Friday, May 1, 2009

Detroit: Employee Ownership and Control

The United Auto Workers’ Union “is likely to emerge as one of the biggest shareholders in the three Detroit carmakers: GM, Ford Motor and Chrysler … It could end up with 55 per cent of Chrysler, 39 per cent of GM and a sizeable stake in Ford if it accepts shares [which it did on 30 April] rather than cash for a chunk of the companies’ contribution to new union-managed healthcare trusts, due to be set up next year.”... “The prospect of union bosses in the boardroom has sent shivers down investors’ spines. The main front-page picture in the business section of Canada’s Globe and Mail newspaper on Wednesday showed a line of workers in blue jeans and T-shirts at a Chrysler plant in Detroit under the headline: “Meet the new board of directors”.” (Bernard Simon, UAW gears up to join boards of carmakers, FT 30 April 2009).

Employee stock ownership is not uncommon, whether in the form of individual ownership through market purchase or company award; of MEBOs (Managers and Employee Buy-Outs); of ESOPs (Employee Stock Ownership Plans whereby shares are eventually transferred to employees, for instance on leaving the company); or ESOTs (Employee Stock Ownership Trusts, holding shares indefinitely for a changing collective of employees, who only benefit from dividends). Stock ownership enables employees to participate in enterprise results, through dividends and (except for ESOTS) capital gains.

Any form of employee participation in enterprise results encourages higher labour productivity, not so much via greater individual effort, for the employee only gains a fraction of the extra product due to her greater effort, but through the greater intelligence and cooperation with which any given effort is exercised, and through each employee monitoring whether a sufficient level of effort is exercised by all other employees. Employee participation in enterprise results also creates a sense of identity with the company instead of a split between “us” and “them”, improves channels of communications and the chances of avoiding and resolving conflicts within the company. Unlike other forms of participation in results, like profit-sharing, the voting power attached to shareholding gives employees a pro-rata decisional power in company affairs. The dividends and capital gains attached to share ownership give a broader and permanent basis to participation in results, unlike the uncertain periodical revision of profit sharing parameters at labour contract renewals. Thus employee ownership transforms dependent labourers into part-capitalists/entrepreneurs. Employee ownership is part of both the Thatcherite “property-owning democracy” and the Blairite “stakeholders’ economy” (workers being the primary category of stakeholders, above managers, suppliers and creditors, buyers and debtors, local communities, the environment).

There is a European Federation of Employee Share Ownership (EFES) acting as “the umbrella organization of employee owners, companies, trade unions, and any persons and institutions looking to promote employee ownership and participation in Europe”, . There is a Central Eastern European Network for Employee Ownership and a Manifesto for the 2009 European Parliamentary Elections . In the last eighteen years the European Commission has issued no less than four major Reports on P.E.P.P.E.R., an acronym standing for Promotion of Employee Participation in Enterprise Results, which I happen to have contributed as part of an EC-funded research project on the subject, undertaken at the European University Institute in Florence in 1988-1990. The four Reports specifically endorse employee stock ownership. [1] The PEPPER Report IV (2008, cited in footnote 1) "presents conclusive evidence, regardless of data source, that the past decade has seen a significant expansion of employee financial participation in Europe. This is true of both profit-sharing and employee share ownership, although profit-sharing is more widespread" (see Ch. II and III).

If employee share ownership is common and desirable, a total stake sufficient to exercise control over the company, let alone an absolute majority stake, is an extremely rare occurrence; MEBOs are no exception, since there control is bound to be exercised not by employees but by managers, who have interests of their own. Sometimes a controlling stake by employees is the result of a generous benefaction by a successful tycoon without heirs – or without likeable heirs – wishing to reward those who have most contributed to his fortune. In the post-socialist economies of Central Eastern Europe employee ownership and control on a large scale has been the unexpected result of privatisation; for instance in Poland where MEBOs have been the privatisation form of the largest number of state enterprises, and in Russia where about 60 per cent of state enterprises involved in mass privatisation through the distribution of vouchers have ended up with a dominant shareholding by employees and managers.

In a market economy, most frequently, a company on the verge of bankruptcy may be taken over by employees at a token price, or in exchange for an outstanding or forthcoming liability otherwise incurred by the company towards its employee. This is the case of the Detroit carmakers. The guarantee of participating in the future benefits of company restructuring at a time of crisis makes the associated sacrifices more palatable to employees. On the other hand, substantial employee share ownership exposes them to the double risk of losing both employment and wealth in case of failure (as demonstrated by employee losses from Enron’s collapse).

Employee ownership is bound to have a positive impact on corporate governance, through employees monitoring directly, as insiders or, better, as members of the Board, company affairs and the information provided officially. The acquisition of a controlling share in company ownership by employees, however, creates the possibility of their exploitation of other shareholders, through the choice of strategies favouring the controlling employees and the appointment of managers inclined so to favour them. Thus shareholding employees will be in a position to promote higher wages and/or higher employment than would be consistent with the maximisation of share value for the benefit of all shareholders. This possibility is bound to occur if a controlling interest is in the hands of employees who, individually, hold a higher share of employment than in company stock, for in that case they will gain more from higher wages and employment, as employees, than what they lose as shareholders. [2]

This of course is not a unique problem associated with employee share ownership, but is common to all cases of ownership by any stakeholder. Indeed share ownership by company suppliers or customers is much more likely to produce such a conflict of interest between shareholding-stakeholders and other shareholders. In fact employees are many, while other stakeholders can be one and act more effectively; and other stakeholders can be a company exercising a controlling interest much greater than its ownership share through “chinese boxes” – a chain of companies holding a controlling interest in other companies ultimately controlling with a minimal equity participation the company in which the stakeholder is trying to assert its interest to the detriment of other shareholders. In this case the direct and indirect shareholding can be sufficient for control, while the direct interest is lower than, say, the supplier’s share in some input’s supply to the company, and a conflict of interest with other shareholders can very easily arise.

In Detroit the employee share ownership in Chrysler, Ford and GM will be vested in a single trust, a Voluntary Employees’ Beneficiary Association (VEBA), which the three carmakers agreed in 2007 labour contracts to set up as a way to keep healthcare costs down. Transferring obligations to the trust, they will strengthen their balance sheets and transfer risk to the union and its members, whose future benefits would depend on performance of the trust’s investments. In this case by definition the employees share in company employment (100%) is higher than their share in company equity, therefore the temptation of exercising control collectively to the benefit of employees and the detriment of other shareholders is present.

The risk of exploitative behaviour by employee representatives however is mitigated by the VEBA being managed by independent trustees with a fiduciary responsibility to protect retirees’ benefits. Moreover, “In keeping with the low profile that union leaders have maintained throughout their talks with the carmakers, the UAW has given no inkling of how it will behave as a shareholder. But union watchers predict that it will be less confrontational at the boardroom table than at the bargaining table.” And “VEBA trustees in other sectors have made diversification a key element of their investment strategy. Should the managers of the GM, Ford and Chrysler trusts follow suit, they are likely to sell most if not all their shares when the carmakers are on the road to recovery”. (John Read, FT 28/04/2009, . Finally, part of the Chrysler-FIAT deal is a FIAT share rising from 20% to 51% by 2016, thus eventually removing control from the AWU.

All’s well that ends well, then. But it goes to show that corporate governance and stakeholders interests can have unexpected, disquieting connections.

[1] Milica Uvalic, The PEPPER [I] Report: Promotion of Employee Participation in Profits and Enterprise Results in the Member States, Supplement No. 3/91 to Social Europe, Luxembourg, Office for Official Publications of the European Communities, 1991.

Commission of European Communities, Report from the Commission: PEPPER II – Promotion of participation by employed persons in profits and enterprise results (including equity participation) in Member States, 1996, COM (96) 697 Final, Brussels 8 January 1997.

Jens Lowitzsch et al., The PEPPER III Report: Promotion of participation by employed persons in profits and enterprise results in the New Members and Candidate Countries, Inter-University Centre Split/Berlin, Institute for Eastern European Studies, Free University of Berlin, Rome-Berlin June 2006

Jens Lowitzsch et al., The PEPPER IV Report: Benchmarking of Employee Participation in profits and enterprise results in the Members and Candidate Countries of the European Union, (Preliminary Version for Presentation to the European Parliament in Strasbourg, May 21 2008), Inter-University Centre at the Institute for Eastern European Studies, Free University of Berlin, Berlin May 2008.

[2] Nuti D. Mario, "Employeeism: corporate governance and employee share ownership in transition economies", in Mario I. Blejer and Marko Skreb (Eds) Macroeconomic Stabilisation in Transition Economies, Cambridge, CUP 1997, pp. 126-154, in particular the Appendix. Almost entirely downloadable freely at,M1


Anonymous said...

Hello Mario,
Interesting blog. So again some pepper in industrial relations?!
Here some ineresting comments on the US auto industry:
From NCEO: "At Chrysler and GM, It's Not Employee Ownership
The health-care trust arrangements at General Motors and Chrysler do not really constitute employee ownership". Corey Rosen has written a complete article on this. See below.

As part of their efforts to recover, General Motors and Chrysler both are pursuing agreements with the UAW to provide the union with company stock to help fund retiree health-care trusts. There have been a number of articles in the press saying that as a result, the employees will now be owners of General Motors and Chrysler. In fact, what is being proposed is not really employee ownership in any meaningful sense.

Chrysler had agreed with the UAW to give shares to the union health fund trust valued at 55% of the company and a promissory note for $4.59 billion to be paid with interest in installments. But if the shares can be sold for more than the price at which they were contributed, the U.S. Treasury gets the difference. It is still possible, if unlikely, that Chrysler's bankruptcy negotiations will undo this arrangement. GM is negotiating for a similar deal to fund half of its $20.4 billion obligation, leaving the UAW with 39% of the company.

A VEBA (voluntary employee benefit association) will hold the shares. United Auto Workers President Ron Gettelfinger told NPR Friday that "We do not have the ability [to hold a long-term stake] because of the cash needed in the VEBA." He said the VEBA will start selling the shares as soon as possible.

So how does this compare to conventional employee ownership through an employee stock ownership plan (ESOP), broadly distributed stock options, or similar arrangements? Unlike participants in such plans, employees involved in one of these VEBA arrangements do not see personal gains or losses from the share price other than to the extent that if the shares do go down enough, the VEBA may not have sufficient funds for retiree health care programs. Many, and perhaps most, current employees may never benefit from these programs, which very well could be reduced or eliminated in the future if the companies do not recover quickly. If the stock does perform at all well, it will be sold as soon as it meets the VEBA obligation, providing no potential upside.

Second, in actual employee ownership plans, employees individually have ownership attributed to them; here, the ownership is held on a short-term basis by a trust associated with the UAW.

Finally, employee ownership is very rarely used in troubled companies, despite all the media attention to companies such as the Tribune Company and United Airlines. Well under one percent of all employee ownership plans are used this way. Plans are typically set up in healthy businesses as a way to provide an equity stake to employees and, in the case of ESOPs, very often to transfer ownership over time to employees in a way that does not require them to use their own money to buy shares.

See also: Auto changes will create some strange bedfellows on page

With best regards
Marc Mathieu - European Federation of Employee Share Ownership

D. Mario Nuti said...

Hallo Marc, I am glad to see that the European Federation of Employee Stock Ownership is keeping a keen eye on what is going on also in the US.

Corey Rosen (Executive Director, National Center for Employee Ownership, has published a good article. I concur with his proposition that the Detroit arrangements, between GM, Ford, Chrysler and the Voluntary Employees’ Beneficiary Association (VEBA) run by the United Auto Workers’ Union trustees, are not a standard form of employee ownership. It is not an Employee Stock Ownership Plan because shares are never going to be distributed to employees. They are a kind of Employee Stock Ownership Trust (that holds shares for employees without ever distributing them) for the benefit of current and future retirees rather than of current employees. It is no more no less as much of a form of employee ownership as that of any ESOT.

The $4.59 billion promissory note mentioned by Rosen covers the other half of Chrysler’s liability towards the provision of retirees’ health benefits and affects only the scale not the nature of the arrangement. There are a few special strings attached, such as the U.S. Treasury’s entitlement to half the capital gain if and when the shares are sold, which is beside the point. “Chrysler's bankruptcy negotiations [might] undo this arrangement”; so, it’s not in the bag yet, though Rosen agrees “it’s unlikely” to be undone. And similar negotiations with GM might involve only 39% of the company in the hands of UAW: not a majority interest but most probably large enough to involve control in principle.

All the same, if the VEBA trustees behaved opportunistically, and took also the interests of current employees (who after all are future retirees) to heart and not just those of current retirees, a conflict of interest with other shareholders would arise. But in my post I did recognise that trustees were independent and charged with protecting the interest of retirees; that they were likely to sell their shares if only in order to diversify, if not also to provide a cash flow larger than dividends alone. And I pointed out that in any case eventually FIAT would end up holding a majority interest in Chrysler. I should have added that VEBA trustees will be in a minority of one in nine members of the Board, which clinches their inability to behave opportunistically even if they wanted to.

On the last point made by Corey Rosen there is a need for an important qualification, namely the distinction between an employees’ modest share of company capital, and a controlling interest with or without majority. Corey writes: “Finally, employee ownership is very rarely used in troubled companies, despite all the media attention to companies such as the Tribune Company and United Airlines. Well under one percent of all employee ownership plans are used this way. Plans are typically set up in healthy businesses as a way to provide an equity stake to employees and, in the case of ESOPs, very often to transfer ownership over time to employees in a way that does not require them to use their own money to buy shares.”

Yes, employee ownership on a modest scale, or even on a significant scale as long as it does not amount to a controlling interest and therefore does not challenge the company power structure, is “typically set up in healthy businesses”. But No, a controlling interest by employees is an extraordinarily rare event, except for “a troubled company”, precisely because a “healthy business” has no reason, or incentive, to surrender company control to employees; indeed it has every disincentive to give employees the opportunity to appropriate (“to tunnel”) corporate wealth to the detriment of other shareholders.

Thus it looks as if employee ownership on a sufficiently large scale to warrant control will happen only in a troubled company – apart from the atypical exceptions exemplified in my post. When it takes place for whatever reason, a controlling interest in the hands of employees is unlikely to be stable, as the changing collective of employees is unlikely, on departure or retirement, to transfer their shareholdings to other employees.

I looked up the other link you recommended, John Torinus, Auto changes will create some strange bedfellows ( The article is informative and dwells on the implications of the Union being “on both sides of the bargaining table”: advantages like more efficient health plans, motivation improvement, leaner work practices, but also disadvantages such as protectionist pressures, aversion to high managerial salaries, the additional cost of supporting green and mileage standards, forcing unionisation on suppliers. The issue of modest employee shareholding versus a major controlling interest is not considered.

Corey Rosen said...

Mario --

I don't know the source of your statement that employee majority ownership is extremely rare outside of troubled companies. In fact, there are at least 4,000 ESOPs in the US that a majority owned by the plan, and the percentage of the total 11,400 ESOPs that are majority owned continues or rise. All but perhaps a couple of dozen of these were set in profitable companies with no employee concessions. So I think your statement on this comes less from data than from anecdote. Employees have varying amounts of actual managerial control in these companies, but even when they do have a great deal, these companies run very much like other companies, just better. The real key is not control of the board but day-to-day input into how jobs are done, and these companies tend to have a great deal of that.

I would reiterate that I think what is going in at Chrysler and GM has very little to do with employee ownership. In fact, the UAW plans to sell its shares, according to them, "as soon as possible." I can't see this as making any long-term difference in what goes on at either company.

D. Mario Nuti said...

Corey -

Thanks for the good news. I am happy to stand corrected but I would like to know how many of those 11,400 majority employee owned companies have been born that way - in which case they would be a form of workers' entrepreneurship as unsurprising as cooperatives - and how many have been the result of non-employee shareholders voluntarily surrendering control. Willingness to surrender control of a successful company on such a scale is what I find surprising. Until this point is clarified I would like to reserve my position.

I have now joined your National Center for Employee Ownership, so once I get my username and password I expect I will be able to consult your Database and find out directly, but perhaps you can let me know on the blog.

I agree with your proposition that "what is going in at Chrysler and GM has very little to do with employee ownership", for many reasons:

because it is an ESOT not an ESOP, because it is retirees' instead of employees' ownership, because it is a temporary arrangement (terminated by FIAT getting a majority stake by 2016, if not sooner by VEBA declared intention to diversify) and anyway because VEBA representation on the Chrysler board is inexplicably constrained to a minority position in spite of the majority shareholding.

D. Mario Nuti said...

Italian-speaking visitors to this blog - who according to Google Analythics appear to be quite a few - may be interested in visiting This is the "goodwinbox" blog of the Faculty of Economics of Siena University, where a shorter Italian version of this post has generated some discussion.