Worker Participation in Decision-making Processes within Firms
Worker participation in decision-making processes within firms is increasing. This is expressed in the principles of the mutual gains enterprise that were mentioned earlier (Kochan and Osterman p. 131-6; Kochan et al. p. 34; Cappelli et al. p. 56-75; Osterman p. 121-142).
While teamwork and worker participation in decision-making at the shop-floor level have become quite common in modern firms, such involvement in strategic decision processes is rare. Kochan and Osterman (131–6) discuss, for example, the small and unusual history of employee representatives sitting on boards of directors in American corporations. They conclude that a prior condition required for the success of such a structure is the existence of a viable and supportive business strategy for the long run, one that supports mutual gains.
A central form of worker participation with a potential of involvement in strategic decision-making is the American-style works council, which is very relevant to the rationales presented in the next section. Freeman and Lazear (p. 29-56) conducted an economic analysis of works councils which arrived at the following results. First, neither employers nor workers have incentives to create voluntary councils with the power to maximize social value: an optimal division of power can be achieved only through government intervention. Second, councils with rights to access information reduce economic inefficiencies by moderating worker demands during tough times. Third, councils with consultation rights can produce new solutions to the problems facing the firm. Fourth, co-determination rights that increase job security should lead workers to take a longer-run perspective on firms’ decisions, thus investing more in firm-specific skills and giving workplace concessions that enhance enterprise investment in capital. This result will be used to support the argument that worker participation in strategic decision-making improves firm performance.
Why is a Social Contract in the Workplace Required?
From a purely economic perspective, it may be argued that there is no need to institutionalize the relations between employers and employees in a contract other than an employment contract. If we view the labor market as a buyer-seller market, then it will reach an efficient equilibrium under the condition of perfect competition. Firms will hire the most suitable employees for their purposes and payment ability, while workers will find the most suitable workplace for their skills and wage expectations. However, labor markets are characterized by information asymmetries, control problems and training costs, which create imperfect competition. In fact, these characteristics explain the need for long-term attachments between employers and employees or the evolution of ‘internal labor markets.’
Internal labor markets, as identified by Dunlop (p. 32), are ‘the complex of rules which determine the movement of workers among job classifications within administrative units … these movements may be transfers, promotions, demotions, or layoffs to the exterior labor markets’. Internal labor markets improve performance because they reduce the costs for firms of training the work-force and retaining skilled labor.
More specifically, internal labor markets emerge as a result of ‘skill specificity’ and the need for on-the-job training (Doeringer and Piore p. 63), as well as due to ‘job idiosyncrasy’ (Williamson et al. p. 250-278). Similarly, new institutional economics suggests that long-term employment relationships enhance efficiency and performance because they minimize transaction costs, resolve principal-agent problems and create job stability (Wachter and Wright p. 240-262). Osterman (p. 124-152) suggests that all these explanations are part of a more general class of arguments which emphasize the issue of control. The firm has to find the best mechanism to elicit effort from its labor force, while minimizing the ability of employees to act in their personal interests rather than in the interests of the firm. Internal labor markets help resolve the problem by providing long-term opportunities to observe employee behavior, creating employee investment in the firm and hence raising the costs of cheating or poor effort, and establishing an employment framework that permits development of wage systems that harmonize agent and principal interests.
In fact, the emergence of a specific internal labor market can be understood as the evolution of a specific social contract in a particular workplace. In order to be accepted by both employers and employees, such a contract should be efficient and stable from the employer point of view, while at the same time satisfying employee interests. The rationales developed here suggest that all these conditions can be met through participatory rules. We first discuss interest representation and organizational stability, and then explain the perspectives of workers and employers.
Interest Representation and Organizational Stability The structure of decision-making rules significantly influences both the efficiency and the stability of an organization as well as worker satisfaction, loyalty and co-operation. Therefore, we argue that interest representation and decision-making rules stand at the core of a new social contract in the workplace. This argument is well rooted in the framework of social choice theory, which offers a framework explaining the difficulties in reaching an agreement on a common goal. Arrow’s Impossibility Theorem (Arrow p. 38), as well as other models, shows that when individual preferences vary no social welfare function exists that will satisfy either stability (or efficiency) and fairness (McKelvey p. 472-482). Consequently, there is no optimal decision-making or representation mechanism. This argument clearly applies to organizations whenever the question of interest representation is addressed. Freeman and Lazear (p. 54), for example, analyze the preferred representation mechanism in works councils; more specifically, ‘how well does the subset of the population (works councilors) reflect preferences of the population (work-force)?’ They consider the preferred size of the council, proportional representation and the jury system as ways to guarantee minority representation. Clearly, decision-making procedures at all levels of the firm can be analyzed on the basis of social choice theory.
Given that social systems cannot remain unstable for long periods, stability is induced by norms and rules that limit available alternatives or the participation of certain players in the decision-making process. Therefore, they also undermine the fairness of any decision-making procedure. This, and the fact that under any policy equilibrium there are players who are dissatisfied with their payoffs, create the potential for changing the status quo, i.e. either the outcomes or the rules or the norms (Riker p. 432-447). This means that rules and norms induce only temporary and relative stability, since they may be subject to change by dis-satisfied players. Yet norms, which represent values and conventions, are more difficult to change than formal rules. The latter are often changed as a result of the immediate interests of a coalition of players, while changing norms requires belief change.
This framework suggests that people who are not satisfied with their outcomes (payoffs) and want to stay in the group/organization will undergo the following process of change in their behavior. First, they will attempt to alter the outcome under the given rules and norms. If unsuccessful, they will try to change the rules, and finally they will try to change the norms of the group/organization in which they operate.
This rationale can be exemplified by the socio-political processes that led to the voluntary establishment of works councils in many Italian firms during the 1970s. After the Second World War, worker representation in the workplace was institutionalized by internal commissions (commissione interna). At first, they were granted broad rights following worker unrest, but these functions were revised several times in ways that reflected the decline of the institution (Regalia p. 78-92). In the early 1970s the internal commissions were de facto and abruptly replaced by other representative institutions, in a period of grass-roots mobilization and protest during which they were labeled as ‘old’, ‘bureaucratic’ and ‘ineffective’. Thus, worker dissatisfaction was transformed into a mass movement demanding changes in the basic rules. Furthermore, unions attempted to gain control over the movement by several initiatives that finally led to the unexpected outcome of the widespread establishment of works councils in Italy beginning in the mid-1970s (Regalia p. 78-92).
Thus, in the late 1960s Italian workers were dissatisfied with either their outcomes or their level of involvement in the firms’ decision-making processes. As a result, they initiated a protest movement demanding militant, ‘direct’ forms of worker involvement and participation (Tarrow p. 111-132). By doing so, they attempted to change both the rules and the norms of their organizations. The fact that this pressure led both unions and employers to rethink their strategies exemplifies the power embodied in grass-roots movements even in the industrial sector. Since participation in such movements also strengthens norms of participation among workers, the formation of a grass-roots movement will be presented later as a central strategy for unions to achieve structural change.
To sum up, a stable organization is one that guarantees that players will co-operate with the norms and rules, while providing accessible channels whereby they are able to change outcomes and payoffs within the structural setting. We argue that this can be achieved by participatory rules and norms.
The Workers’ Perspective: Participation, Co-operation, Loyalty and Stability
Participatory, or democratic, rules provide enough opportunities for players to change outcomes and improve their payoffs since they incorporate many players and interests. Yet, participatory rules are also more stable than non-participatory rules, owing to the vagueness they create regarding the true connection between rules and outcomes.
To explain this argument, let us assume that a certain player is not satisfied with outcomes, and after several attempts to improve her payoffs she considers the possibility of changing the rules. In order to know what rules or norms need to be changed and in what direction to go, the person has to know the true effect of rules and norms on outcomes. For example, in a decision-making process that gives one person all authority, the effect of rules on outcomes is clear: unsatisfied players may want to replace the person with total control or to change the rules that give that authority to a single person. Yet under a complex structure of rules the player cannot be sure what rules or norms need to be changed, and she will therefore attempt to change policy within the rules and norms.
It follows that, as the level of vagueness about the true connection between rules and outcomes increases, people will become more unsure about which rules need to be changed in order to improve their payoffs, and therefore will come to accept the rules (Przeworski p. 87-91). Such vagueness is achieved as the rules become more complex, incorporating many people, organizations and interests in decision-making processes, i.e. democratic or participatory rules. Thus, as the set of rules, i.e. the institutional structure, involves more people, interests and alternatives in decision-making processes, it will tend to become more stable. Moreover, players will be more satisfied with their outcomes as the rules are more participatory and give players the opportunity to express their preferences.
This conclusion is also supported by democratic theory, according to which participation in decision-making processes increases player responsibility for the outcomes, so that players tend to accept and co-operate with the system (Putnam p. 24-51). Moreover, participation in decision-making processes may strengthen the sense of group identity and, correspondingly, loyalty to the group/organization (Osterman p. 75). In other words, democratic and participatory rules increase loyalty through participation rather than through material incentives or long-term employment.
Applying this rationale to the workplace, as decision-making rules become less hierarchical and more participatory, it is harder to recognize the true connection between rules and outcomes. Therefore employees will be more inclined to attempt to improve their payoffs within the rules of the game rather than to try to change the rules or simply leave the firm. Furthermore, as explained earlier, norms are more stable than formal rules, and democratic rules are more stable than non-democratic rules. This means that the strongest source of structural stability is democratic norms in the organization. That is, not only are workers allowed to participate in decision-making processes, but also, the organizational values and culture are based on the principle of mutual respect for the opinions of others and a deep recognition of the need to share ideas. It follows that not only structural conditions, but also, and perhaps most importantly, cultural conditions are central to the stability of a firm.
This rationale is relatively new in the industrial relations literature. The most common justification for worker involvement in decision-making processes concentrates on its contribution to firms’ efficiency in terms of communication, quality of decisions, loyalty and commitment. Yet the stabilizing effect of decentralized rules and institutions, as explained above, rarely appears in the literature. As a result, this literature offers very few empirical examples regarding this effect.
Employers’ Perspective: Efficiency and Decentralized Authority
The structure of decision-making rules influences not only worker motivation and the stability of the organization, but also efficiency. Since transaction, enforcement and influence costs are likely to be much higher in centralized systems than in decentralized systems, economic inefficiencies are likely to be deeper and to trigger instability more quickly in centralized systems than in decentralized ones (North p. 41-56, p. 89-94; Milgrom and Roberts p. 98-106). Transaction costs are those associated with the measurement and enforcement of agreements. North (p. 89-94) suggests that in economic markets such costs consist of the measurement of the physical and property rights dimensions to goods and services, and of the performance of agents.
To clarify the difference between centralized and decentralized systems in the context of transaction cost economics, Milgrom and Roberts (p. 98-106) develop the concept of influence costs. They characterize any centralized organization by the authority and autonomy of its top decision-makers and management — that is, their broad rights to intervene in lower-level decisions and the relative immunity of their decisions from intervention by others. They argue that discretionary authority results in a type of cost that is incurred even when the central authority is both incorruptible and intelligent enough not to interfere in operations without good reason, and they term them ‘influence costs’. These are the costs resulting from the attempts of individuals and groups within an organization to influence decision-makers (Milgrom and Roberts p. 98-106). First, individuals and groups within an organization expend time, effort and ingenuity in attempting to affect decisions to their benefit. Second, these ‘influence’ activities may lead to inefficient decisions — for example regarding the rents and privileged regulation received by influential players or interest groups. Third, the attempts of decision-makers to control or prevent influence involve costs for the organization or society.
Thus, they conclude that increased centralization leads to increased influence and, as a result, to economic inefficiency. This means that non-participatory or non-democratic organizations are more likely to produce economic inefficiency, leading workers to understand that improving their payoffs is pre-conditioned by changing the rules or simply leaving the organization.
This rationale explains the strong interest of managers/owners in constructing participatory rules and even in encouraging the development of participatory organizational values and culture. Yet, social choice theory enables us to argue that employers/owners are likely to move only partially in this direction, creating participatory procedures but leaving enough power in their hands to manipulate outcomes. In other words, as long as employers are the people who plan the structural changes and the terms of the new social contract, they are most likely to set rules that give the impression of wide participation in decision-making processes, while in fact maintaining control of the key points in these processes in such a way that they are able to manipulate outcomes to their own ends.
This analysis actually brings us back to Riker (p. 432-447), who argued that the rules serve the interests of those who set them. In a participatory set of rules, the problem is further intensified because the vagueness created by such rules allows those who set them to hide their agendas and manipulate the formal rules, thus maximizing their interests. Furthermore, it has been shown by many studies that, as the set of rules become more complex, it opens a wide range of possibilities for manipulating the outcomes. This means that this form of social contract is likely to be stable only as long as employees do not recognize that their interests are not truly represented. Since it may take some time for them to recognize this fact, there is an appearance of stability.
The incentives of employers to set participatory rules on the one hand and control the key decision points on the other hand can be clearly exemplified by the establishment and operation of European works councils. In his comparative analysis of European works councils, Streeck (p. 78-93) concludes that, beginning in the 1970s, the broad move from mass production to flexible production, as well as the dramatic increase in the number of decisions and the speed with which they had to be made, led employers radically to decentralize managerial decision-making and fundamentally to alter the kind of productive co-operation that was required from work-forces.
Yet it was not only the organizational changes that brought employers to set participatory rules. As mentioned earlier, the establishment of European works councils followed a wide wave of worker unrest which demonstrated the high ‘influence’ costs of centralized authority. As a response, employers all over Europe recognized the need to create a representation mechanism, and in many cases co-operated with initiatives to establish works councils. Indeed, where representative participation is strongly established, employers often and typically express their satisfaction with it (Streeck p. 78-93). The extreme example is, of course, Italy, where works councils were established voluntarily by employers following a dramatic increase in influence costs.
However, both in Italy and elsewhere in Europe, employers attempted to control key points in the decision-making process. Rogers and Streeck argue that the attempts of European employers to limit worker involvement in the 1950s and 1960s led to ‘a “trust gap” among workers who came to believe, in the absence of enforceable management obligations to consult or inform, that management turned to councils only if doing so served its own interests’ (p. 18). As a result, both sides became disappointed and lost interest, and joint consultation systems gradually dried up. As explained, this process finally led to intense waves of worker unrest demanding greater representation.
In the 1970s French employers also began aggressively to set up union-independent structures of direct participation that they controlled (Streeck p. 328). In the Netherlands nearly half of the works councils indicated, in 1985, that information on economic, financial and technical issues was obtained only after management has made its decision (Visser p. 123-142). A majority of managers and council presidents in the Netherlands also agreed that the council is involved only in the final stages of decision-making. Even in the German case, which is usually regarded as exceptional, co-determination in itself does not in general seem to have brought true worker participation at the board level, which effectively remains in the hands of investors (Hansmann p. 174).
The theoretical analysis and empirical illustrations presented so far enable us to draw several conclusions. First, a social contract in the workplace is required to minimize transaction costs, resolve principal-agent problems and create job stability. In doing so, it increases efficiency and performance. Second, a stable organization is one that guarantees that players co-operate with the norms and rules, while providing accessible channels to change outcomes and payoffs. Third, participatory rules and norms within an organization have a stabilizing effect, since they create vagueness regarding the true connection between rules and outcomes. In addition, participatory rules have other positive effects, such as improved communication, quality of decisions, loyalty and commitment. Fourth, a high level of worker involvement in decision-making processes may encourage workers to adopt rent-seeking behavior, attempting to maximize their own interests rather than those of the firm. In addition, when unions concentrate on wage bargaining, they create fears among the management that rent-seeking behavior will indeed characterize workers. This means that the optimal level of worker involvement in decision-making processes is a function of the firm’s characteristics and other structural factors.
Fifth, decentralized systems in general and participatory rules in particular reduce transaction, enforcement and influence costs and therefore create strong incentives for employers to construct such rules in order to improve efficiency and performance. Sixth, employers are likely to recognize this fact as a result of structural change, either in the form of economic pressures that require worker co-operation or in the form of worker pressures that express their dissatisfaction. Seven, as long as employers are the people who set rules, they are likely to set them in a way that gives the impression of wide participation in decision-making processes, while in fact enabling them to maintain control of the key points in these processes so that they can manipulate outcomes to their own ends.
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