Democratic corporate governance

Are corporations authoritarian or democratic?  Corporations are hierarchical institutions in which workers often feel like they are working within a communist dictatorship, but compared with privately-held companies, corporations are extremely democratic.  A privately-held company can be owned by one person who calls all the shots whereas a public corporation is usually owned by thousands or even millions of people who in theory should have a democratic voice in how the corporation is governed.

Most people don’t think of a corporation as a form of democracy because corporate democracy violates the democratic ideal of one-person, one-vote.  Corporations are plutocratic democracies where wealthier people get more votes.  Each shareholder votes as many times as the number of shares she has.

Just as mass democracies could not exist before the spread of literacy and cheap communication that Gutenberg’s printing press brought about, corporations were impossible for all of history for the same reason.  It was simply impossible to communicate with numerous voters who were spread across a wide geographic area.  Even for shareholders with non-voting shares, information flow is crucial because they can still vote with their feet and sell shares in a company that is making bad decisions.  It would be irrational to buy shares in a company that doesn’t communicate well about what it is doing.

This requires accounting and which was unknown until the printing press could first spread what was one of the first bestselling management self-help books.  It was Luca de Pacioli’a Summa de Arithmetica which introduced double-entry bookkeeping to the world for the first time. It seems to have developed in a few Renaissance cities in northern Italy over the prior two centuries, but it immediately spread widely across Europe after this book was published.  The book not only spread the foundations of accounting, but also some radical changes in mathematics such as the concepts of negative numbers, zero, and the Arabic numerals that gradually replaced Roman numerals across the West along with the new math called algebra that the the Arabic numbers represented.

Before the printing press it was difficult to communicate mathematics and accounting information to a large population because copying errors are too common in other methods of reproducing information.  The printing press enabled the spread of accounting standards that could be used the same way everywhere and without those accounting standards and the means to accurately communicate accounting information, corporations could not exist.

Glyn Holton noticed that early forms of corporations first appeared in nations that had democratic governments.  The earliest progenitors of the modern for-profit corporation were the publicani of the Roman Republic which were phased out when Rome abandoned democracy and became an empire.  A similar corporate structure later arose in the democratic city states of northern Italy such as the Genovese maone.  The first stock exchange was set up in the Dutch Republic and were soon copied by their democratic neighbors across the English channel.  Could it be a coincidence that so many of the earliest examples of republican governments also set up republican forms of business?

But just as there are many forms of democratic governments (parliamentary, presidential, electoral college, direct vs. representative, etc.) there are many possible forms of corporate government that are dictated by the laws of the countries where the corporations are chartered.  One of the big differences is whether other stakeholders besides shareholders have any votes or representation on the board.  The US is unusual in that our government gives exclusive sovereignty to shareholders.  In many countries other stakeholders also share power on corporate boards such as employees, creditors (usually banks), and/or government representatives.  For example, most OECD nations require some amount of codetermination whereby employees are guaranteed representation on corporate boards.  Germany decided that banks have the right to representation on corporate boards when corporations borrow a lot of money from them.  In China, the Communist tradition has always given the government considerable direct power over the management of large corporations partly because the government owns shares in most large companies among other mechanisms.

Justin Fox examined how it has worked to put workers on corporate boards in Germany in order to asses how it might work in America.

one of the world’s most successful capitalist nations, Germany, currently requires 50 percent employee representation on the supervisory boards of large corporations, and …most countries in the European Union now also encourage or require some such form of employee “co-determination.”.. How did German corporations end up giving all those board seats to employees?  … The short answer is that in the aftermath of World War II the managers and owners of Germany’s large industrial concerns were discredited, with some headed for trial in Nuremberg as war criminals, while the country’s trade unions, which had been banned by Adolf Hitler in 1933, were considered by the Allied occupying forces to be free of Nazi taint. The most heavily industrialized part of the country was in the hands of the British, who were in the process of nationalizing several major industries back home and were inclined to do the same in Germany. Having experienced de-facto nationalization under the Nazis, though, the leader of the union movement in the British zone …pushed instead for negotiated deals with company owners to give workers equal board representation. Greatly preferring this to nationalization, several big iron and steel concerns in the British zone assented.

It helped that German businesses and workers already had some experience with co-determination. It had been a major if inconclusive topic of debate at the country’s first democratic assembly, the short-lived Frankfurt Parliament of 1848 and 1849, and in subsequent decades German business owners experimented with various systems to give workers a voice in company affairs, mainly in the form of employee-chosen “works councils” that deliberated over workplace conditions. In 1916, wartime labor shortages led to a law that required every adult male in the country to work but also required employers of 50 or more to institute works councils. At the Great War’s end, unions and employer groups agreed to make the councils permanent. This was ratified into law in 1920; a year later the Weimar government followed up with a requirement that workers get one or two seats on company supervisory boards, depending on board size… After the war… West Germans elected their first government in 1949, and Christian-Democratic Chancellor Konrad Adenauer soon moved to make co-determination the law of the land for companies in the coal, iron and steel industries … with more than 1,000 employees. That legislation was enacted in 1951. … In the 1960s, the union movement renewed its push for full co-determination. Business leaders were vocally, often histrionically opposed — the left-leaning Der Spiegel ran a cover story in 1968 ironically titled “Co-Determination: End of the Market Economy?” — but the mostly positive experience of the iron and steel industry and the election in 1969 of Germany’s first Social-Democratic chancellor since 1930 (Willy Brandt) eventually led to the Co-Determination Law of 1976, which requires almost all German firms of more than 2,000 employees to have half their supervisory boards chosen by employee vote.

In a 1979 paper that hasn’t aged well, American economists Michael Jensen and William Meckling — the scholars probably most responsible for the widely held belief in the U.S. that the sole role of the corporation is to maximize shareholder returns — predicted that the new German law would turn out to be either irrelevant, as weak and divided worker representation allowed shareholders to continue to exercise “complete control over the affairs of the firm,” or transform the German economy into a “Yugoslav-type system” characterized by underinvestment, stalling growth and heavy government interference.

Neither happened. German corporate governance is markedly different from the Anglo-American variety, with German companies seemingly placing more weight on worker concerns like job security and less on short-term shareholder value maximization. But the German economy hasn’t stalled; in fact, the country’s annualized growth in real per-capita gross domestic product since 1976 (1.8 percent) has been a smidge faster than that of the U.S. (1.7 percent).

And Justin Fox follows up by explaining the history of how this kind of democratic capitalism where labor and management jointly decided policies had evolved in the US, but was squashed by laws that were ironically intended to help private labor unions (as opposed to the sort of company worker organizations that used to help run companies):

…The U.S., it turns out, also used to have entities much like works councils, which went under names like “employee representation plans,” “company unions” and just plain “industrial democracy.” They came into vogue later than in Germany, but constituted a major movement from about 1915 through 1935, when Congress put a stop to them …

In the late 1800s, as European workers joined forces in labor unions and some European employers strove to amplify workers’ voices, the U.S. remained uniquely hostile to all forms of worker organization. …The U.S. government in those days was spectacularly corrupt, and industrialists and financiers had far more money than anyone else with which to corrupt it.

Although the courts and law enforcement remained reliably on the side of business owners and against attempts to organize workers well into the 20th century, the political and intellectual tides in the U.S. began to shift in the 1890s. The first significant business experiment in giving workers a voice in the U.S. began in that decade as well.

This occurred at Filene’s, the Boston department store, where company president Edward Filene in 1898 enlisted a committee of employees to help administer an insurance plan and medical clinic. By 1905 the employee-run Filene Cooperative Association was not only running benefit programs but also had the right to change any store rule by a two-thirds vote. The association’s arbitration board adjudicated disputes between management and workers, ruling against management 46 percent of the time, while an accountant hired by the association pored over the company’s books to make sure they were on the up and up.

Filene, … seems to have been concerned mainly with motivating his workers and making their jobs more fulfilling. For a lot of the other company executives who started works councils in subsequent years, fending off unionization was a top priority.

The most famous works council plan was instituted in 1915 at Colorado Fuel and Iron Co., then the nation’s second-largest steelmaker. After company efforts to break a coal miners’ strike led to the notorious 1914 “Ludlow massacre,” John D. Rockefeller Jr., whose family was CFI’s biggest shareholder, turned to Canadian labor relations expert and future prime minister Mackenzie King for help. King devised a system of elected employee representation that became known as the Rockefeller Plan and was widely imitated.

The combination of wartime labor shortages and the first overtly union-friendly presidential administration led to big gains for both organized labor and works councils during World War I. Amid labor unrest in 1918, President Woodrow Wilson created the National War Labor Board to adjudicate company-labor disputes, and the board frequently pushed companies to create works councils as part of the labor deals it devised. While the pressure from Washington eased soon after that, works councils and company unions kept being formed. By 1926, according to labor historian Greg Patmore, there were 432 U.S. companies with employee representation plans covering almost 1.4 million workers…

My favorite among the employee representation approaches was what became known as the Leitch Plan. Stockyard-worker-turned-business-guru John Leitch wrote an entertaining 1919 book about it, “Man to Man: The Story of Industrial Democracy,” which describes production workers electing a House of Representatives and foremen and other middle managers electing a Senate, with this legislature empowered to propose workplace changes to a cabinet composed of top management. At Goodyear Tire and Rubber Co., which seems to have implemented its plan without any help from Leitch, production workers elected both House and Senate, and in 1922 those two bodies voted workers a 15 percent pay raise, then successfully overrode a cabinet veto.

Even at the companies most enthusiastic about worker participation, though, there was still the awkward question of who really called the shots. “Capital and labor are not alike,” Leitch wrote. “They travel the same road up to the division of profits; there the road forks and we do not yet know just how the profits may reasonably be divided.” At Filene’s, younger brother Lincoln Filene finally got fed up with the way Edward was dividing the profits and united with other shareholders to seize control of the company in 1928 and merge it with the Federated Department Store chain (now Macy’s Inc.). …

The political equation changed too, as a Democratic Party committed to empowering independent trade unions — and suspicious of company unions — took power in Washington after the 1932 elections… [They] pushed through a National Labor Relations Act [NLRA] in 1935… arguing that company unions made “a sham of equal bargaining power,” his legislation no longer allowed employers “to dominate or interfere with the formation or administration of any labor organization or contribute financial or other support to it.”

…Arms-length negotiations between corporations and unions became the rule, big increases in unionization followed, and big pay increases for working Americans followed that. For a long time, labor economists and historians adjudged this to have been the right move for workers. Since the 1980s, though, revisionist scholars have been showing that some company unions actually did a pretty good job of promoting both employee well-being and company productivity. And with unions now absent from most of U.S. economic life — only 6.5 percent of private-sector workers belonged to one in 2017 — the lack of any kind of organized worker representation today is glaring…

In 1994, a commission appointed by Commerce Secretary Ron Brown and Labor Secretary Robert Reich recommended that Congress revisit the NLRA to provide a safe harbor for employee involvement programs. The next year, the Republican-majority House and Senate did just that with the Teamwork for Employees and Managers Act of 1995, but in the face of opposition from organized labor, President Bill Clinton (Brown’s and Reich’s boss), vetoed it…

Recently there have been proposals in the US to once again make it easier for employees to go back on US corporate boards and although wealthy CEOs don’t like this idea because workers don’t vote for higher CEO pay as much as the typical board crony.  Workers also have more inside information than the typical outside board member, so workers can hold CEOs accountable in ways that ordinary outside board members cannot.  Workers have more inside knowledge about what is happening in a company because they are in the company year round and know hundreds of other workers.  Ordinary board members are outsiders who only know a few top managers (and are often their cronies) because they only visit for board meetings a few times per year.  It is definitely good to have some outside experts on a corporate board, but employees certainly have additional information that is useful for decision making too and they have a different perspective because they have more of their portfolio at stake in a company than most outsiders. Having employees on the board can also improve the morale of employees and improve communication between management and employees.  That is why corporate owners have invited employees to join the board at many times in history both in America and abroad.  The US made this illegal in 1935, but it is time to revisit that ban and give US corporations more freedom to include workers on their boards of directors.

One of the pathologies of American corporate culture is the commonplace antipathy between management and labor.  These people need to work together and a team in symbiosis for the company to be successful, but the artificial dichotomy between management and labor has often created a culture of mistrust or even mutual hatred within corporations in America.  Codetermination increases communication and blurs the artificial line between management and labor and can create the kind of synergy that is more commonly seen in successful Japanese and German manufacturers.

Employee representation on corporate boards even works well when taken to the extreme where corporations are entirely employee owned.  Worker-owned companies are often structured as cooperatives and some countries like Costa Rica have policies that encourage cooperative employee ownership. Costa Rica’s economic model seems to have worked better than most of its neighbors.   If purely employee-run corporations can work well, then surely a tiny bit more balance between owners and workers would also work in America.  One of the advantages of a democracy is the greater ability to aggregate the information and wisdom of the crowds.  Including a few employees on corporate boards would bring in new sources of information and hopefully lead to wiser leadership and maybe reduce some of the perennial tensions between management and labor.

Posted in Labor, Managerial Micro, Public Finance
One comment on “Democratic corporate governance
  1. […] that allowed corporations to dramatically expand was the printing press.  A corporation is a form of mass democracy and just as democratic participation in government is limited in scope by communication […]

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