Human Capital and Corporate Governance

Abstract

Governance in the firm is a mechanism to help empowered claimants protect their interests, principally by giving them “voice” in corporate decisions. Germany and some other European countries have explicitly mandated a formal role for employees in corporate governance, whereas the “Anglo-Saxon” systems of the United States and United Kingdom have basically restricted governance to representatives of the providers of financial capital. The recent relative success of the American economy — transforming itself in the 1980s and achieving low unemployment and sustained growth since then — has raised the question whether shareholder value should also become the over-riding objective of European (and Japanese) business.

At the same time, the purportedly increasing importance of knoweledge and human capital might suggest that the provides of this capital shouls be accorded more representation in governance processes: they are providing more of the total capital and these investments may need protection. Note that, in fact, in professional service firms, where the only important capital is human, the full powers of ownership are in the hands of providers of this human capital. More generally, employee stock holdings are often significant in human capital-intensive corporations.

In this paper we discuss these matters in light of a series of comparative statics exercises that examine the effect of increasing the ralative importance of human capital on the optimal role of workers in governance. We find support for the position expressed in the preceding paragraph. We also find that the attractiveness of shareholder-dominated governance when significant reallocations of capital are indicated depends on the extent that workers’ interests are protected by outside employment options (“exit”) and on the possibilities that they have to use value-destroying bargaining devices such as strikes to promote their interests.

Many of the ideas developed here emerged in discussion with Sheila Bonini, Jonathan Day and Bengt Holmström. We are indebted to them and to the participants at the Humboldt Forum who made comments and suggestions on our work. Van den Steen’s work was supported by ICM/CIM.