The puzzle of profit sharing (not)

After I posted recently about the new book, Climate Shock, by Gernot Wagner and Martin Weitzman, Frank Koller (author of the excellent book Spark: How Old-Fashioned Values Drive a 21st Century Corporation about Lincoln Electric) alerted me to an earlier (1986) book by Martin Weitzman, The Share Economy. This argues for linking wages to the success of the business – profit sharing. Frank wrote to me that recovering from prolonged slow growth: “[I]s only possible in an environment where employees can trust that over the long term, as they share with management in the firm’s ups and downs, everyone will bear the risk and rewards equally. That kind of trust is pretty rare, of course. It’s at the heart of the system I explored in my book about Lincoln Electric and others with no layoff policies.”

Climate Shock: The Economic Consequences of a Hotter Planet  Spark: How Old-Fashioned Values Drive a Twenty-First-Century Corporation: Lessons from Lincoln Electric’s U  The Share Economy : Conquering Stagflation / Martin L. Weitzman

Many others have noted that this was of course Henry Ford’s great insight when he doubled the pay of (some of) his workforce – although he had to battle a lawsuit from his minority shareholder Dodge, as they argued it was damaging to shareholders’ interests to pay workers more and invest more in the business. (Ford lost the case, but bought them out.)

It’s interesting in political economy terms that profit sharing is so rare, despite the reasonable amount of economic evidence that it does increase productivity and profitability. The one UK example always given is John Lewis, a hugely successful business, but I can’t think of any others of large scale. Does anybody have an explanation other than short-sighted greed?

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7 thoughts on “The puzzle of profit sharing (not)

  1. The typical agency theory explanation is that profit sharing makes wages uncertain and employees ask for a risk premium (i.e. higher wages in expectation). Because typical employees only have little control over firm profits, the risk is quite high for them. There is some work from Lazear showing that the additional risk premium can outweigh the increase in productivity.
    Profit sharing is also renegotiable so employees really need to trust and companies need costly commitment mechanisms. Lastly, top management has control over the accounting system, i.e. the calculation of profit. Again, employees need to trust that top management will not fudge the numbers in the disadvantage of employees.

  2. Diane …

    I should have automatically added mention of a recent book exactly on this issue by Richard Freeman, Joseph Blasi and Douglas Kruse.

    THE CITIZEN’S SHARE: Putting Ownership Back into Democracy (Yale) is a wonderful analysis of the nearly always consistently higher performance of firms with larger degrees of employee ownership as compared to other competitors in similar industries/sectors/etc..

    The book explores the variety of possible mechanisms to create employee engagement through increased ownership of their firm. The context is American, but readers anywhere will enjoy not just the insights, but most importantly, the rock solid evidence of higher performance.

    Frank

    http://yalepress.yale.edu/book.asp?isbn=9780300192254

  3. In Germany news magazine ‘Der Spiegel’ is another interesting example. Also interesting to note that ‘Spiegel Online’ employees do not take part in the partnership.

    http://www.fundinguniverse.com/company-histories/spiegel-verlag-rudolf-augstein-gmbh-co-kg-history/

    For several years, there had been discussions going on among SPIEGEL employees about getting more influence on the company’s business. Left-wing liberals and journalists who called themselves socialists especially favored a bylaw that would guarantee certain rights in decision-making. However, Augstein came up with an even more radical idea. Within the next two years he drafted and promoted a company structure which made SPIEGEL employees co-owners of the enterprise. This model not only awarded employees the right to a say in major business decisions, but also a share of the responsibility for their consequences. In 1974, Augstein handed a 50 percent share of the company over to its employees.

    Every SPIEGEL employee who had worked for the company for at least three years could elect to become a shareholder in the Kommanditgesellschaft Beteiligungsgesellschaft für SPIEGEL-Mitarbeiter mbH & Co. which owned about half of SPIEGEL-Verlag. According to the new organization’s bylaws, major decisions among owners required at least three-quarters of all votes, which meant that all three owners had to agree. Such decisions included hiring and firing editors-in-chief and directors of the company, approving annual budgets and balance sheets, changes in the magazine’s principal concept and new business ventures. The rights of the employee-owners were represented by five directors elected for a three-year period who fulfilled these duties in addition to their regular jobs for no extra pay. At the end of the business year, every employee-owner received a part of the 50 percent profit share, based on their years of service and annual income. The additional profit-sharing income was mainly seen as a means of saving extra money for retirement since SPIEGEL didn’t offer a pension plan. Despite several attempts by top managers to get rid of the employee-ownership model, the company’s organizational structure endured.

  4. I think peer effects may be important.

    Just as people choose their clothes, jobs, tastes based on what everyone around them chooses (often forgoing better opportunities that exist) maybe firms choose certain ownership structures just because most others choose the same.

  5. My impression is that many firms actually do have some version of ‘profit-sharing’, but that it usually takes a very weak and superficial form.

    Years ago when I worked at Walmart in Canada, we would get a cheque once or twice a year that was theoretically linked to the strength or weakness of the company’s (or store’s?) recent performance. IIRC, it was never more than $100-$200 dollars, but it was hyped by the management as a reason to work harder and gave them an excuse to call us ‘partners’ or something rather than ’employees’. Certainly some of my co-workers took it very seriously.

    From the owners’ point of view, this sort of scheme has (most of) the benefits of profit-sharing in terms of morale, but crucially it leaves them in full control. They get to decide how much profit to ‘share’ and they can ensure that the amount never makes a significant dent in their own pay-off.

  6. Just another couple of notes, first from the Freeman book then from my research …

    Put somewhat vernacularly, the data in Richard’s book shows that the “more” power/profits/ownership is shared with employees, the “greater” the positive gap between the performance (on a broad list of indicators) of that firm versus the norms of the others of that industrial sector. I.e. share more and everyone seems to do better.

    In Lincoln’s case, this is a Fortune 1000 public company with all the openness that implies and requires. The firm assigns 32% of pre-tax profits (EBITB) to the profit-sharing pool. Extraordinary by any measure in a North American context. But so is its global market share position as unchallenged #1 for many many decades, despite strong competition from others who do not share similar organizational values. That’s a correlation to take note of, even if you want to be cautious on causality.

  7. Pingback: Why not worker ownership? | Homines Economici

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