Jonathan Preminger and Guy Major propose a new ownership model to protect jobs and firms, and democratise business
Workers are likely to bear the brunt of heavy debt repayments as firms emerge from the coronavirus crisis. To mitigate this problem, we propose a debt-to-equity swap with a value-added or surplus-sharing mechanism locking investor interests to worker interests. This will protect firms and jobs while promoting employee ownership, and the democratisation of businesses.
There were many calls for reforming our extreme form of shareholder capitalism even before Covid-19 highlighted the weaknesses and inequalities within our society. Such calls came from across the political spectrum, along with proposals for more diverse ownership and more democratic control of organisations.
The pandemic, shining a spotlight on the financial insecurity afflicting millions of people, has been seen as an opportunity for such reform. However, the way we define a problem and the kinds of solutions we propose will depend on the kind of society we envision emerging from the pandemic.
Any response has a cost, as well as benefits, so the question is – who pays and who benefits? In the current crisis, we have already seen vast government spending – but what are the likely outcomes of this spending, and how will our society and economy be changed?
A heavy burden of debt
Apart from furlough pay, the main form of assistance being offered to firms is loans. However, even before the pandemic, corporate debt was already high, following decades of relentless focus on shareholder dividends which reduced reinvestment and squeezed wages. Now, small and medium enterprises (SMEs) are likely to emerge with two or three times more debt than they had before the crisis, straight into a deep recession. This will affect their credit rating too, while firms relegated to junk status face even higher borrowing costs and an even greater burden of debt.
Workers are likely to bear the brunt of this debt, in the form of wage erosion, pay cuts and dismissals. Moreover, a firm’s efforts to repay debt are liable to impact re-investment, undermining the firm’s ability to ensure an optimal mix of labour and capital, and further weakening it.
As many mainstream publications have noted, one solution to this problem is equity investment, with firms paying variable dividends depending on their success instead of servicing and repaying debt. Some commentators have called for a state holding company to support SMEs by buying a stake and reselling when the economy recovers, or a social wealth fund to acquire a range of public assets.
Project Birch envisages the government rescuing key strategic industries via equity stakes, as a last resort. Since we’re already familiar with the idea of the government holding stakes in important firms, why not the smaller ones too?
We agree with the idea that equity will serve better than debt, because its repayments are not a fixed burden, the initial investment never has to be repaid, and it explicitly shares risk between firm and investors. We propose that as firms emerge from the pandemic, they should be given the option to swap government-backed debt for tradeable equity shares, to be initially held by the government.
However, a couple of aspects must be considered. Firstly, many firms are likely to want to retain control of their businesses and be unwilling to cede control to external holders of traditional voting shares. Relatedly, potential investors are likely to be wary of investing when they have no control over their investment.
Moreover, we would like to see the massive injection of public funds as a way to develop and support a different ownership structure – one that leads to a more equal wealth distribution and greater democratization of businesses.
Therefore we propose a mechanism that explicitly locks together the interests of current owners, workers and investors (including the government, at least initially). This mechanism leaves control of the firm in the current owners’ and/or workers’ hands. It also explicitly protects investors – while also boosting the performance of the firm via the well-established synergy between profit sharing, employee ownership and employee participation in management.
Sharing risk, maintaining control: non-voting, surplus-sharing shares
The core idea of this mechanism is very simple: the firm’s value-added (sales minus non-labour costs) is split between workers and investors, using a pre-agreed formula. So when the firm does well, both workers and investors benefit, and the risk is shared between them too. Thus workers, by making efforts to increase their own wages, are automatically working in the interests of investors.
This basic idea can be adjusted to suit differing circumstances and to fit existing ownership structures, such as employee ownership or an employee ownership trust. For example, a basic fixed wage could be deducted from the value-added, so that at least some of workers’ take-home pay is stable and predictable. However, some component of wages would still be variable, and workers would share in the fortunes of their firm.
We could, then, define a firm’s ‘surplus’ as the value-added remaining after fixed basic wages are deducted. The surplus is then split into a number of equal ‘slices’. Each worker gets a pre-agreed number of these slices (effectively their variable pay), and each share gets one slice (its dividend, or pre-tax profit). By working to increase their variable pay, workers would also be maximising earnings per share, thus automatically working in the interests of investors.
In return for unpredictable wages, workers could be granted greater participation in management, or the organisation’s management could be democratised. This may not work for all organisations, but some firms would surely benefit – much research highlights the substantial improvement to performance from the combination of profit sharing, employee ownership and democratic management, benefiting outside investors as well as workers.
These “non-voting, surplus-sharing shares” would be tradeable, offering investors (including the government) a natural exit strategy. The government could later sell off these shares in a secondary market which it should set up, facilitate and regulate, or keep some of them via a sovereign wealth fund or similar instrument.
In short, a debt-to-equity swap combined with this value-added surplus-sharing, non-voting share mechanism would greatly reduce the debt burden faced by firms emerging from the crisis, while improving their performance. It would therefore increase the chances of survival for these firms and protect jobs, so that the burden and risk does not fall disproportionately on workers.
Crucially, it locks together investor interests with worker interests without undermining the current control structure of the companies concerned: ownership is separated from control, while investors are protected via the explicit value-added sharing formula. For this reason, it can be readily applied to a broad range of ownership structures, including employee-owned or employee-controlled firms.
It therefore potentially contributes to a more equal distribution of wealth and the democratisation of businesses, helping to achieve the much-needed reset of our economy in the post-pandemic world.
This article was based on a presentation given at Cardiff Business School’s Breakfast Briefing on 21 May 2020. For details of the mechanism and how it might be implemented, see here, and for a peer-reviewed, open-access academic article with worked-through examples, see here.