The economics of worker-owned businesses

I just finished two books that run through, in gory detail, the economics of cooperatives. My purpose here is to review their key findings, especially in regard to worker ownership of businesses, and offer some thoughts of my own.

The first book, Henry Hansmann’s The Ownership of Enterprise, examines the costs and benefits of being an owner of a business (whether a standard investor-owned corporation, which is basically still a cooperative of capital providers, or a worker-, producer-, or consumer-owned cooperative), as opposed to having a contractual relationship (as a worker or consumer or provider of capital) with the same firm. The second book, Gregory K. Dow’s Workers’ Control in Theory and Practice, uses a similar logic, but seeks to answer the more focused question of why there are so few worker-owned businesses in the United States. (The number I hear most often is that there are around 300 worker-owned businesses in the United States.)

Both authors acknowledge that there are economic explanations for why worker-owned businesses are not common in the United States (and, relatively speaking, in other parts of the world). Hansmann lays the most significant blame squarely on the costs that workers face when trying to organize and run a business (“governance of the firm”). In particular, if the workers have widely divergent preferences for what the firm should be doing, what it should be paying for labor, etc., and no governance structures for essentially muting that heterogeneity, governance becomes extremely-time consuming and hence costly. Having spent considerable time trying to organize a consumer cooperative, I can attest to the deadly costs of highly divergent preferences in that realm, so I find Hansmann’s rationale compelling. Investors (providers of capital) who seek to organize and run a firm (through the usual channels of a board of directors and management) are likely to have much narrower interests (earning a profit) and hence face lower costs (“transaction costs”) of running the firm.

Both authors run through a long list of potential lowered costs that worker ownership can provide. For example, having workers be owners can lower the costs of monitoring management and determining worker remuneration preferences. However, Hansmann in particular concludes that these foregone costs are insufficient to outweigh the costs of governance that worker ownership entails. While Hansmann goes to the well of purely economic logic a bit too often (“we don’t see a lot of these firms, so the costs must outweigh the benefits”), the evidence is nevertheless compelling.

Dow attributes the dearth of worker ownership to a wider range of forces. He and Hansmann both consider the possibility that workers will have a more difficult time obtaining capital for business operations or expansion, but while Hansmann largely discounts this as a negative force due to highly functional capital markets in the United States, Dow does consider it to be a significant factor working against worker ownership. Investor-owned firms come with their own capital, so obtaining it is not nearly as much of a challenge for them, while obtaining workers on the market via contract is relatively easy. In particular, if the assets being purchased by borrowed capital are less fungible, lenders will be less willing to provide capital on a contractual basis, thus disadvantaging worker-owned firms.

Besides governance of the firm and obtaining capital, Dow assigns blame for the relative lack of worker ownership to a third set of factors, which he calls “commodification asymmetries.”  The idea is that labor and capital are fundamentally different; in particular, it’s easy to sell shares of investor-owned (publicly traded) firm, but a worker-owner must often quit his or her job in order to appropriate the value s/he has accumulated in the role of owner. In a similar vein, an investor who contributes 90% of the capital to start and run a firm can easily lay claim to 90% of the profits or residual value of an investor-owned firm, while a worker who contributes such disproportionate effort (or has invented something extremely valuable to the firm, or done any other number of good things for the firm) is unlikely to be able to appropriate that value; he or she must essentially be willing to share all that with fellow worker-owners. Here too, I see echoes of this phenomena in consumer co-op formation, where it is said that for a food  co-op to get off the ground, there must be one or two or three “heroes,” people willing to work extraordinarily long and hard to get the co-op going.

So, to summarize, according to these researchers (both of whom are accomplished economists who presented a very impressive array of research and knowledge to support their claims), the lack of worker ownership is attributable to:

  • difficulties in workers governing a firm (Hansmann, Dow)
  • difficulties in workers obtaining capital (Dow)
  • difficulties in workers appropriating the full value of their efforts (Dow)

If this were all there were to the issue, then the prospects of expanding worker ownership in the United States would seem dim. While obtaining capital can be creatively approached (see Michael Shuman’s latest, Local Dollars, Local Sense), depending on “heroes” essentially to be good souls and donate a huge amount of effort to starting and running a worker-owned business is not sustainable, and overcoming governance issues might be even more problematic. But perhaps there’s a role for brainstorming here, in the context of organizational design and/or policy.

However, both authors leave some stones unturned. (Charitably, we could say that at the time that Hansmann and Dow were writing, these stones hadn’t achieved their current prominence in economic research.) What comes to my mind are two important potential benefits of worker ownership: signalling, and networks.

Signalling refers to communicating information to other parties in economic exchanges. The need to communicate information in economic exchanges is pervasive: “this is a good product,” “we will be good partners in a joint venture,” and “we can pay the money back” are messages that businesses want to communicate at various times…but the businesses also have an incentive to misrepresent, and the intended target has to decide if the firm sending the message is to be trusted; this situation is known as “asymmetric information.” There are various ways to overcome asymmetric information; firms can offer a money-back guarantee to consumers, or offer up collateral for a loan. These indirect ways of communicating are known as “signalling.” Economic actors have developed numerous ways of signalling, but these steps are usually costly, and often there is no really efficient way to communicate trust effectively. I would suggest, however, that being a worker-owned business signals a certain amount of trustworthiness, which is an economic benefit right up there with obtaining capital and effective firm governance. Worker-owned businesses need not be saintly, but merely by having undergone the relatively arduous task of organizing as worker-owned, a business is saying that it has values and priorities other than only making financial profits; this in turn can make it easier for the firm to overcome informational asymmetries and thus conduct business in a less costly way.

The other stone left unturned is that of networks. Worker-owned businesses are cooperatives (in the sense that distinguishes them from investor-owned firms), which connects them in a very strong way to all other cooperatives. Almost all cooperatives ascribe to what are usually referred to as the Rochdale Principles, and one of those principles is that cooperatives help and support other cooperatives.(Check out the Principles here.) In my experience, this principle is not hollow rhetoric; I’ve never come across a consumer co-op or worker-owned business that didn’t take the principle seriously. Being a fellow cooperative meant automatic preference and assistance for a firm. Thus, worker-owned businesses are automatically immersed in an extremely useful, economic network. These days, it is cliche to say that economic networks are extremely valuable, a great source of economic benefit, and worker-owned businesses have a tremendous advantage over investor-owned business in this regard. And it’s easy to see how networks and signalling complement each other: the label “worker-owned business” carries the informational signal that immediately fosters networking; the two build in each other recursively.

So, signalling and networks are two economic benefits of worker-ownership that have largely been under-appreciated in the economic literature. Of course, we are still left with the result that there aren’t that many worker-owned businesses, so one might ask what is the point of identifying additional benefits? Well, the key bit about these two benefits, signalling and networks, is that by being under-appreciated by (the all-powerful) economists, they have probably been under-explored as means of fostering worker-owned businesses. There’s a funny thing about economic policy: things that have not been explored theoretically rarely find their way into policy or “how to” literature. The knowledge is out there, but it’s tacit, meaning known but not written down or otherwise easily communicable, and hence hard to share with others. Because of this, while we might, if we rack our brains and get really imaginative, be able to find some undiscovered opportunities to counter or obviate the three major explicit obstacles of worker ownership (obtaining capital, firm governance, and appropriation of value), it’s fairly likely that there are ways we can harness in new ways the signalling and network advantages that worker-owned businesses have.

To borrow from Monty Python, I’m not dead yet. Worker ownership may make up a very small sliver of the economic activity in the United States, and there may be significant economic disadvantages to them. But our contemporary economy is never static; new forces emerge that constantly create new opportunities. Signalling and networks aren’t just recently emergent ideas in economic theory, they’re also growing exponentially in importance in the real economy.  I’ll report back when I’ve collected (no doubt in concert with some of the very cool people and organizations working on this issue) good ideas about harnessing signalling and networks (and other unturned stones) for fostering worker-owned businesses.

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