Kokkinis and Sergakis – A Flexible Model for Efficient Employee Participation in UK Companies by Andreas Kokkinis & Konstantinos Sergakis, 17 Feb 2020 (download), provides several insights that may be helpful in guiding US efforts as well. As mentioned in my coverage of the recent SHARE Summit, #SHARE2020, I am investing in public companies with employee ownership. I am hoping such investments will be good for my portfolio, workers, society and the environment.
I am also thinking of submitting shareholder proposals aimed at advancing the idea of employee ownership and worker representatives on corporate boards as a way of addressing problems stemming from short-termism, inequality, lack of meaningful work, lagging motivation and productivity. Proposals in this area were submitted this year to Automatic Data Processing, Inc., Badger Meter Inc., Boston Scientific Corporation, IDEX, Square and Stryker Corporation for the 2020 season.
The UK has grappled with ideas around employee ownership and participation in a more systematic way recently than has the US. Kokkinis and Sergakis argue a natural progression would start with the introduction of formal employee advisory panels, then moving to employee share ownership schemes with special rights to elect a minority number of directors. That seems like an approach that might win more support than proposals urging the boards to prepare a report to shareholders describing opportunities for companies to encourage the inclusion of non-management employee representation on the Board. Boards, managers and the Big 4 funds that control a plurality of votes at many companies may be more likely to embrace employee advisory panels as an intermediary step.
Kokkinis and Sergakis argue that formal employee advisory panels could provide the necessary channel for companies and employees to get adequate experience before employees actually take board seats. Some of the anticipated benefits are as follows:
- Participation would enhance security of tenure leading employees to make more firm-specific investments and requiring less need for hiring and training by employees.
- Better informed decision-making because employees have special knowledge about the firm.
- Employee owners would be less diversified investors, with a stronger incentive to monitor management.
- Reduces shareholder myopia, since employee owners are long-term owners.
- Exert pressure on boards with a tilt towards more ethical corporate behavior.
- Reduced income inequality.
On the down side, transaction costs could increase, primarly by lengthening decision-making process. Optimal employee ownership for a publicly traded company would be something less than half. If more than half, employees would be tempted to convert so much profits to wages that few would buy shares because their would be little chance of dividends or appreciation.
If employee-ownership and representation on boards is so great, why have we not seen more? Kokkinis and Sergakis argue that employee particpation may be value-decreasing for shareholders, because a higher portion of profits would go to employees, but such arrangements can still be socially optimal, since such participation brings larger benefits to employees and society due to higher productivity. Such firms also probably have a lower tendancy to externalize costs.
Reorganizing corporate governance to include employee-owners on boards would involve upfront costs, while benefits will only materialize over the long term. Employee participation, initially through employee advisory panels, would be a low-cost way of helping to assess if such an arrangement is likely to be beneficial at any specific company.
For example, such representation may be most additive to productivity where it is difficult to value and apportion work by management monitoring. Kokkinis and Sergakis believe much of the work in the services sector is creative and collaborative, payoffs more likely. I read that as payoffs are more likely in companies where the proportion of intangibles are high. That will soon apply to almost all companies. See Intangible Assets And The Path To Growth, which found in 1975, intangible assets were estimated to make up around 17% of the value of the S&P 500. Fast forward to 2015 and the percentage of value attributed to intangibles rose to 87%.
Here’s an interesting observation from Kokkinis and Sergakis that struck me. In Anglo-American experience, labor is viewed as external to the firm and its corporate governance, whereas in much of Europe labor is considered internal to corporate governance. I suppose that is one of the central causes of our short-term perspective. I will not go into diverging frameworks here, other than to note that UK Corporate Governance Code, effective at the beginning of 2019, requires companies to engage with their workforce using one or a combination of the following on a comply or explain basis:
- A director appointed from the workforce of the company.
- A formal workforce advisory panel.
- Designating a director to liaise with workers, gathering their views.
The last appears the least onerous option. My guess is that’s “one and done,” with no real necessity to listen or learn. Not many companies are not called out for noncompliance unless the company suffers losses. That seems more likely now, with COVID-19 eating away at balance sheets. Additionally, growing interest in ESG may lead companies to see the need for a more inclusive approach to corporate governance.
Kokkinis and Sergakis: Employee Advisory Panels
Kokkinis and Sergakis see the need for a shif in corporate culture by boards, managers, employees and investors to view the workforce as a valuable corporate governance partner, rather than adversary. Those seeking such change have a leg up on Americans, sine the legal framework alreay points in that direction:
Introducing such panels will also provide a useful disclosure framework for company directors to explain how they engage with employees. Indeed, according to the new regulatory requirements, the directors’ report must contain a statement in relation to the actions taken to introduce, maintain or develop arrangements for, inter alia, the systematic provision of information to employees, their regular consultation, and the achievement of a common awareness of all employees of the financial and economic factors that affect the company’s performance.
The panels have the capacity to combine engagement with education on both sides of the worker/management divide. Kokkinis and Sergakis believe,
advisory panels should be conceived and introduced as ‘preparatory labs’ for the creation of a new generation of employees that will be called upon to assume decision-making roles within companies in the future.
Aiming to reinforce this employee preparation phase, some companies may also want to combine such panels with the appointment of a non-executive director in direct contact with the advisory panel employee members. This additional communication channel may prove particularly useful to accelerate employees’ familiarisation with decision-making challenges since the non-executive director will have the task of not only receiving feedback from the panel, but also providing assistance to prepare its members to take on more responsibility as board members in the future.
Kokkinis and Sergakis: Employee Board Representation
Kokkinis and Sergakis see this as a second phase, after advisory panesl have proven successful. Board representation would come with an expanded stake by employees in the companies with a portion of pay invested in shares. Those shares would be a distinct class, entitled to vote for employee director candidates, which could constitute up to a third of the board. The authors begin to discuss details such transferability, ‘one share one vote,’ who nominates, fiduciary duty, etc., which I will not go into here. One interesting suggestion is the need for some form of insurance for employee shares (basically, a hedge), since employees would become even more vulnerable in corporate insolvencies. Losing one’s job and a large part of personal wealth would, indeed, be a hardship worthy of considering in advance.
So, what do you think? To me, it looks like the strategy suggested by Kokkinis and Sergakis could work in the US as well, even though we do not have the UK’s experience or framework with/for employee advisory panels. Like always, I would love comments.