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”, http://www.efesonline.org/ . There is a Central Eastern European Network for Employee Ownership http://www.efesonline.org/CEEEONet/servCEEEONet.htm and a Manifesto for the 2009 European Parliamentary Elections http://www.efesonline.org/2009/MANIFESTO/EN.htm . 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, http://www.ft.com/cms/s/0/be80a37c-3419-11de-9eea-00144feabdc0.html) . 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 www.efesonline.org/LIBRARY/2006/PEPPER%20III%20Final%20Print.pdf

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. http://www.efesonline.org/2008/seventh%20european%20meeting/Presentations/Draft%20PEPPER%20IV%20Report%20-%20Strasbourg%20Edition%20-%20Jens%20Lowitzsch%20and%20others.pdf.

[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 http://books.google.it/books?id=jTu-4jdiNlAC&pg=PP11&lpg=PP11&dq=nuti+employeeism+skreb&source=bl&ots=lkpNUarX0b&sig=PS4J18l1C9qhqu29dB-MQP3vfPU&hl=it#PPA150,M1