Abstract
This paper develops a simple principal-agent model to determine the occupational choice of some individuals between entering the labor market as workers and setting up a labor-managed firm. The start-up requires external credit, which is provided by a monopolistic lender. We show that the occupational choice depends on both the reservation utility of workers and the loan profitability of the bank.
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Notes
In this respect, the model developed in this paper is close to Hueth et al. (2005).
We thank one of the referees for suggesting this interpretation.
As argued by Pérotin (2006), members of labor-managed firms are likely to have a lower level of initial wealth than capitalist entrepreneurs (and thus are more likely to be vulnerable to unemployment). The lack of initial wealth can also explain why cooperative entrepreneurs do not set up two distinct businesses where profits are not shared.
Viganò and Salustri (2015) show that, in addition to cooperatives, non-profit organizations can play a useful role in boosting growth during downturns.
Pèrotin (2006) also shows that the presence of a Left government has a positive effect on the entry of SCOPs (+ 17%) and a negative effect on overall entry (− 10%). She argues that Left governments can foster entry through its influence on past capital and labor income shares.
We follow the interpretation of Meade (1972), who defines labor-managed firms as “a system in which workers get together and form collectives or partnerships to run firms; they hire capital and purchase other inputs and they sell the products of the firm at the best prices they can obtain in the market for inputs and outputs; they themselves bear the risk of any unexpected gain or loss and distribute the resulting surplus among themselves, all workers of any one given grade or skill receiving an equal share of the surplus.”
In the model, the firm’s expected return is not affected by the labor market conditions. The final output might be positively related to the employment rate, and this would affect the quantitative results, but not the qualitative properties of the model as long as the variability of y is lower than that of e.
The presence of a monopolistic bank is not strictly necessary to obtain a counter-cyclical behavior of labor-managed firms. In Remark 1 below, we briefly discuss the case of perfectly competitive banks.
In general, the participation in cooperative firms is based on one vote per member, irrespective of shares or equity owned. This implies that, in most cases, the majority of equity shares are owned by workers/members and that the main source of external financing for cooperatives is typically bank credit (in France and in Italy, for example, some external capital ownership is compatible with the cooperative form). However, there are numerous examples of cooperatives that introduced innovative capital structures and, in particular, of external ownership, which can also convert the cooperative firm into a conventional private or public limited company (see on this topic, Van Bekkum and Bijman 2006).
Note that the inequality p L y − L < 0 in Eq. (1) does not rule out the possibility that LMF members can choose the low-effort strategy.
If one of the two LMF members chooses high effort, the other member faces the same constrain in ( IC ). The role played by the bank is partly related to Holmstrom’s (1982) external budget breaker in team production, which can credibly punish team members if they do not provide the efficient effort levels.
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The paper has substantially benefited from the comments and suggestions of two anonymous referees.
Appendices
Appendix 1 Bank-PMF relationship
Consider a conventional profit-maximizing firm (PMF), with an owner (employer) and a subordinate worker (employee). The probability of output realization depends on the effort level exerted by the owner and the employee: if both members exert high effort, the project succeeds with probability p H , and if one applies low effort, the probability is lower, p L < p H . The investment loan is provided by the monopolistic bank, which will always promote high effort. Thus, there will be two moral-hazard problems: the first concerns the effort chosen by the subordinate worker in the owner-employee relationship and, the second, the effort chosen by the PMF owner in the bank-owner relationship. To make the analysis consistent with the LMF case, assume that the reservation wage of the subordinate worker is e ∙ ω.
We first consider the labor contract between the employer and the employee, in which we assume that the former has all the bargaining power. The employer chooses the wage, w H , paid in case of project success, such that the employee’s incentive constraint is satisfied:
The employee’s participation constraint is
Thus, the equilibrium (efficiency) wage will be such that either Eq. (9) is binding, w H = c/(p H − p L ), or Eq. (10) is binding, w H = (c + e ∙ ω)/p H .
Now consider the financial contract between the bank and the PMF owner. The monopolistic bank chooses the repayment in case of success, R, that satisfies the PMF owner’s incentive constraint
The PMF owner’s participation constraint is
Again, we distinguish between two cases: (1) e ∙ ω < p L c/(p H − p L ); (2) e ∙ ω ≥ p L c/(p H − p L ).
Case 1
In this case, Eq. (9) is binding for the worker, since e ∙ ω < p L c/(p H − p L ) implies e ∙ ω < p L w H from Eqs. (9) and (10). Thus, the equilibrium wage is w H = c/(p H − p L ).
Similarly, when e ∙ ω < p L c/(p H − p L ), Eq. (12) is binding for the PMF owner. In equilibrium, the bank sets R such that p H (y − R − w H ) − c = p L (y − R − w H ) or R = y − 2c/(p H − p L ) = R IC . The equilibrium payoffs for the PMF owner and the bank are
and
The worker obtains the same payoff as the PMF owner, p L c/(p H − p L ). Therefore, the equilibrium payoffs are equivalent to those derived in the bank-LMF analysis.
Case 2
e ∙ ω ≥ p L c/(p H − p L )
In this case, e ∙ ω ≥ p L c/(p H − p L ) implies p L w H ≤ e ∙ ω. Thus, the subordinate worker’s participation constraint is binding, and the equilibrium wage is w H = (c + e ∙ ω)/p H .
If e ∙ ω ≥ p L c/(p H − p L ), the PMF owner’s payoff participation constraint is also binding, since the payoff in Eq. (13), deriving from R = R IC , is negative. So, in equilibrium, the bank sets R such that p H (y − R − w H ) − c = e ∙ ω or R = y − 2(c + e ∙ ω)/p H = R PC . The equilibrium payoffs are
and
The worker also obtains e ∙ ω. So, again, the equilibrium payoffs are equivalent to those in the bank-LMF analysis.
Appendix 2 Pro-cyclicity of PMFs
Consider that the PMF owner has some initial (illiquid) wealth, W, which can be used as collateral in the financial contract. Assume that the PMF owner has no opportunity cost other than W (otherwise, the PMF would always have a disadvantage compared to the twin LMF). We assume that economic conditions do not affect the size or value of W (even though, the following analysis would still be valid if the variability of W is lower than that of e ∙ ω).
We consider the case in which the loan availability is constrained, so the bank must choose the most profitable borrower between the LMF and the PMF.
Case 1
In this case, the subordinate worker’s equilibrium (efficiency) wage is w H = c/(p H − p L ). If the collateral transferred to the bank in case of project failure is equal to W, the PMF owner’s incentive constraint can be written as
The equilibrium repayment is such that Eq. (17) is binding, that is
However, note that the owner’s expected payoff, evaluated at the repayment in Eq. (18), is
which can be either negative if W is high enough or lower than the payoff obtained by the subordinate worker. Hence, we assume that
Under Eq. (20), the equilibrium repayment must be such that the PMF owner’s participation constraint is satisfied, that is p H (y − R − w H ) − (1 − p H )W − c = W, or
The equilibrium payoffs are
and
The difference between the bank’s expected profit on the LMF (from Sect. 3) and on the PMF is
which is positive under assumption (Eq. 20). Therefore, if e ∙ ω < p L c/(p H − p L ), the bank prefers to lend to the LMF.
Case 2
In this case, the worker’s equilibrium wage is w H = (c + e ∙ ω)/p H . Again, the bank must set R such that the PMF owner’s participation constraint is binding, that is p H (y − R − w H ) − (1 − p H )W − c = W, or
The equilibrium payoffs are
and
We have that
which can be negative if W is not too high. For example, if p H = 0.7, p L = 0.35, y = 15, c = 1, e ∙ ω = 1.35, L = 2, and W = 1.5, we have e ∙ ω − p L c/(p H − p L ) = 0.35, and E[π] LMF − E[π] PMF = − 0.3.
Therefore, if e ∙ ω ≥ p L c/(p H − p L ) and W ≤ e ∙ ω/p H , the PMF can be preferred as a borrower by the bank.
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Monteleone, S., Reito, F. Cooperative firms in hard times. Small Bus Econ 51, 171–179 (2018). https://doi.org/10.1007/s11187-017-9929-8
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DOI: https://doi.org/10.1007/s11187-017-9929-8