Title:

Employees and Corporate

Governance
Written BY:
M.M. Blair and M.J. Roe
Reviewed by:
Hafiz Haris Khalid Roll No: MP15-07
M. Phill (2015-17)

Submitted to:
Prof. Dr. Hassan Mobeen Alam

Hailey College of Commerce, Punjab University

Lahore

Employees and Corporate Governance: by Blair, M.M. And Roe, M.J. Washington, DC:
Brookings Institution Press, 1999, 570 pp, Reviewed By Hafiz Haris
In the USA, employees of public corporations (except for top management) typically own little
company stock and are seldom represented

on boards

of directors.

In Germany

(and

perhaps in Japan), employees also own little company stock, but, here, they have substantial
representation on supervisory boards (which are roughly equivalent to US boards of directtors). Why should or why shouldnt employees own stock and have a hand in running their
employing firm? and What accounts for the variation in the extent of employee
involvement in corporate governance among firms and across countries? These questions are
the organizing theme for the 11 essays in this volume. Nine of the essays were written for a
Columbia Law School conference on the topic; the other two (including an introduction by
the editors Margaret Blair and Mark Roe) were written specifically for this volume.
Gregory Dow and Louis Putterman lead off with a survey of proposed

answers to the

query Why Capital (Usually) Hires Labor. Since labor and capital are both inputs in
production, why should the typical arrangement be one in which capital is the residual
claimant and decision-maker (owner) and labor is the contracted input (employee)? Why
shouldnt we be just as likely to see labor as the residual claimant and decision-maker
(owner) and capital as the contracted input (employee)? While this question has provoked
substantial writing, as evidenced by the long accompanying bibliography, it has always
struck me as peculiarly ill conceived. Semantic sloppiness labels both physical capital (orchards, trucks, ...) and financing as capital. It is the former that is symmetric to labor in a
production function. But it is the latter, specifically equity financing, that typically holds the
residual claim. It is not puzzling that ownership should link the right to direct inputs
within the firm (or to name and oversee the manager who is delegated these responsibilities)
to the residual claim. By linking rewards to decisions, this leads to more valuable use of the

inputs. And since providers of equity capital necessarily have a residual claim, they are
natural owners. That is, equity financing hires both labor and physical capital. So, the relative
absence of worker owned firms should not provoke the question Why does capital hire
labor? but rather the question Why is it rare to see the provision of equity financing
restricted to employees? And the answer is Le Chaterliers: more constrained choice is likely
worse than less constrained choice. The fundamental puzzle isnt the relative absence of workerowned firms, but the fact that they e6er exist. That is, are there ever circumstances for which
restricting ownership to employees could make a firm more valuable?
Margaret Blairs essay offers a possible answer.

Sometimes employees invest to make

themselves especially valuable to their employer. Moreover,

contracting problems prevent

explicit contracts from arranging and rewarding such investments. As a consequence, these
employees are in a position similar to that of providers of equity financing; they contribute to
the firm with no contractually specified reward. Both, then, may claim the residual and the
attendant governance rights. Making employees owners unites these claims and allows for the
provision of both equity financing and firm-specific human capital. This argument suggests that
worker-owned firms (or perhaps the degree of employee ownership) should be more likely
where investment in firm-specific human capital is more important. Further, it offers one
explanation for governance structures that enfranchise workers separately from ownership
such as mandated worker representation on the board. Ed- ward Rock and Michael Wachter
incorporate Blairs argument and others in their useful survey Tailored Claims and Governance:
The Fit between Employees and Shareholders. Especially interesting is their discussion of
close corporations in which shares are not freely tradable and are generally held by those who
participate (as employees) in the firm, a kind of employee ownership.
Three essays focus on codetermination in Germany.
Katharina Pistor.

The first, and most interesting, is by

She begins with a nice history of codetermination. Beginning in 1952,

legislation has regulated the composition of the supervisory boards of large German firms. The
most recent statute (1976) fixes both the number of members of the board (20 for the largest
firms) and requires that one-half be chosen by workers (previously, this was one-third) and onehalf be chosen by shareholders. Pistor then argues that this forced heterogeneity of board
members makes decision-making

difficult and so reduces the boards effectiveness at

monitoring managers.

The result is that managers are less constrained (more in control

themselves). Mark Roe suggests that the decline in the effectiveness of the supervisory board
should be met with a rise in another mechanism for monitoring managers, specifically the
maintenance of large blocks of stock by one or a few share- holders. With more at stake, a
large block holder has a greater incentive to monitor managers himself. So increased blockholding should partially substitute for the political emasculation of the supervisory board
that

accompanies

co- determination. Unfortunately, Roe offers no evidence. A simple

comparison of the extent of block holding before and after the 1976 law would be a start.
Theodor Baums and Bernd Frick provide a different sort of empiricism. They argue that despite
the obvious disadvantage in monitoring managers, codetermination may have offsetting
advantages. And they conduct an event study analysis of court decisions strengthening or
weakening codetermination. They find essentially no effect of the outcome of litigation on the
relative (to the market) stock prices of litigating firms. Its hard to know what to make of this.
The authors suggest two interpretations. The announcement of the outcome of litigation was
anticipated (and so, not an event) or codetermination really has little effect on the performance of
firms (any monitoring disadvantages are just balanced by some other advantage). I could suggest
another. Since codetermination similarly affects all firms (not just the litigants), litigation
outcomes may alter all stock prices absolutely but not the relati6e stock price of the litigants.
The two essays focusing on Japan discuss employees (lifetime employment, enterprise unions),
but ignore governance. This is a shame because there are likely singular characteristics

of

Japanese boards. From what I know casually, these boards are typically larger than US boards
and they tend to be dominated by insiders (employees). And some board seats are reserved for
retired government officials (selected by government authorities) who descend from heaven
(Schaede, 1995). A treatment of the makeup of Japanese boards similar to that of
codetermination in Germany would have been a welcome addition to the volume.
The final essay by Jeffrey Gordon looks at an interesting recent case in which US firms have
dramatically increased employee ownership and the role of employees in governance. This is the
deregulation induced restructuring of the airline industry. Deregulation brought competition
from low cost entrants, and existing firm survival required renegotiating with employees whose
contracts contained regulatory rents. But renegotiation is inherently contentious. Gordon argues

that trading wage concessions for stock eases renegotiation since making employees partial
owners divides the realized gains from renegotiation and so reduces the incentive to
posture about the likely size of these gains. In addition, partial employee ownership
automatically pays out these gains and so is immune to reneging (the stock price goes up
automatically, it requires no additional action). More generally, Gordon argues that (significant)
employee ownership facilitates dealing with transitions motivated by any dramatic
environmental change (not just deregulation). In the airline case, where the change is discrete,
this may mean that employee ownership is a temporary phenomenon and will soon disappear.
But Gordon also suggests that his story may account for the greater use of employee
shareholding (and stock options) in high tech industries where dramatic change is a constant.
Indeed, several of the essays in this volume contain very interesting ideas, but they contain little
except anecdotal evidence. And the rationale of path dependence is too often relied upon to
account for variation in the anecdotes (we dont need any stinking theory). The incidence of
employee ownership is an interesting issue, and this volume offers a very accessible introduction.
Someone looking for questions here will be well rewarded. But someone looking for answers
will be disappointed. There is still work for the rest of us to do.
Reference:
Schaede U. 1995. The `old boy' network and government business relationships in Japan, Journal of
Japanese Studies 21: 29-317.