The Firm: Theory and Practice  

Table of Contents



Talk on: Three cases for the Democratic Firm: property theory, contract theory, and democratic theory.

Talk on: The Structure of the Democratic Firm.

Goodwill: A Present Property Right or Only An Anticipated Future Right? The notion of "goodwill" is controversial for good reason. The usual treatment of goodwill as a present property right, e.g., in the accounting treatment of "purchased goodwill" as an asset, is based on a rather fundamental confusion. Unfortunately, the confusion extends to some of the basic ideas and formulas of finance theory so the matter has long resisted clarification. My purpose here is to present the argument why goodwill is not a present property right in a brief and simple manner.

Three Themes about Democratic Enterprises:  Capital Structure, Education, and Spinoffs. While I have elsewhere argued for democratic firms based on first principles, in this paper I delve into three 'side arguments.' Labor-managed firms are sometimes pictured (by both critics and some proponents) as having an inherent capital structure resulting in the "horizon problem." Yet this is only a minor technical problem which is solved by the system of internal capital accounts which have been (re-)discovered at least four times?he best known example being the Mondragon cooperatives. The second theme concerns the attempt to implement participative management and the related ideas of active learning in educational theory in the workplace. The point is that the democratic firm is the natural setting to implement these ideas, not the conventional firm where the staff have the legal role of "employees" rented by the company. Father Arizmendiarrieta, in part, used these educational ideas to justify the cooperative structure of the Mondragon firms. And finally, I re-examine the old canard the cooperatives are incompatible with entrepreneurship. My rethinking of the issue was inspired by the analysis of the late Jane Jacobs who emphasized that the primary means of growing economic "biomass" is through economic offspring (e.g., spinoffs)?n analogy with the biological principle of plentitude. Yet the conventional form of ownership operates as a fetter on this process since the ownership and management wants to expand its empire and maintain "ownership" of any potential offspring. But that constraint against spin-offs is absent in democratic firms, and the Mondragon complex has indeed illustrated how to foster and catalyze this process of growth through offspring. Thus far from being inconsistent with entrepreneurship, cooperatives can be seen as the natural setting to foster the primary means of job creation and growth through economic offspring.

On the Role of Capital in "Capitalist" and in Labor-Managed Firms. This paper is divided into two parts.  The first part outlines the "fundamental myth" about the structure of property rights in a capitalist economy, namely the idea that being the residual claimant in a productive opportunity is part of a bundle of property rights known variously as "ownership of the firm," "ownership of the means of production," or, to economists, "ownership of the production set (or function)."  Residual claimancy is contractually determined and there is no "ownership" that legally determines how future contracts are made.  The fundamental myth leads to a basic fallacy in capital theory and in corporate finance theory.  Understanding the myth also allows us to clarify the role of capital in the system misnamed "capitalism."  The underlying theme is that the key institutional feature of "capitalism" is not any special legal rights of capital ("ownership of the firm") but the employment contract for the renting of human beings.  In the second part, the role of the fundamental myth in capital theory is restated in slightly more formal terms and then attention is turned to a right-by-right comparison between the structure of rights in a conventional corporation and in a democratic firm (a labor-managed firm).  Of key importance is the role of the internal capital accounts in a democratic firm.

The Two Institutional Logics: Exit-Oriented Versus Commitment-Oriented Designs for Companies. Throughout human affairs and even in mathematics, science, and engineering, there are two logics that are dual to one another (series-parallel duality).  Albert Hirschman investigates the two logics as the parallel-oriented logic of exit and the series-oriented logic of commitment, loyalty, and voice.  Economics focuses almost exclusively on the logic of exit so that all questions of institutional design are seen through that market-oriented lens.  One goal here is to flesh out the alternative commitment-oriented logic of institutional design for corporations.  The large Japanese-style firm is a major example of the commitment-oriented design in an organization.  The large publicly traded American firm represents a muddle between the two design logics.  Those who legally have voice, the absentee shareholders who are the de jure "members" of the firm, operate according to the opposite logic of exit, the Wall Street rule (sell your shares if you don't like how things are going).  And what stability and efficiency the large American corporations have is not due to the exit-oriented behavior of the electronic herd of stock-traders but due to the commitment and firm-specific learning of the long-term staff of the company (the de facto members of the firm) even though the staff are legally just the external suppliers of labor without any formal voice in the company.  The gap between the two design logics has allowed top corporate managers to wield corporate power in their own short-term self interests without any genuine legitimacy and without any long-term commitment to the company as a human organization.  The conclusion is that American corporate law should evolve toward a coherent design that reunified the de jure and de facto firm in a commitment-oriented model.  That is how to extend the virtues of the family firm and family farm to the large corporation.

  Translatio versus Concessio:  Retrieving the debate about contracts of alienation with an application to today's employment contract. Liberal thought is based on the fundamental question of consent versus coercion.  The autocracies and slavery systems of the past were based on coercion whereas today's democracy in the political sphere and employment system in the economy are based on consent.  This paper retrieves an almost forgotten contractarian tradition, dating from at least the Middle Ages, that based political autocracy and economic slavery on explicit or implicit voluntary contracts.  Hence the democratic and antislavery movements had to hammer out arguments not simply in favor of consent and against coercion, but arguments based on the distinction between contracts to alienate (translatio) sovereignty versus contracts to only delegate (concessio) self-governance rights.  They argued that the alienation contracts were in a certain sense inherently invalid so that those basic rights were inalienable even with consent.  These inalienable rights arguments from the democratic and antislavery movements are also retrieved, arguments that liberal thought neglects when the basic question is simplistically posed as consent versus coercion.  Finally, it is noted that the basic inalienable rights argument?hat a de facto person cannot fit the de jure role of a thing even with consent?pplies equally well to the employment contract which can be seen collectively as a contract for the employees to alienate management rights over their work to the employer or individually as the contract to rent oneself to the employer for limited periods rather than to sell oneself as in the self-enslavement contract.  In conclusion, the paper considers various paths to get from the employment relation in a firm to a democratic firm where the members are the people working in the firm.  This is a reprint from Politics & Society (Sept. 2005). (Click on title to open memo or paper.)

Putting Jane Jacobs to Work: Enterprise Creating Schemes Suggested by her Writings. This memo extracts some policy advice from Jane Jacobs' economic theories.  It outlines four ways that jobs and enterprises are created in vibrant economies and thus four ways that policy schemes might try to catalyze the process. Slides for a talk given in Leuven Belgium on this topic.

On the Russian Privatization Debates: What Has Been Learned A Decade Later?.  A decade has passed since the privatization debates raged in the international financial institutions (IFIs) concerning Russia and the other transition economies.  It is time for reflection and evaluation of these debates within the Bank and the other IFIs.  This article in Challenge May-June 2003 tries to pull together thoughts on two questions: the overall institutional change strategy and the alternatives to and arguments against voucher privatization. (Right-Click on title to download the file)  For David Warsh's Economic Principals e-column on the article, see:

Management and Employee Buy-Outs in Central and Eastern Europe: Introduction This paper about using management and employee buy-outs (MEBOs) in privatization in the transition economies was written in 1992 and published in 1993 by the Central and Eastern European Privatization Network (CEEPN) in Ljubljana, Slovenia.  Many of the questions treated in the paper are still being debated today--although now in retrospect.  The paper is posted here a decade later not simply because the original may be hard to find but because, in the author's humble opinion, the views expressed in it (although not every detail) have stood well the test of time.  Now we know, more or less, what worked and didn't work in the transition during the last decade so it is useful to see who had foresight and not just hindsight about the transition. (Click on title to open memo or paper.)

Transforming the Old into a Foundation for the New: Lessons of the Moldova ARIA Project.  This is a case study, coauthored with Vladimir Kreacic, of the ARIA restructuring agency in Moldova.  ARIA is one of the best results of a World Bank projects in the FSU.  It shows how in the context of the poorest country of the FSU, one can implement a restructuring bankruptcy ("Chapter 11") program and a liquidation bankruptcy program to seed new start-ups in industrial park/incubators, how capacity in the local private consulting sector can be built up, how to foster spin-offs as systematic restructuring strategy, how to have "Marshall Plan" study tour programs for managers as well as blue collar workers, and how to have systematic implementation of continuous improvement ("Japanese-style") programs in firms. In addition, it shows how the gastarbeiter phenomenon can be harnessed as a tool for development.  (Click on title to open paper.) This paper is World Bank Policy Research Working Paper and can also be downloaded from the World Bank's website.

Voucher Privatization with Voucher Investment Funds: An Institutional Analysis.  Almost a decade has passed since the socialist countries of Eastern Europe and the former Soviet Union embarked on the transformation to market economies.  One of the primary tasks facing these economies was the privatization of the bulk of their enterprises.  Debates raged in the early 90s about the best method of privatization.  The method that at first seemed to work in the Czech Republic was voucher privatization with voucher investment funds.  This "solution" was eventually promoted by the multi-lateral development agencies and Western academic advisors throughout the transition economies from Slovenia to Mongolia.  This paper examines the "economic" arguments put forward in favor of voucher privatization and it gives an institutional analysis of how the investment funds might be expected to behave in spite of expectations seen through rose-colored glasses.  As one of the "great" social experiments of the late 20th century, some lessons for the future are drawn.  This paper is also available as a World Bank Policy Research Working PaperAnother version of this paper was later published as: Lessons of East Europe's Voucher Privatization, Challenge. July-August, pp. 14-37. (Click on title to open memo or paper.)

ESOPs for Privatization and Restructuring.  This paper explains the functions of Employee Stock Ownership Plans (ESOPs) and the basic structure of ESOP transactions.  When considering "transplanting" ESOPs to other countries, special attention should be paid to several ESOP innovations (not shared by some other employee ownership arrangements): 1) the payments by the company, not the workers, for the shares, 2) the stability of the employee ownership in the trust, 3) the broad-based nature of the ownership within the firm, and 4) the transition mechanism (buying back shares from retiring workers and reallocating them to current workers).  In addition, any new ESOP could adopt a "rollover plan" where the share buy-backs took place after, say, ten years instead of being triggered by retirements.  There is also the consideration of whether the ESOP should be implemented using an external trust (e.g., in countries without trust legislation) or by an internal ESOP mechanism.  Finally, I consider a number of ways that ESOPs could be used in restructuring transactions such as debt-equity swaps and spin-offs. (Click on title to open memo or paper.)

The Case for Workplace Democracy. A concise summary statement of case for the democratic firm based on the labor theory of property (standard juridical principle of responsibility applied to property appropriation) and the inalienable rights critique of the contract for renting people (employment contract).  A version of this paper was published as: "Responsibility and Workplace Democracy."  Peace Review. Vol. 12, No. 2 (2000), 189-95. (Click on title to open memo or paper.)

Who Pays for ESOP Shares?: ESOP Analysis and Evaluation.  When a loan to a company is channeled through an ESOP (instead of being made directly to the company), the employees end up owning shares in their ESOP accounts and yet they pay no out-of-pocket money for those shares.  Who really pays for those shares?  If the employees do not pay for the shares indirectly with concessions in wages and benefits or through productivity increases, then I show that the shares are paid for by a combination of tax breaks and dilution of the existing owners.  When the ESOP loan money goes to buy new shares, then the company in effect pays twice for the injection of money: once with the issuance of new shares and again with the ESOP loan payments.  But the second payment is deductible from taxable income, so for a firm in a 40% tax bracket, the shares are paid for 40% by the tax break and 60% by dilution of existing owners. (Click on title to open memo or paper.)

Entrepreneurship Development in Transitional Economies  One of the great social transformations of recent times is now well underway, the transformation of the formerly communist economies into various forms of private enterprise market economies.  The success of this massive transformation will depend in large part on the success in freeing and developing entrepreneurship in the transitional economies.  One of the few success stories in many of the Central European economies has been the explosive growth of the new private sector.  The transformation of the privatized enterprises is proceeding much more slowly than was originally expected.  Its success will require finding ways to combine the entrepreneurial energy of the new private sector with the restructuring needs of the privatized or to-be-privatized enterprises (e.g., through spinoffs including split-ups).  This paper will outline some of the developments and strategies in entrepreneurship education and support, and address some of the entrepreneurial response problems in the slow-reforming transitional economies such as: the socialist culture of risk-avoidance, the absence of entrepreneurial finance mechanism, and the predator problem (e.g., bureaucrats and bandits). (Click on title to open memo or paper.)

Decentralizing Strategies for Restructuring Russian Enterprises  Privatization is not enough, particularly voucher privatization.  Enterprises throughout the post-socialist world are in need of massive restructuring.  Decentralizing strategies within the firm, such as setting up separate profit centers or even spinning off assets in new firms, have emerged as particularly appropriate restructuring strategies in Russia and in the former Soviet republics.  This paper will focus on the advantages and drawbacks of spin-offs?ith profit centers seen as a less extreme version of decentralization. (Click on title to open memo or paper.)

The Mondragon Cooperative Movement.  This is a reprint of Case No. 1-384-270. Harvard Business School 1984.  It gives an overall view of the Mondragon cooperative movement of the Basque country in northern Spain as it was in the early 1980s.  The particular focus was on their "factory factory," the Empresarial Division of the Caja Laboral Popular.  This division of the CLP worked with groups of workers to create new cooperative companies so it represented something like the institutionalization of the entrepreneurial function.