Participatory in general: Conceptualization, Viability and Potentials Part I

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Participatory Ownership and Manage- ment in Greenland and Other Circumpo- lar Regions

Gorm Winther

In November 2000 the Greenland Home Rule Department of , , Research and Church in cooperation with the Department of Administration at the ‘Ilisimatusarfik’ (University of Greenland) and the Centre for North Atlantic Regional Studies at the Roskilde University, Denmark organized a four-day seminar in Ilulissat. The purpose of the seminar was to learn from participatory alternatives in other parts of the world than Greenland. Especially experiences in Alaska, Nunavik and Nunavut were in focus. Yet, general experiences with these alternative enterprises in The , the former Soviet bloc and the EU were in focus too. Moreover, the purpose was to debate theoretical contributions in the social scientific field of participatory and sociology.

In Greenland as in other parts of the Arctic, there are already some experiences with these alternative or- ganizations, wherefore this field of research may gain significantly in importance. This is especially the case in Greenland, where most of the economy is characterized by operations. This is not just the case in traditional Government sectors such as education, , infrastructure, administration and the like - in tradable goods sectors such as fishing and food production, the companies are Home Rule owned and operated. In the none-tradables sector even such areas as retail and whole sale operations, tele- communication, transportation and tourism are operated by the Home Rule Government. The so called ‘percentage of collectivism’ is high leaving some 20% of the GDP to private small and medium sized firms. This has led to labelling Greenland as a so-called ‘classic socialist’ economy along with Cuba and North Korea. For several reasons this is of course bogus, first Cuba has moved in the direction of reforms and second planning in Greenland after the inception of Home Rule in 1979 never really gained the same prominence as it did in the sixties, when the Danish State established its industrialization pro- gram. In those days and in terms of material development, central planning was a tremendous success, creating record high economic growth rates. Looking at Greenland and comparing her to other Arctic re- gions, one should not forget, that Government always was a necessary prerequisite for development and supply of goods and services. Yet, one may focus on one important difference and that is, that State own- ership plays a larger role in Greenland than in Alaska and Arctic Canada. The traditional social democratic model of the in 1959 took another path - for a decade the State was expecting that private investors would engage in development ventures especially in exports and import substitution. It never happened! For pragmatic reasons, the State then established fishing industries along the West Coast and launched State firms for all the activities where private initiative showed a low propensity to invest. It has ever since been the idea, that a should take place, nonetheless it never happened and there- fore the Home Rule State is still a dominant factor of the economy.

Recalling, that this has happened because there was nothing else to do, it seems far-fetched to engage in value impregnated discussions on ‘Classic in Greenland’. If we for a while take up this discus- sion, which besides the entertainment value only may call upon an intellectual’s affection for giving ‘the ’ a correct label, it would be more correct to label the social formation of Greenland ‘Etatism’ or ‘State ’. This is due to the fact that the Government controlled and operated firms never took up forms of that points to self-management of workers and other producers like for instance fishermen and sheep breeders. Experiments have been commenced in that direction. Never-

7 theless, they never got off the ground and today a techno-structural network of the local elite and Danish enterprise managers, administrators and planners control the economy.

That is why ‘a third way’ between traditional private and state firms becomes so interesting. For the last decade a privatization debate has been on going. A debate that much too often aims at traditional take overs by foreign, in some cases transnational investors. Yet, many Greenlanders want something else. In the Spring session of the Home Rule parliament, this became quite obvious in relation to the privatization plan of the Government owned retail chain ‘KNI corporation’. It was difficult to reach an agreement be- tween the majority parties, because of the question regarding, how much should be sold to a foreign inves- tor in a joint venture. The majority in the Home Rule parliament opted for a ‘forty nine-fifty one’ solution, i.e only 49 percent of the shares should be sold to foreign investors. In the public debate and in the parlia- ment, voices have disclosed sympathetic feelings for the idea of employee ownership as a part of the take over process. The decision has been postponed to the Fall session in Parliament, because the politicians did not feel that the decision base was sufficient.

A Conceptualization of Participatory Ownership and Management

In his work from the early seventies ‘The General Theory of Labor-managed Market Economies’, Jaro- slav Vanek makes distinctions as to what is the qualitative difference between Labor-managed Systems and Systems controlled by either Capital or State (Vanek, 1970). In the privatization debate it seems fruit- ful to consider labor-managed systems as an alternative to foreign and local private take overs or contin- ued Home Rule operations in Greenland. This type of model for running a market-based system can be an important alternative for two reasons. First, it is a part of Inuit culture to operate things collectively, this has been the case since the early days, when hunters went to the hunting grounds to engage in common endeavours to sustain their livelihoods. Second, the motivation of the local work force is still low and embodied as alienated perceptions of work. There is a high labor turnover in most firms, shirking among employees is quite common - the work force is an unstable factor. Research on employee ownership has demonstrated that there may be a positive effect from ownership and participation that lead to a higher motivation, a higher labor productivity and better economic results.

In the figure Vanek makes a first order distinction and a second order dist inct ion in order t o distinguish between labor-managed systems and Capitalist and Etatist systems. The first order distinction refers to control and management of the firm and income of capital either related to ownership per se or de facto control to assets in the same way as private owners in capitalist social settings, while the second order distinction refers to different types of ownership. Ownership is either , private ownership or joint ventures between the State and private investors. The term ‘national’ refers to the Vanek concept of U and B-ownership - U owners being active participants in the firm, i.e the employees and B-owners being investors, e.g the State, trade unions and other associations, private investors and pension funds. The term B-owner does not include traditional ownership rights to control and manage the firm. B-owners can only earn an income on their investment, hence the B -owner does not invest in instead he puts his capit al int o specially issued bonds. Despit e it s ingenuit y, t he U-B ownership concept never gained popu- larity in relation to the operations of participatory and labor-managed systems.

In former Yugoslavia workers’ self-management involved the same features regarding management and control as in Vanek’s model. Nonetheless, prevailed as something distinct from state and national ownership. Social ownership meant that employees had a de facto right to an income and could participate democratically in decision making through workers’ assemblies and councils.

The phrase ‘private’ could be anything from traditional forms known from publicly traded or closely-held companies to consumers’, suppliers’ or employees ownership. Mixed ownership, a model very well

8 known in Greenland often means a joint venture of either equal shareholding between the Home Rule state and private investors or unequal holding based on a majority - minority split.

The first order distinction between participatory and traditional firms relates to control, management and capital income. In traditional firms these are related to ownership per se, and this implies that the capital owner controls and manage the operations of the assets and he receives an income or a for his out- lay. Control and management can take different forms from the owner managing the closely-held firm to professional management responsible to the stock holders in public companies or to a politically appointed board in a State enterprise. Whatever constellation in Capitalist or Etatist type firms either private owner- ship, the disposition of assets by privates or the actual control of State owned assets by the State prevent labor’s inclusion in significant participation in decision making, finance and capital income. This is the gist of Etatism, Capitalism or combinations of them - it is Capital or State that hires and commands labor, it is Capital or State that gains from ownership and not the opposite of Labor hiring, disposing of, or con- trolling Capital or State and earning an income of capital. Taken as an archetype system, the opposite of capital or State, the labor managed system presupposes that labor collectively owns capital or enjoy a ‘usu fruct’ right to the assets. Furthermore, it means that labor shares value added in the utilization of capital either as a whole among members in the collective, or after deducting the cost of paying external co- owners. Covering capital cost implies either a rent to financial investors or a lease of real capital. This division is denoted d in the diagram. The owners supplying the collective with capital could be private, mixed, state or nationally owned. The difference between traditional and Labor-manaced firms is that decision making is either ‘democratic’ or highly participatory. It is the employees that control and man- age, they share income above wages after paying a rent to the suppliers of capital and they may even own the firm.

One way of operationallizing this in micro economics is to assume that the firm operates in a market eco- nomic system. In neoclassical terms this implies that the firm operates in pure competitive markets with free mobility of labor and capital. The firms are democratically governed according to the principle of one person - one vote at general meetings. The board is a democratically elected body e.g a ‘committee’, workers’ council or collaboration board. Management operates with responsibility to the employees and the marginal value product added of labor is with above normal profits higher than in capitalist and Etatist firms. This is due to the maximand of value added per head. The participatory firm adds labor incremen- tally to the optimum, where the marginally added employee covers his market wage plus a share of profits. In terms of ownership, the employees are either equipped with a ‘usu fruct’ right t o t he means of produc- tion or they own the assets cooperatively. If a ‘usu fruct’ right is involved either the State, wage earners or pension funds are the formal owners refraining from exercising their traditional ownership rights de- scribed by t he right side of t he first order dist inct ion in Vanek’s diagram.

Of course empirical studies cannot completely corroborate to these ideal structures. Some firms are not that democratic, some are forced to hire labor occasionally and some firms may still maintain structures in common with the traditional capitalist and Etatist firm. Notwithstanding the purity of the ideal labor- management model discussed by t heorist s, it could be argued t hat t here are firms at least resembling some of the democratic features of profit sharing and of workers’ ownership.

What came close to Vanek’s ideal conceptualization was the worker-managed Yugoslav firm between 1950 and 1989 (Horvat, 1982), some democratic workers’ as for instance the Plywood coop- eratives in the US or the Mondragon cooperatives in Spain and some majority employee-owned firms with a significant degree of participatory management (Thomas and Logan, 1982, Whyte and Whyte, 1988, Cheney, 2000).

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Participatory management in conventional firms

Composites of the participatory organization and the organization determined by ownership to capital asset s suggest t hat t here are ways of combining t he t radit ional organizat ion and t he labor-managed organi- zation. Whatever type of ownership, employee participation in decision making is still feasible, so we can imagine one of the four, for instance traditional private ownership incorporating elements of participation (the middle ‘overlap’ of the row of participation and ownership in Vanek’s schematic classification of labor-managed and other systems). Participation could of course be both financial, i.e we are talking about employee ownership or it could be solely ascribed to decision making, or both. For the participatory firm, we will first look into decision making.

We could as Levine and Tyson dist inguish bet ween t hree t ypes of part icipat ory decision making (1990):

• Consultative participation where employees have a say without invading too much on manage- ments’ rights to control and without being able to take decisions regarding capital income. The purpose of this is to improve information and to overcome agency cost problems without reform- ing the basic economic power structures. Employees being able to throw suggest ions into boxes or being able t o present suggest ions wit hout being involved may not feel that different from employ- ees in the traditional of capitalist and Etatist firms. It probably suffices to say that con- ventional companies have introduced this on several occasions in order to improve work relations and the economic results. Among organizational theorists, it is claimed that this is the same as, what the farmer could do. If he installs music in the cow stable in order to encourage the cows to produce more milk, the cows may get more happy, and hence the farmer succeeds in this venture. In relation to US conventional companies, empirical research suggest s t hat managers inclined to- wards Doughlas Mcgregor’s theory Y and William G. Ouchi’s theory Z may only experience a ‘novelty effect’ (Mcgregor, 1960, Ouchi, 1981, Rosen and Young, 1991). After a while, employ- ees realize, it is business as usual and motivational effects and enhanced productivity due to such experiments vanish. • Substantive participation where employees participate in all types of decisions. In operational de- cisions employees may even decide on their own in autonomous work groups and problem solving teams. If we are approaching the consensus seeking organization, this means that employees have more than a say. It is probably not in many of the traditionally owned firms, we find this prac- ticed. Yet, if the management philosophy is related to the Z type organization, we may see it here. In the debate in the US, we are now talking about a new O type organization (O for ownership). If employees are owners, this is a better prerequisite for significantly participating in decision mak- ing - employees without ownership rights may accept exclusion or even seek to avoid being in- volved. That is not the case with employee owners (Rosen and Young, 1991, Young et. al, 1997, Winther, 1999). • Representative participation where employee representatives are elected to the board of the com- pany, to bodies for cooperation between management and labor, as ‘worker directors’ and in rela- tion to shop steward systems. In Scandinavia and Denmark (samarbejdsudvalgene) and in Ger- many (betriebsräte) this has been practiced for decades. The evidence on the operations of these bodies in terms of cooperation is mixed. Worst case scenarios emphasize examples of employee representatives without information on essentials such as mergers, acquisitions and lay offs. The essence is that employees do not experience the representative bodies as something that gives them more influence or power. Research in the US on employee representation in companies with employee st ock ownership plans suggest s t hat t here are no posit ive correlat ion between represen- tative participation and economic performance, which is quite understandable as long as, the em- ployees experience these bodies as fictional participation.

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However, if participation does have an impact on economic performance of the firm it is often stressed that motivated employees have a higher predilection of sharing information with management. First, if the employees are less alienated, management may see their best interests served by employees and employ- ees may see their best interest served by management. The agency cost problem could diminish if there is confidence between these occupational categories. Again this may be easier to accomplish in organiza- tions characterized by significant participation and by employee ownership of the assets. Second, im- proved work place relations and participation in ownership and decision making increase individual com- mitment, trust and good will to such a degree that motivation, productivity, cost cutting and creativity increase - hence the result is an improved economic performance. Third, there are minor losses due to strikes and lock outs. Fourth, overhead costs are brought down because employees will seek to supervise each other instead of having costly supervisors and middle management doing this.

Profit sharing firms

As for decision making employees may also be included in sharing the income of capital through profit sharing. In that sense income in the conventional firm whatever type of ownership (second order distinc- tion) need not be exclusively associated with ownership of assets. A profit-sharing scheme may involve some or all of the participants in the organization despite ownership or not. We are again referring to the middle ‘overlap’ of the row of participation and ownership in Vanek’s schematic classification of labor- managed and ot her syst ems. However, t his t ime t he ‘overlap’ describes income sharing instead of ‘sharing of control and management’.

Profit sharing can be set up in order to establish flexible pay systems instead of wage remuneration - hence, employees share risk with management and may have an incentive to supply more labor in terms of intensity, duration and quality. The management philosophy behind profit sharing could also be to induce especially key personnel and management’s commitment.

We may speak about two types of profit sharing or combinations of them

• Cash profit sharing where this means that the employees pay is either the ordinary wage or a payment in advance plus a share of profit after the end of the fiscal year provided of course the firm does not operate with losses • Deferred profit sharing where employees profit shares are used for investments in shares and bonds. In the United States there are both profit sharing plans and plans (or some other arrangement for employee ownership like for instance thrift plans based on both employer and employee contributions). Some has claimed that the difference between the two is largely ‘bogus’ (Blasi, 1988), because quite many profit-sharing plans invest in stock of the company, where the employees are employed. The employee stock ownership plan (ESOP) though is another model to be described in the next section, here it suffices to say that an ESOP is a special exempted plan. Combinations between profit sharing plans and ESOPs may occur meaning that the contribution plan consists of both employer stock, stock in other companies and maybe in other assets like bonds.

Employee Ownership firms in the United States

Turning to the second order distinction again we could imagine either private ownership or mixed private and state ownership connected with employee stock ownership. Hypothetically, we could imagine that such firms have a considerable degree of employee involvement in control and management. Employee ownership and participatory decision making in US firms may at a first glance appear as organizational arrangements that enhance economic and industrial as described in Vanek’s classification

11 scheme. Yet, the approximately 12,000 American ESOP firms do of course not live up to the assumptions of the scheme. Despite, the discrepancy to the conceptualized purity discussed by theorists, it could never- theless still be argued that a majority case could be an interesting point of departure in research, because there are ESOPs at least resembling some of the democratic structures. For some, it appears justifiable to expect a majority ownership program to be a better basis for finding substantial employee participation in decision making related to the operations of the firm. In an evolutionary context, some employee owner- ship firms - even minority owned - could be considered embryonic structures partially resembling the features of majority ownership, democratic voting rights and substantive participation in decision making.

The ESOP is rooted in the late Louis Kelso's theories of a ‘democratic’ or ‘popular capitalism’. Kelso, it seems, distanced himself from the philosophy underlying cooperatives and from any sort of association with . Given his background as a banker and corporate attorney during the American postwar boom, it is perhaps understandable that Kelso would assume a sharp separation between man- agement and rank and file employees inside firms (Kelso and Hetter, 1967).

Kelso believed in an restoring the virtues of Says and laissez faire capitalism through the annual issuing of stock to mainly low income families. He envisaged the redistribution of stock through ownership plans to be a substitute for competition for corporate capital on the stock ex- change, leading to little employee ownership of assets. It was argued, that as economies become more capital intensive, reformed institutions are necessary in order to provide households with other sources of income than labor. A highly automated and capital intensive economy without a compensatory aggregate demand to offset substitution of labor necessitates that everyone has a sufficient share of capital owner- ship.

Kelso influenced Senator Russell Long, in the 1960’s and 1970’s the most powerful voice in the US Con- gress on tax matters. As a result the ESOP became part of American pension law through the Employee Retirement Income Security Act of 1974.

The ESOP is a trust, a ‘legal fiction’ designed to hold stock on behalf of employees until they retire from the firm. Most ESOPs are financed out of corporate profits or retained earnings, with the firm either plac- ing st ock in t he ESOP t rust or giving t he t rust sufficient cash t o purchase t he st ock it self. In this non lev- eraged case, corporations in a given fiscal year can deduct ESOP contributions up to 15% of pay roll as a before tax expense. Virtually all full-time employees must be included in any ESOP plan, with the major exceptions being unionized workers (who may negotiate to join the plan) and non citizens. Stock is usu- ally allocated to each employee on the basis of that person’s share of total payrolls, though it can be allo- cated on the basis of seniority, a combination of a seniority and payroll share, or, in rare instances, on the principle of equal shares to all participants. In addition, other rules are in place to insure that most of the benefits do not go to the better paid employees.

A minority of ESOPs are ‘leveraged’, that is the trust borrows the (or the firm borrows the money for the trust) to buy stock from the firm or on the open market. In this case, firms can deduct as a pretax expense the value of the loan’s principal payments up to 25% of the payroll (and American tax law allows all firms to deduct loan interest expenses as a pretax expense). Moreover, dividends paid to the trust are deductible if they are passed straight through to the participants or are used to pay off the loan. In the case of leveraged ESOPs that result in majority ESOP ownership, lenders pay on only 50% of their inter- est income from that loan. This gives financial institutions an incentive to make such loans, and these in- stitutions will typically share some of their savings by offering interest rates at about 82% of the market rate.

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American securities and benefit law provides other means for employees to own firm stock and for firms to deduct at least a portion of the value of that stock from their tax bills. However, most other benefit plans such as the ‘401-k’ plan give fewer tax benefits and are typically diversified with other stock purchases. Stock options of various kinds are also available, but the voluntary nature of these schemes usually means that they do not play a large role in creating an employee ownership culture that involves most of a firm’s employees.

The ESOP has inspired political decision makers in transformation economies like Hungary to adopt an ESOP law after the US example. Employee ownership is one important tool in privatization processes of Eastern and Central Europe. Especially in Slovenia, Baltic countries, the Czech Republic, Poland and the former USSR, there are quite many cases. There are similar schemes in the UK and in Japan. In the EU an association like The National Center for Employee Ownership in Oakland, California has been set up. The European Federation for Employed Shareholders in Brussels represents several EU countries and trans- formation economies’ employee ownership associations, trade unions and employee ownership research- ers. Employee Ownership is gaining momentum in EU countries like France and Italy.

Cooperative firms

Workers’ cooperatives are very close to the archetype labor-managed firm described by Jaroslav Vanek in the classification scheme. Cooperatives can be ordered in three main categories, suppliers’ cooperatives, consumers’ cooperatives and workers’ cooperatives all set up to meet the members need for an alternative to the exploitation inflicted upon citizens by Capitalist and Etatist firms. The epitome of the is basically defensive - if consumers felt capitalist merchants exploited them through high prices on con- sumer goods, the need for low priced quality goods, would lead to the inception of shops owned in com- mon by the consumers. The same with suppliers in primary trades like fishing and agriculture - if a mo- nopsony (a landlord) exploited the suppliers, they would set up their own cooperative as a place for selling t heir harvest at higher prices t han obt ained from t he propriet or. W orkers in dire need of a work place pay- ing a decent wage and offering humane work relations would set up a working mens ‘association’ or a cooperative.

The worlds first cooperative adopted the well-known Rochdale principles proposed by the Christian So- cialist , and still statutes of most consumers’ cooperatives abide to these principles:

• The democratic control principle of one person - one vote at the general assembly • Open membership • Profit sharing in proportion to what is bought in the consumers’ cooperative, what is sold of the harvest to the suppliers cooperative and what is supplied of labor to the workers cooperative • Limited possibilities to withdraw capital. Cooperative shares can only be sold at face value to new members. Members are only liable for the value of their share to external creditors (limited liabil- ity company) • Education of members

Its of course an open question whether consumers’ or suppliers’ cooperatives seen as private firms in rela- tion to the second-order distinctions in Vanek’s classification scheme are particularly closer to the princi- ple of the labor-managed firm, than the conventional private firm is? Often these cooperatives hire labor in the same way, i.e the wage earners do not enjoy the same rights as the members of the cooperative do? Still, there are examples of equal rights of all members for instance employees and consumers or suppliers and employees share t he right s laid down in t he st at ut es (Rochdale principles) in mult i-purpose coopera- tives.

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The Mondragon cooperatives in Euzkadi (The Basque region of Spain) are such an example. Employees and other members of consumers’ and suppliers’ cooperatives enjoy the same rights as members of sec- ond-degree cooperatives. The Mondragon cooperative movement has today, nearly half a century after the creation of the first cooperative, in terms of both sales volume and number of workers, the largest business operation in the Basque Country, and the eighth largest in Spain. According to the home page (h t t p ://www.mo n drago n .mcc.es/in gles/) o f t h e Mo n drago n cooperatives, there are more than 53.539 em- ployed, an impressive growth since 1975, where there were 13.308 cooperative members employed in the cooperative group. The first cooperative was established in 1956 by the five ‘founding fathers’ group cen- tered around the cooperative innovator Jose Maria Arizmendiarietta. Since t hen development has proved, that a cooperative system with its own supporting structures can and will survive in market environments. Empirical comparat ive performance st udies have suggest ed an impressive record on ot her economic indi- cators than employment figures.

The Mondragon group has its own financial institution the Caja Laboral Popular, it has its own health system including cooperatively owned and operated hospitals, it has its own research centre, university and poly technical school and it has managed to avoid lay offs and strikes to a much larger degree than seen anywhere else in Spain. It has kindergartens, housing complexes and manufacturing of goods in- cludes all main lines of business in the Spanish Economy.

The economy of workers’ self-management

One can of course not refer to Vanek’s classification scheme of labor-managed and other systems without referring to the system of worker-managed socialism in Yugoslavia from 1950 to 1989. The Yugoslav system came close to the Vanek first order distinction, and at the micro level of the firm, it also came close to the cooperative Rochdale principles just described.

Yugoslavia was a unique socioeconomic system based on something different than the central command systems of Eastern Europe. Often the of Paris was mentioned as the main inspiration for the Yugoslavs. Eugen Pusic a well-known Yugoslav sociologist, described this as:

Karl Marx's 'Civil War in France', a corrected version of a report to the Executive Committee of the First International about the Commune of Paris in 1871, has become the main source for most of the practical advice about socialism that can be found in Marx. It is a sketch of a commonwealth com- posed of well-nigh autonomous local communities governed by the most imagi- nable under conditions of a late 19th century European large city. All functions of authority, in go- vernment or in industry, are elective and subject to recall. Governmental work cannot be remunera- ted above the level of an average workman's wage. Shops as well as administrative agencies are es- sentially under the control of those who work in them. And government is a body of delegates from all the shops and agencies and other organizations within a local territory. The assembly of delega- t es is in charge of t he execut ive as well as t he legislat ive funct ion. T his blueprint was uppermost in the minds of Yugoslav political planners of the fifties, not less than it was in the mind of Lenin, when he wrot e ‘St at e and Revolut ion’, a mont h before t he revolut ion was t o st art wit h t he canon from the ‘Aurora’.

Outside observers often described workers' self-management as an experiment - Yugoslavia was a so called ‘social laboratory’. According to Yugoslav social scientists nothing could be further away from reality than conjectures of this kind. The League of Communists was both committed to the ideology of -Leninism as well as to cultural factors. This meant that Tito, Milovan Djilas, Edward Kardelj and their associates were trying to find a way that could develop Socialism without violating the traditions

14 specific to Yugoslavia. A ‘’ approach at the local level was for centuries the main method of from social welfare to armed insurrection.

Except for small plots of land and for small family owned retailing-, craftsmanship and restaurant busi- nesses, the were socially owned. This meant that each citizen had the right to engage in cooperation with other citizens in Basic Organizations of Associated Labor (BOALs). The social own- ership principle implied that the employees had a ‘usu fruct’ right to the means of production, and that they had to pay a tax considered an interest due on the socially owned assets. A BOAL consisted of up to 500 associated workers, and each organization had its own democratically elected workers' council and its own manager. Ideally the workers' council were the body in control. According to the 1976 Associated Labor Act, all main technical and economic decisions in BOALs were to be taken by the workers or their delegates. In practice a double hierarchy seemed to prevail. Management held much power, still, the workers had a de facto veto right, and they could dismiss management in case of grievances. Larger or- ganizations were organized as several BOALs in Work Organizations of Associated Labor (WOALs) and even larger ones were organized as Composite Organizations of Associate Labor (COALs). These eco- nomic units were simultaneously the government electorate, when delegations were appointed to elect municipalatory and republic political organs (the socioeconomic chamber of a commune council or a re- public). Members of workers councils, delegations and sociopolitical councils could be recalled and re- placed by their electorate, and they could only be elected for a limited four year term.

What evidence does exist on worker managed firms tends to favour the supporters, not the critics of profit sharing, participatory or labor-managed firms in Yugoslavia. For Instance Branko Horvat, using dat a compiled by the World Bank economists Bela Balassa and T.J. Bertrand found t hat during t he fifties and early sixties, after Yugoslavia had instituted workers' self-management but yet had to lose control over investment policy, the Yugoslav economy grew faster than comparable capitalist and planned economies. Moreover, Horvat found t hat four Yugoslav Indust ries grew fast er during t his period t han t hey had done during their previous short history, which featured periods of both Capitalism and a Soviet style com- mand-economy (Balassa and Bertrand, 1970, Horvat, 1982).

The New Economy

Economists argue whether ‘the new economy’ in fact is something differently as compared to trends originating from past economic development. If, such an ‘economy’ exists, it may be related to new forms of IT based organizations with highly educated employees. These developments introduce us to new types of labor-managed firms. In the old companies, technology was not neutral in the sense that , aut horit y and cont rol disappeared, whet her t he firm considered it self eit her labor-managed or conventional private or Etatist. The double hierarchy just mentioned prevailed. It was depicted by the ‘hourglass’ model of two pyramids one reversed on top of the other (Horvat, 1982). In the traditional labor-managed organi- zation there are two hierarchies. The first is a technical-economic hierarchy of several layers of manage- ment and their department superior to departments below or subordinated to departments above. In this techno-structural hierarchy professional management still had more influence than other staff. On top of this hierarchy and on its head, we find the second hierarchy of interest related decisions. In this, decisions shall be taken democratically by the employees in accordance with the one person - one vote principle. However in the double hierarchy, participatory decision making was constrained by the power relations embodied in the traditional technology - analysis of ‘Tannenbaum’ control curves often suggested, that it was business as usual, with professional management holding more influence than other occupational groups.

The and knowledge-based organizations are characterized by a high labor turnover, because the neatly defined job has vanished. A multiplicity of qualifications is a requirement if an em-

15 ployee seeks to enter the modern organization based on IT-technology. In this organization the ‘all chan- nel network’ becomes dominant with each employee or group of employees holding ‘knowledge monopo- lies’ that ensure a more equal distribution of power, because there is interdependency between each ‘knowledge monopoly’. The traditional hierarchy just described epitomize an oligarchy that maintain an unequal distribution of power or influence, while the network embodies the opposite, a polyarchy. In this t ype of organizat ion, human capit al has become t he most import ant fact or of product ion, accordingly it is of utmost importance to the organization to maintain a cohesion between the ‘knowledge monopolies’. That cohesion can only be preserved if there are incentives for employees to stay in the organization. In other words the stable knowledge based organization needs something different from one of the virtues of neo-liberalism - free mobility of labor. Highly educated employees are not just motivated by the pay roll, they seek responsibility, challenges and participation in ownership and management.

The fact that real capital can be owned while human capital cannot, has led some to argue, that there is a mismatch between the assets that makes the company successful and the financial assets (Leadbeater, 1998). In order to alleviate employee’s turnover intention in a labor-market for highly qualified employees characterized by a high turnover of labor, employee ownership and significant participation in control and management or combinations of the two, is the spine that can provide a cohesive and flexible organization. Yet it will be employee ownership or labor managed control and management of a different kind than seen in the traditional organization described by hierarchy and by power to professional management at all levels (the ‘hourglass’ model).

The abolition of hierarchies or at least the introduction of flat hierarchies has recently led to conjectures regarding a new theory O as something different from theory Y and theory Z. The archetype theory O organization in terms of both ownership and decision making could be conceptualized by ordering differ- ent forms of ownership and participation by the two crucial factors:

• inclusion in decision making • inclusion in ownership

Inclusion in ownership can be related to the allocation of stock between employees and external investors, and it can be related to the allocation of assets between different groups of employees. Additionally, the degree of influence can include either the extent of participation, i.e, what decision types are the employ- ees involved in, or it can involve the influence distribution among different groups of personnel. Then both allocation of assets and influence can be unevenly distributed among occupational groups, and own- ership can be either minority or majority ownership. If the O type organization is something different from the Y and Z type, it must imply, that no employees are discriminated in terms of inclusion in ownership and decision making. It must also mean that the distribution of power is more equally distributed and that all occupational categories of employees experience their participation as significant in relation to all types of decisions. The O type organization then is both highly participatory in terms of control and manage- ment and it is owned by the employees, either as a full employee owned firm or as a joint venture with external investors, where the employees still hold a majority of stock (Winther, 1999). In terms of Vanek’s classification scheme that will be a Labor-managed organization of a new kind, because intellectual work or work with highly-developed skills and will replace the less educated employees in the tradi- tional firm.

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The contributions to this book

The Ilulissat seminar in November 2000 had as its main purpose the following intentions.

First, we found it important to conceptualize participatory ownership and decision making, because it is often emphasized in the privatization debate in Greenland that Inuits and other citizens of Greenland should be included in ownership, when the Home Rule Government privatize the hitherto state owned companies. A ‘Greenlandization’ of ownership does of course not exclude traditional private ownership as described above in relation to the second-order distinctions of socioeconomic systems. However, in the light of what I have presented here, it is obvious, that no system will secure the local empowerment and participation more than a labor-managed or a participatory system. The first part of the papers presented at the seminar aspired to present conceptualizations, problems and potentials of this system globally speak- ing. Furthermore, the question of efficiency of labor-managed systems as compared to capitalist and Eta- tist systems were discussed. Of course, one could always advocate participatory and labor-managed sys- tems on an ethical foundation. Participation, democracy and social justice will probably appeal to a major- ity. Yet, the question of efficiency has a connotation to the welfare of the citizens in a society and conse- quently the economic viability and the dynamics in terms of growth and development of these systems become crucial for political decision makers considering participation in decision making. Thus, the of the first day of the workshop was ‘International Experiences: Participatory Ownership in General - Conceptualization, Viability and Potentials in Relation to Privatization’. This is part one of this anthol- ogy.

Second, we found it very important to include experiences in the circumpolar regions. In both Alaska, Nunavik and Nunavut of Arctic Canada, Inuit corporations and cooperatives have been established, and Greenland already gained some experiences with cooperative societies. Accordingly, the second and third days of t he seminar were devot ed t o models of ownership and organizat ion in Inuit corporations and coop- eratives in Alaska and Canada, participation in Home Rule owned and operated enterprises in Greenland and the historical experiences with the cooperative movement in Greenland. Session two, the second day was organized under the head line of ‘Co-management, Inuit Cooperatives and Inuit Corporations in Arc- tic Regions’, and the third day was organized under the head line of ‘Co-management, Cooperatives, Home Rule Enterprises and Privatization in Greenland’. Because some of the articles included both ex- periences in Greenland as well as other circumpolar regions in order to discuss similarities and differ- ences, we have below organized the contributions from American, Canadian, Danish and Greenlandic social scientists and practitioners in one section ‘Co-management, Participation, Inuit Cooperatives, Inuit Corporations and Home Rule Owned Enterprises’ - the difference between co-management and participa- tion is of course not obvious, because we are dealing with two concepts one from research on how to in- clude the local expertise of hunters and fishermen on management of living resources and another more broadly focussed on control and management in enterprises. The term co-management could also be trans- lated into co-determination after the German word ‘mitbestimmung’ or the Danish word ‘medbestem- melse’. In this case the expressions are the same as participation. To accommodate to the authors use of the terms, we have regardless of their similarity chosen to include them both.

Participatory Ownership in general: Conceptualization, Viability and Potentials

Peter Abell in his opening article ‘The Viability and Competitiveness of Participatory Firms in Market Economic Systems’ underscores t hat est ablished management circles may be quit e reluct ant t o assist the implementation of participatory and labor-managed firms. This type of argument is of a less optimistic kind than the ones introduced in the new economy section above. He argues that management may hinder any voluntary, evolutionary dynamic, which would confer greater participation in management and own- ership upon labour. Thus, it would be difficult to draw the conclusion that any central players in evolution

17 have conducted an experiment that found labour participation or labor-managed firms particularly want- ing? One very important point in this line of reasoning is related to management retaining favour and seeking unsupervised access to rents created in pursuit of sustained competitive advantage. Abell’s article gives associations to the Greenland social scientific debate. Rent seeking has by Danish supply-siders inspired by theories been stressed as an extraordinarily important problem for Greenland. Managers compet ing for resources allocat ed via Government budget s or resources available through priva- tization may be very reluctant to support a participatory privatization unless they can maintain control.

In the paper ‘ESOPs for Privatization and Restructuring’ we are introduced to the structure and function- ing of the American employee stock ownership plan (ESOP). David Ellerman stresses that politicians wanting to ‘transplant’ the ESOP as a part of a country’s privatization program should be aware of the specific features of the ESOP not shared with other employee ownership programs. The fact that it is the company and not the workers that pay for the shares in the ESOP is an important point. Furthermore, one should observe the stability of the employee ownership in the trust and the broad-based nature of owner- ship within the firm. Finally, the transition mechanism of buying back shares from retiring workers and reallocating them to newcomers and current workers is presented as crucial for the viability of the plans. Instead of using retirement, the ‘roll over’ of ownership could be enhanced to share ‘buy backs’ after a certain period of time. As a part of the considerations regarding ‘transplantations’ to other countries, Ellerman argues for the use of external trust funds or an internal ESOP mechanism.

In ‘Economic Performance of Employee-owned Enterprises - Theory and Some Evidence from the Baltic Countries’, a comprehensive data compilation on performance in different types of firms reveals that em- ployee owned firms fare quite well on central economic indicators. Niels Mygind in one of his concluding remarks emphasizes, that there is no indication that employee ownership worsens performance in com- parison with other types of domestically owned firms. It seems that employee owned firms show relatively good results in relation to profitability and factor productivity although this may not be entirely explained by the ownership arrangement, and the evidence seems mixed when including other economic data. My- gind distinguishes between state owned firms (SO), employee owned firms (EO), management controlled but employee owned firms (MCEO), management owned firms (MO), management controlled but outside owned firms (MCOO) and outside owned and/or foreign owned firms (OO/FO). This may also be a useful tool in discussions on operationalizing different privatization strategies. The theoretical predictions are confronted with some of the results from ongoing empirical research in the three Baltic Countries Estonia, Latvia and Lithuania.

Gorm Winther in his paper ‘The Affinity Between Participatory Ownership and Social Coordination Mechanisms’ commences from theoretical debates between neo-liberals and market socialists in order to confront t he argument s wit h comparat ive st udies. T he Paper, first present ed t o t he conference in honor of Jaroslav Vanek at Columbia University in 1999, takes Martin Okun’s equity-efficiency trade off and Ja- nos Kornais affinity hypothesis as its point of departure and confronts these theories with an equity- efficiency synergy hypothesis. An equitarian socio-economic system is by the author related to three dis- tributions, the distribution of income, wealth and power. A more egalitarian distribution implies profit sharing, employee ownership and employee participation in decision making. This synergy was already established theoretically by Vanek in part three of his ‘General Theory on Labor-Managed Market Economies’ from 1970. Empirical studies point in the same direction as in Mygind’s st udy o n t he Baltic count ries. What ever evidence we have, it oft en suggest s a synergy effect inst ead of a t rade off. Empirical studies on the Yugoslav system, cooperatives and employee-owned firms in Europe and especially studies on performance of ESOP firms in the US mainly point to the same - participatory companies, profit- sharing companies, employee ownership companies or combinations of the three often come out with good results on performance.

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Gurli Jakobsen in her paper ‘Cooperative and Training Dimensions in Entrepreneurship: A Study of the Methodology of the Saiolan Centre in Mondragon’, emphasizes t hat t he Mondragon Cooperative Corpora- tion (MCC) since 1999 adheres to the four corporate values of cooperation, participation, social responsi- bility and innovation. Instead of competition so often stressed as a necessary part of a privatization pro- gramme and innovations in a market system, cooperation is an essential part of the corporate culture and very much linked to the process of innovation. Jakobsens main thesis is, that cooperative values are prac- tised both economically and socially, as illustrated in the current initiatives for the promotion of better business management and innovations. This is the case both in the community and within it, in the coop- eratives engaged in an interaction with the community and the region. Especially the educational and co- operative initiatives taken is considered imperative in the MCC today.

Søren Christensen and Ann Westenholz argue in their article ‘Employee Representatives as Company Stra- tegic Actors - in an Enacted World’, that boards of directors in Danish companies today play a far more strategic role than twenty-five years ago. Among others, one of the explanations for this is the entrance of employee representatives at the board, which according to the authors has led to a further professionaliza- tion of strategic management. The employee representatives have in cooperation with the other board members elected at the general assembly assisted in the formulation of a vision for the companies in which they work. The board has been able to convince stakeholders, the press and the public in general about t his concept of t he company. Not t hat t he company always can st ret ch out and convince or control its surroundings, nevertheless, if the company succeed in engaging the environment in its development projects, employee representatives play a pivotal role. The development of Danish companies is unique, because employees much more than anywhere else have been integrated into management of the com- pany. This situation may in the future become an important competitive parameter, because countries, Denmark competes with internationally are far behind in terms of participatory management of strategic decisions.

Co-management, Participation, Inuit Cooperatives, Inuit Corporations and Home Rule Owned Enterprises

It is an open question, whether conventional Greenland companies have succeeded in promoting participa- t ory management st ruct ures t o t he same level as discussed by Christensen and Westenholz in relation to board representation in Danish Companies. The article ‘Inter-cultural Leadership and Cultural Co- management in the Greenland Labour Market’ emphasizes, that Greenland is a multi cultural society with a multi cultural work force. Wolfgang Kahlig in this article addresses barriers to inter-cultural manage- ment and action even among managers with a low or absent turnover intention. Danish managers who only expect to stay in Greenland over a short time horizon are probably the ones least suited for the pro- motion of co-management involving local employees. The article demonstrates that specific inter-cultural competences and leadership are required for managers. However, identifying three managerial prototypes, it is argued on the base of qualitative data, that mostly, none of these managerial categories have sufficient knowledge and qualifications regarding operating a multi-cultural business involving local empowerment. Kahlig argues t hat managers should be t rained t o pract ice int er-cult ural management and t hat consciously practised co-management calls for other management philosophies than the still existing ‘scientific man- agement’ philosophy or the ‘theory X’ philosophy - in Greenland this means, that management through training should realize that they may be in unpropitious need of the ‘culture interpretation qualifications’ so urgently needed for the practice of other management philosophies based on co-management.

Gerard Duhaime, Alexandre Morin, Heather Myers and Dominic St-Pierre point to Greenland standing at a cross road with a welfare state under attack from neo-liberals. In their article ‘I n u it Business Ownership - Canadian Experiences, Greenland Challenges’ the authors warn, that a swift change toward privatization could lead to significant structural changes of the Islands economy with repercussions for the Greenland-

19 ers welfare. These changes if implemented could be seen as threatening steps taken towards social pro- gress in general and the living conditions in the small settlements in particular. This move could at worst turn into a grandiose fire sale of the home rule state owned assets to either Danish or foreign investors. The experiences of the arctic regions of Nunavut and Nunavik in Arctic Canada could be an inspiration for the Greenland Home Rule Government, if there is a sincere will to prevent privatisation to dominant for- eign strategic investors. Such developments could be detrimental for the long term development of the Greenlandic economy. In the Canadian experiences of the last two decades, two models of business come to the authors’ attention. The first was ‘a bottom up’ movement with a moderate financial success. The Nunavik cooperative movement has maintained the cooperative principles discussed above, and the growth has been constantly increasing since the sixties. The second is not as participatory, nevertheless when compared to privatization plans involving transnational companies, it is an example of an ownership model that can secure that ownership stays local. The native corporations are a ‘top down’ initiative origi- nating in the land claim agreements.

It has often in relation to discussions on suitable ownership arrangements been stressed, that the subsis- tence sectors of circumpolar economies are established as alternative forms of organizations founded in traditional social organizations and cultural systems of indigenous populations. Robert Wolfe suggest s that many elements of the subsistence sector in Alaska’s North will find counterparts in Greenland settlements. Actually political decision makers in the early years after the inception of Home Rule in Greenland, in the early eighties emphasized, that a kind of ‘communal ownership’ should prevail as a ‘bulwark against capi- talism’. The sense of community is by some observers and social scientific analysts still observed as a unique Inuit value. Taking this into consideration in relation to Vanek’s classification scheme, it is obvi- ous, that these traditional social organizations have more in common with the participatory or labor- managed system, than it ever will have in common with the two other socioeconomic systems ‘imported’ t o Greenland by Danes wit h a ‘Euro-cent rist ’ pre underst anding of Greenland. In relat ion to this, coopera- tive societies have been mentioned numerous times as a vehicle to overcome the gap between the tradi- tional and the modern. The question is of course what is about today in a region like Alaska, where we see native corporations as a result of the Alaska Native Claims Settlement Act, but not that many cooperatives. Robert Wolfe in his paper ‘Subsistence Food Production and Distribution in Alaska: Social Organization, Management and Issues’, points out, that in Alaska during the late 20th century, wild fish stock and wildlife populations are public assets owned and controlled by the State or Federal Government and managed for a sust ained yield. Allocat ions are made by Government to private entities for three types of harvests - subsistence, commercial and recreational. The scale of subsistence production in Alaska is discussed with emphasis on economic and other historic factors influencing work group composition and scale of operation. Moreover, the impact from other sectors in the Alaskan econ- omy on subsistence economics is discussed.

Gorm Winther presents the policies of participatory strategies formulated by both the Danish State and the Home Rule up unt il t he mid eight ies. In t he paper ‘Participation and Self-management in Greenland Re- visited’, it is argued that Greenland in the future can choose between a participatory way in concert with traditional Inuit organizations and values or a paternalistic development based on Danish neo-imperialism. Most of the participatory structures presented above have one way or the other been politically articulated, yet neither the State nor the Home Rule never whole heartedly followed up on the proclamations on local empowerment. The article presents the different forms of participation and cooperatives. Explanations are offered regarding why these organizational structures never got off the ground? The suppliers’ coopera- tives eked out a nonessential existence between a dominant Government sector and a weaker private sec- tor. There was a profound lack of education and knowledge regarding the gist of cooperative ideas. Fur- thermore, the indigenous population was and still is anesthetized by the benevolence from the Danes para- lyzing cooperative initiative. Finally, Peter Abells’ theoretical points made in the opening article seemed confirmed - opposition among Danes belonging to the post-colonial elite and opportunism among politi-

20 cians was an important constraint to the development potentials of the cooperatives. Rent seeking and attempts to hold on to power could explain the opposition and disapproval regarding cooperative take- overs.

Nonetheless, amidst the gloomy perspectives represented by neo-liberal dominance in Greenland’s priva- tization process, there may be newer developments, that still allot some optimism - in ‘Privatization Based on Employee Stock Ownership Programs’ excerpts from Flemming Enequist’s masters degree thesis in administration and political science from ‘Ilisimatusarfik’ (Greenland University) are introduced. The resume originally published in Inuit and Danish language is presented in a provocative way as a call for a popular debate on whether there is an alternative to neoclassical ideas of market economies and privatiza- tion. Employee ownership is considered an important alternative to traditional privatization. In 1999 Greenland saw its first employee owned company ‘KIMIK IT Inc’. Yet, the tax system in Greenland is not encouraging employee ownership to the same degree as in the US. As stressed by David Ellerman in this book, it is the company in the US and not the workers that pay for the shares in the ESOP. Moreover, it is the company that receive considerable tax exemptions, while the employee owners in Greenland only re- ceive limited tax deferrals. The financial burden in Greenland is solely the employees, because the em- ployee ownership program is financed out of the pay roll and not out of profits or value added of the com- pany.

In the closing article ‘the grand old man’ of the cooperative movement in Greenland, the former manager of the cooperative ‘Sipeneq’ in Sisimiut (Holsteinsborg) Angmalortoq Olsen present s a case on the general trends discussed in other articles. In ‘Cooperative Societies in Greenland - What Went Wrong?’, we are introduced to the problems of setting up and running a Cooperative in Greenland. One, significant prob- lem was members of the cooperative working against the interest and goal of their interests. The members of the cooperative preferred to sell their harvests on the ‘’, because it gave a higher price than selling to the cooperative and receiving dividends in proportion to the annual sale of fish, land and sea mammals. Angmalortoq Olsen summarizes the lesson learned and points to new ways: First, before starts, the future participants in a venture have to be fully informed and maybe educated, and moreover it is im- perative to have their full accept of their role, duties and rights alike. Second, it is quit e as important, that the future labor force will be fully informed and trained. Third, it is necessary to establish a solid eco- nomic base, both with private capital and from authorities and banks, to finance facilities and secure op- erations. Fourth, it is imperative to know, how big the planned raw-material source is, and how to keep it stable in order not to exploit it so greedily, that it is unable to renew itself. Fifth, t he cooperative needs to create clear plans for produce and markets, and to know infra-structural problems, and secure sources for power and water. Finally, the cooperatives have to secure approval from the relevant authorities and poli- ticians.

References

Balassa and Bertrand. “Growth Performance in Eastern European Economies and Comparative Western Economies”. American Economic Review 62(5):777-95. Blasi JR. “Employee Ownership, or rip off”. Bollinger, New York, 1988. Blinder A. “Paying for productivity”. The Brookings Institution, Washington DC, 1990. Cheney G. “Values at Work, Employee Participation Meets Market Pressure at Mondragon”. ILR/Cornell University Press, Ithaca, 1999. Horvat B. "The of Socialism - a Marxist Social Theory". M.E. Sharpe Inc., New York, 1982. Horvat M, Supek R, eds. “Self-governing Socialism”. Vols 1 and 2, International Arts and Sciences Press, 1975. Kelso and Hetter. “Two Factor Theory, the Economics of Reality”. Vintage books, New York, 1967.

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Leadbeater C. “A Piece of the Action, employee ownership, equity pay and the rise of the Knowledge Economy”. Demos, , 1997. Levine and Tyson. “Participation, Productivity and the Firms Environment”. In: Blinder, “Paying for pro- ductivity”. The Brookings Institution, Washington DC, 1990. Macgregor D. “The Human Side of Enterprise”. Mcgraw-Hill, New York, 1967. Ouchi WG. “Theory Z, How American Business Can Meat the Japanese Challenge”. Addison Wesley, Reading, MA, 1981. Pusic E. "The Yugoslav System of Self-management". Ovo je tekst referata odrzanog na konferenciji "Snage i putovi rata i mira", u Zagrebu 12 rujna 1975 godine. Rosen and Young. “Understanding Employee Ownership”. ILR Press, Cornell University, New York, 1991. Thomas and Logan. “Mondragon, an Economic Analysis”. George Allen and Unwin, London, 1982. Vanek J. “The General Theory of Labor-managed Market Economies”. Cornell University Press, Ithaca,”. Cornell University Press, Ithca NY, 1988. Winther G. “Theory O - Is It Case Closed”. Economic and , Sage Publications1970. Whyte and Whyte. “Making Mondragon, the Growth and Dynamics of the Com- plex”. London, 1999;20:269-93.

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The Viability and Competitiveness of Participatory Firms in Market Economic Systems1

Peter Abell

Over the years many scholars have sought to advocate the participation by employed labour in both the management (i.e decision making) and the ownership of the productive assets of firms. Self-owned and managed producer cooperatives are perhaps the most extreme embodiment of these ideas. Such arrange- ments depart from the standard picture of the capitalist firm where external capital owners retain the ‘right to manage’ or delegate this right to their denominated agents.

The reasons given for advocating labour participation of either or both sorts are varied, ranging from sup- posed improvements in efficiency and performance (i.e when compared with capitalist firms) to issues of distributive justice and human rights. If, however, superior performance is, indeed, achieved by ‘partici- pation’ then we might ask why the competitive forces inherent in market economies have not (so far at least ) select ed t he superior forms? It would be difficult t o argue t hat labour part icipat ion in either owner- ship (equity) and/or management is a predominant practise anywhere, except where it has been introduced (e.g co-determination Germany) under the auspices of the law or tax inducements. In the United States, for example, over 12 000 organisations, we are informed, (Blasi et.al, 1996) are currently making some use of ESOPS and over 10% of ‘workers’ hold stock in the companies in which they work, but it is gener- ally recognised that tax-breaks have played a significant role in the generation of these statistics.

Is the relatively low incidence of ‘labour participation’ in both management and ownership (in the absence of inducements) attributable to (a) the lack of any productivity/performance consequences or, indeed, pos- sible negative ones or (b) the existence of non-competitive forces preventing, in some way, the natural evolut ion of part icipat ive firms or (c) (and relat ed t o (b)) a slow learning process where t he above statis- tics may provide some indication of the early stages of an evolutionary process?

The question of first importance is whether or not participation (of whatever sort or degree) does, indeed, have a discernible impact upon performance, however measured. In this respect it is natural to look in the direction of systematic research. But even then, as we shall see, drawing conclusions is not at all easy. In an ideal research design the effects of ‘participation’ would be detected by taking a sample of otherwise identical start-ups, some adopting ‘participation’, others not and studying their performance henceforth. In practice research is far from this ideal.

It, furthermore, could conceivably be the case that regulatively ‘induced’ participation could have a differ- ent impact from ‘spontaneous’ participation and could be heterogeneous by sector, capital intensity and so on. If, for instance, any performance effects, arise from labour motivation then they may only show up in labour intensive sectors.

Before we begin t o address some of t hese quest ions and issues it might prove useful t o t hink in terms of a rather simple diagram (figure 1) which gives us a rough and ready indication of the various types of par-

1 I would like to thank Professor David de Meza and Dr Ray Richardson for their kind help in improving the first draft of this paper.

23 ticipation available by combing varying levels of labour’s (L) participation in both management and own- ership.

I have also, in brackets, depicted the axes using the nomenclature of the property rights theory of the firm (Hart, 1995). The horizontal axis, may sometimes be conceived to represent variations in the participation by labour in the (non-contracted) residual control of assets, whilst the vertical axis may depict the varia- tion in participation by labour (i.e those who work in the firm) in residual (non-contracted) remuneration though the latter participation can arise without ownership. As is well known the proponents of the prop- erty rights theory of the firm construe organisations (i.e firms) as mechanisms for controlling these two residuals. Indeed, they opine that if ex ante all contracts could be costlessly closed, anticipating all future contingencies, then firms would not be necessary, being displaced by individual market contracting.

The diagram also indicates some of the possible institutional arrangements, located on either axis, which can all be found in one place or another. Although not all possibilities are neatly captured in such a simple diagram, it does enable us to locate the traditional capitalist firm somewhere near the origin (i.e external capit al owners wit h de jure managerial cont rol and remunerat ion) and what we might t erm producer coop- eratives at the top right hand corner (i.e with self ownership and management). Twentieth century histori- cal experiences in OECD countries (with perhaps the partial exception of the Anglo-Saxon countries) seems to indicate, firstly, a drift (often in stepwise movements) along the horizontal axis (increasing managerial control being vested with labour) and, secondly, a drift up the vertical axis (increasing owner- ship to labour). One can, thus, detect a net move up the diagonal away from the ‘pure’ capitalist firm. I should hasten to add that this story, as presented, is palpably under nuanced, but probably contains a broad truth. It has, however as I noted above, been significantly propelled by a framework of regulative injunc- tion and tax inducements. The counter-factual question may accordingly be posed as to whether or not we would have witnessed something similar even in the absence of this framework? Has the state sometimes anticipated what competitive forces would have procured anyway? Or, indeed maybe it has stepped in where competitive forces would have failed? There are those, however, – both scholars and practitioners – who lament any moves from the bottom left hand corner of the diagram feeling that they are associated with efficiency losses. So let us now turn in this direction.

I do not int end t o review in any det ail t he lit erat ure, which at t empt s t o assess the impact upon performance of labour participation in both management and ownership. This has been carried out by many others before, most recently by Doucouliagos (1995) though it is, unfortunately, true to say that much of the re- search leaves an awful lot to be desired and as a consequence it is only with caution that any general con- clusions can be drawn. In particular, the majority of studies are cross sectional and suffer from a selection bias. Not surprisingly, researchers have reported all manner of results, positive, negative and negligible, about the impact of participation upon various measures of performance. This applies to participation in both ownership and management. Results in respect to management appear, however to be more consis- tently positive.

Research into the functioning of producer cooperatives (the top right-hand corner of figure 1) is also inde- cisive. Out st anding examples exist , like some of t he Israeli kibbut zim and t he Mondragon group of coop- eratives in Northern Spain, but most observers seem to feel that special nationalistic sentiments underpin their relative success. The early experience of the former Yugoslav ‘self-managerial socialist market sys- tem’ – despite its very special features – is also sometimes paraded as a positive exemplar but, once again, sharp differences of opinion co-exist amongst those who have studied this historical period.

In the face of these various results, it is perhaps best to rely upon systematic meta-analysis and so to fol- low Doucouliagos who finds a small interactive effect of the participation in both management and owner- ship upon ‘firm productivity’. Others have over the years found similar results (Rosen and Quarrey 1987,

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Winther and Marens 1997, Conte and Svejnar 1990). Cable and Fitzroy (1990) were probably the first to report this sort of finding. There are those, of course, who find larger and independent effects, both posi- tive and negative. Furthermore, the studies do not allow us to easily access the possible effects of ‘partici- pation’ across the full range of variation implied by the two axes in figure 1. From a theoretical standpoint an interactive effect in both types of participation upon performance would make considerable sense. If participation in management does not bring an improved share in any residual rents, in the absence of assumptions about a ‘taste for control’ (i.e more generally intrinsic rewards) it is difficult to see where the incentives lie. One should, nevertheless at the same time be sensitive to Vanek’s (1977) arguments con- cerning internal financing and the impediments which risk-aversion, on labour’s behalf, might impose upon the optimal participation in ownership.

It would, in the light of these deliberations seem judicious to try and provide an answer to the evolutionary puzzle with which I opened - why so little voluntary as opposed to legally imposed participation – in the context of three different scenarios? First, where the joint effect of labour’s participation in management and ownership is weakly positive; second, where it is weakly negative and, third, where it has little or no discernible impact. It should be noted here that in each case arguments may be proposed for the net desir- ability of either type of participation on grounds other than their impact upon performance (e.g intrinsic, human rights, impact on income distribution). But unless we have independent evidence for ‘tastes’ for these sorts of consequences, they will not enter into any evolutionary analysis.

The impact of each of the three scenarios will depend upon those assumptions, which we care to make about the nature of evolutionary competition itself. I shall contrast two extremes. Firstly, where the stan- dard assumptions of full information and perfectly competitive markets hold and, second, where markets exhibit significant levels of ‘sustained competitive advantage’. The former is largely the brainchild of economists whereas management theorists put sustained competitive advantage at the centre of their pic- ture of things.

I shall also propose that we should conceive of three types of agent/actor as the dram atis personae in the evolutionary process – capital, labour and (top) management. I hope the justification for including top management as an independent group will become evident as I proceed, but a few initial remarks might be appropriate. In a pure, perfectly competitive, capitalist system (bottom left-hand corner in figure 1), where risk bearing capital hires (contracts with) labour (at a market clearing wage rate) and retains any post contractual residual rights to both control and remuneration, then (top) management is technically but one of the categories of contracted labour. Likewise, in a pure, perfectly competitive, ‘cooperative sys- tem’ (top right hand corner in figure 1) the roles of labour and capital are reversed and management is now a category of labour which hires capital. In either case the role of (top) management, as a particular interest group, does not (in theory) enter the picture and if, in addition, we assume competitive markets which shape all returns, then there is also no room for rents. In between these polar extremes, however, there is, in my view, ample evidence (see below) which should lead us to the conclusion that ‘top’ man- agement should be treated as a group with its own distinct objectives or interests in any evolutionary dy- namics. In this respect it is also probably important to demarcate ‘top’ management and not to include all line management. Richardson (2001) for instance shows that these groupings adopt distinct attitudes to- wards participation.

I propose that we should examine any evolutionary arguments under two differing assumptions concern- ing the motives (utility functions) of top management. First, the standard one of monetary utility and, second, where, in addition, top managers gain some utility from exerting (residual) control (i.e retaining a ‘right to manage’). There does seem to be survey evidence to justify the latter assumption, though no doubt some would contest this, feeling, moreover, that it over easily preordains the conclusion of the ar- gument. For these reasons it is perhaps important to see how far the standard assumption can take us.

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The Evolution of Participation in Competitive Environments

The argument with standard utility assumptions seems pretty straightforward. If participation of any sort, taken either singularly or in concert, improves the performance of the incomplete contracting between labour and capital – even only slightly – then competitive forces (in capital, labour and product markets) should eventually select through entry, exit and emulation the appropriate participatory arrangements. Even if the effect turns out only to be sector specific or, for instance, realisable with high labour/capital ratios then the forces of selection should still have their sectional way. There are those, particularly in the economics profession and amongst top management, who feel history has kindly conducted an experiment for us and found ‘participation’ wanting. No economy, they would urge, has ever spontaneously selected significant levels of participation. Any drift we may have witnessed away from the bottom left hand cor- ner of figure 1 has been prompted by (sub-optimal) regulations of one sort or another. Left to its own devices any competitive economy would find repose somewhere, close to the origin in figure 1. And, of course, if this story is in any way correct we should be able to locate small but detectable negative conse- quences of drift upon performance. Even if participation were to have no appreciable effects (though may be favoured for other reasons) it is unlikely to evolve spontaneously. Furthermore, both the concentration of risk and labour’s relat ive risk aversion argue against residually remunerat ed labour. Wit h increasing wealth labour’s relative risk aversion may, however, decline and some level of self-ownership (along with participation in management – if the interactive model is correct) may become the optimal choice. This may be what we are observing (in addition to any regulative inducements). One would expect to dispro- portionately observe any effects in firms where labour is relatively wealthy – that is with ‘high’ levels of human capital. I have no systematic evidence on this matter (nor on the relative importance of induced and spontaneous drift) though I suspect that research would reveal the observation to be correct. Cer- tainly, companies like Microsoft are located well away from the bottom left hand corner of figure 1 and increasingly look like ‘human capital cooperatives’. Is there a glimpse of the future here?

Speculation of this nature aside, if we continue to assume perfect competition but now add a taste for ‘de- cision making’ amongst (top) management, which would inevitably be compromised by labour participa- tion, then the story is less clear. It would be easy to set up a model where the elasticity of substitution between ‘income’ and ‘control’ in management’s utility schedule is such that they could have an incentive to block any potential increase in participation induced productivity on labour’s behalf. This seems to me to be one of the central problems of the ‘history has conducted an experiment for us’; what we get out of the historical testimony depends so heavily upon the assumption we care to make about the motives of the dramatis personae. It is difficult to draw any precise conclusions but, furthermore, what happens if we replace the assumption of (near) perfect competition by one of ‘sustained competitive advantage’?

Evolution of Participation under Sustained Competitive Advantage

It is clear from a conventional theoretical standpoint, that if firms are envisaged as more or less success- fully seeking to locate and then to sustain their not easily replicable advantages, then we are speaking of, at least temporarily, sustained monopoly power. In my view this is a more tenable starting point upon which to base any evolutionary analysis. Indeed not only mine, no less a luminary than Larry Summers recently opined that ‘the central driving force of the new economy is the force of monopoly power’. The argument, though, has to be broached cautiously for we need, in the first place, to know why competitive firms do not undermine, through entry, exit and emulation, any existing competitive advantages. But, if they do not then the issue is: would one expect ‘participatory arrangements’ to be selected in a world of imperfect competition if they have any one of each of the three performance consequences mentioned above – slightly positive or negative or no effect at all.

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Although monopolies have been around for a long time, the ‘new economy’, may be driving us in the direction of even more monopolies (i.e ). The drift up the vertical axis of figure 1 does seem to coincide with the founding of the new economy. Developments in information technology often imply large fixed costs (development costs) but low variable costs. Match this with the possibility of network consumption effects then and the likelihood of contestation are substantially diminished. Sustainability in this sort of economy can, however, always be stretched by stifling innovation which is endogenously developed by the existing monopolies. Certainly, there appears in the last decade to be a quickened interest in regulating monopoly power. In the last decade, for example, the number of mergers reported to the anti-trust authorities has doubled and in the EU increased four times.

In contrast to the perfectly competitive world, in the world of sustained competitive advantage rents are captured for sufficiently long periods for issues about their distribution to become of motivational conse- quence within the firm. An evolving economy is best envisaged in terms of a perpetual struggle to grasp the significantly lasting, though finite, rents occurring from a flow of both exogenously and endogenously generated opportunities. The competitive process is one of protecting rents which are not quickly com- peted away, within the confines of a motivationally significant time horizon. Thus, the distribution of significantly sustainable rents between capital, labour and (as I shall argue) top management become of central significance in the portrayal of evolutionary dynamics (i.e selection). We can without too much imprecision construe the distribution of rents as equivalent to the distribution of residual remuneration in figure 1.

In the capitalist system, (bottom left hand corner of figure 1) characterised by the quest for sustained com- petitive advantage, where equity owners are dispersed and ill-organised (perhaps because of free-rider problems), top management is able to capture a significantly large proportion of any sustained rents. Fur- thermore, labour with no rights to residual remuneration has little (though perhaps varying) power to wrest the rents away from management. I will try to justify the truth of these two propositions below but first we must see how they shape any evolutionary selective dynamics. We might note however, that again and again surveys have found evidence that (top) management is resolutely opposed to labour participation at the higher levels of management decision making (‘the right to manage’ is the ideological epithet which is characteristically invoked) though they seem more relaxed about participation in ownership and even par- t icipat ion at lower levels (e.g consult at ion). In t he lat t er respect , inst it ut ions impinge, of course, upon the ‘right t o manage’ of lower-management much more t han on t op management . W hilst in the last decade or so top management has by and large welcomed labour (including their own) participation in equity it has been vociferous in supporting the role-back of legally imposed high level participation in management. For instance, strong objection to clauses on worker directors in the European Fifth Directive.

The previous argument rests heavily upon the assumption whereby a rent-seeking and sustaining economy benefits top management if they can secure de facto rights to residual control. What evidence is there that managers do manage to extract rents in capitalist economies? As far as I am aware there is no definitive study which unequivocally establishes their success in this respect, let alone whether or not their remu- neration rewards their appropriate contribution to the creation of any rents. Certainly gross statistics are suggest ive. For inst ance, t able 1 depict s t he rat io of CEO remunerat ion as a mult iple of manufact uring employee total remuneration. Three things stand out: the size of the ratios, their variability across coun- tries and a lack of any correlation with GDP. It would be difficult to explain the variability other than in terms of the different institutional frameworks which impinge upon rent extraction. Certainly, any attempt to invoke varying managerial productivity is likely to flounder. There is, however, some indication of pattern; the USA - a country with little of no ‘participation’ – is markedly exceptional but the rest of the figures t end t o suggest t hat t he European count ries (where ‘part icipat ion’ is t o some degree developed) have a lower ratio than the others. One cannot make too much of this – but, maybe, rent extraction by m a n a ge m e n t i s m o r e di f f i c ul t i n t h e p r e se n c e o f ‘ p a r t i c i p a t i o n ’ . Fur t h e r m o r e , t h e f i gur e s m i gh t suggest

27 multiple equilibria in respect of CEO remuneration. In particular, it is difficult to believe the difference between, say, Switzerland the USA is attributable to differing productivity. Perhaps for historical path dependent reasons Switzerland has found a ‘low’ equilibrium in contrast to the USA.

We are sometimes told that we are living in the age of globalism where competitive market forces cut across national boundaries equalising returns everywhere. Table 1 lends little credence to such arguments, at least at the moment. If we concentrate upon the USA, the most extreme country represented in table 1, then the chosen ratio has changed from 42 in 1980 to 84 in 1990 and now stands at 475.

Table 1. CEO Total Remuneration as a Multiple of Manufacturing Employee Total Remuneration (1999) Argentina Belgium Brazil Canada France Germany Italy Japan

44 18 49 20 15 13 27 11

Mexico Netherlands Spain Sweden USA Switzerland UK Venezuela

46 17 17 13 475 11 24 50

Source: www.aflcio.org/paywatch/ceopay.htm Some research is st rongly suggest ive in respect of rent -ext ract ion by t op management . Cryst al (1991) suggest s t hat de fact o CEOs set t heir own pay wit h a weak const raint set by share prices (he calls it ‘skimming’). Thus, for him the world of optimal contracting – even in near competitive conditions let alone in non-competitive ones – is remote. Bertrand and Mullainthain (2000) largely agree. They say:

In poorly governed firms the skimming view fits better (pay for luck and little charge for options) where in well-governed firms, the contrasting view fits better (filtering out luck and charging for options).

Core et.al (1999) also find that less effective boards lead to increases in CEO compensation. Hallock (1997) in a similar vein find firms with interacting directors give higher salaries to their CEOs.

So let us henceforth assume that attempts to control the distribution of rents significantly shapes the selec- tion process in a capitalist economy (Lazaer, 1996). Furthermore, as argued above, this is a particularly so in the ‘new economy’. A rather simplistic model may help in fixing what is involved in understanding the impact of ‘participation’ upon this distribution.

Let the degree of ‘participation’ by labour be L. In the spirit of the discussion above, L is an interactive function of labour’s participation in both management (C) control and equity remuneration (R). So let us say:

L = βCR (1) If the rents generated by participation within the firm (Y) are dependent upon the level of L:

Y = f(L) (2)

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If S is t he share of t he rent s (Y) which labour can capt ure, t hen allow t hat S also depends upon the level of L:

S = ∅(L) (3)

The reasons for this are manifold but essentially revolve around increasing transparency of the process of management and, thus, the bargaining power of labour.

Rent seeking management will maximise:

Y (1-S) (4)

Thus, select a Y, L combination where:

∂Y ∂S (1− S) + Y = 0 (5) ∂L ∂L and

∂Y ∂S ∂Y = Y (6) ∂L ∂Y (1− S)

Any conclusions we may draw will turn upon the assumptions we choose to make about the shape of both functions (2) and (3). In respect to (2) we may assume that Y increases, from Y(L=0), in L but at a declin- ing rate (figure 1) (indeed, it may eventually decline (figure 2)). Function (3) will probably be monotoni- cally increasing in L. The joint maximum in rents will be at the value of L, from (2), where dY/dL=0. When, however, management maximises and where ϑS/ϑY>0, then ϑY/ϑL>0. So management will not select the joint optimum, choosing a lower level of L (figures 2 and 3). Likewise labour maximising its returns will seek a point where ϑY/ϑL<0 (i.e where L is above (figure 2) or at the optimum (figure 3)). Unless management and labour can find a way of resolving these differences (or indeed a solution is im- posed!) then the maximum rents will not necessarily be achieved. Bargaining t heory would suggest a contract could be negotiated in order to attain the maximum but whether this would be enforceable must be open to question. If also, in addition we add an independent utility, on management’s behalf, in a ‘low’ S (i.e a taste for control) the problem is clearly exacerbated. Furthermore, if ‘good’ managers exit firms where labour has managed to move nearer to (or beyond) the joint optimum than participatory firms may also experience a managerial deficit. It does seem that under reasonable assumptions rent seeking agents will undermine any supposition that evolutionary forces will deliver an optional level off participation.

Conclusions

I have tried to make a case for the argument that entrenched management may hinder any voluntary evolu- t ionary dynamic, which would confer great er part icipat ion in management and ownership upon labour. If the argument carries any merit at all then it would be difficult to draw the conclusion that history is (or has) conduct ed an experiment and found labour part icipat ion want ing.

References

Bertrand M, Mullainthain S. “Do CEOs set their pay? The ones without principals do”. Working Paper 431, Industrial Relations, Princeton University, 2000.

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Blasi J, Conte M, Kruse D. “Employee stock ownership and corporate performance among public organi- sations”. Industrial And Labour Relations Review 1996;50:60-79. Cable JR, Fitzroy FR. “Productive efficiency, incentives and employee participation: Some preliminary results from West Germany”. Kyklos 1990;33:100-23. Conte MA, Svejnar J. “The performance affects of employee ownership plans”. In: Blinder AS, ed. “Pag- ing for Productivity: A Look at the Evidence”. Brooking Institute, Washington D.C, 1990. Core JE, Holthausen RW, Larcker DF. “, chief executive officer compensation and firm performance”. Journal of Financial Economics 1999:51, 371-406. Crystal G. “In Search of Excess: The Overcompensation of American Executives”. Norton, New York, 1991. Doucouliagos C. “ Worker part icipat ion and product ivit y in labour – Managed and part icipat ory capitalist firms: A meta-analysis”. Industrial and Labour relations Review 1995:49, 58-77. Hallock KF. “Reciprocally interlocking boards of directors and executive compensation”. Journal of Fi- nancial and Quantitative Analysis 1997:32, 331-44. Hart O. “Firms, Contrasts and Financial Structure”. Oxford University Press, Oxford, 1995. Lazaer EP. “Personnel Economics”. MIT Press, 1996. Richardson R. “Participation”. Mimeo IIM at LSE, 2001. Rosen C, Quarrey M. “How well is employee ownership working?”. Harvard Business Review 2001:65, 126-32. Vanek J. “The Labour Managed Economy: Essays”. Cornell University Press, Ithaca, 1977. Winther G, Marens R. “Participating democracy may go a long way: Comparative growth and perform- ance of employee ownership firms in New York and Washington State”. Economic and Industrial Democracy 1997:18, 393-422.

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ESOP’s for Privatization and Restructur- ing1 David Ellerman

Employee Stock Ownership Plans (ESOP’s)

In the United States, an ESOP is a special type of benefit plan authorized by the Employee Retirement Income Security Act (ERISA) of 1974. As in any employee benefit plan, the employer contributions to an ESOP trust are deductible from taxable corporate income. But, unlike an ordinary pension trust, an ESOP can take out a loan to buy shares and can invest most or all of its assets in the employer’s stock. This makes an ESOP into a new vehicle for worker ownership, but it is not a substitute for a diversified pension plan.

ESOP’s have received strong tax preferences so for that reason, if for no other, their growth has been sig- nificant. From the beginning in 1974, 11,000 ESOP’s sprung up in the United States covering over 10 per cent of the workforce (in comparison, a comparable or smaller per cent of the workforce is unionized). There are perhaps 1000 ESOP’s holding a majority of the shares in the company. The main tax advantage to the company is the ability to deduct the value of shares issued to an ESOP from the taxable corporate income.

Structure of ESOP Transactions

In the leveraged ESOP transaction, the corporate employer adopts an employee stock ownership plan (ESOP) which includes a trust as a separate legal entity formed to hold employer stock. The ESOP bor- rows money from a bank or other lender (step 1 in figure 1 below), and uses that money to purchase some or all of the employer stock at fair market value (steps 2 and 3). The loan proceeds thus pass through the t rust t o t he employer, and t he st ock is held in t he t rust . Ordinarily, t he company guarantees repayment of the loan by the ESOP and the stock in the trust is pledged to guarantee the loan.

Over time, the employer makes contributions of cash to the ESOP in amounts needed to repay the princi- pal and interest of the bank loan (step 4) and the trust passes the payments through to the bank (step 5). Thus, the employer pays off the loan gradually by repayments to the lender through the ESOP—payments t hat are deduct ible from t axable income as deferred labor compensat ion. T his deduct ion of bot h interest and principal payments represents a significant tax advantage since the employer ordinarily can deduct only the interest payments. Prior to the loan payments, the shares in the ESOP are held in a ‘collective’ Suspense Account. As the loan payments are made, a proportionate amount of the shares are assigned to the individual share accounts of the then-current employees.

An ESOP can also be used partially or wholly to buy out a company from a private or public owner. This is called the ‘leveraged buyout transaction’. The ESOP borrows money (step 1 in figure 2 below) and the loan payments are guaranteed by the firm with the purchased shares as collateral. The shares are then purchased from the outside owner, such as the government, with the loan proceeds (steps 2 and 3) - instead of buying newly issued shares from the company.

1 The findings, interpretations, and conclusions expressed in this paper are entirely those of the author and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to the members of its Board of Direc- tors or the countries they represent.

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Again the firm makes ESOP contributions which are passed through to pay off the loan (steps 4 and 5). A variation on this plan is for the seller to supply all or some of the credit. By combining the functions of the bank and outside seller in the above diagram, we have the ‘pure credit’ leveraged buyout transaction.

Transplanting ESOP’s

Sometimes the acronym ‘ESOP’ is used to refer to most any employee ownership arrangement. But that broad use of the phrase is likely to overlook some important innovations in the ESOP design. I will focus on four important innovations worthy of being preserved in any ‘ESOP’ arrangement for other countries and one innovation not used because of the way ESOP’s were legislatively implemented in the USA.

1. Payments for worker shares are company payments coming out of revenues, not directly out of workers' pockets. Then the worker ownership needs to supplemented by workplace participation and productivity improvement programs so that the shares will, in effect, be paid for by the increased pro- ductivity. There are nevertheless good psychological reasons to have each worker make some signifi- cant out-of-pocket payments even though this is not required in the American ESOP’s. 2. The ESOP is a stable form of employee ownership. The workers cannot individually sell their shares at any time (the company usually buys back the shares when the worker leaves or retires). The ESOP can be overturned by a collective decision (say, a two-thirds vote) but individual workers cannot be stampeded into selling by 51% tender offers (ie, offers to buy only 51% of the shares so the workers who didn't quickly offer their shares would be left without control and without a market for their shares). With stabilized ownership, workers will focus on getting more value out of their ownership by making the company more profitable rather than constantly scanning for sharp share-selling deals. 3. ESOP’s have broad-based ownership within the firm. As the ESOP loans are paid off, the shares are allocated according to payroll to the current employees. Thus ownership is automatically going to the primary stakeholder group (the people working in the firm) and it is going to everyone in the group, not just to a small group of managers (e.g as with most stock options plans). 4. ESOP’s have an available transition mechanism so that as the old workers retire and new workers come in, the ownership shifts from the older to the younger generation. So many ad hoc employee ownership arrangements benefit just the original group and have no built-in transition mechanism. As workers retire or otherwise leave, company contributions to the ESOP trust are passed through to buy back the retirees shares at their appraised value over a period of years and the shares repurchased by the trust are reallocated to the currently employed workers.

In the American ESOP, the share buybacks are timed to retirement or termination because the legislation was implemented as a part of pension law. However in new ESOP legislation in other countries, one could imagine an improved arrangement so that risk did not accumulate for the older workers. For instance, one could have all shares repurchased and reallocated after they have been in a worker's account for, say, ten years. This ten-year ‘rollover plan’ would then take the pressure off retiring in order to cash in shares. Everyone, retired or not, would get a flow of share buyback payments ten years after the shares first went into their accounts. From the company's viewpoint, the repurchase liability would not be a random event triggered by retirements but would be known ten years in advance.

External and Internal ESOP’s

One major feature of the American ESOP that proves not to be necessary in different legal environments is the external trust as a vehicle for the ESOP. The ESOP can be moved into the company itself to form an ‘internal ESOP’. As is illustrated by professional partnerships or worker cooperatives (‘share coopera- tives’), an enterprise or organization can be employee owned without having an external trust or associa-

32 tion to ‘hold the ownership.’ The structure of the internal ESOP can be written into the articles of incorpo- ration and by- of the company itself or it could be based on existing cooperative legislation.

The equity of the firm with an internal ESOP could be partitioned into the usual external equity and the workers’ portion of the equity structured as the internal ESOP, or in more generic terms, an internal worker trust.

With an internal ESOP, the authorized and issued common voting shares would be divided into the exter- nally owned shares (ie, shares owned outside the ‘ESOP’ by individuals or organizations) and the internal shares held in t he worker t rust . T he basic division of vot ing right s and dividend right s bet ween the ESOP and the other owners would follow that division of shares.

The ESOP agreements and trust documents would be replaced by sections in the articles of incorporation (the ‘constitution’ of the firm) and the corporate by-laws that would spell out the structure and governance of the internal ESOP. It is important that the external shareholders not have right to overturn the ESOP arrangements. Thus this internal ESOP can be implemented in any country that has joint stock company law. If t here were no ext ernal shares, t hen t he int ernal ESOP might be much like a worker cooperative or a worker-owned joint-stock cooperative. If the ESOP was to have tax benefits, then the tax legislation would have to recognize some standard form of the external or internal ESOP arrangement for special treatment.

Using ESOP’s in Debt-Equity Restructuring

An ESOP-like mechanism can be used for debt-equity swaps (D/E SWAP) between banks and companies. Let us assume that the original plan for the D/E swap envisaged a separate Special Purpose Vehicle (SPV) to hold the shares of the company issued in exchange for the non-performing debt of the company to the bank. The bank assigns the loan to the SPV which swaps it for company shares, and the bank controls the shares through the SPV.

There are two problems with this scenario which might be alleviated or resolved by restructuring the SPV as an ESOP. Firstly, the bank has no automatic ‘market’ for the shares. The debt-equity swap would probably only be contemplated in the first place, when there was no outside strategic buyer for the shares—so one cannot just ‘assume’ an outside buyer. Secondly, it is unwise to assume that banks that make bad loans are going t o be any bet t er at indust rial rest ruct uring. And even if t he bank knew what to do, there is likely to be a very imperfect principal-agent relationship between the bank and company. As it stands, the management and workers are supposed to do all that is required to restructure and rebuild the company, only to have the bank sell the large and perhaps controlling block of shares to some as-yet- undet ermined part y.

As a pilot project, some of the SPVs could be restructured on an ad hoc basis (pending new legislation) as ESOP’s to address both of these problems. The SPV/ESOP is inserted into the loan relationship as if the original loan had been channeled through the ESOP, and new shares would be issued to the SPV/ESOP. The company and bank agree to a future repayment schedule through the ESOP where, if possible, the future loan payments through the ESOP should be treated tax-wise as a deductible expense.

The agreement restructuring the SPV/ESOP would stipulate that the bank would control the shares in the suspense account so, in the short-run, the control arrangements would be like a debt-equity swap. As the rescheduled future debt payments are made through the SPV/ESOP, the proportionate amount of the shares would be assigned to the individual share accounts of the then current-employees (e.g in proportion to their part of current payroll). The employees would exercise the voting rights and enjoy the dividend

33 rights of the shares in their accounts but could not sell the shares until they terminated with the company (as in the US ESOP arrangements). In the absence of a liquid outside market, the company or the ESOP itself would be legally obligated to buy back the shares of departing or retiring employees.

If the debt has simply been rescheduled without the ESOP and without an equity swap, then the managers and workers would be making all the sacrifices and efforts involved in restructuring largely for the benefit of the existing old ownership. If a debt-equity swap was made but was not converted to an ESOP, then the efforts would be for the benefit of the bank. With the conversion to an ESOP, the managers and workers are self-motivated to restructure the company and pay off the ESOP loan in order to get the shares them- selves. While the bank still controls the shares until they are paid for in the ESOP arrangement, the bank ‘finds a market’ for the shares.

Restructuring with Spin-Offs

From ‘Bigger is Better’ to ‘Small is Beautiful’ Why do small and medium-sized enterprises (SMEs) tend to work well and overcome some of the en- demic problems of large firms? When there are many people in a firm, each person might feel they could only have a 1/N effect—which would be such a small effect that they are not strongly motivated. The firm is just t oo huge t o feel t hat you can make a difference. In a small or medium-sized firm (say, up t o 500 workers), an individual might be able to see the difference that he or she, or the team they work in, might make. That alone should call forth more individual effort. Moreover, people can more easily see what others are doing so that non-cooperative behavior will face more social approbation.

From the viewpoint of decision-making, small firms have less bureaucratic hierarchy and are thus more agile in responding to changing conditions. In America, they are called ‘gazelles’ because they can change direction so quickly. Information has a shorter distance to travel from top to bottom and from bottom to top. And management will tend to be newer and more entrepreneurial in a small and medium-sized firm. They will be building for the future—rather than, as in some of the larger firms, just trying to hold to- gether the remnants of the past.

Spin-offs can add new customers and new suppliers. A spun-off parts supplier can find new customers; they are no longer a captive part of a vertically integrated firm. The trucking part of business, once spun off, can find new business. And so fort h. Wit h t he prospect of new cust omers, t here needs to be innova- tion and learning to get and to hold the new clients. These are the sorts of market-driven processes of learning and transformation that are fostered by spin-off restructuring.

How to Do Spin-Offs? One place to start spin-offs is to undo some vertical or horizontal integration. Every factory does not need its own exclusive parts-producing shop, its own trucking fleet and vehicle repair shops, its own food ser- vice, its own printing and reproduction shops, and so forth. If there are different factories producing a product for different regions of the country, there is probably no good reason why they have to be in the same firm. There could even be some competition in adjacent territories. Some factories have found that they have to start producing several new products, but those products could just as well be produced in new spin-offs.

Who does t he spin-offs? It is best t o st art wit h middle managers and t heir st aff and production personnel. It is important to preserve the organizational capital of well-functioning teams. Once dispersed, it is hard to put a good team together again. There might be other partners local or more distant partners either in the beginning or later. Since it is the middle manager that might become the top manager in a spin-off, the

34 manager would t end t o be younger and more disposed t o build new value (rat her t han just grab what one can in the face of a rapidly approaching retirement - as sometimes happens in the case of some older man- agers).

Following out this scenario, the middle managers and as many as possible of the workers in the spin-off would form a new company. The new company would buy at a negotiated price in a lease-purchase ar- rangement the necessary assets from the mother firm (e.g building, machinery, vehicles, and inventory). The mother firm might well owe the workers some past wages and benefits, so those arrears might be written off as partial payment for the assets and would be part of the new shareholders' equity in the spin- off.

Why is it important to have broad ownership of the staff in the spin-off? Doesn't concentrated ownership on the part of the manager create sharper incentives? One of the under-appreciated problems has been the ‘no exit’ problem for concentrated owners. SMEs with concentrated or family ownership often have an exit problem. T he firms are usually unsuit able for float at ion on a st ock market and in any case, the occa- sion of the retirement of a tried and tested owner-manger is hardly the time to attempt a floatation. Often the only buyer for a firm might be the competition that wants to shut it down.

This problem of ownership transition in America has been addressed by over 11,000 employee stock own- ership plans or ESOP’s wherein a closely-held company itself buys back the retiring owner's shares over a period of years and redistributes the shares to the current employees. Without some such mechanism of exit in the post-socialist environment, controlling owner-managers will be tempted to slowly liquidate or ‘tunnel’ the firm to get their retirement nestegg, all to the detriment of the workers, suppliers, customers, and local community. Thus it is a good idea to have a broad enough internal ownership in an insider- owned firm to prevent that sort of ‘tunneling’. With broader ownership, the retirements come in smaller chunks so the firm could use something like the ESOP mechanism to slowly buy out the retiring owners and redistribute the shares.

T he mot her firm might be a minorit y shareholder in t he spin-off, but it would defeat much of the purpose to make it a controlling shareholder. The remainder of the lease-purchase payments would be made by the spun-off firm over a period of years. Ordinarily the payments might be made to the mother firm, but if the mother firm had bad debts to a local bank or another creditor, then the lease payments might be assigned to the creditor. In that manner, the spin-off would have been part of a restructure of both the assets and the liabilities of the mother firm.

Financial Structure of Spin-Off Transaction In a typical example, the management and staff destined to work in a proposed spin-off will incorporate a new company using some amount of cash (possibly with a small loan). Then the mother firm drops down the necessary assets into the new firm in return for some combination of common or preferred stock or debt notes issued by the new company (or by assuming some debts of the mother company). If only a minority of the outstanding common voting stock went back to the mother, then the spin-off would be heavily leveraged but the insiders would have majority control (and thus a rather clear incentive and ca- pacity to go their own way).

In designing a spin-off transaction, consideration must also be given to the creditors of the mother firm. Ordinarily some consent of the creditors might be necessary before major assets were spun off . It might also be possible to drop down liabilities (as well as assets) into the spun-off firm. Such a reassignment of debts would typically require the consent of the affected creditors. If the mother enterprise was distressed (as would often be the case), the creditors might prefer their chances of being paid directly by the spun-off firm.

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The following is an example of a spin-off using an asset drop-down transaction.

The staff of the to-be-spun-off business unit invests 1,500 in a new company (perhaps through an ESOP trust). Assets worth 6,000 are dropped down to the spin-off firm in return for 4,000 worth of preferred stock and dropping 2,000 worth of debts.

A variation on this would be where the mother firm owed the spun-off workers 1,500 in back wages. Then 1,500 in cash or other assets would be dropped down to the new firm to pay that debt and to provide the beginning equity for those workers.

Role of the Government This sort of spin-off restructuring is possible with no new physical or financial resources. But it does re- quire new init iat ives and new mind-set s. It requires t he middle managers and t he workers in t he unit t o see that their prospects are brighter and their fate more in their own hands if they do the spin-off into a quasi-separate firm than if they remain part of the ‘empire’ of the large mother firm. And it requires a change in the top managers of the mother firm to let the ‘empire’ transform itself into a looser complex of contractually-related small and medium-sized firms. Above all, it means moving away from the strategy that bigger is better either in terms of market power or lobbying power with the ministries for subsidies and favors.

If ambitious middle managers have to wait for the top managers to voluntarily agree to a part of their em- pire to become partly independent, then they might have to wait a very long time. Here is where govern- ment support might be crucial. There has to be a pincer action on the top management of the large dino- saurs to promote the spin-offs: middle managers pushing from below and government pushing from above. have many levers of action such as tax, utility, and wage arrears as well as precondi- tions for any future assistance. In the reorganization type of bankruptcy, spin-offs of the viable parts of a firm should be a standard option.

Thus there could be a public program, perhaps sponsored by a ministry for promoting small and medium- sized firms, where spin-offs would be fostered in any large firm (say over 1000 workers) which had tax, utility, or wage arrears or ‘required’ some form of government assistance, ie, in most if not all large firms. If the middle managers and the workers in a unit could satisfy certain objective requirements, then the top management in the mother firm would be obliged to negotiate in good faith to arrange the spin-off (or have default terms imposed by law).

36

Economic Performance of Employee- owned Enterprises - Theory and Some Evidence from the Baltic Countries

Niels Mygind

Introduction

Employee ownership constitutes an important element in the ownership structure of enterprises in many transition economies (Uvalic and Vaughan Whitehead, 1997). This is also the case for the three Baltic Countries (Mygind, 1997 and 2000). It is a widespread assumption among Western economists that this type of ownership will have an economic efficiency inferior to that of other types of private enterprises (Lipton & Sachs 1990, Hinds 1990, Boycko et.al, 1993). Thus, when privatization results in employee- owned enterprises it is assumed only to be a ‘halfway’ privatization, which still maintains important ele- ments of the old inefficient system. Such conclusions are rooted in theoretical models based on quite nar- row assumpt ions. T he empirical foundat ion is even weaker. Most of t he analyses made of t he economic performance for different ownership types in Eastern Europe are based on a limited number of enterprises and a very short and very unstable period. The level of analysis is simple. As an example the conclusions in the European Bank of Reconstruction and development (EBRD) report (1995) were mainly based on the average percent of change for different owner groups of enterprises. In this respect, our data-material from the Baltics is relatively large and detailed, and we are able to perform a multi-variable analysis that should bring more reliable results. However, at this point in our analysis, it is still necessary to point out that the results are preliminary.

The focus will be a discussion of the theoretical predictions for the performance of different forms of ownership in the special transitional context. First, it is necessary to point out the special assumptions not only concerning the specific types of ownership, but also the institutional framework characterizing transi- tion economies and the specific situation of the production system etc. From these basic assumptions the problems concerning corporate governance of specific types of ownership can be found and after this analysis more specific predictions about the behavior can be given. These predictions or open questions are then confronted with the preliminary results of the empirical analysis (Jones & Mygind, 1996-99)

Basic assumptions

To structure the analysis, the framework introduced in Mygind (1994) for a transitional economy will be used. The model with four sub-systems was developed for an analysis at the level of society. However, the model may also provide an overview of the situation at the enterprise-level as illustrated in figure 1.

The stakeholders are individuals, groups or legal entities with specific resources and with specific interests and rights in relation to the enterprise. In this analysis the following outside stakeholders shall be in- cluded: the state, suppliers of debt (banks), suppliers of risk capital (venture capital or portfolio investors), suppliers of goods, customers. The last two groups could be foreign strategic investors. The inside stake- holders can be divided in managers and other employees. The stakeholders make up the social system of the enterprise. The power of different groups is determined by their rights and their resources (Mygind, 1999). Their behavior depends both on their formal role in the enterprise and on their interests or objec- tives based on the value system - the culture of different participants. These interests are different for vari-

37 ous stakeholders and make the economic behavior dependent on who has the ownership control of the enterprise.

If the individualistic culture is dominant, the main objectives of the employees are assumed to be em- ployment and wage. The wealth, the profitability of the enterprise, will have some influence if they are owners. However, in the special conditions of transition the capital markets are far from perfect and the employees might be imposed to a liquidity constraint so that they have to give higher priority to a mini- mum level of wages compared to an increase in profits for the enterprise. It can be assumed that for the managers this constraint is not so tough, and when the banking system starts functioning they will often be in a better position to get loans than the rest of the employees. For outside owners it is assumed that profit (wealth) maximization for the enterprises is the only objective.

The institutional system in figure 1 shows the formal structure of the enterprise. In this article we will focus on the ownership structure - the distribution of residual rights .

Table 1 illustrates the different ownership types to be analyzed. The formal distribution, especially of the ownership right to control, can vary from the real distribution of controlling power. This is assumed to be the case in the state-owned enterprise in the . The economy is liberalized giving scope for t he management (M) in t he st at e-owned ent erprise t o make decisions about pricing, buying and selling goods etc. At the same time the enterprise is still state-owned. The actual possibilities of the managers might be so large that they can recover part of the surplus, marked by (0) for the right to surplus in table 1.

In the employee-owned enterprise the employees (E) are assumed to have de facto control with manage- ment. Still, the manager retains a share of the ownership rights as an ordinary employee. In the manage- ment controlled employee-owned enterprise the managers have the real control and the control of other employees is limited accordingly (Earle & Estrin, 1995 also use this distinction). The manager also has a share of the right to surplus and wealth, but assuming an equal distribution in a large enterprise his part will be only a fraction of the total.

In the pure form of management ownership the manager simply has all three ownership rights.

In the outside-owned enterprise with diversified ownership, the manager can exert a high degree of real control. This is especially the case during the transition with capital markets, and financial information systems in a very preliminary stage. The threat of takeover and external monitoring through the capital-markets will be quite limited, and the power of the manager versus the outside owners will be even stronger than in a similar ownership type in the developed markets in the West. This picture changes when outside ownership is concentrated with a core-owner. This is typically the case for foreign owner- ship.

Closely connected to the real distribution of control is the question about the flow of information to the different groups involved in the enterprise. This is also illustrated in table 1. We assume asymmetric in- formation - managers have some essential information about the activities of the enterprise, which is costly or impossible for the outsiders to get. In case of outside core ownership it is assumed that the out- side owners use many resources to get information and to monitor management. Therefore, the core-owner has quite good access to information from the management. Other employees also have access to most of this information, and this is particularly considered to be the case in the situation of pure employee owner- ship with more transparent decision-making. Provided that pure employee ownership is the case, the em- ployees can hire new management if they do not feel they are well informed.

38

The production system in the typical transitional enterprise is under strong pressure to be restructured. In the command economy, the system was adjusted to fulfil the directives of the plan. After , the price structure and the motivation structure changes dramatically. The enterprise has to change both prod- ucts and production methods to follow the demand and cost signals of the market. To undertake such a restructuring, both management skills and large investments are necessary. It takes time and the result for virtually all enterprises as well as for the whole economy is first a period of ‘reactive restructuring’ with a steep fall in production before new products and new markets are developed and production starts to grow again. This development means a J-shaped curve for several of the variables measuring economic per- formance: sales, employment, profit etc. Resources for investments are crucial for the development in the second stage with ‘strategic restructuring’.

Figure 1 also highlights some relations to the surrounding world. Some of these relations in the transi- tional context are shown in figure 2. The governance structure (Mygind, 1999) is determined by the own- ership structure at the enterprise level and the interaction with external institutions. These institutions are in a transitional stage.

The state is changing its role and it takes time to build up the necessary legislation for private contracts, propert y right s, bankrupt cy et c. It t akes even more t ime t o build up a legal framework to control and facili- tate the functioning of the system. For example, in most countries there is still not a functioning registra- tion of ownership rights for land and buildings. This was delayed by the complex process where the own- ership structure from before the socialist takeover is sought to be restituted. Before such a registration system is operational, it is difficult to develop a property market. It is also difficult to develop much of the banking system, because collateral in property is often necessary to give loans to enterprises.

The pressure from the capital markets is very weak. In a developed economy this takes the form of threats of hostile takeovers and the capital markets provides a benchmark for assessment of enterprise perform- ance. This applies pressure on management to make more efficient use of the resources of the enterprise.

In the transition economy, the banking system is not playing its potential role as external monitor of man- agement. In the initial stage of transition it is because many enterprises have accumulated substantial debts, most of which the banks cannot expect to be paid back. In a normal banking system, bank pressure and the threat of bankruptcy would discipline the enterprises. However, in many cases the banks them- selves are reluctant to take such measures, because it would reveal that the banks - had actually accumu- lated excessive bad debts. Even when this problem has been solved the common picture is that bank loans are scarce and expensive and only used to a very limited extent by enterprises in the early stages of transi- tion.

The competitive pressure from other enterprises increases with the progress of liberalization. This pressure often develops into a squeeze for many enterprises because of the steep fall in demand in the initial stages of transition.

In many economies, especially of the North European type, the conditions of employees are effectively supported by unions and state regulation. This is only to a limited degree the case in most transition economies. In most other countries, unions have lost much of their legitimacy because of their close links to the former command system.

A well functioning market for managers might discipline these managers to fulfil the interests of the own- ers. Successful performance of the enterprise could be a strong argument for the manager for increased salary in the current or another enterprise. However, the ‘noisy’ environment for all enterprises in the economies of transition makes it difficult to evaluate the relation between enterprise performance and

39 quality of management, and the market for management skills are at a very preliminary stage in Eastern Europe, ( Jones & Kato, 1994).

Governance problems and other basic problems

Given these basic assumptions, each ownership structure will have some basic problems - some of them connected to the corporate governance of the enterprise. These problems can be divided into agency prob- lems; problems when stakeholders have dominating ownership at the expense of a minority owner; prob- lems connected to diversification of risk; problems of adjustment of the production process to the prefer- ences of the participants; problems of adjustment of the ownership structure through a market for control; and dist ribut ional problems, (figure 1).

The agency problems arise because of limited and asymmetrical information coupled with opportunism. In the current analysis it concerns three levels: between the owners and the manager, between banks and the owners of the enterprise and between managers and employees.

The first governance problem covers the situation when the manager as the agent has appropriated much of the right to control, while the principal, the owner, has the right to surplus and wealth. There is a divi- sion between the person who makes the decisions and the individuals who assume the risk. The manager has an interest in decisions bringing benefits to himself (income, status etc.), and these decisions are not necessarily optimal seen from the point of view of the owners.

This is a serious problem for state-owned enterprises. It was partly present in the command system, but it is even more serious in the transitional society with more autonomy for the managers. It is unclear who takes the responsibility for the states actions. Formally, the role as owner is assigned to some level in the bureaucracy, but the bureaucrats themselves do not risk their capital although they might risk losing pro- motion opportunities if they do not fulfil their role. However, in the very unpredictable period of transition it is extremely difficult to define what is an acceptable performance for an enterprise. This makes the role of the state bureaucracy very complicated.

The state enterprise will often face some hardening of the budget const raint because the state budget is under pressure in the stabilization period. Enterprise deficits must be covered by the employees in the form of reduced income. In this way the right to surplus or, more precisely, the risk of losing income is transferred to the group of employees. In this situation the state-owned enterprise might have some simi- larities with the employee-owned enterprise.

The management controlled outside-owned enterprise has many similarities with the state-owned enter- prise because lack of efficient institutions gives the diversified outside owner low influence and quite limited reliable information about the enterprise. For a small shareholder it is not profitable to use many resources for monitoring while the other shareholders are ‘free riders’. The manager lacks a counterpart - a real owner. In developed market economies, competition between different groups of man- agers inside a large enterprise and a well-functioning market for managers might limit this problem.

A strong external owner or an active group of employee-owners could dismiss the manager, if they recog- nize opportunistic behavior. In case of an external core-owner the decision-making process among the owners is not a problem, but the distance might imply lack of information. However, when the core owner has a large share in the company, it is profitable to pay the cost for quite intensive monitoring. In case of employee ownership, it might take both time and effort to reach a majority decision to fire the manager, but the employees would probably have easy and low cost access to information about the performance and potential of the enterprise. In the management-owned enterprise this governance problem disappears.

40

The relation between the bank as the principal giving a loan to the agent, the owner, is important for pro- viding finance for restructuring. From the point of view of the bank it is important to have a secure collat- eral, reliable information and predictable behavior of the enterprise. As noted in the basic assumptions, the employee-owned enterprise can be expected to give a higher priority to employment and wage than to profit. Combined with the transitional problems of lack of collateral and low quality of accounting infor- mation this increases the agency problems in relation to the bank and is a serious problem for the em- ployee-owned enterprise (Nuti, 1995). Therefore, an external supplier of debt (or equity without control, see later) risks that the goal is not to maintain and pay return to capital but return to labor (Earle & Estrin, 1995).

In case of management-controlled employee ownership the relation to banks might be softened somewhat. Still the existence of the governance problem might imply that the banks have a well grounded fear that the manager will prefer a higher risk profile for the enterprise than desirable for the suppliers of capital. This argument also covers the case of dispersed outside ownership.

In case of management ownership where the manager himself runs the risk of losing capital the banks can feel more secure. This is also the case when a core outside owner has a strong capital commitment in the firm. The relation to the state-owned enterprise is also not so problematic from the point of view of the bank if t he st at e guarant ees t he loans. However, if hard budget const raint s are imposed on st at e-owned enterprises the situation is similar to the other management controlled cases.

The third principal agent problem concerns the relation between the manager/owner and the employees. This is the classical conflict between capital and labor. The workers get a fixed wage and the capital gets the residual surplus of the activities. Given the level of employment and intensity of work, higher wages means lower profits. The employees as the agents have an interest in supplying less effort than the princi- pal has contracted for. Assuming limited and asymmetrical information the solution to this problem is that the employees get the right to the residual. The problem disappears with full employee ownership.

The problem between dominating stakeholders and minority shareholders has been stressed by Nuti (1995). Assume that a group of stakeholders has the control of the company. They can have an incentive to fulfil their interest as stakeholders on the expense of their interest as shareholders and on the expense of the minority group of shareholders. If, as an example, a large group of employees controls the company, they might benefit the most using the residual as payment for their own stakes - higher wage and/or em- ployment. These extra costs are taken from profits and thus from the income of all shareholders. If they own less than a ‘balanced share’, they will earn more as stakeholders than they loose as shareholders by such a transaction. Nuti's solution is that each employee with shares must hold a share at least as high as his share in the total wage bill.

When the manager owns the majority of shares and there is a considerable minority shareholding, he has an interest in transferring values to his own or another enterprise owned completely by himself. In some types of wild , managers have ‘tunneled values’ of the state owned enter- prise to another company owned by themselves.

For the core outside-owned enterprise there might also be special stakeholder interests for the majority shareholder. For instance, the majority owner may be a company supplying essential inputs to the enter- prise in question. By transfer-pricing, the surplus of the enterprise can be acquired by the majority owner at the expense of the minority group.

41

When managers and other employees own their company they have concentrated a considerable risk. If the company fails they will not only lose their shares, but also their jobs. As expressed by Meade (1972):

While property owners can spread their risks by putting small bits of their property into a large number of concerns, a worker cannot put small bits of his effort into a large number of different jobs. This presumably is a main reason why we find risk-bearing capital hiring labour rather than risk-bearing labour hiring capital.

Such a concentration of risk implies a high risk-premium and point in the direction of lower investment for insider ownership. In the three other cases, the owners can diversify their risk over many different en- terprises. This means a lower risk premium and thus, ceteris paribus, higher investment.

However, in the insider-owned enterprise there is a factor pointing in the other direction. The manager reaches a higher degree of satisfaction if he himself makes the decisions concerning his workplace. He is willing to pay for this by greater effort, by accepting a higher degree of risk and/or accept a lower return on investments.

For the remaining types of ownership, the scope for manager activities is more narrow, but the managers usually have the possibility of finding another job if he is not satisfied. Therefore, this is not marked as an important problem in table 2.

A similar argument can be used for the employees. This is connected to, what I have called ‘internal effi- ciency’ (Mygind, 1992). The activities inside the enterprise should be adjusted to the preferences of the participants. Given the restrictions of the outside market, the employees should be able to adjust their working conditions and the related income to their own preferences. This might result in increased effort and/or acceptance of lower remuneration. However, there is a problem of defining the preferences for a group of employees, especially if the group is very heterogenous (Hansmann, 1988). The solution pre- ferred by the majority might be different from the one preferred by minority groups. This might cause conflicts and it means that internal efficiency is impossible to achieve for all participants.

During the early stage of transition with high inflation and many changes in relative incomes some people get rich quickly, while the majority have steeply falling real incomes. Different forms of privatization favors different groups and the resulting distribution of ownership could be far from the market equilib- rium in later stages. It is necessary with a market for ownership to secure a dynamic adjustment of the ownership structure. Continued state ownership does not support such a development; the first round of adjustments could be privatization. The three insider-owned structures have also some disadvantages con- cerning dynamic adjustment of the ownership structure. In case of management ownership, no adjustment will take place as long as, the owner does not want any changes, and the enterprise is not declared bank- rupt. This could mean many years with sub-optimal economic performance, but still satisfactory seen from the point of view of the manager. Limitations in the possibility of trading employee-shares might create barriers for developing a market for control. If the insiders have a large majority, outsiders might be dis- couraged from buying shares because of the risk connected to the minority-problem. A majority takeover is a more likely scenario. But are the employees interested in selling their shares unless the company is in financial trouble? Without a functioning market for shares owned by employees it might be difficult for an outsider to buy enough shares from the insiders.

Trading shares is no problem in the diversified outside-owned cases, but a majority core-owner can post- pone an adjustment of the ownership structure. Also in this case the minority owner might stay away be- cause of fear of the stakeholder owner/minority owner problem. If the core owner owns shares in a higher

42 proportion than his stakes there is no problem and the minority shareholders may get a free ride on the monitoring effort conducted by the core owner.

Employee ownership in transitional economies is nearly always ‘individual’ ownership (Mygind, 1986). The individual employee can sell his share when leaving the enterprise, and he will have a capital gain, if the enterprise has been successful. However, in most of the literature about employee ownership it is as- sumed t hat t here is ‘collect ive’ t ype ownership. T he cont rol right s and right t o surplus is connected to each employee, but they cannot withdraw their capital when they leave the company. Assuming that the em- ployees pursue the objective of maximizing their average income (wage) the theoretical predictions about the collectively employee owned enterprise show an inefficient adjustment of supply in the short run and an inefficient adjustment of investment in the long run (Ward, 1958, Domar, 1966 and Vanek, 1970). In case of individual ownership the objective of maximizing the average income can be transformed to an objective of maximizing profits and the difference in behavior between the employee owned enterprise and the outside owned ‘twin’ disappears (Sertel, 1982 and Mygind, 1986). This conclusion assumes a perfect capital market and risk neutral employees. Because of lack of a well functioning capital market and/or because of restrictions in the tradability of employee shares, lack of transparency, problems with registration of ownership etc., it might be difficult for an employee to sell his share and get a capital gain. In this respect there are elements of in transitional economies although formally the ownership is individual.

We assume that the ownership is distributed so that an employee receives the same amount whether the surplus is paid as an addition to the wage or an increase in profits. This is based on the assumption that the accumulated profit can be used as collateral for a loan to the employee in a perfect capital market. How- ever, capit al market s remain highly imperfect during t ransit ion. T herefore, t he employee will not be indif- ferent and the liquidity squeeze in the depressed transitional economy results in a preference for cash for most of the employees. Furthermore, the employees are risk-averse, and this will limit their accumulation of wealth in their enterprise. In short, there are conditions pointing in the direction of elements of some ‘Illyrian’ behavior even for the individual-owned enterprise.

The distributional consequences of different ownership structures are summarized in table 2. Continued state ownership supports an objective of equality because the state can determine the wages for different groups in state owned enterprises. Similarly, with state ownership, the distribution of wealth is quite equal. Employee-ownership provides a broader group of shareowners in the population compared to ownership by managers or concentrated outsiders. Voucher privatization can result in dispersed outside ownership belonging to a broad group of the population. This form is more equal than employee ownership. If the ‘people’s shares’ are concentrated in investment funds this type of concentrated outside ownership would mean a more equal distribution compared to employee ownership.

T he different ownership st ruct ures have been t reat ed as pure forms, but oft en more t han one group will be owners. In most cases, one of these groups will be dominating so they control the enterprise. Nevertheless, other groups can have a considerable part of the ownership rights to surplus and wealth. Management minority shares are often used for aligning the incentives of managers to the preferences of the majority owners. This is the case for stock options and similar incentive systems for managers in the West. In this way the principal-agent problem between managers and owners can be partly solved. In the same way the manager-employee problem can be limited by minority shareholdings to broad groups of employees. Such non-controlling interest by employees in their own enterprises can motivate the employees and result in improved productivity, better labor relations, more flexible workforce etc. (Nuti, 1995). This is why the diffusion of employee ownership and other types of financial participation e.g profit sharing is encouraged in the European Union (Uvalic, 1991).

43

Ownership and economic performance

Now the analysis may proceed from the basic problems of each ownership form to more precise predic- tions about the economic behavior. The main elements in this analysis are illustrated in figure 3. Back- ground elements are shown on the left and the elements to measure in the empirical analysis are shown on the right.

The privatization methods together with the initial conditions for each enterprise determines the initial ownership type after privatization. In the following period an adjustment of the ownership structure is expected. This is closely connected to changes in the capital structure, access to loans, external capital emissions etc.

The ownership structure has implications for the motivation of employees and the ability to restructure. Access to finance can be included under the ability to restructure although it is illustrated separately in figure 3. The motivation of the employees is important for how the human resources can be used by dif- ferent ownership types. In figure 3 this is illustrated by the arrow from the motivation box to the economic performance measure for productivity. The restructuring ability determines how successful production can be changed and marketed so sales recover. Restructuring also includes the ability to minimize costs and adjust employment. This can be seen on the effects of productivity. Access to finance is an important ele- ment determining the potential for investment in the enterprise.

The arrow from the starting conditions to the box of economic performance must also be noted. Good economic performance can both be explained by favorable starting conditions and by the economic behav- ior connected to the specific ownership type. In the empirical analysis it will be essential to try to separate these elements. This is difficult because the indicators for the value of the enterprise in the early stages of transition were of low quality because the had not started to operate appropriately. The esti- mated value of the enterprise played a big role in the privatization process. A nominal historically based price with some indexation was often used to determine what the new owners should pay. This price often had no relation to the real earning potential of the assets. Instead, the productivity and profitability after the liberalization of prices would be appropriate measures for whether the enterprise was initially a ‘golden or rotten egg’.

The possibilities for different groups to Chose in the first round of the privatization process could also be used as indicators for a possible selection bias. This is the basic determinant used in table 3. Selection by insiders gives insider ownership an initial advantage indicated by ‘+’. Managers with superior knowledge will try to select the best enterprises if possible. Leftovers will later be sold e.g to outsiders, indicated by ‘- ’. However, an external core owner will only be interested if the investment is expected to be profitable - indicated by ‘0’ in the figure.

The starting conditions can be considered it to be negative for insiders if they are left out in the first stage of privatization and enterprises are sold for cash from the highest bidder as was the case in Hungary and East Germany. In these cases, outside core owners had the best position to select the ‘cream’ of the assets. If there were no external buyers, insiders could buy the ‘left-overs’ at a lower price often as an alternative to a close down. If managers had the opportunity they might take over the best of these and only include the employees if necessary for getting enough capital. Therefore, management ownership is indicated by ‘0’.

In both cases it is assumed that state-owned enterprises are leftovers from privatization indicating quite bad starting conditions for economic performance. However, there might be cases where some ‘golden

44 eggs’, natural monopolies and enterprises considered to be of strategic importance to the country are kept longer under state ownership.

The motivation of employees is closely related to the agency problem between manager and employee and the question concerning the adjustment of the production process to the preferences of the employees. In these respects employee-ownership has a strong advantage marked by ‘++’ in table 3. The management controlled employee-owned enterprise has a ‘+’, because the employees still get the surplus, but the pro- duction process is not adjusted to their preferences to the same extent as in the former case.

Some authors like Alchian and Demsetz (1972) argue that this type of ownership lacks an owner to moni- t or t he effort s of t he employees. In large ent erprises wit h N employees t he incent ives for each employee will be low because his return of an extra effort will only be 1/N. There will be a tendency to free-ride. However, the employees’ direct interest in the performance of the enterprise gives a strong incentive for mutual monitoring. Most empirical results point in the direction that employee-owned enterprise, e.g in Mondragon (Thomas and Logan, 1982), can cut down on the number of middle level monitors because of this mutual monitoring. Against the efficiency of employee ownership Hansmann (1988) has argued that for a heterogeneous group of employees it will be difficult and involve conflicts to reach decisions about the management of the enterprise. The internal efficiency might not be so high for some of the minority groups among the employees, but it cannot be expected to be lower than in the other types of ownership where decisions concerning working conditions etc. are taken by a manager who is not appointed. On the other hand, the efficiency of the decision-making process might be quite low and time-consuming, if at- tempts are made to try to include all workers. The literature on the empirical evidence from the West con- cerning motivation of employees and indicators of productivity in employee-owned firms shows reduc- tions in working days lost through strikes, reduced labor turnover, increased employee commitment to the firm etc. (Kruse & Weitzman, 1990, Bartlett et.al, 1992 and Bonin, Jones & Putterman, 1993).

The main questions concerning restructuring in enterprises with different types of ownership are 1) Do they have an efficient management system, which can find and implement the best solutions seen from the point of view of the owners. 2) Do the objectives of the owners support restructuring? 3) Does the enter- prise have access to the necessary capital? These questions are included in figure 3. In table 3 the answers for the different types of ownership are spread over different measures: Quality of management, produc- tivity, employment and wage, and finance.

The quality of management is difficult to predict on a theoretical level. One question concerns whether there is a mechanism to dismiss unqualified managers. This mechanism is expected to be weak in cases where managers are in control of the enterprise. Only for employee ownership and outside core ownership there is an effective counterpart for management. The quality of management also concerns the decision- making process inside t he ent erprise. If it is dominat ed by conflict s bet ween different groups of employees as suggest ed by Hansmann (1988), there will be a low quality of management, marked by ‘-’ in table 3. If, on the other hand, the decisionmaking process is organized to balance the interests of different groups and they support the strategy of the enterprise, there will be a high quality of management. If the employees feel that the goals of the enterprise are in accordance with their interests of long-term employment rela- tions etc. they will be more motivated to join restructuring efforts and utilize their accumulated experience and firm-specific knowledge. This type of relationship is most likely to develop, when the control of the employee-owned company is not dominated by the manager.

But do the employees have enough skills to select managers with solid qualifications and can they do the necessary monitoring? The educational level of the dominating groups of employees is important for the quality of management. The low tradability of employee-owned shares makes the external monitoring

45 over the capital market even smaller in the employee-owned enterprise than in other privately owned en- terprises.

Because of the governance problem, the quality of management in a state-owned enterprise is generally considered to be low. In case of management ownership, it depends critically on the specific manager taking over the enterprise, but there might be a tendency for a positive selection bias, since the managers who understand the new opportunities in the are also most likely to try to take over their own enterprise. This bias does not apply to the diversified outside-owned enterprise, which gets a more negative evaluation. Strong outside core-owners, on the other hand, can select well-qualified managers.

Good or bad management and the motivation and flexibility of the workforce will show up in the ability of the enterprise to restructure the combination of outputs and get a positive development in sales. In the early stage of transition, reactive restructuring with unbundling of unprofitable activities and thus a fall in sales is necessary for most enterprises. But after this stage of reactive restructuring the increase in sales and especially exports can be considered a measure of the success of deep restructuring.

In table 3 it is assumed that state-owned enterprises will show the worst performance concerning sales. Foreign-owned companies, using cheap labor for export or for developing the local market, are expected to show the best performance. Employee-owned enterprises are not considered to have negative supply behavior. We only expect to find ‘Illyrian’ behavior to a limited degree because, as explained earlier, this ownership type has more individual than collective characteristics.

An important part of reactive restructuring is to cut away labor hoarded as hidden unemployment in many enterprises in the former command system. This includes taking away those parts of production which are not profitable. The risk of unemployment and loss of firm-specific human capital are included in the ob- jective function of the employees. They will internalize this into the costs of dismissing employees from the enterprise, and this will make the employee-owned enterprise less willing to cut production and dis- miss employees and restructuring will be delayed. In the state-owned enterprise there will be some politi- cal pressure and in the management-controlled employee-owned enterprise the managers will probably also be under some pressure from employees not to cut employment. Therefore ‘0’ is marked for these cases. In the other cases it is assumed that employment will be adjusted without much resistance from the employees because they are generally in a weak position. Most radical restructuring on the employment level will probably take place in the foreign-owned enterprises.

However, the adjustment of employment can also be viewed from another perspective in a situation of high unemployment. In areas with a single firm dominating the local economy considerable lay-offs would be disastrous. Although the reluctance of employees to dismiss their colleagues will postpone re- structuring, internalization of the costs of unemployment can be taken as a positive element for the whole society.

Productivity is a key measure of economic performance because it includes many of the earlier mentioned variables. The motivation and effort of employees and the quality of management are behind restructuring efforts and the development in sales and cost minimization. This determines the value added to the enter- prise in relation to inputs of labor and capital.

If t he employee-owned ent erprise ret ains higher employment t han t he ot her ownership forms it will have negative consequences for productivity. This type of ownership had, on the other hand, a high score on employee motivation. The result depends on the relative strength of opposing forces, indicated by ‘?’ in table 3.

46

The state-owned enterprise is expected to show quite negative results on productivity as a result of nega- tive developments in the elements behind value added and in employment. The remaining forms are ex- pected to do fine with some moderation for the diversified outside ownership where the results for the quality of management counts in a negative direction. The outside core-owned enterprise, especially for- eign ownership, is expected through high investment, new technology and new management methods to show a high level and growth in labor productivity. It is assumed that the return on investment is so high that capital productivity and total factor productivity also increases.

T he special considerat ion of cost of unemployment and loss of firm specific human capital does not neces- sarily mean a fall in profitability of the employee-owned enterprise. Reluctance in cutting down employ- ment might be balanced by higher wage-flexibility (Nuti, 1995 and Earle & Estrin, 1995). Such a trade-off is most likely when employees control both the company and get the residual. In case of management control they still get the residual, and some trade-off is still prevalent. In other cases a more traditional wage-earner attitude is expected.

A high level of factor productivity means that there is a large ‘cake’ to divide among the input factors. If the distribution between gross profit and wage is given, high factor productivity will result in high gross return on total assets, ROA. Gross profit is divided between equity capital and debt capital. The capital structure determines the net return on the equity capital, ROE.

Access t o capit al is import ant for deep rest ruct uring of t he ent erprise. First , t here is t he possibility of get- t ing capit al from int ernally generat ed resources, ie. from net profit . It depends on t he profitability and the owner's decision whether to pay dividends or not. In table 3, the signs follow the profitability except for foreign owned-enterprises. At some stage the external owner takes out profit from the enterprise (divi- dends) as payment for the initial and often large capital contribution. For the employee-owned enterprise internal savings depends to a high degree on the profit level and on the preferences of the employees. A high risk aversion, preference for paid-out income, and the element of collective ownership draw in the direction of low internal accumulation of profit. On the other hand, the employees have an interest in se- curing their jobs and this might make it necessary to inject additional money into the enterprise. In this way reducing the risk of lay-off and loss of firm-specific human capital may mean that the employees actually invest extra money into the enterprise (Earle & Estrin, 1995).

This argument can be taken a step further as an argument for mobilizing capital contributions from the personal savings of the employees. Such ‘internal emissions’ are most likely when the employees have cont rol and gives a bet t er guarant ee for at t empt s t o maint aining employment . Similarly for the other pri- vate ownership forms, owners may attempt to attract additional capital from employees both to increase capital, but also to improve the incentives for the employees.

As discussed earlier, getting loans from banks can be more difficult for employee-owned enterprises than for other private ownership types. The bank might add an extra risk premium because of a fear that the employees will follow objectives like increased wage and stable employment as opposed to wealth maxi- mization.

The possibility of attracting capital to the employee-owned enterprise in the form of capital emissions sold to external owners depends on whether this is a minority or majority shareholding for sale. A minority shareholder will be discouraged in a situation where employee stakeholder interest dominates the employ- ees interests as shareholders, implying a negative return to shares and extra high returns to labor. This problem, to a certain extent, also concerns the management-controlled case and management ownership. For outside-owned enterprises there should be no problem in getting extra capital in this way. An emission of shares where an external owner takes over the majority is possible in all cases (for a state-owned enter-

47 prise it means privatization).

As emphasized previously, investment is the crucial element for deep restructuring. The following ele- ments are important for the level of investment: ownership structure (specifically in relation to the degree of collective ownership), objectives and degree of risk aversion of the owners, quality of management, the profitability of the enterprise, and access to external capital.

We assume that employee ownership is of the individual type with some collective element connected to the limited tradability of employee shares. The more difficult it is for the employees to sell their shares and get a capital gain as compensation for accumulated capital and improvements in the performance of the enterprise the more pronounced is the ‘horizon’ problem (Furubotn & Pejovich, 1970 and Vanek, 1971). If the majority of employees expect to leave the enterprise before an investment has been fully depreciated they will only include the returns of the investment within this time horizon. Therefore, only investments with relatively high returns or with a short time horizon will be made in the collective-owned enterprise. This means underinvestment compared to the traditionally owned twin. For individual em- ployee ownership high risk aversion of the employees combined with the risk concentration means lower investment. This might to some degree be counterbalanced by the motive of cutting the risk of lay-offs through higher investments. In table 3 we predict that the combined effect of the specific ownership struc- ture and the objectives of the employees will show a tendency toward relatively low investment. However, the main factor for employee ownership will probably be the limited access to external capital.

For the management-controlled employee-owned enterprise, the risk aversion problem will disappear, but the financing problem will continue to be important. For the remaining private forms both objectives and access to capital point in the direction of high investments. This is especially the case for foreign-owned enterprises. State-owned enterprises are at the other end of the specter. Waiting for privatization, managers may postpone investments. This is particularly the case if the manager himself has plans to take over the enterprise and if such investments imply a higher privatization price. Access to capital is also expected to be limited unless the state considers the specific enterprise to be of strategic importance.

Table 3 does not include the cases where managers or the other employees own a minority share. As de- scribed in the earlier section for this type of ownership the basic agency problem will be reduced. The motivation of managers and other employees will increase. At the same time minority inside ownership is a source for internal supply of capital. Therefore, such financial participation is expected to improve the performance for nearly all the variables mentioned in table 3.

Empirical analysis

Introduction and overview This section presents a short summary of some preliminary results of the study of economic performance by enterprises with different ownership structures. The presentation does not go into detail with the actual distribution of ownership after privatization and the dynamic change of ownership in the following years. For a deeper analysis see Mygind, OECD, 2000. The presentation is based on earlier published results by Mygind and Jones. The relation between ownership and economic performance is described for each country in separate sections and the results are summarized and compared with the theoretical predictions in the conclusion.

Ownership and economic performance - Estonia A stratified random sample of 414 enterprises was surveyed for our project in January 1995 about the dis- tribution of ownership. This data set was supplemented with 227 state-owned enterprises and 25 foreign owned enterprises. This means a total of 666 enterprises in the data set, (table 4). Since then the ownership

48 survey has been repeat ed every January. For t hese ent erprises we report financial data for 1993-1997 from the Estonian Statistical Office (ESA), and for a subset.also specified information on wage-levels and in- vestment levels and sources for finance in 1994-1997. We also use the results from ESA’s 1997 financial survey covering all large enterprises and a representative sample of small enterprises, with information on foreign, but without information on insider ownership, (table 5).

An analysis of the institutional framework (Mygind, OECD, 2000) show that insiders had some advan- tages in the early privatization. This concerns many of the small enterprises and a few large enterprises in Estonia. Therefore, it can be expected that insiders took over some of the best performing small enter- prises in the first rounds of privatization. The later stages of privatization of mainly large enterprises did not include special advantages for insiders.

Both at the time of privatization and in later stages foreign-owned enterprises had a relatively high capital- intensity while the opposite was the case for insider-owned enterprises, (table 4 and Jones and Mygind, 1999a). Because insiders, especially concerning small enterprises, often had the first choice it could be expected that they had ‘skimmed the cream’. In the relatively few observations with information about profitability before privatization we do not have any significant results indicating that insiders took over the most profitable enterprises (Mygind, 1997). However, insiders might have acquired their enterprises at a relatively low price. This was often the case in the early small privatization. Foreign investors on the other hand have the advantage of access to capital and have been able to buy highly capital intensive en- terprises.

In a multivariate analysis based on the early data it was found that state-owned enterprises were signifi- cantly more reluctant to reduce the labor force. To some extent this was also the case for the majority of employee-owned enterprises, because the wage was used as a buffer instead of employment. For upwards adjustments of employment the early results show a tendency to increase employment relatively more in majority employee- and management owned enterprises (Mygind, 1997).

In the large data set for 1997, (table 5) based on simple averages sales per employee are by far the highest for the group of foreign-owned enterprises, and they also have the highest share of exports. Labor produc- tivity is also the highest for foreign-owned companies although the difference is not so significant, indicat- ing that foreign owned enterprises only process a relatively small part of the whole value chain in Estonia.

Results based on simple averages give a strong weight to large companies, and it does not count for a number of other relevant factors such as size, sector, location, fixed enterprise effects, etc. For Estonia we have made a more sophisticated analysis on total factor productivity including these factors (Jones and Mygind, 1999b). The analysis is based on panel-data for the period 1993-1997. Depending on the exact specification of the model the analysis show that private ownership has 13-15% higher factor productivity than state ownership. Majority ownership by foreigners are 19-21% higher, majority management owner- ship 15-31% higher, and majority ownership by a broad group of employees 13-24% higher that state ownership. This is noteworthy, both because of the high reliability and because standard theory does not predict so high efficiency by insider-owned enterprises.

The high labor productivity of foreign-owned enterprises can to a large extent be explained by the high capital intensity, but if the productivity of capital is relatively low it will turn out as low total factor pro- ductivity. The high labor productivity for foreign-owned enterprises might also partly be explained by high advantages in recruitment of labor. On average foreign companies pay much higher salaries than their domestic counterparts in the private sector. This was both the case in 1997 and earlier years. Data for Oc- tober 1994 on wage levels for different occupational groups shows that both foreign-owned and domestic

49 outside-owned enterprises had quite high wage levels. The levels for insider-owned enterprises were rela- tively low indicating that they hold back wages in times of trouble (Mygind, 1997).

Profitability measures for the early years show that insider ownership has quite high profitability, while foreign ownership, especially for return on assets, are quite low. However, this might be connected to high levels of asset s, which at t his point in t ime have not st art ed t o pay off. T he surprisingly high profitability measures in table 6 for state-owned enterprises might be explained by the dominance of some natural mo- nopolies doing quite well in 1997 – e.g telecommunication and energy. There are no significant differ- ences between domestic and foreign ownership in the private sector.

The indicators for investment levels in 1997 point out that foreign-owned companies take the lead in rela- tion to domestic private enterprises. The high level for public enterprises might again be explained by sector specific factors. Investment data for earlier years for the small sample shows in a multivariate analysis with total assets and number of employees as explanatory variables and with control for branch and location that foreign owned enterprises clearly have the highest investment level (Mygind, 1997).

On average 80% of the investments were financed by internal funds, but for foreign-owned enterprises this percentage was only 64%. Foreign owned companies had a relatively high financing by banks. Insider- owned enterprises on the other hand have much less debt and bank loans per employee than the average for the whole group (Mygind, 1997).

The data for 1997 show that private enterprises have a faster turnover of their assets and a higher debt/equity ratio than state enterprises. Within the private group domestic enterprises have a faster turn- over of assets than their foreign counterparts, again indicating that foreign enterprises still have not em- ployed their huge capital assets in the most efficient way. The higher debt/equity ratio in domestic firms compared with foreign ownership can be explained better by low equity than by a high level of debt. The same explanation is behind the observed high debt/equity for insider owned enterprises (Mygind, 1997).

Ownership and some indicators of economic performance - Latvia We have a total data set of 5585 enterprises including summary information on ownership group distrib- uted on state, municipality, insiders, foreign, and domestic outsiders for January 1995. This data set.also includes some data on employment and wage levels. Based on a survey on managers in 167 enterprises, we have evidence for the distribution on owners between managers and other employees, (table 6). Tables 7 and 8 give some indicators of the capital structure and performance of 1997 for a sample of nearly 4000 firms, but for quite broad ownership groups.

For the initial condition around privatization we found that insider-owned enterprises, and especially man- ager-owned enterprises have a quite low capital intensity, while foreign-owned enterprises on the other hand have a very high capital intensity. Insider-owned enterprises tend to be relatively small. We do not have any information about profitability before 1994.

Growth in sales for 1997 is highest for foreign enterprises, and private are higher than state.

A multivariate analysis based on the early data show that labor adjustment in Latvia is considerably lower than in Estonia and Lithuania. Only foreign ownership show some more dynamic adjustments. Foreign- owned enterprises have the highest growth in employment in 1997, and private is higher than state, (table 8).

Production function analyses based on cross sections from 1994 and 1995 do not show any significant differences in factor productivity between ownership groups (Jones and Mygind, 1999c). However, the

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1997 data show that labor productivity is much higher for foreign-owned enterprises than is the case for the remaining groups, (table 8).

For the 1997 data the wage level is like in Estonia the highest in foreign-owned enterprises, while other private enterprises are lower than state-owned enterprises, (table 8). We have not yet results on the wage level in insider-owned enterprises.

Table 8 show that private enterprises have higher profit margins than state-owned (but there are no big variations within the group). However, foreign enterprises are doing worse than their domestic counterpart on return on assets. This result is confirmed on multivariate analysis on earlier data. Like in Estonia, for- eign-owned companies cannot at this stage report profits following the relatively high level of assets. The highest returns on assets are found in enterprises with insider majority (Mygind, 1997).

Looking at the capital structure a multivariate analysis for the 1995 data shows that the debt ratio for in- sider-owned enterprises is significantly higher than for state owned enterprises. Table 7 shows that the private enterprises in general have a higher debt/equity ratio than state-owned enterprises and that foreign- owned have a slightly lower ratio than other private enterprises. However, foreign enterprises have the highest bank loans per employee and also slightly higher access to long term loans than the other compa- nies.

The 1997 data shows that net investment per employee is the highest in foreign-owned enterprises and private is higher than state, (table 7). Analysis on earlier data shows the same tendency, and also shows that insider-owned tend to be higher than outside domestic-owned enterprises (Mygind, 1997).

Ownership and some indicators of economic performance - Lithuania 357 large manufacturing enterprises included in the database at the statistical department were surveyed about the distribution of ownership in July 1994 and again in July 1995. In the second round 127 enter- prises from construction and trade were also included. For these enterprises we have got financial data for some variables dating back to 1992, but with the best coverage for 1994. For a large sample of 5-7000 enterprises we have data for 1996-97 but without specification of insider ownership.

The early data shows that management ownership had a higher incidence in small enterprises, but em- ployee ownership had a quite high frequency both in small and large enterprises, (tables 9 and 10). The data for the very early years do not indicate a bias in direction of low capital-intensity for insider-owned enterprises as in Estonia and Latvia. In Lithuania high capital intensity has not blocked takeovers by em- ployees, because vouchers combined with a preferential price favored the group of employees. There does not seem to be a selection bias according to profitability (Mygind, 1997). In Lithuania the legislation in the first part of the 1990s gradually improved the positions of employees. Employees had the possibility of buying the majority of shares in medium and large enterprises through the voucher privatization process 1991-1995. Since then insider advantages have been abolished. Outsiders had the best opportunities in relation to small privatization and in the very early transition and in the second half of the 1990s-, see Mygind, OECD, 2000.

The data from 1993-94 show that the highest growth of sales (lowest decrease) is found in foreign-owned ent erprises, but also management owned ent erprises are doing bet t er t han t he rest , while employee-owned enterprises follows the average, domestic outside owned enterprises are below the average (Mygind, 1997). These results fit well with the 1997 data, (table 13). Foreign-owned enterprises have again the highest growth in sales. Enterprises owned by domestic persons are also doing relatively well, while en- terprises owned by domestic enterprises, especially those with financial ownership, are underperforming.

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The early data on employment adjustment give some indicators of a somewhat hesitant adjustment process in employee-owned enterprises (Mygind, 1997). For 1997 data the growth in employment is negative for the median enterprise owned by state or domestic private owners. Employment is constant for the median domestic private owned, but growing 8% for the median foreign-owned company.

A cross section analysis on factor productivity levels for the early data show no clear tendencies of varia- tion between owner groups (Jones and Mygind, 1999c). Averages for the early data indicates that insider- owned enterprises have quite high labor productivity (Mygind, 1997). The results from the large sample show that foreign-owned enterprises have the highest labor-productivity for the year 1997, while enter- prises owned by domestic companies, especially financially owned, have low labor productivity, (table 13).

For the early data foreign-owned enterprises clearly have the highest wage-level, but also employee- owned enterprises have for 1994 a wage level above the average (Mygind, 1997). In the 1997 data foreign owned enterprises have an above average salary per employee, and enterprises owned by domestic persons are lower, (table 13).

In the early data employee-owned enterprises are doing well compared to other groups both in relation to profit margin and return on assets. Management-owned enterprises are around the average (Mygind, 1997). Foreign-owned enterprises have quite low return on asset. For the 1997 data the return on assets is relatively high for both foreign-owned enterprises and enterprises owned by domestic persons. For domes- tic persons, however, this is partly due to the quite low value of assets. The profit margin is somewhat lower than for foreign dominated enterprises.

The early data confirms the observations from Estonia and Latvia that insiders have relatively low bank loans (Mygind, 1997). The data for the capital structure in the large Lithuanian sample ultimo 1997, (table 12) shows that foreign-owned enterprises have the highest debt/equity ratio. Surprisingly enterprises dominated by domestic financial companies have relatively low debt equity, only state-owned enterprises have a lower ratio, while enterprises owned by domestic persons are higher than the average. Most of this debt is short run loans for all the domestic firms, while for most of the foreign companies long loans are higher than short loans. Bank loans are quite rare, the median for bank loans per employee is 0 for all owner groups. Domestic financial enterprises have the highest proportion of enterprises with bank loans. State-owned enterprises and firms owned by domestic persons are on the low side, while enterprises dominated by foreigners and by domestic non-financial enterprises are higher than the average.

The 1994 data on investments per employee shows that employee- and management-owned enterprises have relatively low investment levels, while foreign and domestic outside-owned enterprises are higher than the average (Mygind, 1997). The 1997 data shows that enterprises with high investment are mainly found in the groups owned by foreigners and by domestic persons. Most of the state-owned enterprises and enterprises owned by other enterprises have negative net investments, (table 13).

In general the 1997 data shows that enterprises dominated by financial ownership have low growth in sales, low productivity and negative net investment. This indicates that many of these enterprises were taken over by banks because of economic problems. Financial enterprises do not have a strong role as owners in Lithuania. On the other hand financial takeovers of firms in economic crisis indicate that credi- tors try to enforce financial discipline. In this way financial enterprises have an important role for corpo- rate governance by enforcing their rights as creditors.

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Overview over economic performance

To get an overview over the general tendencies it is necessary to understand the relation between the dif- ferent variables. Table 14 shows an overview over the preliminary results. It is difficult to make clear gen- eralizations in some fields because of differences between countries both in variables and sophistication of analysis. Looking at the economic results for different ownership structures quite strong general trends in all countries are apparent, and these trends are both covering data for small samples of the early periods of transition, 1993-1995 and large samples covering 1996 and 1997. Some of the results are based on deeper econometric analysis, e.g factor productivity for Estonian panel data, but many of the results are based on simple descriptive data and should be taken as preliminary.

Concerning the starting conditions we found that management dominated enterprises tended to be rela- tively small. This was not the case for broader employee ownership. For both types in Estonia and Latvia there was a tendency for low capital intensity. This was not the case in Lithuania probably because of fa- vorable conditions for employees to take over both large and capital intensive enterprises. Foreign-owned enterprises have a rather high intensity and this concerns both privatizations and start-ups. Although the institutional background should indicate that especially in Estonia and Latvia the initial profit potential should be higher in insider-owned enterprises our data cannot confirm such ‘cream skimming’ for any of the three countries. However, both the description of the early privatization and the data on capital- intensity indicate that insiders might have acquired their enterprises for a relatively low price. Foreign owned and management-owned enterprises are the result of both new start ups as well as privatizations, while broader employee ownership are in nearly all cases established through privatization.

The success of restructuring can be measured in the ability of the enterprises to turn around the initial fall in sales to new growth. At the current stage of our analysis we have only results about insider ownership from Lithuania on growth in sales from 1993 to 1994. The results show that management ownership have a higher increase and employee dominated ownership the same increase as the average for all enterprises. On a more aggregated level for Estonia and Latvia it can be seen that foreign-owned enterprises have a higher growth in sales than the other ownership types. For Estonia foreign-owned companies also have a significant higher level of exports compared to the remaining groups.

For Estonia and Lithuania we can find some parallel between the development in sales and employment, although especially employee-owned enterprises following the theoretical predictions seem to be a little more sluggish in t heir downward adjust ment of t he labor force. For reduct ions of t he labor force t his is also confirmed by the results from Estonia, and the relatively high reductions in Latvia for insider-owned enterprises confirms the prediction that management dominated enterprises tend to have steeper downward adjustment of the labor force. Somewhat surprising is the steeper increase in the labor force in the majority employee-owned enterprises compared to other enterprises in the Estonian sample with increasing em- ployment.

The slower reduction in the labor force could end up with lower productivity in employee-owned enter- prises. This is, however, not confirmed by the data. Based on a large panel of Estonian enterprises an econometric analysis indicate that the factor productivity for employee owned and management-owned enterprises is on the same level as for foreign ownership and it is higher than state and domestic outside- owned enterprises. For Latvia and Lithuania the results are not significant at the current stage of the analy- sis. For Estonia the results indicate that employee-owned enterprises have labor productivity on the aver- age level. For Lithuania both employee-owned and management-owned enterprises have relatively high labor productivity though not as high as foreign-owned enterprises.

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The results for employee ownership indicate that the positive effect from employee motivation and align- ment of interests seems to play a decisive role for the level of productivity. These effects are stronger than t he negat ive effect s from t he more sluggish reduct ion of t he labor force.

The results on wage levels do not show the same pattern between the countries. In Estonia the downward flexibility of wages seem to characterize employee-owned enterprises. In connect ion wit h t he sluggish downward adjustment of employment, employee ownership means that lower wages are traded off for job security. In the early Lithuania data the wage level is higher for both employee and management owner- ship and this is also the case for other ownership types with a considerable minority of employee shares.

However, it seems that the labor productivity in the Lithuanian cases have been high enough to make room for these relatively high wages (lower fall in real wages). Wages have not been excessively diluting the profitability of the enterprises. For the early data profitability measured as operating profits on turn- over and by net profits on total assets shows a relatively high level for employee-owned enterprises. For enterprises with a considerable employee minority share profitability is also on a relatively high level, and for management ownership it is around the average for all enterprises. For Estonia both employee and management-owned enterprises have above average profitability and this is also the case for insider- owned enterprises in Latvia. It is worth noting that profitability of insider-owned enterprises are higher than domestic outside-owned enterprises and more remarkable also higher than for foreign-owned enter- prises.

The analysis of the financial structure of different groups of enterprises show that the debt to total asset is higher for insider-owned enterprises both in Estonia and Latvia and around the average in Lithuania. For this group of enterprises bank loans measured in relation to total debt are also relatively high in Estonia, but in the other countries they are relatively low. When taking into consideration the low capital intensity the picture also changes for Estonia, and for all three countries the general result is that bank loans per employee is relatively low for all groups with insider ownership. These enterprises will have to rely on internally generated capital for investment. In fact, the evidence from Estonia shows that for all enterprises in general 80% of the investments are financed internally.

For Estonia both employee-owned and management owned enterprises have an investment level around the average. This is also the case in Latvia for the insider-dominated enterprises. However, for Lithuania our preliminary results point in the direction of lower investment both for management and employee dominated enterprises. An explanation behind the Lithuanian results might either be the lack of external finance or less willingness to invest.

For all countries foreign owned enterprises have the highest investment level and this adds to a capital intensity, which was already high from the foreign takeover. Combined with high growth in exports and sales, increasing employment and high labor productivity it is evident that these enterprises are in front in relation to strategic restructuring. However, foreign companies also have quite high wages, high capital costs, and since factor productivity is not higher than insider-owned companies the return on assets are lower than insider-owned enterprises although foreign ownership has advantages in management and easy access to international market networks.

The insider-owned enterprises seem to be examples of more reactive restructuring with cuts in employ- ment alt hough somewhat sluggish, relat ively low wages, problems of get t ing bank-loans, low investments. The relatively good results on profitability and factor productivity is related to low capital-intensity at the starting point, but it also indicates that they have done some restructuring and improved their use of scarce resources in a direction of higher efficiency. Compared to domestic outside-owned enterprises insider ownership are doing surprisingly well in most measures across the three countries.

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The most important deviation from the general trend is a somewhat higher capital intensity in employee- owned enterprises in Lithuania. This was the result of the first stage privatization program enabling em- ployees to use vouchers for buying relatively expensive enterprises. This made room for somewhat higher wages in these enterprises although still significantly lower than in foreign-owned enterprises. For Lithua- nia we also have results from 1997 showing that enterprises predominantly owned by financial companies are doing worse than other private enterprises. This is an indication of banks taking over enterprises in economic crisis. In this way financial companies have started to play a role as active creditors, but we see no strong signs that financial institutions play an active role as owners in the economy in general.

The analysis of economic performance is still preliminary. However, we can conclude that there is no indication that employee ownership means worse economic performance than for comparable domestic enterprises in the private sector. There is also no evidence for the often cited conclusion that insider take- over is only ‘a half way privatization’ including many of the defects from the former system. Employee- owned ent erprises might be a lit t le more sluggish in t he downward adjust ment of employment, but produc- tivity and profitability seems often to be better than for other domestic enterprises. This indicates that pro- duction have been restructured as much as in other domestic enterprises, and products and production methods have been adjusted to meet the new conditions both on the cost and the revenue side. For deep restructuring employee-owned enterprises seem to have a problem of lack of finance from banks. This is one reason why foreign-owned enterprises show much stronger strategic restructuring.

The results on economic performance suggest s t hat not only foreign companies can implement restructur- ing, also management - and employee-owned ent erprises undert ake rest ruct uring alt hough oft en more de- fensive than foreign-owned enterprises. The task for the Baltic economies will not only be to further de- velop the cooperation with foreign investors, but also to improve the conditions for the domestic-owned enterprises to match the foreign advantages. This could be the case in relation to access to capital, man- agement training, building networks for exports etc. Important for the development of a business infra- structure would be the development of the financial markets in general and the development of credit- schemes for small and medium-sized enterprises. Also the development of institutions for management training, management consulting and activities promoting export connections and international networks for SMEs can be important elements in restructuring the Baltic economies. Concerning employee-owned enterprises some consulting efforts could further develop their advantages in relation to employee partici- pation, motivation and alignment of the interests of owners and employees.

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56

The Affinity Between Participatory Own- ership and Social Coordination Mecha- nisms

Gorm Winther

After the disintegration of both central command and market socialist economies, controversies on the transformation of these systems had a definite prejudice in favor of the and the heroic entre- preneur. This analytic misery was probably best represented in the early nineties by Francis Fukuyama declaring the end of history. The twin crises of authoritarianism and central command planning had left only one compet it or st anding in t he ring as an ideology of pot ent ial universal validit y (Fukuyama, 1992). According to this point of view, the field of comparative economics is of less relevance, since most of the world now is converging into the prototype ‘laissez faire’ market economy prescribed by the DECD, IMF and the World Bank.

Yet a contesting point of view could emphasise that the world is still a heterogenous place! Some coun- tries still adhere to , and in the transforming economies state owned firms remain nation- alized assets in many sectors. Even within the capitalist systems differences prevail - in this context these qualitative differences should be underscored; there are many varieties of capitalism from the ‘laissez faire’ version via ‘planned market capitalist systems’ to Scandinavian market capitalist systems. Evi- dently, global problems of inequality, poverty, famine, ecological disasters and stagnant economic indica- tors still jeopardize the process of capitalist globalization perpetuating a radical approach to economics. We are still in search of both an alternative efficient and humane socioeconomic system (Rosser and Rosser, 1995).

For many years the Yugoslav system of workers’ self-management became an inspiration to scholars, politicians and political activists. After the tragic events in former republics and autonomous provinces of this country one may ask, whether it is pertinent to contend the relevance of a democratic and egalitarian economic system? Such a system was analyzed in depth by my mentor Jaroslav Vanek of the Program on Participation and Labor-managed Systems at Co r n ell Un iv er sit y . Fo r quit e m an y years he stressed both the comparative efficiency aspect and a humanistic economic system, and in his path breaking work he argued on a t heoret ical foundat ion t hat part icipat ory syst ems are superior t o all ot her known social coordi- nation mechanisms. Vanek’s inspiration also derived from Yugoslav worker’s’ management, yet he in- sisted that there is a difference between his global vision of participatory systems, and the way the Yugo- slavs were trying to institutionalize an empowerment of workers. In an evolutionary framework the transi- tion toward ‘a third way’ between capitalism and central command systems could take place at several levels starting with labor-managed firms that could become a third sector of the economy and ending with a national labor-managed economy (Vanek, 1970, 1971, 1974 and 1977).

Of course, an overwhelming majority of firms in the global economy of today do not live up to the as- sumptions of Vanek’s theory. However, maintaining the evolutionary approach to a gradual transforma- tion to economic and , our focus now is at the micro and the meso level of the economy. On a global scale, we see cases representing participatory decision making, profit sharing, co- operatives and employee ownership. Recently it has been stressed that the knowledge economy has caused a change of ownership and management of firms. The modern firm based on advanced information tech- nologies requires a flexible organization with skilled and experienced employees. Human capital gains in importance supporting an organizational development toward participation. When the firm cannot own the

57 factor of production most valuable to it, it sees participatory employee ownership as one of the ways to overcome principal-agent problems.

T he crux of t he mat t er appears t o focus on whet her democrat ic and humanized workplaces are compatible with efficiency, innovations and entrepreneurship as this is advocated from mainstream economists. What ever alt ernat ive suggest ions t o capit alism, we can be quit e sure t hat our argument s will be rejected as utopian dreams introduced by starry-eyed lectern socialists. Often such arguments are put forward without confronting available evidence with theories. One example is the affinity hypothesis championed by the Hungarian Janos Kornai. This hypothesis can be condensed to a concept of participatory forms of owner- ship incompatible with market mechanisms. Kornai’s affinity theory partly corroborates what the Austri- ans and Schumpeter already said. Only traditional private capitalist ownership can secure economically viable firms and systems, while most other forms, including participatory ‘third way alternatives’, are doomed to fail (Kornai, 1990). This approach resembles the supply siders trickle down or equity-efficiency trade off arguments. will result in less efficiency, and hence less development and growth. Instead, it is believed that an unequal distribution is necessary to create incentives attracting productive and innovative agents. A participatory system has a potential for more equal distributions - it can distrib- ut e income more equally t hrough profit sharing, it can dist ribut e wealt h more equally t hrough by employees and it can dist ribut e power more equally t hrough part icipat ory decision making. Thus, it is not surprising to see arguments stressing inefficiencies of participatory firms from neo liberals and supply siders.

In essence Vanek’s work challenges the well-known postulates. It is the purpose of this paper to confront the theoretical discrepancies and to include available evidence on comparative economic performance with the two main positions of the controversy. It is the affinity and the equity-efficiency trade off argu- ments versus what we may call Vanek’s humanization-efficiency Synergy argument. As the paper will demonstrate, we do not see the negatively inclined trickle down theories validated by the extensive body of empirical research done on cooperatives and employee ownership firms. Participatory ownership and management do not represent a trade off to efficiency; rather the opposite appears to be the case!

Private ownership, entrepreneurship and efficiency

T he hedonist principle of maximizing ends by a minimum of effort s was already incorporated in econom- ics by classical liberalists. Individual decisions made by craftsmen and tradesmen acting in their best in- terests create the best of all conceivable worlds. If society consists of such individuals only, the profit incentive and individuals acting in their self-interests explain how the division of labor emerges to the benefit of all members of society. The marginalist revolution refined these arguments further to the con- cept of rational utility maximizing consumers that receive maximum incomes for supplying factors of production to the markets for labor, capital, land and other inputs. Income commands goods and services supplied by profit -maximizing producers. A st at ic Paret o efficient allocat ion of product ion and consump- tion results, because consumer sovereignty exists in pure competitive markets. Resources are reallocated as long as an agent can be better off without others being worse off. In equilibrium there are no further marginal gains on reallocation, hence an optimal allocation is established. The Austrians were as the neo- classicists keen proponents of free markets and private ownership - State interventionism is the road to serfdom, and is a condition for avoiding oppression. A free society may experience an unequal dist ribut ion of income, wealt h and power, yet t his is not an act of deliberat ion by anyone, it is the result of a free choice. Each individual can freely choose his position in society, hence a majority of the decision makers will prefer a life as wage-earners with a limited responsibility, a minimum of risk and a relative secured life income. However, a minority of decision-makers is not risk averse and they seek re- sponsibility - it is among these decision-makers that knowledge exists about the management of economic

58 life. Whatever hampers the decisions taken by entrepreneurial business owners, it would be the same as opting for a less efficient system.

The younger Schumpeter’s glorification of heroic small-scale entrepreneurs’ personified ownership consti- tutes the vehicle of dynamic capitalism. For the older Schumpeter it was depersonified ownership in the form of external stockholders that could internalize the cost of research and development. Such corpora- tions represent a large development potential, however Schumpeter also considered the lack of an identity between ownership and management as a problem. The gist of his arguments is the qualities of the entre- preneur, a unique individual more self-cent red t han t he average individual. Inst ead of relying on the utili- tarian axiom in neo-, Schumpeter elucidates entrepreneurial behavior in social terms. First the dream to find, what the entrepreneur considers his own private kingdom, is rooted in several individual mot ives from ambit ions t o climb up t he social ladder t o common snobbishness. Second, the entrepreneur exhibits a remarkable competitive urge to conquer the world, and third he is a personality that takes pride and finds pleasure in seeing things done. He is a unique person, who enjoys using his en- ergy and creativeness (Schumpeter, 1934:91-94).

Seen in the context of the ownership controversy, the interesting aspect is that in the first mentioned anomaly to hedonism, private ownership is a prerequisite, while for the second and third deviation, other ownership structures are congruous with productive and creative behavior. In his path breaking work ‘Capitalism, Socialism and Democracy’, the older Schumpeter still emphasized the entrepreneurial busi- nessman. Skills, energy and above normal work efforts are the innovative entrepreneur’s characteristic behavior despite the fact that many ambitious businessmen only receive moderate rewards (Schumpeter, 1947:72-74). It is exactly the social selection that is the corner stone in the capitalist arrangement. Busi- ness fortune will reward the innovative entrepreneurs and affiliate them and their families with the bour- geoisie. Former successful entrepreneurial individuals will on the other hand be forced to accept degrada- tion from this social class, if they cannot keep up with the newcomers.

Private ownership is crucial; therefore it worried him that a mere parcel of shares substituted the walls and machines of the factory. Capitalism attacks its own institutional base when

It loosens t he grip t hat once was so st rong - t he grip in t he sense of t he legal right and the ability to do as one pleases wit h one’s own; t he grip also in t he sense t hat t he holder of t he t it le loses the will to fight, economically, physically, politically, for his ‘factory’ and his control over it, to die if ne- cessary on its steps. And this evaporation of what we may call the material substance of property - its visible and touchable reality - affects not only the attitude of the holders, but also that of the workman and the public in general. Dematerialized, defunctionalized and absentee ownership does not impress and call fort h moral allegiance as t he vit al form of propert y did. Event ually t here will be nobody left who really cares to stand for it - nobody within and nobody without the precincts of the big concerns (Schumpeter, 1947:142).

The pessimism of the older Schumpeter focused on a distant future, where all technical production possi- bilities have reached an order of perfectionism. Evolution is substituted with a permanent stationary state that renders the entrepreneurs superfluous. The circles of the that thrives on above normal entrepreneurial profits will disappear and the efficient and dynamic capitalist system will become social- ized.

Schumpeter’s development theory and the crucial importance he ascribed to private property are as elitist as the apologetics of the Austrians, when assessing distribution aspects of societies. He accused socialists in support of workers’ councils and common ownership arrangement for possessing ‘a smack of utopian- ism’. Describing the deliberations of the German commission in 1919, he especially empha-

59 sized Karl Kaut sky’s and t he commission’s at t empt t o ignore any idea of indust rial and economic democ- racy. The members of the commission did not believe that could work (Shumpeter, 1947:300). To avoid the relaxation of industrial discipline, effective management of the socialist economy to Schumpeter meant not dictatorship of but over the in the factory. He never regarded the be- havioral characteristics of the entrepreneur a potential faculty of a universal character that could be re- leased if ‘the workman’ was included in profit sharing, ownership and control. This is where he failed to see a potential new and powerful leverage for a further and qualitatively different way of growth and de- velopment. In essence theories on participation, employee ownership and labor-managed firms are the answer to Schumpeter’s problem of preserving commitment and creativity in economic life.

The Affinity Hypothesis

In terms of incentives and efficiency, all the schools of economic thought just mentioned in brief stress the importance of private ownership. Furthermore, the schools stress market mechanisms as most efficient, when considering what allocative devices that are most suitable for promoting the alleged advantages of an elitist monopolized ownership of capital.

In the debate on comparative efficiency, the question is, what potentials, combinations of centralization and have, when it comes to the build up of a viable economic system. The often quoted Hungarian economist Janos Kornai appears to represent the currents in the debate of the nineties. Kornai’s affinity hypothesis is illustrated with figure 1, illustrating what he judges efficient and stable combinations of ownership forms and resource allocation mechanisms. In the scheme efficient forms are narrowed down to basically two: Markets with private entrepreneurship and State ownership with bureaucracies (Kornai, 1990). These two can generate a stable or strong affinity between ownership and social coordination, while all remaining combinations of centralization and decentralization represent a weak affinity. The concept affinity refers to a dominant ownership type and its relations to a dominant social coordination form. ‘Strong’ and ‘weak’ affinity describe what Kornai considers ‘natural linkages’ between ownership and coordination:

T he not ions ‘st rong’ and ‘weak’ linkages do not imply a value judgement or do not indicat e any preference on the part of the author. These are descriptive categories. In accordance with the general philosophy of this paper, a linkage between an ownership form and a type of coordination is strong if it emerges spontaneously and prevails in spite of resistance and counter measures. It is based on natural affinity and a cohesion between certain types of ownership and certain types of coordination mechanisms respectively. The adjective weak refers to linkages, which are to some extent artificial and not sufficiently strong to resist the impact of the stronger linkage. Weak linkages are pushed aside by strong ones time and again, whether the intellectual and political leaders like it or not (Kornai, 1990:18).

The strong linkages in figure 1 are State ownership and bureaucracy (1A) and private ownership and mar- kets (2B). The first resembles what other have been conceptualized as the Etatist model based on multi- level hierarchies of control and coordination principles.

Subordinates in this type organization are dependent on superiors control at all levels, information flows are of a vertical character and power rests in the hand of policy makers and a planning bureaucracy. Cen- tral planning systems of this type have especially in development phases characterized by extensive growth proven a capability of generating a rapid industrialization. There is a remarkable difference be- tween Kornai and the neo-liberal and neoclassical lines of economic thought quoted above. Kornai does not renounce the central command systems (etatism) as stable and efficient systems, and in that sense he

60 seems more in line with the older Schumpeter who did not excluded ‘central command’ socialism as a viable society.

The alleged stability of a market economy with private ownership (2B) may employ two theoretical ap- proaches of either a static or a dynamic character. If stressing allocative efficiency as most important, the general equilibrium concept based on competitive markets and Pareto-optimality suggest t hat privat e profit-maximizing agents always adapt to the preferences of utility maximizing consumers to the point, where there are no further gains by reallocation. The other approach, emphasizing the Schumpeterian the- ory on private entrepreneurship as explanatory to economic development, does to a higher degree resem- ble Kornai’s explanation on a strong affinity between especially private ownership and markets. It is the younger Schumpet er glorifying t he ent repreneur t hat seems t o resemble Kornai’s reasoning. Above nor- mal profits and the direct linkage between effort and reward are the incentives that spur entrepreneurial activities. In a later book in 1990, Kornai actually emphasized small-scale entrepreneurial activities as a necessary prerequisite for developing the Hungarian economy (Kornai, 1990b).

The remaining links in the diagram illustrate weak affinities - labeling the combination 1B a weak link implies that Kornai considers market socialist experiments in reforming Etatist systems as unstable and inefficient, because bureaucratic coordination prevailed and pushed out the influence of market mecha- nisms. The private sector in former Etatist systems appears to be spontaneous existing, whenever it gets the chance to operate within the framework of the bureaucratized planning system. Nevertheless, bureau- cratic coordination will always hamper the realization of the full potentials of private ownership (Kornai, 1990a:9):

The dimensions of the growth of private economic activity are even more remarkable, if one takes into account the fact that the private sector must adjust to the hostile environment of the half- heartedly reforming socialist economy. Despite some improvements the daily life private business is still characterized by a multitude of bureaucratic interventions and restrictions. The private sector has limited access to material supply, and almost no access to credits and to foreign exchange.

Finally, Kornai raises what he may have thought was a question with an obvious answer - is there a third way based on the idea of associative socialism, self-government, free associations, altruism and mutual voluntary adjustment (3C). Experiences related to the in the thirties, the self- management system in Yugoslavia and the Cultural Revolution in China represents experiments with self- management and associative coordination. According to Kornai the link between cooperative and labor- management ownership and both associative and market allocative mechanisms represent less efficient or stable links. Allegedly, the Yugoslav approach to socialism comprised a highly imperfect attempt to move in the direction of a third way to socialism.

Kornai’s affinity discourse will probably provoke discussions on the viability and attractiveness of the two combinations representing strong affinity. In other words normative twists and advanced story telling could lead t o prescript ions based on value judgement s. Nevert heless Kornai’s t heory should not be used prescriptively, instead, it should be used in a pragmatic way: Did this combination of ownership and coor- dination prove institutionally stable, did it accomplish macroeconomic stability, and did it experience fast growth and development? Kornai carefully describes his approach as an attempt to use positive analysis. He does not exclude that empirical data later may prove his determination of strong and weak affinities wrong. Compilation of historic data determines the analysis of affinity for each case included in discus- sions on the affinity between ownership and social coordination. Despite this important reservation, Kor- nai’s affinity discourse still raises several questions.

61

First, it should be recalled t hat comparat ive analysis on Yugoslavia and comparable capit alist economies point s t o an impressing record, suggest ing t hat Kornai may be wrong in labeling t he Yugoslav economy inefficient. Macro growth data in Yugoslavia from the early fifties to the mid sixties in two studies sug- gests quite the opposite. We will return to this below in a section on comparative macro affinity. Second, including micro analysis, the link between participative ownership forms and market coordination appears to be a more feasible combination than utopian forms. Including these types of ownership to discussions, Kornai’s suggest ions again seem unsubst ant iat ed. A preponderance of performance studies on participa- tory management structures, employee ownership and cooperatives suggest t hat t hese t ypes of ownership are viable and competitive when compared to conventional forms of ownership and control. The question of course is whether these forms of ownership can be labeled an undiluted collective ownership structure. It is difficult to draw a line here, because many case studies, even studies on cooperatives, will disclose that the pure form does not always exist. We may be dealing with embryonic structures that nonetheless in terms of comparative efficiency prove themselves competitive and growth oriented. Yet, adopting a quasi- collective approach, and assuming even better comparative results if the participatory firms could evolve further toward egalitarianism, it appears justifiable to reject the link 3B as representing a particularly weak form. We will return to the empirical validation of this in a section below on micro affinity.

Third, Kornai’s approach modified t o west ern social set t ings, lacks a ‘fourt h way’ st ruct ure. T his cannot be held against Kornai; he did not include economies in the west in the affinity discourse, because his analysis was mainly concentrated on former Etatist systems in Eastern Europe. In a broader comparative context, however we need to consider bureaucratic organizations as analyzed by Oliver Williamson wit h in the framework of a so-called market economy. Bureaucracies or rather hierarchies may exist in market economies within large privately owned and operated organizations, simply because it is a better solution than markets. Williamson has described this as the impact of the cost of contracting, or transaction costs - to establish or run economic activities as markets are not done at zero cost. If costs related to bargaining and haggling become too high, if market failures frequently occur and if the insecurities related to compi- lation and processing information are too high, there are incentives for economic agents to integrate their economic activities. Internalizing the market within a hierarchy may be the best solution after all, the hier- archical large organization establishes procedures and guideline for operations that would otherwise re- quire costly contracting, it establish procedures for information compilation and processing, it stretches out and control its surroundings, in other words planning and control remove some of the insecurities re- lated to small firms operating independently on competitive markets (Williamson, 1975).

Kornais emphasis of the weakness of ‘third forms’ is supported by several other theoretical contributions, mostly of a neo-classical heritage, over the years. In most of these analyses alternatives to the mainstream capitalist firm have not fared well. Summing up the theories, it seems that we have two main approaches to the analysis of a range of firms with either one of or combinations of the characteristics: profit sharing, employee ownership, participatory decision making and democratic control. Negatively inclined theories of the equity-efficiency trade off or affinity kind stress inefficient use of resources. For several reasons the firm may in t he short -run produce less t han it s capit alist t win. Moreover t he firm may face a lack of capital - if t rue, an inefficient use of bot h labor and capit al suggest s t hat t he firm is not part icularly efficient or growth oriented. The problem of free riders is occasionally considered especially severe in participatory and profit-sharing firms, because monitoring is rewarded less. Owners of firms may face higher transac- tion or agency costs because of participatory arrangements, again it then appears that the firms are less profitable or less growth oriented. On the other hand positively inclined theories of the equity-efficiency synergy kind stress the human factor as an important input not present in traditional firms. If committed to the philosophy of an alternative type of firm, the employees may be more motivated and productive. Pris- oners’ dilemma games could be less relevant to analysis than cooperative games in participatory groups. The members of a collective may anticipate mutual monitoring based on social norms for work behavior in peer groups and that combined with significant degrees of ownership could have a significant influence

62 on performance? This brings us to the opposing radical or socialist point of views to the ‘trickle down’, affinity and comparative efficiency discourse (Winther and Marens, 1997).

Toward a humanized economics

Objections to the great bourgeois thinkers come from the market socialist camp. In a foreword to Oscar Lange’s controversy with the Austrians on the efficiency of the socialist economic system, Lippincott puts emphasis on the essence of democracy and equity. The distribution of wealth and income in a capitalist society creates an inegalitarian social system. Alternative ownership forms can abolish some of the privi- leges connected to traditional private ownership to capital. An egalitarian distribution creates a higher degree of need contentment among consumers, the freedom of choice could be even freer and an increase in the supply of labor could occur because of higher marginal value products added of labor.

Social ownership is not as stressed by Hayek and von Mises t he st raight road t o serfdom. If t yranny exists anywhere in a capitalist society, it is exactly within the sphere where private capitalist ownership rules. Private ownership may be a guarantee that Government does not tyrannize industry, on the other hand, it is private property that tyrannizes Government and the employees in enterprises. Seen from this angle socialized ownership and political democracy may enhance the possibility to remove the autocratic rule behind the gates of the factory:

A democratization of the administrative authority of industry will lead to the introduction of legali- zed behavioral patterns in whole industries and furthermore this would lead to an effective consulta- t ion bet ween workers and management . T o consult human beings t hat live under and feel the results of directions and administrative precautions, to attach importance to their experience and to repre- sent them in a suitable manner in decision making bodies could enhance the spiritual health and mo- rale for the whole working population (Lippincott, 1974, translated from Danish, GW).

In debates on market socialism participatory management and ownership play an increasing role these years. The advocates for main stream capitalism have the same problem as Schumpeter had. Probably very few today will dispute the advantages attached to what Schumpeter called vital ownership, the point is that it has vanished and has been replaced by depersonified ownership, accordingly capitalism has lost its vital- ity.

The organizational forms that follow from depersonified ownership are the bureaucratic or hierarchical organization, which continuously seems to be the dominant management philosophy. The effect of this is alienated perceptions between employees and this induces efficiency losses that could have been removed through the introduction of participation in ownership and management. It is in this context that Hayeks and Schumpeters elitism is revealed - responsibility and initiative are for these thinkers a privilege for few instead of many - this is either because a majority of people do not want to take responsibility or because animal spirit and intellectual capacity is absent. An alternative and democratic approach could instead stress that exactly the capitalist arrangement - private ownership and elitism - is the cause for unreleased innovative potentials existing outside traditional capitalist stockholders and corporate executive officers meeting rooms. These potentials will not be released unless the participatory economy will prevail - the effects of the slumbering vital ownership that disappeared may surface again, if employees participate in control and management of economic life.

A think tank in the New Labor party of the UK has focused on the knowledge economy, a concept parallel to this line of reasoning that has its proponents in the US too. In the US Rosen and Young int roduced a new theory O in extension of Doughlas Mcgregor’s theory Y and William G. Ouchi’s Theory Z. The most import ant fact or of product ion t hat advanced firms have is human capit al t aking t he form of knowledge,

63 creativity and ideas. This factor cannot be owned in the same way as real capital and consequently an anomaly results. At one hand we have the traditional concept of ownership rooted in possession of real capital and at the other hand the most important asset to the firm cannot be owned as real capital can. Firms are to an increasing degree a part of non-hierarchical network organizations, and it is particularly participatory employee ownership that best adheres to the flexibility requirement that typify this organiza- t ion. As ment ioned, part icipat ory ownership and decision making could be t he lever t hat releases innova- tive and creative faculties among the employees. This development could at the same time imply a begin- ning socialization of monopolized capitalist ownership (Mcgregor, 1960, Ouchi, 1981, Rosen and Young, 1991, Leadbeater, 1997, Winther, 1999).

The s upply of labor and incentives

However, theory O and the knowledge-based economy with its emphasis on a humanized organizational principle are not that new - Jaroslav Vanek’s book “The General Theory of Labor-managed Market Economies” also stressed this important aspect:

Conceived as a fundamental principle of human production, labor management thus appears as a principle founded on integral, active human involvement. As such it is in sharp contrast with mana- gement and control by the owners of capital, who need not be and most often are not humanly and actively involved. The moral, psychological, and social implications of these facts are far reaching. Perhaps the most important is that we have in labor management a precondition for a truly egalita- rian and . Moreover, the status and dignity of human work and activity are increa- sed and thus a more natural balance is attained with ‘the status of ownership’. Finally, in an active involvement in labor management resides a way - perhaps the only way - out of alienation of the workingman in modern industrial society (Vanek, 1970:5).

The implications of the egalitarian labor managed society are quite contrary to both the trickle down and equity-efficiency trade off arguments and to the affinity hypothesis. In part III of General theory Vanek analyzed incentives and efficiency in a labor-managed firm, and he tries to develop a theory that includes the social psychological behavioral factors of motivation and commitment among employees participating in profit sharing and decision making. In order to give behavioral theories an economic content he in- cludes two types of incentives in comparative analysis. Both profit sharing and participatory decision making are incentives for the supply of labor to the collective (Vanek, 1970:238-48, Vanek, 1989:97-103). The essence of Vanek’s approach is presented in a modified form in figure 2 below. The key variables denoted L and -L refers to the situation where an employee either can supply labor (L) or he can demand it as his own leisure, i.e he does not work (-L). The work effort has at least three components, namely dura- tion of work measured in hours per day, intensity of work and quality of the product or service rendered. Classifying efforts in this way is important, because comparatively speaking both the profit-sharing incen- tive and the participation in ownership and decision making incentive will cause a higher value added in the participatory or labor-managed firm than in any other known firm not having these characteristics, ceteris paribus.

In figure 2 we are comparing a representative or average employee in the democratic firm to an employee in a conventional capitalist firm. Moving to the right along the horizontal axis from the origin 0’ increases the demand for leisure (decreases the supply of labor) and moving to the left from the origin 0 increases the supply of labor (decreases the demand for leisure). At the vertical axis the income per employee is measured as both the ordinary wage and a share of profits; the curve in the plane is then an income possi- bility curve, and it starts at point D with a negative income, because the efforts supplied are insufficient to cover the fixed costs per head. The lower income curve represents income per head without the motiva-

64 tional incentives attached to participative decision making, while the upper curve depicts a participatory firm with profit sharing.

The employee in a capitalist firm is hired under a contract that fixes the pay roll and the conditions under which the job is to be performed - the fixed wage is Yo (w for wage) will be constant no matter how much labor is supplied by the representative employee or how much leisure the same employee demands. The point a at the horizontal double axis (L and -L) represents the zero profit equilibrium, while the point b represents a situation with an above normal profit per employee. A short-run fluctuation in demand could increase profits in the capitalist firm. The distance AA’ then measures the representative employee’s profit contribution to the owner of the firm. Provided that the firm operates with these excess profits, the dis- tance 0b represents the agreement between the employer and the employee on the minimum acceptable effort . If t he employees supply less labor t o t he right of b, t hey would be breaking t he contract and if they supply more labor t o t he left of b, t hey would be ‘eager beavers’, i.e t hey would for instance force the pace at piece work too much - in the capitalist firms there are pier pressure mechanisms to counteract this be- havior, in most cases we would expect an alienated behavior resulting in exactly the point b: no more - no less. Had we included representative indifference curves, we could have shown that the average employee in a capitalist firm had a lower total utility than the employee in the democratic firm (Vanek, 1970:238- 53). In the democratic firm, the average employee is not contributing a profit share to the owner; instead he receives his profit share after all capital costs are covered. This creates an above normal monetary re- ward to the representative employee in the participatory and labor-managed firm. Depending on whether the substitution or income effect is strongest the pecuniary effect of profit sharing in itself could lead to a comparatively speaking higher supply of labor in the democratic firm than in the capitalist firm.

Including t he behavioral incent ives of part icipat ory and labor-managed firms, t he income possibility curve turns upward around D with a higher value added to share among the members of the collective of em- ployees. The employees are more committed and less alienated than seen in the capitalist twin, he needs less supervision, he is more productive and creative in terms of cost savings of the firm, accordingly he may decide to supply more labor than in point c in terms of duration, intensity and quality. If the income effect were stronger than the substitution effect, it would still imply a higher welfare than for the employee in the capitalist firm to the right of c.

Provided that the work efforts are more durable, has a higher intensity and are of a higher quality, when it comes to the quality of products and services, we would not expect to see participation, profit sharing and employee ownership firms to be less efficient, productive or growth oriented than comparable capitalist firms. Actually, what we may be seeing here is an equity-efficiency synergy, t he int egral human involve- ment in decision making; income sharing and wealth sharing could prove the equity efficiency trade off and affinity arguments wrong. Vanek’s theory rests on the assumption of participatory and labor-managed firms operating in competitive markets, if the theory can be validated by empirical evidence on participa- tory firms operated within market system, the alleged weak link between third way forms and market mechanisms appears to be false.

Macro Affinity

Strong or weak affinity refers to the concepts of viability, efficiency and economic stability. The empirical approach to these concepts in this article could at the macro level be illustrated by analysis of growth and development and at the micro level by analysis of economic results, employment and ability to create mo- tivation, productivity and innovations. In the two following sections, I will condense the affinity discourse to respectively empirical discussions of macro and micro affinity. Regarding the macro approach we can include two comparative studies on workers’ self-management in former Yugoslavia in the period of 1951-1965. For the micro dimension, we will include empirical studies in western type economies on par-

65 ticipatory decision making, cooperative firms, firms with employee ownership stock ownership plans or other arrangements. As mentioned above, we will consider these embryonic structures resembling some of the features of participatory and labor managed firms.

Comparative growth studies are abundant on western type capitalist economies and Etatist command type systems in the former USSR and Eastern Europe. When it comes to comparisons between Etatist systems, capitalist systems and the self-management system of former Yugoslavia, there are few studies available. One of the few approaches that enables comparisons between the Yugoslav economy and comparable capitalist and Etatist systems were published by in 1970. Balassa and Bertrands’ product ion function stud- ies in centralized and decentralized systems covered the period of ‘new economic policy’ from 1952 to 1965 in Yugoslavia. The variables for comparisons were growth in industrial output, growth in labor and capital inputs and growth in factor productivity. The Yugoslav economist Branko Horvat modified these results to a tripartite approach of comparing capitalist economies, Etatist economies and the self- management economy of Yugoslavia. (Balassa and Bertrand, 1970, Horvat, 1982:202-9, 578-80).

In order to eliminate differences in production factor equipment, the countries were included as low de- veloped, medium developed and high-developed countries. Greece, Yugoslavia, Bulgaria, Spain, and Ru- mania were classified as low developed, Ireland, Poland and Hungary as medium developed and Norway and Czechoslovakia as high-developed systems. Except for the annual average growth in Capital input over the period, the self-management economy was in terms of the output annual growth rate, the labor input growth rate and the combined factor productivity growth rate outperforming the comparable Etatist and capitalist systems.

The swift changes of the Yugoslav economy from capitalism before the Second World War to administra- tive socialism in the period 1945-1951 and to market socialist developments in 1951 to 1989 give a unique opportunity to compare the periods. After 1951 Yugoslavia saw periods with different attempts to decen- tralize and improve the space for the operations of self-management decision-making bodies. The period of regulated markets in 1951 - 1965 maintained investment control, the laissez faire model of 1965-1974 made the dinar convertible and included Yugoslavia in the world market and the period of self- management agreements and social contracts in 1974-1989 was an attempt to create what Kornai above labeled associative social coordination mechanisms. From 1911 to 1940 Yugoslavia had a capitalist sys- tem, after the war Etatism was established and from 1954 to 1965 Yugoslavia had a decentralized system. Using the same variables Horvat compared annual average growth in manufacturing, , construction and crafts for the three periods of capitalism, Etatism and self-management. Compared to the capitalist development phase, the self-management system periods had faster growth for all variables and compared to the Etatist development phase the self-management period was distinguished by a relative higher annual average growth for output and combined factor productivity.

Of course there are the usual methodological pitfalls doing such comparisons, yet the results are remark- able in the sense that they do no let support to the trickle down, equity efficiency trade off or affinity ar- gument s. In t erms of income dist ribut ion, Yugoslavia had as t he Et at ist count ries lower gini coefficients than both advanced capitalist countries and welfare states in the period of comparison (between 0.21-0.25 for the Etatist countries, 0.25 for Yugoslavia, for the welfare states 0.36 and for the other capitalist coun- tries 0.40, Horvat, 1982:204). At the same time Yugoslavia introduced market reforms and workers self- management, and yet in terms of comparative efficiency indicators worker-managed socialism seemed to outperform their capitalist and central command comparisons!

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Micro Affinity

The atrocious tragic of former Yugoslavia does of course not justify arguments supporting that we should ignore the experiences of the self-management system and the results of research just presented. Nonethe- less, research on employee ownership and cooperatives in market systems is of greater relevance, when assessing the theoretical controversies on comparative systems. Looking at organizational democracy, cooperatives or employee ownership in market economies, virtually all research points to higher produc- tivity rates or better performance indicators than for conventional firms. Surveying the literature suggest strikingly similar results in most studies (Levine and Tyson, 1990, Winther and Marens, 1997).

Of special interest here, is employee ownership in the United States. Since the late eighties, ESOP re- search oft en suggest s a posit ive and discernible st at ist ical relat ion bet ween part icipat ory employee owner- ship and economic performance. Research on the effects of employee ownership has been done since 1978 with different methods and with severe sampling problems - ESOP data are extraordinarily hard to come by. The US General Accounting Office is to date the most comprehensive project on American ESOP’s, and as ment ioned by t he aut hors t o t he GAO report t he general pict ure in t he late eighties looked quite patchy: ‘. . .the evidence from prior studies of ESOP effects on corporate performance is inconclu- sive. Few studies have reported statistically significant positive effects for ESOP’s. Most of the studies, whatever their findings, suffer from deficiencies in samples examined, the performance measures used, or the designs employed’ (General Accounting Office, 1987:48).

In table 1 the results from employee ownership studies in the US since 1978 are listed. It is especially since the mid eighties that some of the deficiencies of earlier studies disappeared. Comparative studies in the late eighties and the early nineties seem to generate results allowing more confident generalizations than before.

Rosen and Quarrey reported that firms with some form of employee ownership grew faster than control firms in both simple comparisons after the commencement of employee ownership and in longitudinal comparisons. Moreover, sales t ot als grew even fast er t han employment , suggest ing t hat both employment and a crude productivity proxy tended to increase with the introduction of an ESOP. The partial correla- t ions run by t he aut hors suggest ed employee part icipat ion as measured by managerial percept ions of em- ployee influence to be a consequential variable. Participatory decisions mainly had positive strong and statistically discernible correlations with both Post-ESOP growth rates and positive differences between the relative Post-ESOP and Pre-ESOP rates. Simple correlations implied that the contribution to the ESOP, the degree of ownership, voting rights and employee board representation were not reliable predic- tors for the variance in growth leads to control firms (Quarrey and Rosen, 1986).

In a 1987 General Accounting Office study of the effects of ESOP’s on productivity and profitability measures, Russell, Grasso and Hanford reported that the only statistically discernible variable positively correlated with higher productivity was participation in decision-making (US General Accounting Office, 1987; Russell, Grasso and Hanford, 1990). In general the GAO found little evidence of strong employee ownership impacts on productivity and profitability performance. In another study, Conte and Svejnar used a split sample in the form of an unbalanced panel of firms at the national level. The sample included profit-sharing plans, ESOP’s and Plywood Cooperatives in the Pacific Northwest. The purpose was to estimate the impact of employee ownership, profit sharing, participation and unionization on value added in relation to production function analysis. Contrary to the GAO and NCEO studies and similar to Euro- pean findings, Conte and Svejnar reported ownership per se effects in their regressions: ‘As for the effect of ESOP’s on product ivit y, t he st udies suggest t hat it is posit ive at low and moderat e levels of ownership, but diminishes at high levels.’ (Conte and Svejnar in Blinder (eds.), 1990:166). As in other studies, a posi-

67 tive discernible relation between participation and productive efficiency was found for the firms (Conte and Svejnar, 1988:149).

Table 1: Performance studies on esop firms in the United States 1978 - 1995 Performance Method or (+/÷)2 Significance of Variable Comparison Causal Relation Conte/Tannenbaum 1978 Pre-tax profits to Indust ry (+) Amount of Equity sale averages Held by Employ- ees March/Mcallister (1981) Productivity Indis- (+) n.r.4 Proxy3 try/National Rosen/Klein (1983) Employment Eight Sectors (+) n.r. Wagner (1984) Sales growth Matched (+) n.r. Average return on Pairs (+) equit y Quarrey/Cohen (1986) Sales Growth Matching (+) n.r. Employment Groups (+) Gro wt h Quarrey/Rosen (1986) Sales Growth Matching (+) Participation Employment Groups (+) participation6 Gro wt h 5 Russel/Hanford/Grasso (1987) Return on assets Matched (+/÷) Productivity Pairs (+/÷) Participation Proxy7 Conte/Svejnar (1988) Out- Product ion func- Participation put/productivity tion Winther (1994) Sales growth Matching (+) Participation8 Employment groups (+) Participation growt h Kardas et.Al. (1994) Sales Growth Matching (+) Participation Employment groups (+) Participation9 growt h

Finally, this complementary effect of ownership and participation was confirmed in two studies that I con- ducted at the State level in the early nineties (Winther, 1994, Winther, 1995, Winther and Marens, 1997). In both simple and longitudinal studies on sales and employment growth comparisons, employee owner- ship firms were found to grow faster than comparable conventional firms. Running partial correlations on ownership and participation variables only participation was found to have a positive statistically discerni- ble effect on New York sales and sales per head data. For the Washington data simple comparisons sug-

2 A (+) indicates relative better performance than control, a (-) relative poorer 3 Compensation to sales divided by industry compensation to the GDP 4 Not reported 5 The comparisons were significant. 6 Both longitudinal and simple, significance on both causal relations. 7 Value added to employee compensation 8 Both longitudinal and simple measures. Significance only for partial correlations on comparisons in the period after the incep- tion of the ESOP 9 Not for correlations. The simple comparisons showed participatory ESOPs to outperform participatory conventional firms

68 gest ed t hat in t he case of comparing part icipat ory employee ownership firms t o participatory conventional firms, the employee ownership firms would still grow faster. These results are at least indicative for a po- tential stronger effect from participative decisions in employee ownership firms than in conventional firms.

Conclusions

The trickle down, equity-efficiency trade off and affinity hypotheses rest on the assumption that egalitari- anism will result in less efficiency, thus it is not surprising to see arguments from neo-liberals stressing inefficiencies of participatory and labor-managed firms. In essence Vanek’s work challenges the postu- lat es by int roducing a humanization-efficiency Synergy argument.

Taking the analysis presented by Branko Horvat as our point of departure, it should be clear that the affin- ity hypothesis is debatable. A cautious interpretation of the results by Balassa, Bertrand and Horvat could at least state that there is nothing in the macro data on the Yugoslav economy that pointed to workers’ self-management having a particularly harmful impact on growth and development.

In sociological, economic and statistical literature on participative ownership, control and decisions, evi- dence is found suggest ing innovative and entrepreneurial behavior that can be ascribed to others than owners, management and key personnel. Creative and productive faculties may not just be for the few, and stretched out to the employees, we may see powerful comparative performance effects. If participatory ownership structures can function within the framework of market systems, and if these structures most often do better than conventional firms, an explanation lacks why this is feasible at the micro level of the firm and not in a macro economic system that has institutionalized these organizational principles. These findings do casts doubts on Kornai’s rigid enthusiasm for the elitist approach to development, entrepre- neurship and private ownership originally presented by Schumpeter. The theoretic-empiric debate at the micro level of the firm, do not justify a validation of the negatively inclined theories. Of course that may be explained by firms not fitting to the assumptions of the theories - on the other hand, participatory deci- sion-making linked to stock ownership (deferred profit sharing) does possess some features of profit shar- ing and workplace democracy so frequently dismissed by different theorists. The theoretical contributions hypothesize that either profit sharing, cooperative and employee ownership, participatory decision making and democratic control or combinations of them are doomed to foster allocative inefficiency. With an inoptimal use of labor and capital resources, with employees inertly shirking, with management disincen- tives due to eroded profits after sharing residuals with employees, with relative higher transaction costs in peer group associations or with relative higher agency costs to encourage employees to join participatory arrangements, the last thing we would expect to see is employee ownership firms outperforming their matching conventional firms on different economic performance measures. We would not expect our em- ployee ownership firms t o be part icularly growt h orient ed. So far, t he evidence present ed does not support positions claiming that participatory decision making and employee ownership harm the comparative growth performance. Confronted with the bleak approaches to the analysis of participatory and employee ownership firms, our research suggest s t hat ot her, rarely discussed, compet it ive advant ages may prevail. It is the early theoretical work of Jaroslav Vanek that deserves merit in this context. It is in his analysis of incentives and efficiency in General Theory that the competitive advantages of the labor-managed firm are revealed. He argued theoretically that labor-managed systems will be superior to all other known socio- economic systems. Later empiric analysis of firms possessing the characteristics of labor-management to more or less degrees all appear to confirm his theory. Participatory and labor-managed firms do not appear to represent a trade off between equity and efficiency, instead they appear to represent a fruitful syner- gism. This may be a substantiation of an efficient third way between central planning and market capital- ism, a way that may prove more appealing than other known strategies for the build up of a future democ- ratic and egalitarian market society.

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Cooperative and Training Dimensions in Entrepreneurship10 A study of the methodology of the Saiolan Centre in Mondragon Gurli Jakobsen

Saiolan is a centre for training of entrepreneurship and the development of new entrepreneurial ventures, within the Mondragon Cooperative Corporation (MCC). As presented elsewhere in this anthology the Mondragon cooperatives have since the fifties developed a corporation of more than 100 cooperatives wit hin machine-indust ry, domest ic appliances, daily consumer goods dist ribyt ion, IT -t echnology, finance, education and research. It employs more than 53.000 people. MCC originates and has its center in Mondragon in the Basque country in Spain, but has to-day affilated cooperatives from Catalunia and Va- lencia, and has acquired or opened enterprises and filials in various European, Asian and Latin American Countries. In this paper I present their educational model and analyse the notion of entrepreneurship prac- tised here. This experience underlines the importance of cultural and cooperative dimensions in what is often seen as a rather individual phenomenon - becoming an entrepreneur. The analysis is guided by two questions: What role does cooperation play in this entrepreneurship process? and: How is the relation be- tween education and the idea of a new entrepreneurial venture? Finally the paper looks at the role of the Saiolan Centre itself as an example of social entrepreneurship.

The practice at Saiolan, although being cooperative, does not necessarily lead t o t he formation of coopera- t ively owned firms. T his brings up t he rat her t ricky quest ion of t he relat ionship bet ween cooperative own- ership and cooperative culture in business, asking: what are the relevant empirical experiences when re- searching cooperative entrepreneurship? Cooperative entrepreneurship is often understood to be about the formation of cooperatively owned enterprises. In this study, the cooperative aspects will be related to the entrepreneurial process itself, i e before the constitution of the actual enterprise, and not to the particular ownership structure being established.

Entrepreneurship is understood as the capacity of seeing and realising innovative business projects by combining technology, capital, production and market in new ways. In this respect it is close to the Schumpeter formulation. But more than a quality situated with the singular specially talented individual, or as a function in the development of the capitalist economy (Schumpeter 1934, 1944), entrepreneurship is here understood as a capacity that can be associated with management and leadership and most impor- tant: which can be learned.

Entrepreneurship in the Mondragon Cooperatives

During the 1970’s the Mondragon Cooperative Experience developed a remarkable capacity for setting up new cooperatives and helping weak ones ‘back on track’ A special department ‘division empresarial’ was created within the Cooperative Bank (Caja Laboral Popular)11. T he st rat egy for growth and development, during that period, was to create cooperative firms in the various regions of the Basque provinces. Some 50 cooperative companies were set up or helped during those years (Ormaechea 1990), and a systematic approach to new cooperative business ventures was developed – ‘socialisation of entrepreneurship’ as the

10 This paper draws on a comparison of the conclusions from an earlier stuydy of Saiolan (Jakobsen 1990) with up- dates and new information from later revisits - the latest one in 1998. A shorter version of this paper has been pub- lished in Review of International Cooperation, vol. 93 No.1, 2000 11 Caja Laboral Popular is a cooperative bank whose membership is shared between the co-operatives in the MCC and the worker-members of the bank. The elected board is composed of 50% representing the cooperative member- firms and 50% representing the members working in the bank

72 method was labelled (Ellerman 1982). By the middle of the 1980’s this strategy came to a halt, and has become replaced by one of growth through joint ventures and wholly owned subsidiaries (Clamp 1999). ‘Division Empresarial’ ceased as a special department within the Bank in 1990, and the activities relating to enterprise and engeneering consultancy were continued in a new cooperative LKS S.Coop. In the same period the Saiolan founders started developing their method at the Politechnical School in Mondragon. With time this method has become a strategy for developing entrepreneurial ideas and energies in the re- gion, as well as in in the MCC-cooperatives.

Saiolan tries to create a dynamics that promotes professional self-motivation and gives a basis for strengthening the ability of self-government as well as developing initiatives, where a willingness to risk oneself is present. One of our motivations behind this is that, according to recent investigations, 80% of our young people have as their life goal to become functionaries. They expect security for the rest of their life and not to take responsibility. Armin Isasti, director and founder of Saiolan, in T.U. no.302, April 1987. (translated from Spanish)

The social-economic background for this new experience in the mid-1980ties was the economic crisis that hit Spain, at the time, with unemployment figures of more than 20% in the Basque provinces. Saiolan pursued simultaneously two aims: 1) create work by the creation of new firms, and 2) support young newly graduated students (and other entrepreneurs) in developing the skills necessary for transforming a business idea into a business activity. Saiolan actually means ‘experiment with work’. The purpose was explicitly to contribute to the development of entrepreneurial culture and counteract the wage-earner men- tality prevailing in the higher educational milieus.

Since the start in 1985 Saiolan has been the ‘catalyser’ of 48 companies that gave work to over 500 people in 1999. Saiolan is situated at the premises of the old Polytechnical School, now Mondragon University. It has a staff of 5-7 monitors or teachers and, more or less permanently, some 25-30 students working on business projects. Most of the participants are postgraduates, and a few are experienced entrepreneurs. The students are recruited from all the Basque provinces.

During later years a good number of the business projects at Saiolan have been ‘spin off’s’ from coopera- tive firms within the Mondragon Cooperative Corporation (MCC), but many are new starts or joint ven- tures with firms not directly affiliated with the MCC. 23 companies are run by previous postgraduates, (table 1). In all 185 have worked at Saiolan, of which 88 have created or been the co-creater of a new business venture. The new business ‘typically’ begins as a small enterprise with only the entrepreneurial team working, and eventually grows. In the case of joint ventures the entrepreneur or team of entrepre- neurs, who were trained through the development of the business project normally become the managers of the new venture. Some are formed legally as cooperatives, but it is not many. The law on cooperatives requires at least five people to start as a cooperative, and many of the Saiolan-projects initiate their busi- ness with fewer people, and then get settled in another enterprise type.

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Table 1: Number of firms started from Saiolan 1985-1999, and number of employed. Ultimo 1999. Entrepreneur Firms generated in Number of work posts, Saiolan ultimo 1999 Post graduates 23 128 Experiences entrepreneurs 5 61 In collaboration with other firm (spin off) 10 217 Diversification of existing firm 10 102 Total 48 508 So ur ce: Saio lan

The educational/entrepreneurial process

The educational program at Saiolan lasted between 18 months and 2 years the first years of existence, but has in later years become reduced to in average 12-14 months for a project to become developed. Techni- cally it is a postgraduate program after a completed university level degree. Through the program the en- trepreneurship students learn to identify suitable business ideas, choose one and develop it into a real business project. The more traditional conceptualisation of education does not work for this type of activ- ity. Entrepreneurship is learned in practice, and depends on the capability of self-learning. The Saiolan approach appears as one of the possible frames for taking the first real steps in a learning environment rather than on the market as is the case for most entrepreneurship learning. The following characteristic of the Saiolan educational program concentrate on the cooperative aspects that I have found striking com- pared to other programs of entrepreneurial training.

New business ideas are a common concern. Contrary to many entrepreneurship courses, most of the students at Saiolan do not bring with them a specific business idea. The business idea is considered some- thing which is developed in a social process. It is a shared responsibility to find appropriate business ideas. Both personal at Saiolan, contacts in local business and people from other institutions may contribute to this process. Of the 48 successful business ideas, half have been generated in Saiolan and half by students or existing enterprises. As the method becomes known, relatively more ideas are provided by people and businesses from outside Saiolan.

Work in teams. Saiolan develops managers/owners of new enterprises or business units who have been exposed to cooperation towards the inside/internally in several aspects. Part of the educational tasks occur as work in groups. It is quite common that 2 or 3 join to develop one business idea. Moreover, the 16 students which start the program at the same time have their desk, and do their work in the same big room. In this sense it approaches more a common workplace. They are not placed in individual offices, as would be the case in e.g science parks.

Openness. Exchange of knowledge and information of relevance to the business projects is encouraged as a part of developing fruitful relations of collaboration. The fear and risk of somebody stealing your idea or other forms of distrust is handled in an open and a social situation and not behind locked doors. This point may be helped by the fact that Saiolan is situated in an educational context, and not in a private, for profit consultancy milieu. Moreover Saiolan is situated in the heart of a cooperative business milieu with a tradi- tion of a high degree of openness and exchange of knowledge and innovative ideas, with relatively easy access to information, and in the Polytechnical School where many technical projects have been devel- oped through the years on petition from the industrial cooperatives.

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Cooperation towards the outside is favoured. Very early in the educational program the students have to contact and link up with existing enterprises within the field of the chosen business idea. They learn how to cope concretely with competition and cooperation within a specific business sector while they are at Saiolan. They learn to use available centres of knowledge and information for their project, and thus gradually establish a useful network of knowledge, contact, and cooperation for their specific business idea, parallel to the theoretical development of the business project.

Monitoring and tutoring. This is carried out with a co-commitment to the success of the chosen business idea. The ‘property right’ to the idea, however, remains with the student, or is shared with a company in the case of a joint venture. This function differs both from classical university tutoring and normal busi- ness consultancy.

It is a training as a generalist not a specialist. T he educat ional program on a whole can be said to have a holistic approach. The coming leaders of a new venture are expected to have both the technical, and the economic, and the organisational insights necessary to understand and run the planned enterprise, and they have become t rained in making and using a development st rat egy for t heir business vent ure as well (‘plan de gest ion’).

The ‘exam’ consists in actually getting the new business venture going. There is no formal exam to mark t he end of t he program. T he aim is t o creat e ent erprise leaders wit h ent repreneurial capabilities, not professional project makers, nor firm owners afraid of growth.

Phases in the educational process

The mission statement of Saiolan underlines the individual attention to the particular entrepreneur and the project idea all the way through to its realisation as a new business. Even so certain tasks, processes, and phases are identified as common to all. The process roughly has three phases, whose duration vary with the project. After a few months during which the entrepreneur students develop a study of a particular technology, types of products, or economic sector, a specific business idea is chosen by the student, the Saiolan tutors, and eventually local business people together. Then the student and the project are assigned a tutor from Saiolan, and through the next year and a half a prototype of the product is elaborated, a feasi- bility study, and a business plan. During this phase the student might take specific courses in order to ac- quire the necessary technical competence for the business in question. This phase may last 1 year. Before finally starting the business the prototype product is tested in the market.

Table 2: The sectors and numbers of firms which originated in Saiolan and were functioning by the end of 1996 Period of start-up 1986- 1991- 1996 Total Sector of start-up 1990 1995 Information technology 1 3 1 5 High technology products 7 1 1 9 Service, consultancy, educative, artisanary 2 16 2 21 Total number of start-ups 10 20 5 35 Source: Saiolan

The types of enterprises which have originated from Saiolan are shown in table 2. The range goes from Information technology to production within metal works and high technology to various business ser-

75 vices, artisan production, and educational and consultancy services, as well as firms within the social en- terprise sector. An interesting type of new firm projects has been developed in later years. They are community development projects which combine a commercial enterprise in the urban millieu with an artisan producer enterprise in a rural district, within the same value chain (brand of products). Another new area of project s originat e in environment al concerns. Some have been const it ut ed as cooperatives, but since many initiate their business with few people, most have private ownership or in the case for bigger projects: stock ownership.

.. Saiolan functions in the crossroad between the firms that produce and sell their products, the re- search centres that contribute with their technology, the Mondragon University and other centres of business development and consultancy, like the LKS. In synthesis, it forms an all-together which could be named ‘knowledge on enterprise creation and work’, a raw material which is intangible, but maybe the most necessary one, and also the most scarce one when it comes to creating enter- prises, new business opportunities and new jobs. Conference-paper by José María Ormaechea (1999) Co-founder of the first Mondrag-on Cooperative, director of Caja Labor-al 1960-87

The Mondragon Cooperative Cooperation (MCC) and Saiolan

The MCC created a couple of years ago (1997) a fund to support innovative initiatives within the Mondragon cooperatives. The fund covers the costs of development when member cooperatives address Saiolan with a business idea that they would like to develop into a new spin off’ project. In case of success the financial support will be paid back, in case of failure the fund will cover the loss. This reform has made possible a very interesting innovative form of cooperation between the particular cooperative enter- prise and Saiolan, where Saiolan offers to select the students that will be the entrepreneurs of this project (in consensus with the firm, naturally). On its side, the firm in question, assigns a person to follow the project and accepts that these students, eventually, become the managers of this new venture in case it prospers. Saiolan commits itself to monitor the project development by assigning one or more of its tutors and teachers to participate actively in the successful development of the project until completion. Since this agreement has been signed, 6 entrepreneurial projects in joint venture with MCC-cooperatives have been developed and become new cooperative business units.

Community/social entrepreneurship

Saiolan has acquired an important function locally as a place that develops new knowledge on viable pro- jects and methods in the community. Through time it accumulates experience about conditions and meth- ods for developing new business ventures in the region. This function was apparent in 1990 but has since become much more pronounced. The Saiolan approach has influenced the way the public authorities in the province look at promotion of and support to the creation of new employment. Since 1997 their ideas and methodology have become integrated as one of the ways the MCC promotes for the creation of new jobs in the cooperatives. In this sense Saiolan and its personal have become, what has been called ‘community entrepreneurs’ or ‘social entrepreneurs’, meaning that they contribute to the formation of entrepreneurial energy and processes at community level for local business. (Johannison 1986 and 1989).

The role of the centre in generating a viable business idea, the participation of the monitor in the process, and the combination of education and enterprise generation are the three most specific features of this methodology. These features are not necessarily specific to a cooperative development, but it happens to be very much in the tradition of the Mondragon Cooperative Experience which time and again has gener- ated new organisational ideas from the educational sphere, and whose inspirator, the priest Don José Arizmendarietta emphasised and practised the constant close connection between learning and work ie.

76 between education, enterprise, and community. In this sense Saiolan is one more result of ideas realized by people who are socially and economically embedded in a cooperative business culture. And it gives substance to a hypothesis that with the right mix of social and economic forces (competences and wills) the cooperative values in business are not only no hindrance for the success of a combined efforts of busi- ness economic growths and social developmental concerns, they even facilitate such development, also after year 2000.

References

Clamp C. “The internationalization of Mondragon”. Paper presented at the ICA research conference in Quebec 1999. Ellerman D. “The socialization of Entrepreneurship. The Empresarial Devision of the Caja Laboral Popu- lar”. Sommerville MA, U.S.A 1982. Ellerman D. “Entrepreneurship in the Mondragon Cooperatives”. Review of Social Economy 1984;XLII:272-94. Gartner WB. “A conceptual framework for describing the phenomenon of new venture creation”. Acadamy of Management Review 1985;10(4). Jakobsen G. ”Uddannelse i Virksomhedsivœrksœt t else”. En analyse af uddannelsesmodellen på Saiolan- Centret, Mondragon Spanien. Copenhagen Business School, Copenhagen 1990. Johannison B. “A territorial strategy for encouraging entrepreneurship. Progesss report from field research into stagnating Swedish communities”. Paper presented in Masachusetts, USA 1986. Johannison B, Nilsson A. “Community Entrepreneurship - networking for local development”. Journal of Entrepreneurship and local Development 19898;1(1):1-19. Kent CA, Sexton, Vesper (eds.). “Encyclopedia of entrepreneurship”. Englewood Cliffs, Prentice Hall 1982. Larrañaga J. “El cooperativismo de Mondragon. Interioridades de una ”. Azatza (Otalora), Bilbao 1998. Ormaechea JM. “Orígenes y Claves del Cooperativismo de Mondragón Otalora”. Aretxabaleta 1997. Ormaechea JM. “El Empleo en la “Experiencia” Cooperativa de Mondragón”. Paper for conference in Colombia, January 1999. (manus) Saiolan. “Centre for Forming Entrepreneurs and Development of new Business Activities”. Mondragon 1997. (manus) Schumpeter J. “Theory of Economic Development”. New Brunswick, New York 1983/1934. Schumpeter J. “Capitalism, Socialism, and Democracy”. Harper and Row publishers, New York 1975/1942. Shapiro A, Sokol L. “The social dimensions of entrepreneurship”. In: Kent, Sexton, Vesper, (eds.) Ency- clopedia of entrepreneurship. Englewood Cliffs, Prentice Hall 1982.

77

Employee Representatives as Company Strategic Actors – in an Enacted World Søren Christensen, Ann Westenholz

Introduction

In 1973 the Danish Parliament revised the Corporation Law making it possible for employees to be on the board of directors in companies. If a majority of employees in a company decides that they wish to be represented on the board, they can elect one third of the board members in companies of at least 35 em- ployees. Of all the employees embraced by the law, 60% work in companies that are covered by the law. T he larger t he company is t he more frequent ly t his is t he case. Of companies employing more than 500 persons, 80% have employee representatives on their boards. The percentage for companies employing 100-499 persons is 50, while it is only 13 for small companies employing between 35 and 99 persons. In the article, we will not be discussing the reasons for these differences, but instead draw on a recent study that reveals that employee representatives come to share the view of the other board members (elected by the general assembly) on the market and company strategy. Simultaneously, however, employee represen- tatives seem to maintain their perspective on employee interests.

We will be focusing on what employee representatives have been and can be used for in Danish boards of directors. In our attempt to answer this question we will throw light on the work of boards over the last twenty-five years and the part played by employee representatives. Our perspective is that the board of directors in Danish companies has been constructed and has constructed itself as a strategic body in the management of the company. Through their involvement in the work of the board, employee representa- tives have become part of the board team and have helped pushing the board toward assuming a role in strategic planning.

Employee Representatives on the Board as 'Company Strategic Actors'

From wage earner to organizational citizen Findings from our study12 show that employee representatives on boards of directors have come to share with the remaining board and the management a market perspective on the company, whereas there is a

12 The study which we refer to was concluded in 1995-1999 and the findings are published in Danish in Christensen & Westenholz (red.), 1999a; Westenholz, 1999 and in English in Christensen & Westenholz, 1997, 1999b, 1999c, 2000. The methods used were: • Documents from the period 1945 to 1973. The material cover debates in the Parliament, internal debates in the political parties and in the labour market organisations, archival material at the ministry for Trade and Industry. • A number of analysis on Board of Directors published after 1973. • In 1997 we interviewed 5 members of Parliament including the Minister for Trade and Industry who was in charge of the Ministry in 1973 when the legislation on employee participation in company Board of Directors was passed in Parliament in 1973. • Two representatives from the labour market organisations who were involved in the issue of industrial democracy when the legislation was passed in 1973 • Survey of 41 companies. Telephone interviews were conducted with a total of 219 people, 28 of whom were chairmen/board members elected by the general assembly, 100 were board members elected by the employees, 37 were members of the management board, 26 were members of co-operative committees and were 25 shop stewards. The interviews were structured around predefined categories, which made it possible to do statistical analysis of the data. • 7 high-ranking and experienced chairmen of larger Danish corporation were interviewed. These 7 people were members of a total of 118 board and chaired a total of 56 boards. They were interviewed in dept for 1,5 – 2 hours. The two authors were both present at the interviews that were taped and later transcribed. The interviews were structured but were conducted as conversations around certain categories.

78 greater gap between the perception of employee representatives on boards and shop stewards concerning company issues. Table 1 illustrates this development and gives the criteria that are important to employee representatives and elected board members, managers, and shop stewards in forty-one Danish companies. The higher the figures are in the table, the greater is the importance ascribed to the given criterion.

The fact that employee representatives on boards have developed a market perspective does not imply that they have abandoned the employees that have elected them. Table 1 shows that employee representatives still find it important to take employee interests into consideration when making significant decisions. Furthermore, 73% of employee representatives state that they safeguard the various interests of employees in their board work. Our interpretation of this development is that employee representatives have assumed a role on the board implying that they cater for the long-term survival of the company and use the em- ployee as reference group. In effect, employee representatives on boards do not define themselves as 'wage earners' but rather as 'organizational citizens'. The border, or distinction, between 'us' and 'the others' has moved from employees versus company to company versus market.

What has led to this development? The question is interesting in that employee representatives on boards cannot immediately be viewed as natural 'organizational citizens'. In the following we will argue that em- ployee represent at ives develop t heir ident it y in a social const ruct ion process t hrough which their surround- ings ascribe importance to them as 'organizational citizens' simultaneously with that they themselves begin to behave as company actors and assume the role as such.

The logic of capitalism versus the logic of democracy Processes of social construction are political. Among themselves the participating actors compete for how t o underst and t he ident it y t hat should be ascribed t o employee represent at ives. P art icipant s will be draw- ing on different inst it ut ional logics (cognit ive st ruct ures/frames of references) t hat t hey will apply to con- cretize the situation, and they will be competing for which institutional logic that is valid and appropriate as the 'natural' description of reality. These political actions take place at many different levels of society – levels that are often interwoven in that they affect one another.

Our analyses point toward especially two institutional logics that have been important for the historical development of employee representatives as 'organizational citizens'. One is the logic of capitalism, which, among other things, consists in the perception and practice that the right to manage rests legiti- mately with the owners of the company and their salaried management. The other is the logic of democ- racy, which, among other things, consists in the perception and practice that those involved in the com- pany production – i.e, the employees – have the legitimate right to participate in the management of the company. If one is deeply rooted in the logic of capitalism, applying a logic of democracy to the manage- rial right in the company will be experienced as unnatural and unwise. Therefore, one will reject the logic of democracy, because it contradicts what one finds a natural, right, and meaningful understanding of real- ity. (Friedland & Alford, 1991).

The political processes and combats over which of the two institutional logics that should apply to the managerial right of companies have taken place at many interwoven levels, nationally and internationally. The phenomenon of employee representatives on boards of directors, whose identity we can describe as

• Two companies were monitored closely for 18 months. We made interviews during this period with employee representatives on the Board, with the chairmen of the Board, and the managers and the shop steward. In one of the companies we monitored a process of strategic planning. A case was produced and discussed with and ap- proved by the people involved. • A survey of the courses on Board of Directors offered from 1974 to 1998. • Literature on Danish Boards of Directors during the last 20 years

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'organizational citizens', is the outcome of political processes at many levels among people who subscribe to the logic of capitalism and the logic of democracy, respectively. (Westenholz, 1999).

The international scene. First, the political processes are identifiable on the international scene where Denmark historically has been positioned in the cross-field between an Anglo-Saxon movement that car- ries a logic of capitalism, and a Central European that to a greater degree carries a logic of democracy. The tension between the two logics also characterizes the EU today. In the political processes in Denmark, actors have in different ways drawn on the currents from abroad.

Parliament and the two sides of industry. The political processes in Denmark have been related to the passing of bills and the entering into agreements where the political parties in Parliament and the two sides of industry have battled for which logic it would be natural/unnatural to apply.

Historically, the two sides of industry are entangled in a logic of capitalism in consequence of the Septem- ber Compromise of 1899 that granted the workers the right to unionize and the capital owners the manage- rial right. In effect, the two sides of industry have found it difficult to reach an agreement that rests on a logic of democracy. Therefore, it was the Parliament that in the end implemented the democratization of working life by passing the bill on employee representatives on boards of directors in 1973.

In connection with passing the bill, we witness the paradoxical political processes in the Parliament that the right wing parties, which traditionally view companies from the logic of capitalism, allowed them- selves to be persuaded into supporting the bill. It is our interpretation that they did so not because they favored the initiative, but because Denmark had just joined the European Communities (in 1972), and in their campaign prior to the referendum the right wing parties had strongly advocated for joining the EC. And many of the member countries had similar arrangements. Therefore it was difficult for the right wing parties to go against the bill, especially with the argument that it would be contrary to nature. Also the left wing parties that in the beginning were against the bill – because it was not sufficiently comprehensive – ended up voting for the bill. It is our interpretation that it would not have been legitimate for the left wing parties to go against granting employees a seat in boards.

The labor movement. The labor movement has also been characterized by internal political processes related to the passing of bills and entering of agreements as well as to the design of courses developed for employee representatives on boards. In relation to the latter, the labor movement has been facing new challenges, such as formulating the contents of the courses, and has been searching nationally for people that could contribute. Among others, the labor movement has drawn on business schools, leading to the inclusion of strategic thinking in the courses.

The company. Companies have been arenas for polit ical processes. Aft er t he passing of the bill, employ- ees were to decide whether they would find it meaningful to elect representatives for the board. It is not only companies that have resisted applying a logic of democracy to understand what it means to manage a company sensibly. Also certain groups of employees found it contrary to nature to participate in the man- agement of work. Likewise, not only groups among the employees have advocated in favor of a logic of democracy, this also applies to certain company owners/managers.

The board of directors. Concrete decisions have been characterized by political processes between the managers and the board about what importance should be ascribed to employee representatives as deci- sion-makers. In these processes, we find proponents of a logic of capitalism both among managers and employee representatives as well as proponents of a logic of democracy among both groups. It is at this level that we actually can observe the social construction of employee representatives as organizational

80 citizens. This is where they are ascribed importance as decision-makers and assume character as company strategic actors.

Employee representatives involved in important strategic decisions. At the concrete level, employee represent at ives have, t oget her wit h t he represent at ives of capit al, increasingly been involved in important strategic decisions over the last twenty to twenty-five years – decisions that are characterized by contex- tual uncertainty and ambiguity (Christensen & Kreiner, 1991).The most important problem for the board in such situations is not deficient information. The problem is rather the opposite - an abundance of infor- mation that is combinable in various ways (senarios). Therefore, the board is not in need of more informa- tion and rational decision making. It is rather a question of the board constructing one understanding of reality (Weick, 1995). This is achieved by constructing a meaningful pattern the realization of which it is willing to fight for (Smirchich & Stubbart , 1985). When it succeeds, it is able to impress the company's stakeholders in such a way that they become willing to support the constructed image of reality. Such processes are labeled 'enactment'. Not until the board has decided how reality looks can the board mem- bers remount t heir diverse int erest s in a meaningful way and can subsequent ly at t empt t o concret ize the consequences of a decision for their interests.

In the introduction we claimed that employee representatives maintain an employee perspective and the interests implied by this perspective. In consequence we refute the thesis of co-optation. Employee repre- sentatives on boards have not given in to seduction by the capital and adopted the interests of capital as their interests. Rather than claiming one's interests as premises for a decision (aggregation of special inter- ests), the board (including employee representatives) adopts a development perspective on the company (March & Olsen, 1989). This means that when the decision has been made, the various stakeholders (among others the employee representatives) attempt to deduce interesting consequences (viewed from each their perspective) of the decision.

In the next section we will in detail examine how Danish boards of directors have developed over the last two decades, how this development has affected employee representatives, and the effect of employee representatives as board members on boards of directors.

The Changed Role of Boards in the Management of Companies

Boards have increasingly been ascribed importance by the surroundings As stated above, the role of boards has changed radically over the last twenty-five years. From occupying a passive monitoring role many boards of directors have become actively involved in strategic develop- ment. There are several reasons for this development, the most important being the internationalization of companies. Acquisitions and strategic alliances have been intensified over this period resulting in changed business conditions and other rapid and continuous changes. Oil crises and business scandals have also helped put companies under new pressure and thus given boards a more symbolically prominent role.

Looking at the changes in Danish companies over the last twenty years it is evident that the world has changed. Companies have become more international. They have grown and been forced to in- volve themselves in risky ventures. You cannot just lean back and grow quietly, then you will soon discover that you have been run over by others that through acquisitions and innovations are now ahead of you. Consequently, you must engage in new types of decisions. On the one hand, compa- nies have become more international, which in itself involves high risks, and on the other hand de- cisions on the national market are characterized by greater leaps than earlier. Experienced chairman and member of several boards of directors. Engineer and previous managing director of several Danish companies.

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At the same time, the social climate in society has increasingly been characterized by phenomena, such as 'the political consumer' and environmental issues. This has not only led to greater media attention toward how companies run their businesses, but also to the perception that management is not only a 'technical rational' issue, but has increasingly become an institutional issue. It no longer suffices to ensure share- holders dividend, employees workplaces, and satisfy other stakeholders. Companies must also be able to create and sustain a good reputation in society. The latter two aspects are in reality inseparable. In effect of this pressure on the companies, the management's conditions and the board's role have changed.

If the board wishes to enjoy trust in society, it must be much more active than it was thirty years ago. Years back you could 'lend' the company your name, status, and position as a member of the board. T his in it self would make t he company t rust wort hy. But t he t rust also worked the other way round, i.e, the company trusted the given person. In many ways it was a self-fulfilling prophecy. This arrangements still exists today. When appointing members of a board, it is imperative that they enjoy trust in society. Therefore, you might claim that ethics and trust are sides of the same coin. Today, however, the trust you enjoy in society is most important. Member (elected by the general assembly) of several boards of directors in Dan- ish ompanies and Danish subsidiaries of international companies. MBA and works at a Danish business School.

Certain of these development traits point toward that not only top management but also boards of directors have come to play a more prominent management role. Especially concerning issues, such as growth in number of mergers, take-overs, discontinuations, and strategic alliances that relate to changes in owner- ship. Simultaneously, the growing attention of society toward companies makes it possible for boards of directors to play a different role because the board rather than the top management is being perceived as representative of the overall interests of the given company.

Safeguarding interests versus perception of reality. Many boards have exploit ed t his possibility and proven capable of establishing this competence successfully in situations of high contextual uncertainty and ambiguity. By exerting the influence that has been ascribed to the board, it has been able to create a common understanding of reality among the company stakeholders rather than consensus on the safe- guarding of int erest s.

In our attempt to explain how the board has achieved this status in the eyes of the company and the sur- roundings and how it is capable of staging rather comprehensive 'development leaps' successfully we have already referred to the profound changes over the last twenty-five years that have contributed to change the conditions for survival of the company. We find the decisive cause of the board having assumed this key position to be that the surroundings have ascribed managerial competence to the board.

Management is like caching a cold. In our argument we draw on t he American social psychologist James Meindl (1993) who claims that managerial success not (exclusively) depends on the manager's personal or on the manager having adapted his management style to the situation. Success is not primar- ily due to the manager, but to the persons surrounding the manager, who ascribe 'managerial competence' to him or her. Therefore, the manager is only the indirect sources of his or her own success – management is like catching a cold.

If we apply this metaphor to the board, it is the surroundings that during the last twenty-five years increas- ingly have ascribed 'managerial competence' to the board and hence enabled it to exert management.

T he media have played an import ant role in t he development t oward ascribing increasing responsibility to boards for the development of the company. Whenever the media decide to focus on a company, such as

82 when great public interests are at steak (employment, environment or ethical issues) it is the board of di- rectors, and in most cases the chairman, that acts as representative of the company.

Employee representation on boards has also contributed to this process. First, the fact that the bill was passed unanimously by Parliament in 1973 (which granted the employees the right to elect representatives among themselves for the boards) emphasizes the important that not only the Parliament and the political parties but also the two sides of industry ascribe(d) to boards as significant decision bodies.

Second, the employee representatives have put 'family boards' under pressure by expecting the board to act professionally.

Slowly and quiet ly boards have begun t o debat e issues. Not t hat I want t o boast about it , but it is the employee representatives that have brought about this situation, because we don't hold our tongue. We ask silly questions: 'What does that mean?', 'Why not?' and 'This looks strange’', and 'Have we provided sufficient reserves in that account?', etc. It is obvious that top management is excessively annoyed, but it will have to live with these questions. Employee representative on the board and senior shop steward.

…previous tendencies for in-crowds, shallowness, etc. are disappearing. It does not work to talk about golf or tennis, when employees are present. In that way the law has benefited board members elected by the general assembly more than the employee representatives! Experienced chairman and member of several boards in larger Danish and for- eign ompanies. Lawyer and previous managing director of a Danish owned mul- tinational company.

Among other things, new members of boards have implied that existing board members have been asked to work out a better basis for making decisions. This has not only been for the benefit of employee repre- sentatives, but also the other board members that were not always adequately informed.

The board is successful – by impressing the environment The board is often understood as a coalition of interest groups (various groups of shareholders and of em- ployees). Board members elected by the general assembly are assumed to promote the interests of share- holder groups in t erms of short - and long-t erm profit , whereas employee represent at ives are supposed to promote employee interests, such as high rate of employment and good working conditions. In many cases the various interest groups lack information on how best to safeguard their interests. The processes are political in that all parties attempt to safeguard their own interests but in a way that balances interests. These implies analyzing the situation from the perspective of one's interests (involving more information) and make the other interest groups yield toward one's own interests (using power/influence/negotiations). In this perspective, the board has two important functions in relation to the company and the environment: controlling the company and setting the strategic agenda for the long-term survival of the company. The interest groups fight over exerting the greatest power/influence on these two aspects of managing the company.

We will, however, argue for a different perspective on the board's work. On the one hand, we will main- tain the idea that members of the board bring along to the boardroom different interests. On the other hand, we find that decisions on strategic issues are characterized by ambiguity that the actors cannot re- duce by collecting more information. This means, that more information will not help the board members clarify what serves best their interests. They cannot decode reality and therefore interests are not very use- ful – they cannot be used to govern the decision process. In order to reduce ambiguity the board members must, instead, create meaning from the information they have, and this situation often turns them into a

83 team. In other words, the board creates a shared image of reality that tells it what kind of market, the com- pany is operating in. By acting according to this image of reality the board constructs reality. In deciding how it assumes reality to be, the board members simultaneously enact their decision. But the process does not end by the board's decision. Subsequently, board members 'selling' their image of reality to the com- pany's stakeholders must legitimize the decision. In this part of the process, stakeholder interests play a significant role as the decision must be legitimized in relation to different interests. We will later unfold this view, but first we will turn to the development in the role of boards over the last twenty to twenty-five years.

The ability of boards to 'create reality' and set the development perspectives of the company has two im- portant dimensions. The first involves selecting and socializing board members. The second involves the ability to reach consensus and convince the rest of the company and its environment about the perspec- tives of development plans.

Recruitment and socialization of board members The board reaches consensus on which role it should play by carefully selecting new members. This strat- egy is only applicable in cases of members elected by the general assembly. Here the board exploits its network of personal contacts to ensure that new members not only will contribute with something new (special expertise or experience) but also that their chemistry fit into that of current board members.

As chairman of t he board you begin by ident ifying t en t o fift een persons t hat by and large will fit in- to the board. Then you inquire among the current board members [elected by the general assembly]. Then one of them says 'I know that guy. He is dangerous. Don't touch him.' In that way you shorten the original list and are left with three to four candidates. Then the chairman and the vice-chairman put their heads together. They talk confidentially with people they know. This could be a banker that you know well or who knows the potential candidate. In a small country like Denmark, we al- ways know the three best candidates. Experienced chairman and member of several boards in larger Danish and for- eign owned companies. Lawyer and previous managing director of a Danish owned multinational company.

Naturally the same strategy is not applicable when it comes to employee representatives. In many cases, however, the chairman of the board will socialize employee representatives into their new role and give them a careful introduction to the tasks of the board. In this context, the chairman will emphasize the dif- ference between performing the role of shop steward and that of board member.

When I was elected employee representative in 1990, Mærsk McKinney-Møller, who was chairman of the board at that time, invited me to a meeting in his office. I was really nervous – to meet a man that you only know from the newspapers and TV. Of course the others had told me about him be- cause he had been chairman of the board for many years, but to go and visit him in his office! I would have to put on my best suit. The chairman of the board, Mærsk McKinney-Møller, would introduce me to the board's work. He always did t hat t o new members. It was quit e unusual at t hat t ime, but it was a very good idea. I was shown into Mr. Møller's office and of course I had some ideas about what to say. But all my ideas were for nothing. Mr. Møller started by telling me about his own career, his life, and how he got to sit on boards and his experience. Then he proceeded to tell me about the board's work and said that as a new member of the board there will be many things that one does not understand. Always ask questions, he said, don't forget that. And don't worry about the questions being silly. After this in- troduciton I went back to the factory. Employee representative on the board since 1990.

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Peter Heering (the chairman) called me into his office. He was a personal friend of the royal family and extremely conservative. He was standing up writing. I thought what kind of a guy is this. He carried himself as erect as a broomstick. But I was treated extremely well. That was my introduction to the board of the sugar factory. Later on we actually became good friends, but he remained con- servative whereas I supported the Socialist People's Party. Those were the days when we wore par- tisan headscarfs and long hair. I had long black hair and a ring in my ear so it took him several cups of tea to accept me. Employee representative on the board since 1974 and senior shop steward since 1964. Unskilled worker. Retired in 1998.

If t he employee represent at ives t hemselves do not realize t here is difference bet ween working as a shop steward and on the board of directors, the chairman will often prevent employee representatives from air- ing their opinions. This approach, however, impedes socialization rather than promoting it. Therefore, in order to further socialization (not only of employee representatives but also of members elected by the general assembly) the board will, behind closed doors, develop the perception that stakeholders in the company are often short-term and aim to safeguard own interests. This perception reflects the identity of the board as a strategist oriented towards the long-term company perspective. The establishment of this identity strengthens the among board members and is important for the success of the board.

Another technique for creating group solidarity is that the board always seeks to involve all members of the board and to reach consensus. In specific cases the chairman may let each member speak his or her mind.

That (voting) is something Ann Westenholz I have never experienced. I will not, usually, put up with issues being put to the vote. Then we must go on discussing until we reach agreement. I would not like having to vote down any one. Then we go on until we find a solution. This goes for all companies, I don't think that I would like to live with a majority vote. Experiences chairman and member of several boards of directors. MSc in busi- ness administration and self-employed.

You can also attempt to create a dialogue and in that way make people feel more confident and so- mehow make them talk about what they are thinking. It is important that people understand that although the system of boards institutionally is founded in the corporate law, the work becomes mo- re fruitful if we can have a dialogue on the various issues to be dealt with. Experienced chairman and member of several boards of directors. Lawyer.

Work in the board is instrumental. It is 'serious business', but at the same time the board is surrounded by symbols that are important in the construction of the board as a significant decision making body in the company. The board conference room, the atmosphere during the meetings, the dress code, the humor – it all represents the building blocks for the social construction of the board.

In the boards that I am member of I attempt to keep an informal tone. It is important how we create confidence in a company, especially the employee representatives. Often the various members in- tervene in the debate, and the chairman thanks them for their contributions. You can also attempt to create a dialogue and in that way make people feel more confident and hence make them talk about what they are thinking I do my best to create a good atmosphere, unpretentious and humorous. I find it important that board meetings do not become pretentious in a bad way. Board meetings can both be serious and have room for a few jokes. It is important to have a good dialogue. The good dialogue characterizes

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all the companies in which I am a member of the board. If this were not the case I would not be a member of the board. Experienced chairman and member of several boards. MSc in business administration. Self-employed.

We assume that humor is important for the board being able to function as a team and reach consensus in situations of contextual uncertainty and ambiguity. Humor makes it possible to face threatening situations in a more immediate and spontaneous way. (Hatch, 1997).

If the board members have close contact with their constituencies, they will begin to play games different from what they are expected to do as board members. They might end up abandoning to play the role as board member and only safeguard special interest even though they are still members of the board. Viewed from this perspective the fact that board members are bound by secrecy becomes an advantage in that it protects the members – not only the employee representatives but also those elected by the general assembly – against special interests among their constituencies. On the other hand, professional secrecy also implies that the employee representatives often appear as invisible to their constituencies, which might create problems when having to legitimate decisions.

The board's work and relation to the environment The board as a theater ensemble. In t rying t o underst and how boards in large companies have been able to fulfill successfully their role as company strategic actors and prime movers of larger development pro- jects, we have been inspired by Erving Goffman's book The Presentation of Self in Everyday Life. Goff- man uses the theater metaphor for understanding human behavior as stage performance. Goffman's analy- sis in certain ways resembles our observations of board work. Therefore, we will view the board as a thea- tre ensemble – a team – that scenically is occupied with 'making strategic decisions'. This implies that the board is rehearsing a drama, the manuscript of which in part is written by the top management often in collaboration with the chairman of the board. The board rehearses behind closed doors before it appears on stage to convince the audience that the decision it has made is sensible compared to the multiple differ- ent crit eria and demands t hat t he st akeholders base t heir judgement s on. Some of t he audience is sitting in the front seats, such as the management, the auditors, and perhaps external consultants. Others have seats further back in the theater and only turn up occasionally, such as shareholders, employees, creditors, cus- tomers, suppliers, financial analysts, the media, and the public. When the board in its capacity of writer, instructor, and actor of the performance can move and impress, the audience will leave theatre with a new perspective on their own activities – not necessarily an identical perspective – and the performance can be said to have been successful. The board has succeeded in mobilizing sufficient support to launch a devel- opment project in the company.

Goffman uses the theater metaphor to distinguish between what happens on and behind the scene. Behind closed doors, the board 'rehearses' the definition of a development perspective for the company which the board members are willing to support. The process is one of interpretation. Jointly the board members manage high ambiguity and reach a mutual perception of the identity of the company. Therefore, the board 'rehearses' behind closed doors the 'play' that it will subsequently 'perform' for its environment. Conse- quently, what goes on behind closed doors differs greatly from the stage performance. Not until the board members have reached agreement on what to present to the 'audience' does it appear on stage – or in most cases only the chairman of the board appears. The objective is to mobilize the 'audience' and make an im- pression resulting in that the audience identifies with the message in such a way that it wishes to take part in the change process. The art is to avoid that certain interest groups twist the message in a certain direc- tion by attempting to read into it various concrete interests. If this happens it is most likely that the change process will come to an end or be derailed. The art of this performance is thus not to manipulate the audi- ence, but to mobilize it.

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Whether the audience will praise the board depends on the ability of both parties to comply with certain ethical rules tied to their mutual relationship. Goffman (1959) claims that in order to perform their job successfully, t he 'act ors' must demonst rat e loyalt y, discipline, and circumspect ion t oward the role and each other, and they must demonstrate discretion toward those that watch and assess their work. Success also depends on whether the audience will demonstrate discretion towards the actors. Below we will describe how this makes sense in relation to our empirical data.

Loyalty. The demand for loyalty implies that the board plays its role as mediator of continuous develop- ment and adaptation of the company in response to changing conditions in the environment. The perform- ance aims to convince the audience that the company will always yield profit and be attractive.

There are various techniques for ensuring the loyalty of board members toward their role. One way is to create a high degree of internal consensus on which role the board should play. Another is to reduce con- tact between board members and their constituencies.

Discipline. T he act ors must remember t heir lines in t he manuscript and not make illtimed remarks causing doubt about the quality of the manuscript. This means, for example, that employee representatives will not cause their colleagues to doubt a decision that they have supported as members of the board. Instead their role is to convince colleagues of the sensibility of changing perspective, i.e, attempt to assure their col- leagues of the relevance of viewing their interests from a new perspective in which it becomes relevant to engage in the long-term survival of the company in order to fulfill employee interests. Board members elected by the general assembly are facing the same challenge. They cannot either reveal the 'secrets' of t he game t o t heir const it uencies (diverse capit al groups), but must t ry t o assure t hem of t he sensibility of joining the development perspective.

Second, discipline means that board members whose job it is to present to the audience board decisions on the one hand must merge with the role as board member and play in a spontaneous and honest way. On the other hand, he or she must also be able to dissociate himself or herself from the role in order to find out whether the performance requires special remarks targeted for the specific audience that one is facing. This means that the manuscript is never completed, but continuously adjusted during the performance. Therefore, the various board members that are asked to perform in front of different parts of the audience can further develop the manuscript, which may result in new and diverse input to the future work of the board.

Third, discipline means that board members cannot give in to personal idiosyncrasies when they act as board members. If you quarreled with your spouse/children prior to the board meeting, you leave this role/experience outside the boardroom. You will stage yourself to be a member of the board and not of the family. You will also disregard your dislike of other board members. If one of the board members says something that you find ridiculous or naive you do not laugh at him or her causing the person to lose status as a member of the board. This does not imply, however, that board members cannot have informal con- tact with each other. They often have over lunches or dinners, and such informal contacts seem to have a positive impact on their interaction during the formal meetings. But informal contacts unfold in such a way that they reproduce, and not undermine, the identity of the board.

Forth, discipline means that as a member of the board you will not take over fields of activity that belong to the jurisdiction of top management. It is difficult to draw a clear line between the tasks of the board and of the top management, and the line must be adjusted continuously. However, the mere fact that board members only have a limited amount of time to spend on their tasks helps them refrain from expanding to areas that 'belong' to top management. On the other hand, having limited time for the board work also means that the members must discipline themselves in relation to commenting on issues.

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I don't think that I have been in situations where great decisions haven't been characterized by rea- sonable openness. …Time is short in board meetings, so if you want to be serious about being a member, then you must be active during the meetings. It is my experience that if you argue well for your points, the board will take you seriously. Member (elected by the general assembly) of several boards of directors in Dan- ish ompanies and Danish subsidiaries of international companies. MBA and works at a Danish business School.

Circumspection. In order for t he board t o perform it s t asks successfully it must be careful in presenting its decisions to the audience. Therefore, many boards leave it to a few loyal persons (the CEO and/or the chairman of the board) to make public statements. (This might create problems of legitimacy for the em- ployee representatives that thus become invisible to their constituencies).

The supplemental strategy might be that the board selects the group, for instance of employees of or of certain stakeholders, to which it wishes to convey specific information. The less the group, the less is the risk that information will be passed on to others, and the greater the possibility of 'hitting' the audience in the right place. If information is targeted at employee representatives, certain boards have chosen to let employee representatives perform for the audience in that these are assumed better to be able to stir and move employees than for example the top management or the chairman of the board.

There is at least one situation in which employees can make a specific contribution and that is if the company is in a crisis situation, such as vast lay-offs. I have experienced this situation in a Swedish corporation. Here, the board decided at a meeting, in which the employee representatives naturally participated, to close down a large factory in a small local community which would have serious human consequences for the employees. The situation had been discussed in detail in the board (one of the employee representatives worked at the factory in question), and the decision was unanimous. It was evident to every one that the strategy was right. Nevertheless the media and the political are- na were highly critical of the decision. Here the employee representatives stepped forward and de- fended the decision. This was of invaluable importance to the top management and, which was also important in this case, to the corporation. I must admit that I was happy and proud to call the em- ployee representatives, especially the guy working at the factory and who risked loosing his job, my colleagues. Experienced chairman and member of several boards in larger Danish and for- eign wned companies. Lawyer and previous managing director of a Danish owned multinational company.

Ta c t . The success of the board is not determined solely by the board demonstrating loyalty toward its role and displaying discipline and circumspection in its performance. The surroundings must also play a role in that various stakeholders refrain from insisting on getting behind the closed doors.

If members of the board and parts of the stakeholders nevertheless enter into closer collaboration, and this may include both members elected by the general assembly/their constituencies and the employee repre- sentatives/unions, they keep a low profile. In such cases, constituencies must not give away that they have spoken to certain board members and vice versa. If they do, they will ruin the game that the board tries to stage in its own name.

Goffman mentions two strategies for demonstrating tact toward the audience. One is to be sensitive to criticism from the audience; the other is to avoid saying anything to the audience against one's better

88 judgement t hat will give cause for accusation of having manipulated with the audience. Our findings show t hat boards apply bot h st rat egies.

In recent years, a new type of audience has appeared on the scene: institutional investors that have de- manded more informat ion about board act ivit ies. In t hese cases, t he CEO or t he chairman of the board will regularly invite investors for a briefing. But investors are also kept at arm's length. The CEO/chairman of t he board can refuse t o answer cert ain quest ions referring t o t hat informat ion would ent ail knowledge that could be used for insider trading, which is illegal in Denmark. When informing external stakeholders, that expect certain information, it is difficult for the board to strike a balance. Answering questions might im- ply leaking confidential information that can be used for insider trade or to stop an important development project.

As the board must be jealous of its identity and board members might face situations in which it will be unwise, viewed from the perspective of the board, to tell the whole truth to the stakeholders. The board might be about to launch a development project of high risk – irrespective of what the board decides. In this situation, the board might decide to down play the risk in order to make it attractive to potential stake- holders. But if the board opt for this approach it must do it in a way that makes it impossible for the stake- holders to accuse it of having cheated and manipulated. The board's statement must comply with the 'rules of misinformation', that is, it must ensure that it can subsequently claim not having been able to predict the risk.

Conclusion

We have argued that today boards of directors in Danish companies play a far more strategic role than they did twenty-five years ago. The last twenty-five years have been characterized by growing interna- tionalization and the introduction of new technology. But this development in itself does not explain fully the changed role of boards. The new role of boards must also be understood against the fact that the sur- roundings have ascribed a strategic role to boards. The media has played a strong role in this ascription, and we argue that the entrance of employee representatives on the board scene has led to further profes- sionalization of boards.

But the development has also affected the employee representatives. The surroundings has ascribed them importance as strategic company actors and they themselves have taken this role seriously and acted ac- cordingly. Contextual uncertainty and ambiguity often characterize strategic decisions. In such situation it is impossible to interpret reality or calculate which decisions would most appropriately serve one's inter- ests. Instead, the employees have, in collaboration with the board members elected by the general assem- bly, helped giving meaning to the situation of the company. In other words, they have helped shape a vi- sion for the company, the sensibility of which the board has been able successfully to convince the stake- holder, the press, and the public about. Naturally, the board does not always succeed in convincing the environment. In our opinion, success should not solely be understood in the instrumental qualitative sense of the board's decision, but also in view of the board's ability to convince and engage the environment in the company's development projects. And it is in this context that the employee representatives play a special role in relation the company's employees.

Finally, we have argued, t hat t he development in Denmark has been unique in t hat t he employee represen- tatives have become integrated into the management of the company. In that respect we are far ahead of other countries that we compete with, and we expect this situation for become an important competitive parameter in the future provided that we will understand how to stage it.

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