U.S. Senator Elizabeth Warren has proposed a novel way to reform corporate governance. It would require companies with more than $1 billion in revenue to get a corporate charter from the federal government (rather than from an individual state), which in turn would require a commitment to a broad range of stakeholders, including not just shareholders but also employees and the communities in which the businesses operate. In addition, federally chartered companies would be required to let workers elect 40% of board members. There are other aspects of the proposal, including an aim to limit stock buybacks and stock-based compensation — you can read more about it here or here.

Warren’s vision is to ensure that the success of U.S. companies is shared more broadly, rather than largely benefiting shareholders. But would it have that effect?

The idea seems to be that having a more collaborative decision-making structure would cause better and more-equitable decision making. Here the example of Germany is illustrative. For the past 40 years, corporate governance in Germany has been based on the idea of codeterminance, in which workers have a say in company decision making. Workers elect a substantial share of the board and form work councils, which are groups of employees, distinct from trade unions, empowered to consult with management about decisions. Germany’s codetermination model does seem to lead to a more equitable distribution of company profits, and so Germany is commonly cited as an example of why such an approach should be adopted in the U.S.

But it’s worth thinking hard about exactly how cause and effect works here before forcing companies to change their organizational structure. Collaborative structures like the work councils in Germany may be a product of specific cultural values and norms. For instance, in places where there’s a high level of trust between workers and employers, these structures may be more likely to arise, and therefore more likely to succeed. If this is the case — and having observed companies that have strong equitable cultures, my view is that this is not too far off from reality — then forcing firms to create these structures in places without those equitable norms would not necessarily have the desired results. It could even be counterproductive. In economics terms, corporate governance structure may be “endogenous,” meaning closely connected to and dependent on other factors, like culture, that policy cannot easily shape.

It’s also important to understand another reason that what works in one country may be completely ineffective in another: different institutions. For example, many years ago Harvard’s Richard Freeman and Stanford’s Ed Lazear looked at Germany’s work councils. One of their conclusions was that work councils were effective, in part, thanks to the fact that Germany had a centralized wage-setting structure. As in many European countries, wages in Germany were primarily set through industry-level negotiations, which meant that the worker councils were not primarily responsible for determining how much workers should be paid. As Freeman and Lazear wrote, “Councils fit better in labor relations systems where pay and other basic components of compensation are determined outside the enterprise (essentially bounding divisions of the rent) than in systems where firms set pay, and may help explain why councils are found largely in economies with relatively centralized collective bargaining.”

By contrast, U.S. firms do have the primary responsibility for determining wages, which means that worker involvement in corporate governance is likely to be far more contentious.

None of this means the Warren proposal is necessarily a bad idea. Nonetheless, proponents of this sort of reform need to go into it with their eyes open, and take a skeptical view when considering the examples of countries with different cultures and labor market institutions.

One response to this argument might be that the U.S. should embrace Warren’s proposal for worker representation on boards, but combine it with complementary labor market institutions along the lines of those in Europe, as well as efforts to change the culture. Perhaps. But those changes are hard, if not impossible, to make, and would be even in a world where there was the political will to attempt them.

from HBR.org https://ift.tt/2vShXaG