The 2 Percent Solution: A Practical Path to Employee Ownership and Autonomy

| July 14, 2012 | 0 Comments

By Jonathan Marin

Suppose employees of public companies had controlling or even majority interest in the companies they worked for, would things be different? You bet. Better? Absolutely. And in ways that extend far beyond the benefits to the employees themselves. The corporations, their management, their shareholders and perhaps, most of all, society at large, would benefit greatly.

This article presents a gradualist approach toward majority ownership, by employees, of the stock of the companies they work for. The idea has merit in its own right, and could be strategically important to broader campaigns for the rechartering and redefining of corporations.

Corporations’ power over governmental institutions and the marketplace is diffuse and largely unaccountable. Corporate management operates companies for the benefit of shareholders, subject only to specific, limited, legal requirements. It is their duty to do so. Unions only represent a small fraction of the work force in the United States. Most employees have little voice in decisions that affect their vital interests. When corporate decisions impact the lives of their employees, the cause-and-effect relationship is unmistakable. Just the process of campaigning for these ideas will raise employees’ awareness of how corporations restrict their choices as consumers and as citizens. Achieving it will give them a voice in decisions that directly affect their lives.

Mergers, downsizing, and restructuring eliminate jobs. When companies close facilities and move operations to lower cost locations abroad, many permanent positions are phased out, or replaced with “temporary” positions that provide no sick leave, paid vacation or other traditional benefits.

New technologies reduce market share and squeeze margins. Unless plants keep pace with technology, their plant and equipment becomes increasingly obsolete. Eventually, when they can no longer match costs with competition, the most cost-effective option available to management is to close the plant and relocate its operations elsewhere. But whether the decision to close the plant is made by incumbent management, or follows on a merger or corporate takeover, the apparent cost-effectiveness of relocation usually reflects decisions taken years earlier.

The economy as a whole often realizes little or no net gain from such closings. The savings that the companies achieve are partly or wholly offset by costs borne by others – what economists term an externality. “Downsized” employees bear the costs of their forced relocation. Compelled to sell their homes into a suddenly glutted real estate market, many lose most or all of their home equity. Communities with a reduced and financially stressed tax base are left to pay off the bonds which paid for now-excess infrastructure: schools, parks, water supply, sewers, etc., and must bear increased expenditures for additional social services. In addition to the quantifiable costs, there are always intangible costs that include demoralization, family disintegration, increased drug use and alcoholism, and suicide.

Externalities grate on our sense of right and wrong. The greater part of our civil law is based on the notion that it is wrong to intentionally act in a way that imposes loss on others, and that anyone who does it must compensate for the loss.

Even when there is a net benefit from incremental efficiencies and a more smoothly running economy, the benefits are diffuse, while the costs are concentrated. However much they may be offset by gains elsewhere, the externalities remain. This article presents an approach that will reduce the externalities, and spread the costs. It will make for a healthier economy, and a healthier and more just society.

I. Migration to Worker Control and Ownership – “The 2% Solution”

“The 2% Solution” is a way to give corporate employees a voice in, and ultimately control of, the companies they work for. Companies would continue to be managed for profitability, go public, split their stock, and do all of the things corporations do. The dilution of the interests of outside shareholders will be so slow as to be imperceptible, and will be offset by benefits to corporations that will reflect in their earnings and share prices. Every existing corporation, and every new corporation when formed, would have a ten year grace period during which to become fully established.

At the end of the tenth year, and of every year thereafter, corporations would automatically increase the number of outstanding shares by 2%, compounded. The issued shares would go to an Association owned and controlled by the employees, vested former employees, and retirees. Employees would not own these shares as individuals.

If at the end of year ten a company had, say, 10 million shares outstanding, 200,000 shares would automatically issue. After year eleven, a new 2% of the then outstanding shares would be issued to the employees, and so on. By year thirty-six, the employee pool would contain ten million shares – half of the capital stock of the company. Long before that, the employee pool will have become a force to be reckoned with; many large corporations have no single shareholder who owns as much as 10% of the outstanding shares.

Employee stock ownership plans, profit sharing paid in company stock, and stock option plans would accelerate the process, as would employees’ private purchase of company shares. Any new stock offerings period would include the adjustments necessary to prevent dilution of the employee ownership. The employees of each company would set the rules regarding vesting of rights in the pool, retiree rights, the distribution of dividends, and indeed, all decisions affecting their ownership interest.

Employees of aging corporations will participate in the choice whether to maintain their income by keeping an aging plant open and running at low profitability, or invest in technology and equipment. Where a plant has become unprofitable, they would have the option to absorb a reduction in their pay to make up the shortfall, rather than give up their paycheck altogether. By acting to continue operations, the employees would not only benefit themselves, but avoid burdening their community with externalities, and avoid burdening the economy with inefficiencies in aggregate demand, downward wage pressures in the labor market, and balance of payments problems.

Investors in the primary markets – the entrepreneurs who form companies, the venture capitalists who finance them, and the purchasers of shares at initial public offering – measure their time horizon in years, not decades. They do not invest unless they expect to achieve their investment objectives in less, usually much less, than ten years. The ten-year grace period, therefore, will prevent any noticeable decrease in the capital available to start-ups.

The glacial, nearly imperceptible dilution of equity will have little if any appreciable effect on shareholders of existing companies, the secondary market. The dilution is small in comparison with investor targets. It falls within the “noise” of short-term market fluctuations. In any given year a potential purchaser of the stock is looking at a 2% dilution, a level which is small in comparison with his investment objectives, and less than the commissions formerly paid to brokers as a percentage of portfolio on an annual basis. To the extent that there would be any effect at all, it would be the socially beneficial effect of diverting funds away from the secondary market toward the primary market with its dilution-free grace period.

If the employees were the only beneficiaries of the plan, its effect would be equivalent to a 2% tax on a round-trip stock transaction. In fact, dilution will be largely or fully offset by benefits to companies. Even in companies which already have stock option or profit sharing plans, employee morale and productivity will be enhanced by employees’ financial interest in the company’s long-term success. The plan will soften the adversarial relationship between employees and management, reducing wasteful friction. In time, the existence of an important shareholder constituency with a long time horizon will serve to counter-balance forces that pressure management to plan and act for an unduly short time horizon. These effects will reflect in earnings, and stock prices.

Corporations are a creation of the state. States have the power to set the terms and conditions under which charters can be renewed. A large body of law defines the duties of management and the rights of employees and shareholders, and the public. It is a dynamic area of the law, constantly adapting to changing circumstances, re-balancing those rights and duties in the interest of fairness and efficiency. The 2% program entails a modest realignment of those interests, no greater than those passed from time to time, and certainly less than, say, the creation of the SEC or the NLRB.

The logic underlying the very existence of corporations is that their existence will serve the public interest. The precedence of compelling public interest over the property rights of shareholders has been upheld in matters that far more directly affect share values – price controls, export restrictions, environmental laws, and so on. On a practical level, it is hard to see how anyone could establish, much less quantify, a claim involving the market value of securities that change hands frequently and whose market value fluctuates hourly, against a program that would not take effect for ten years.

The 2% dilution approach recognizes the societal interest in attracting entrepreneurial and venture capital, and accommodates it. It also acknowledges the importance of secondary markets in establishing correct share valuation as a basis for subsequent primary offerings. While retaining the opportunity benefits of free capital markets, it accommodates the reality that employees are committed to a company on a much longer time scale than the shareholders of any given moment. The dilution is of little consequence to investors’ decision buy the stock, or to sell it. It is critical to the interests of the people who will spend years or their whole careers at a company.

Long before employees actually own a majority interest, they will become an important part of the decision processes that affect their lives. They will positioned to prevent the physical deterioration that ultimately makes relocation attractive. Unlike outside investors, for whom selling shares is as easy as a point-and-click, they will be a vigilant guard against any tendency of incumbent management toward complacency, bloat, and inertia.

I take it as axiomatic that no policy that tends to enrich the rich at the expense of the poor can be justified, unless it expands the economy as a whole, or furthers some other compelling public interest. Granting the management of young companies wide latitude to act in the best interests of their shareholders meets this standard, because of the benefits new companies confer. The investors who capitalize new companies expect to be rewarded for their risk, and for their central role in bringing the company into being. Their reward depends on the essential mechanism of the secondary equities markets. Anything that interferes with the ability of that market to attract early investors, will adversely affect the flow in capital into new ventures. As companies age, however, that justification diminishes. After years of turnover the shareholder rolls are many times removed from the original and early investors. Policies that promote the interests of investors and management, vis a vis those of employees, become difficult to defend.

However long shareholders have owned their shares, their connection to the fortunes of a company becomes increasingly remote through time. Whatever their contribution to the present share price of a company, the share price ten years from now will mostly reflect the energy, effort and ingenuity of the employees. In a perfect world, the interests of employees and communities would be a major factor in corporate decisions. A constituency with an interest in the long term health of the company would offset pressures on management to focus on the short-term bottom line. The share of profits taken by the successors to an ancient investment would diminish as the significance of that investment receded into history, while an increasing share would go to the people who produced them. The 2% Solution is a step toward that perfect world.

Copyright 1998, 2012


Category: Economics

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