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How firms with employee representation on their boards actually fare

Board-level employee representation has re-entered the political agenda. Even in countries that have traditionally been skeptical about giving employees more say in corporate decision-making now discuss board-level employee representation. Former UK Prime Minister Theresa May suggested changes in this direction in her country in 2017. More recently, Senator Elizabeth Warren, one of the leading presidential candidates in the United States, has introduced a legislative proposal to require that at least 40% of board members in US corporations be elected by employees. Both proposals follow a recent trend in giving employees more say either at the plant level or at the board level. The map below shows that all OECD countries, except the United States and Singapore, have policies requiring some level of employee representation in at least some firms.

Image credit: Adams, Zoe, Parisa Bastani, Louise Bishop, and Simon Deakin, 2017, The CBR-LRI Dataset: Methods, Properties & Potential of Leximetric Coding of Labour Laws, 33, pp. 59–91

However, while the political debate continues to be heated and controversial, the evidence of the actual impact of employee representation on corporate governance is still pretty limited. Human capital arguably represents the largest source of risk in the world of work. During industry downturns, employers often downsize their workforces. Thus, losing their jobs as a consequence of economic distress is a widespread fear among employees.

Starting in the 1970s, economic theorists have proposed a simple solution: Workers enter agreements with their employers (called “implicit contracts” in the jargon of the economics profession) in which employers guarantee job security and employees accept lower wages. The benefits of such an arrangement are easy to see: Employees receive employment protection and firms receive an insurance premium in the form of reduced wage payments, which reduces their costs. However, to make such agreements work, the contract has to be enforceable—firms must be able to commit to their promise even during economic downturns, when they have an incentive to renege on their promise.

Germany is one ideal country to test how this idea works in practice. The country, at the forefront of board-level labor representation starting in the 1920s, is about average in terms of employment protection rights in the OECD. Germany introduced the “parity-codetermination” act in 1976, which requires that 50 percent of the seats on supervisory boards are elected by employees for firms that have a domestic workforce of 2,000 employees or more.

In industry downturns, a sizeable fraction of employees at firms without employee board representation lose their jobs, whereas those at firms with 50% worker representation (parity firms, hereafter) do not. However, employment insurance does not cover everybody. Only white-collar and skilled blue-collar workers benefit from board-level employee representation. Unskilled blue-collar workers, on the other hand, receive no insurance and lose jobs at about the same rate as those at regular firms. This is because unskilled blue-collar workers are not represented on supervisory boards. This result underscores the importance of participation in governance to enforce agreements.

Employees certainly pay for employment insurance. They accept, on average, 3.3% lower wages when they work for parity firms. Therefore, shareholders benefit from such arrangements through lower wage costs. However, parity firms lose the flexibility to adjust the workforce during industry downturns. Do shareholders still profit from shouldering such risks? And does the employment insurance put parity firms in a bad financial position in the long run? Skeptics of such agreement usually argue that allowing labor representation on the board will have a harmful effect on firm performance, because when workers have too much influence on governance firms may misallocate resources, leading to lower earnings and share prices.

It’s true that economic shocks hit parity firms particularly hard: Their profits and share prices decline more during industry downturns. However, the savings from employees’ wage concessions seem to be just about sufficient to compensate the higher risk. Over the whole business cycle there appear to be no long-term differences in performance and firm value between the two types of firms. This means that all the net benefits go to the workers, who profit from the employment insurance, whereas shareholders receive just enough wage concession to offset the costs of the arrangement, but do not receive any additional gains. It is therefore unsurprising that firms do not voluntarily adopt labor representation, and that such codetermination agreements spread only through regulatory intervention.

Featured Image Credit: ‘Greyscale photography of corporate room’ by Drew Beamer on Unsplash

Recent Comments

  1. fantasticc

    In the study, Allen and his colleagues developed a mathematical model of stakeholder governance. The model involves two hypothetical firms (a duopoly) that are selling products in competition with one another and wish to avoid bankruptcy so that they can survive from one period to the next.

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