U.S. Senator Elizabeth Warren may be too conservative for German business.
In the summer of 2018, the presidential candidate introduced the Accountable Capitalism Act. Like most bills, it serves as a campaign plank rather than a serious piece of legislation. Besides expanding the fiduciary obligation of corporate directors to all stakeholders, it would require all U.S. corporations to let workers elect 40% of board members. The practice of allowing employees to choose directors is often referred to as codetermination.
Radical socialism? Maybe in the eyes of an American capitalist, but recent European history suggests otherwise.
The European Corporate Governance Experience
The representation of workers on boards of directors has a long history in European corporate governance. Emerging as a consequence of post World War II politics in Germany, codetermination spread across the continent in the 1970s and 1980s. Eighteen countries in the EU and Norway have laws requiring employee board participation to varying degrees.
Only Germany and Slovenia mandate parity between worker and shareholder board representation for their largest companies. And in many countries the board requirements are limited to the public sector or state-owned enterprises. Different legal mandates have led to an interesting stream of research on the practical effects of employee representation.
Rose and Hagen (2019) find a minority of employee board representatives in Norway and Denmark feel they have influence on restructuring decisions. Both countries allow one third of seats to be determined by workers. In addition to the level of representation, the national history of labor relations and board-level decision-making processes appear to be important. Waddington and Conchon (2018) note employee board representation is less effective in countries where industrial relations are adversarial, such as France.
But a high degree of codetermination may yield strong benefits to workers and society — without harming shareholders. Kim et al. (2018) find an implicit employment insurance agreement exists between German workers and management if labor fills half the seats on the supervisory board (German public companies use a two-tier board system under which the supervisory board does not include executives). On average, workers accept a 3% cut in wages in exchange for the company retaining 8% more jobs in the wake of economic shocks as compared to German businesses with less than 50% employee board representation. Most of the shareholder-majority boards in the sample still had one third of their seats held by employees.
The study also suggests that parity on the board does not harm firm performance. Implicit employment security does not affect shareholder return metrics like ROA and is not punished by financial markets. Shareholders are sufficiently compensated by the wage discount. And employees are able to reduce their household income volatility — a clear social good.
Income and wealth inequality has become a popular topic again, and rightly so. The levels of disparity across the social spectrum make for eye popping headlines and generate emotional responses. But the volatility of income and wealth matters too, particularly for those with modest savings. Household income has become more volatile since the 1970s in the U.S. Job losses can plunge a family into poverty overnight with lasting repercussions. The incidence rates of divorce, domestic violence, and substance abuse are all tied to economic hardship.
Even though employees may offer wage concessions to win more job security, they likely come out better for the bargain. Yet, job protection appears to be limited to white collar and skilled blue-collar workers in the German experience. Unskilled workers see no benefit. Unsurprisingly, the study finds that board employee representatives hail exclusively from the first two groups.
Corporate social responsibility (CSR) may be another winner where there exists a high level of employee board representation. Scholz and Vitols (2019) developed an index to measure codetermination strength among German companies. They compared it with a set of symbolic and substantive actions related to corporate social responsibility. A positive relationship exists between the index and adoption of substantive policies, but not symbolic ones. These include setting emission reduction targets, adopting separate reporting for CSR measures, and a formal “no layoff” policy.
Lessons for Investors, Socially Responsible or Not
American business executives and investors should rest easy. The most progressive policy proposals still look like a highly diluted form of socialism when the effects of similar laws elsewhere are examined.
The experience of European boards makes clear the distinction between influence and control. Even the German model reserves ultimate control for the shareholders — they choose the chairman that holds the tie-breaking vote in all matters. The concerns of shareholders reign supreme. Other stakeholders may improve their lot through influence with top management, so long as harm does not come to the long-term value of the corporation.
Socially responsible investors should welcome a role for employees on corporate boards in the U.S. Yes, investors can already advocate on behalf of employees. But advocacy on behalf of a group to which one does not belong risks devolving into paternalism. And shareholders working in coordination with employee board members would represent a more potent force than either on their own.