Sep 4, 2008

Workers Share Ownership – Giving it a Second Thought

Germany’s current government is about to implement a law which gives workers stronger incentives to share their companies risks by decreasing the tax burden for those who buy shares in the company. The government’s aim is to increase the current 2 million workers which make use of such schemes by 50%.

My first reaction, following simple economic instinct, was to be in favor of such an incentive system. The simple arguments which come to one’s mind are based on the idea that participation leads to a stronger commitment and hence potentially more productive and profitable firms. Workers get to share the benefits from these efficiency increases and the overall economy gets to gain as well. Looking at it from a very benevolent point of view one may even believe that this leads to a more equal sharing of the profits of a firm, similar to the tone in this FT article.

In the end this seems to be nothing else than what firms try to do with their managers: give them the incentive to work in the company’s shareholders interests.

Giving it a second thought, though, changed my view by 180 degrees.
There are at least three reasons, of which one, most likely everyone will agree with.
Let me start out with the most uncontroversial argument:

1) Optimal portfolio theory teaches us since more than half a century that diversification is beneficial. This implies not only for the single worker but also at an aggregate level that workers should not base all there revenues on a single source of income. Even though shares allow workers to compensate for low wages via increased capital gains, this is only the case if capital gains are negatively correlated with higher wages, i.e. the strongest argument for the participation scheme builds on the assumption that firms are to some extent zero sum and capital gains are made on the back of workers’ wage income. An assumption most people, that do not subscribe to the Marxist theories, at least want to be untrue. Under the extreme scenario a worker under the current scheme could loose both his sources of income if the company goes out of business. Hence, the right approach would be to create incentives for workers to hold shares of industries which are negatively correlated with the own company’s “business cycle”.[1]

2) The comparison between worker’s incentive schemes and those of managers is somewhat misleading. Whether we like it or not there is a clear asymmetry not only in terms of information about the company’s financial situation, but also in burdening the downside risk. Or, did you ever hear of a worker who gets a nice million euro package when “leaving” the company. This recalls to my memory the phrase of Charles Goodhart at a recent conference in Geneva, where he commented on the problematic salary structures in certain industries where upside benefits are private and downside costs are carried by the society (You may guess which industry he referred to).

3) Being rather a sociological than purely economic question, we may nevertheless ask whether it is not exactly the stability in income which makes the difference between a worker and a “capitalist”? Workers accept lower (productivity adjusted) compensation for a given time effort in exchange for reduced risk regarding their stream of income. A compensation system based on shares is working against this principle even if such a system may yield in the long run a higher average income (i.e. higher expected monetary value need not translate one for one into higher expected utility). In the end this is a subjective question since each of us has to answer how much risk we are willing to take in exchange for a potentially higher return. My guess however is that our tolerance level is rather low (unlike most simple utility functions that we use imply), or why are there so few entrepreneurs in the world?[2]

Hence, initially being a supporter of such a law I have turned to at least a strong skeptic. Good I gave it a second thought!

[1] This also implies that the additional tool envisaged by the German government, encouraging participation in a branch wide investment fund, rather than the single company is sub-optimal.
[2] This makes me think about an alternative way of trying to determine a country’s aggregate risk aversion, different to the traditional, rather fruitless one of estimating the Euler equation using GMM: just use the ratio of workers to entrepreneurs after controlling for some other aspects


Dany said...

First of all, Rigotnomics is one of the things that make feel good about coming back to lovely Geneva, long live!!

Cool post Sebastian. There are a lot of arguments in the discussion more than the simple idea of “shareholders workers” having more compromise with the firm. For example, unions can have now representation in the firm directory, as one more group of shareholders. This can be good since workers are participating in the decisions of the company, but also can be a new source of pressure amplifying the insider-outsider problem and other inefficiencies.

Pascal said...

As Dany, I think that the law is an attempt to align the interest of the unions with the interest of the shareholders. A union that holds shares is more likely to agree to restructuring the company and firing people, as it also raises profits. It's probably a morally less contentious approach, than the one taken by Volkswagen....

Dany said...

More about this issue in this VoX article by my favorite Labor Economist (Freeman):