 2000 New York Times reported:

In 2001 United Airlines went bankrupt as a result of the impact of 9/11 on travel and rising fuel costs and was subsequently reorganized as a regular corporation. This had nothing to do with whether the company was “democratic” or not. Even if it was the most democratic institution in the world, it could not operate as a benign oasis in a toxic wasteland. Capitalism forces firms to be profitable. If they are not profitable, management takes action to make them more profitable, including slashing wages or laying workers off.

The Economist 1/12) has also weighed in against a more general move to employee-owned businesses:

But there is little evidence that shared ownership makes capitalism more “responsible”... It does not prevent bad decisions: having a quarter of shares in employees’ hands did not save Lehman Brothers from bankruptcy. And the benefits for staff are questionable. It is rash to put a worker’s livelihood, savings and pension in one basket case; many employees lost everything when Enron, an energy-trading company, collapsed in 2001.

Companies that are wholly-owned by their staff may face barriers to growth. Many firms need a flexible capital base to expand—one reason the partnership model in banking declined. Employee mobility promotes innovation. At base, it is unrealistic to expect many bastions of capitalism to turn their shares over to their workforce, reckons Ian Brinkley of the Work Foundation, a think-tank. It is, he says, hard to imagine someone like Sir Fred Goodwin, the acquisitive former Royal Bank of Scotland boss who oversaw its demise, “being reined in by some workers’ committee.”

Economists Gary Becker and Richard Posner have also written that there are no compelling reasons to favor employee-owned companies:

In reality, the creation of an ESOP is often a management tool to fend off unfriendly takeover bids. This was certainly the case behind the pilot-led ESOP created by United Airlines, and may have played a role in the ESOP to be created at Tribune company. ESOPs that help keep poorly performing management in power would contradict the claim that this organizational form improves rather than contributes to poor performance.

Employee ownership is said to induce employees to work harder because they then have a financial stake in the company where they work. If that were true, owners would not need a tax advantage to create a sizable employee ownership since they would subsidize stock ownership by employees in order to improve productivity. Employees in a small closely held company with few workers may feel part of a family and work harder when they own an interest in the company. But in large companies with thousands of employees, such as Tribune company and other ESOPs like Science Applications International, ownership is not likely to be a strong motivating factor because hard working employees would then mainly benefit the many other employees and stockholders (Becker-Posner Blog 4/07).

Becker and Posner go on:

However, the most powerful argument against the view that employee ownership improves efficiency is that new firms would tend to take this form if it improved efficiency, and many older firms would convert to employee ownership on their own, even without tax advantages from doing so. Yet despite the competitive nature of American industry, with substantial rates of entry and exit of companies, less than 10 percent of employees in the United States work in firms that have ESOPs despite the considerable tax advantages to this organizational form. This more than all the highly imperfect comparisons between the performance of ESOPs and other companies is persuasive evidence that ESOPs would not usually be more efficient. Indeed, given the tax advantages, there would be many more ESOPs if they were equally efficient

As these articles have suggested, there are a number of reasons why the idea of employee ownership is much more of an idealistic hope rather than a practical option.  First, there is a basic conflict of interest between workers and management when both are the same.  Management/ownership may have difficulty in making the cuts to worker roles, salaries, benefits, plant closings, etc. if ‘managers’ stand to lose by these executive decisions.  Reluctance to take these reformative measures would close off credit, thus increasing the speed of the downward spiral.  If a firewall has been created between management and employees in worker-owned companies to avoid conflict of interest, then there is little difference between them and traditional companies. 

Third, regardless of management structure, a worker-owned company’s employees would certainly all want a say in company procedures.  Yet management-by-committee rarely works in business or any other social grouping.  Fourth, there is a long history of companies who put mission first and profits second.  While large corporations are now going ‘green’, it is not because of socially-driven motives, but profit.  Green is good these days, and consumers are already on that bandwagon. In other words, if mission can produce profit, it is good; if not, it can artificially constrain businesses from being competitive. I once worked for a company which valued means over ends – the way health goals were achieved, through a ‘participatory, respectful, inclusive’ process, was as important as the results of that process, improved health status.   Mission drove the company, and it failed in its programs to improve health outcomes.

If one examines traditional capitalist enterprise, it is in fact based on democratic principles.  It is responsible to its shareholders, even those with a small stake in the company.  As in any democracy these small shareholders can unite and form a common front to challenge more powerful interests.  While this does not happen as often as it should (most of us throw the shareholder ballots right into the trash), it can.  Second, all larger companies have Boards of Directors, who in principle are interested in guiding the profitability of the company.  While these Directors are not directly concerned with workers’ concerns, the economic viability of the company will ensure more financial resources to hire and expand.  Collective bargaining, although waning in influence, has always been a way to demand more from profitable companies; but it has been replaced by less intrusive market forces – i.e. when profits are up and companies need to expand, labor becomes more valuable.

Capitalism is a system which is based on profit; and that in turn is based on senior management which can make the most profitable decisions; senior financial officers which can invest and borrow profitably; and a Board of Directors which brings a diverse array of expert opinions to bear on a company’s strategy.  A company which operates in the reverse – first deal with workers concerns, then with profitability – will fail.  The Socialist model fell apart because it operated on that assumption. 

In a highly competitive global market employee-owned companies may have a role to play, but only if they play by the same no-holds-barred rules that traditional companies play by; and if they do, they look no different.  They are hard-driving capitalist companies with a twist. 

A final example from the non-profit world which has relevance to the argument.  In the field of International Development, there are for-profit and not-for-profit companies competing for the same US Government dollar.  In principle the non-profit companies should be contributing something more to the body politic, the taxpayer who subsidizes them; something of overarching worth or value.  In reality, nothing could be farther from the truth.  If you did not know who was for-profit, you could never tell the difference.  This is why successful employee-owned firms will behave just like traditional ones.

As far as profits are concerned, the time it would have taken me to make a sizeable return in my former ESOP plan would have been extremely long, since the company was very niggardly, and reasonably so, in its profit-sharing formulas.  It would have been far better if I had taken the same amount and invested in myself in Apple, Google, or Intel.

In conclusion, there will always be a small role for employee-owned companies, and many will be successful; but the real adjustment process is not structural – changing capitalism – but reforming it, especially finding ways to find a balance between free enterprise and reasonable regulation.  This has always been the case ever since the Robber Barons were successfully challenged and a role for government was identified.  Reformation, as for any social enterprise, requires consumer intelligence and activism.  Shareholders should not be taken for granted and should exercise their rights.  Democracy, like capitalism, has many inefficiencies and is subject to the same problems of fraud, misrepresentation, and venality; and yet no one thinks of replacing it, only fixing it.  For the last two hundred years American has fixed, broken, fixed, broken, and fixed again both democracy and capitalism; and we will continue to do so in the future.