Curing the cancer in capitalism with employee ownership

Shann Turnbull

Employee ownership can cure the cancer in capitalism that has become rampant in Wall Street. This is because employee owned firms introduce a division of power to create checks and balances on mismanagement, hubris, impropriety, malfeasance and fraud.

Without a division of power, the issue of stock and options to executives aggravates the cancer. It is for this reason that many experts blame employee ownership by executives as a major contributing cause of the cancer. However, they are wrong to jump to this conclusion.

There are many firms fully owned by employees that have survived and prospered for generations in competition with investor owned firms. This proves that investors are not required to either create or sustain a business. More importantly it proves that firms do not have to have their shares publicly traded to be competitive.

Economists and business schools who promote the ideology of free markets and privatization ignore these facts. They are Emperors without clothes or consistent logic. They are inconsistent because firms exist because markets fail according to the theory of the 1991 winner of the Nobel Prize for economics! The reasons why markets fail is because they do not directly and immediately communicate the quality or goods and services traded or the integrity of those organising the trading process. However, this insight was suppressed by political ideology as it was developed during the height of the cold war between capitalism and communism. Admitting market failure became treasonable!

However, there are now firms larger than some former communist States that were governed the same way through a command and control hierarchy. This helps to explain why very large firms can fail just like a socialist country. The reasons why cooperatives and employee owned firms become destined to fail is when they blindly adopt the ubiquitous command and control organisational form most commonly found in Anglophone cultures.

The ironic result is that business schools seeking to maximise the power, status and influence of themselves and their graduates exclusively base their teaching on centralised control as found in a socialist State. Alternative organisational forms found in Europe and Japan with de-centralised power through two or more boards are seen as more complicated, less efficient and advanced as the dominant Anglophone system. As a result, the World Bank, IMF and other agencies of the Washington consensus are infecting developing countries with the cancer of capitalism.

Besides being unfashionable, another reason why economists and business scholars do not investigate sustainable employee owned firms is because they do not have a method to analyse and compare firms with two or more boards. Multiple boards are found in all non-trivial sustainable firms owned by their employees and/or other stakeholders. It exists even in Anglophone cultures where a unitary board is the dominant form.

However, around 20% of the Fortune 500 US companies have a major lead investor that acts like a board of review to create a compound board with checks and balances as is commonly found in non Anglophone cultures. Only in the US and the UK is there a majority of publicly traded companies that do not have a dominant active investor to create a compound board with a component external to the business. Compound boards are the rule for companies listed on the 140 or so other stock exchanges around the world. Dominant investors can act like a supervisory board to control the accounting practices, the auditor and excessive executive remuneration and options.

While a compound board is a necessary condition for self-regulation it is not sufficient when the membership of both boards are subject to the grace and favour of a single investor. It is the old problem of power corrupting and absolute power corrupting absolutely.

The solution is a division of power as illustrated by the US constitution. Here power is separated into the legislature, executive, judiciary and an independent media protected by the rights of free speech. A similar separation of power and functions are found in sustainable non-trivial employee owned firms to create a compound board with only internal components.

It is significant that all reported non-trivial sustainable employee and/or stakeholder-controlled business have a division of power, even in Anglophone cultures where a centralised system of governance is ubiquitous. This provides compelling evidence that a division of power is a necessary condition for a business to avoid failure from mismanagement, hubris, impropriety, malfeasance or fraud.

There are venerable examples in Anglophone cultures that prove the ability of internal checks and balances to sustain a business when fully employee owned. It was a common feature of the worker owned plywood factories that began forming from the 1920’s on the West Coast of the US and with The American Cast Iron and Pipe Company that became employee owned in 1922. In the UK there is The John Lewis Partnership that became employee owned in 1950 and the Scott Bader Commonweath in 1951.

All these firms and many others around the world were analysed by Paul Bernstein in his 1980 book Workplace Democratization: Its Internal Dynamics. Bernstein identified six minimally necessary components to sustain an employee-controlled firm. A division of power was necessary for three of the conditions and the other three conditions were facilitated by adopting power sharing along the lines found in the US constitution.

The three conditions that required a division of power were (i) participation in decision making, (ii) guaranteed individual rights and (iii) an independent appeal system. The other three necessary conditions were (iv) economic return to the participants based on the surplus they produced, (v) sharing management-level information with employee, and (vi) a complex participatory/democratic consciousness. One corollary is that employee controlled firms that do not provide these minimal conditions are not likely to be sustainable over the longer term. A second corollary is that investor firms are not likely to be sustainable over the longer term if they introduce significant employee ownership without also introducing a division of power to meet the six minimally necessary conditions.

A most impressive illustration of the success of an internal division of power to sustain and replicate stakeholder ownership on an internationally competitive basis is provided by the many cooperatives formed around the town of Mondragon in the Basque region of Northern Spain. A World Bank study reported that they were more efficient and competitive than investor owned firms. They were outstandingly more sustainable. Typically over 75% of investor owned firms fail in the first five years of their formation while less than 1% of Mondragon firms failed in their first five years.

The existence of venerable employee owned firms and mutual organisations proves that publicly traded shares are not required to either sustain a business or make it competitive. Firms like the John Lewis Partnership and the Mondragón complex are major undertakings that employ over 50,000. Economists and business analysts have not had the intellectual tools for either explaining their success nor the systemic failure in investor owned firms creating the cancer in capitalism. One reason is because economists and business scholars base their analysis on costs and prices and have failed to apply the science of governance to business undertakings.

The science of governance developed in the middle of the last century to explain the self-regulation of living things and for designing automatic control systems such as in manufacturing processes, spacecraft and home gadgets. It is a science that has its own mathematically based foundations that explains the information and control systems of living things to sustain themselves in highly complex dynamic environments with unreliable components. Business organisations face the same problem.

The science of governance has revealed the laws of nature that allow complexity to be simply managed with unreliable components as may be found with the employees of a business. Employee owned firms have unknowingly adopted organisational forms that mimic nature in this regard. Like as in nature, those that did not, did not survive. The fundamental flaws of a command and control systems in socialist States is now being revealed in large Wall Street firms.

The cancer in capitalism can be avoided by adopting the tried and tested organisational forms that mimic the strategies found in nature to manage complexity. Employee and/or stakeholder-controlled firms demonstrate a sustainable way to govern enterprises.