Is Employee Ownership Coming Back?

Henry Hansmann

FLORENCE: Faced with an embarrassing strike by Air France pilots during the World Cup, the French government purchased labor peace by, among other things, offering striking pilots a big ownership stake in their company. Such employee ownership, uncritically lumped together with socialist nostrums over the years, was once widely dismissed as a nutty, ideological illusion. Recently, it has attracted fresh and widespread interest not only as a means to secure more tranquil labor relations, but as a practical means of business organization. In the West, this interest derives in part from declining faith in traditional trade unionism; in the postcommunist East it was stimulated by the speedy collapse of state socialism.

Today, reformers on the left hope that employee ownership will succeed where unionism and government ownership failed in equalizing power and wealth, and in decreasing worker alienation and exploitation. Reformers on the right hope that employee ownership will improve productivity and increase worker identification with the interests of capital.

In many countries, these hopes are stimulating public policy. In the United States employee ownership has been promoted by large tax subsidies and by exceptional provisions in pension laws. In Russia, employees have been awarded majority stakes in newly privatized state enterprise. And in Germany, mandatory worker representation on the board of directors, together with substantial job security, effectively gives employees many of the attributes of owners.

Employee-owned firms have, in fact, always been common. The partnerships of professionals that have long dominated services such as law, accounting, and -- until recently -- investment banking are familiar examples. Nor are they trivial: the largest U.S. accounting firms do business on an international scale and have long had thousands of partners. Transportation is another field where employee ownership is common: around the world, trucking companies, bus companies, and taxi companies are often organized as cooperatives owned by their drivers. There are also important examples in other industries, including plywood manufacturing in America, appliance manufacturing in Spain, and construction in Italy.

Owing in part to encouragement from public policy, employee ownership has been spreading in recent years. A conspicuous example is United Air Lines -- the world’s largest airline -- in which more than 50,000 employees collectively acquired a controlling share in 1994. So, does employee ownership have a bright future in the organization of industry?

It clearly has attractions. Employee ownership improves incentives for employee productivity, and reduces incentives for a firm to exploit its workers by, for example, imposing poor wages or working conditions on employees who, though highly productive, find that for personal or professional reasons their opportunities for alternative employment have decreased over time. It also largely removes incentives for both management and workers to engage in the kind of costly strategic behavior -- such as strikes and lockouts -- that sometimes characterizes labor relations in investor-owned firms.

Undoubtedly these virtues are significant. If they were the most important factor governing the success or failure of employee ownership, however, we would expect employee ownership to be most common in those industries in which workers are unusually difficult to monitor, are relatively immobile, or are extensively unionized. Yet just the reverse is true, at least where employee ownership is not mandated by law. Evidently there are countervailing costs to employee ownership that often outweigh these potential benefits.

Among these costs are the difficulty of raising capital and excessive risk for employees. Yet, while these are important problems, they are not decisive. Employee ownership has long been successful even in industries -- such as plywood manufacturing and investment banking -- that are both volatile and relatively capital intensive. Rather, the Achilles’ heel of employee ownership seems to lie in problems of governance.

To be sure, employees frequently have better incentives and ability to oversee a firm's managers than do investors of capital, who are often remote from the firm. But investors hold an important advantage that employees generally lack: substantial unanimity of interest. Employees with diverse roles within a firm are often affected differently by firm policies. The resulting conflicts of interest can make employee governance costly, both by complicating the process of decision-making and by producing decisions skewed toward the interests of dominant employee groups.

These governance costs appear critical. True employee ownership, with effective employee participation in governance, has generally met long-term success only where there is substantial homogeneity of interest among the employees involved: the employees who participate in ownership commonly do similar work within the firm, have similar kinds and levels of skill, and exercise little hierarchical authority over each other. Partners in a law firm and driver-owners in a transportation firm are typical examples here. Moreover, to reduce even further the potential for conflict, employee-owned firms often adopt costly strategies, such as the rigid seniority-based profit-sharing schemes found in many law firms or the firm-wide job rotation that typifies US plywood cooperatives.

Experience with employee ownership offers a mixed picture. True employee ownership, in which employees participate meaningfully both in earnings and control, appears effective in a surprisingly broad range of circumstances so long as ownership can be placed in the hands of a class of employees who have highly homogeneous interests. But where, as is common, this requirement cannot be met, investor ownership has the advantage. As a consequence, the boldest new experiments in employee ownership - United Airlines, privatized Russian firms, even Air France - seem likely to serve only as temporary expedients in industrial restructuring.