Patience and Property: Corporate vs. Union Management
AUGUST 01, 1990 by ROBERT L. SEXTON, DWIGHT R. LEE
Managers who anticipate a short tenure with their firm unsurprisingly have little interest in long-term solutions to its basic problems. Their goal is to look as good as possible in the immediate future. — Robert Reich, The Next American Frontier
It is a commonly held belief that corporations, in pursuit of short-term profits, shortchange the future. This alleged emphasis on the short run is seen to create a host of problems such as an eroding industrial and human capital base, a productivity crisis, a lack of competitiveness in world markets, the energy crisis in the 1970s, mounting levels of corporate debt, and environmental pollution. The solution advocated by Robert Reich and others is to substitute more control by representative government and labor. However, this would be a terrible mistake.
Property Rights and Incentives
Individual decision makers, whether acting as managers, union leaders, politicians, or workers, will appropriately weight the future when it is in their interests to do so. This is the reason why private property ownership is critical to efficient, future-oriented economic decisions. If property rights are well-defined and enforced, then current owners will benefit from any foreseeable increase in the future value of resources they control. And, if private ownership rights are transferable, this will provide the incentive for individuals to concern themselves with outcomes that extend far into the future.
With corporations, transferable property rights exist in the form of shares of stocks. Since corporate stocks are easily transferable, any management decision that is considered to inhibit a corporations long-run wealth position will be translated quickly into lower stock prices. On the margin, it only takes a few to recognize the short-sighted business policies of management. Once this mismanagement is translated into lower stock prices, even relatively uninformed shareholders will notice and understand that it may be time to call their broker. Thus, transferable property rights in the form of stock reflect the future consequences of corporate decisions.
However, unions do not have the equivalent property rights, and that is why the long-run wealth effects of present decisions are not clearly registered in a way that feeds back into unions decisions. This leads to several important implications. One, without transferable property rights (which reflect the present value of employment opportunities in a firm or industry) the control of union members over union management is restricted. To some extent, union members have control over union management through their right to vote on some issues and on their union leaders. Therefore, members can restrict union management from deviating too far from the collective interests of the members. However, any union-member voter has little motivation to be informed since a single vote will not likely have a decisive impact on any decision, and each worker’s time horizon extends only as long as his employment tenure.
This is not the case with corporate stockholders. They have much more control over their agents than union members have over theirs. The stockholder has the ability to buy and sell stocks. In order for union members to protect themselves in an equally effective way against poor union management decisions, they would have to change jobs and move to an employment setting with either a different union or no union at all. Hence, union leaders have a greater ability to maximize their personal goals and advantages and promote their own agenda than corporate managers, since union members have little or no effective recourse. In other words, unlike the market for corporate control, the market for union control is very ineffective.
Consequently, union decisions on many issues do not correspond with the interests of the members. The position unions take is often at odds with the political preferences of their members. Professors Dan Heldman and Deborah Knight found that in a majority of questions posed to union members in opinion polls, their positions differed (sometime diametrically) from the positions which their union leaders were lobbying in Congress.
But, even if unions were perfectly responsive to the concerns of union members, they would still tend to be insensitive to future wage and salary decisions. Since workers don’t own transferable "employment stock" that reflects the long-run value of their jobs, they have little incentive to take the long view when balancing current wage demands against the long-run gains from maintaining and expanding a productive capital base. But owning employment stocks would require that workers own their jobs with the right to sell them to whomever they please. This would remove the control over employment decisions from those who have supplied the capital and hence would greatly increase the costs of raising large amounts of capital.
However, when workers are in charge of management decisions, this often leads to myopic investment practices. For example, in worker-managed firms in Yugoslavia, employees are entitled to residual profits, but claims are retained only if the worker remains with the firm. So, it is in the workers’ best long-term interests to take their higher wages out of the firm in order to invest in items which have a permanent title (for example, furniture or jewelry) rather than investing in the long-term capital needs of the firm. This is true even when the returns on capital far exceed those of alternative investment opportunities.
Under reasonable property rights arrangements, workers will be less sensitive to the long-term employment effects of current salary, wage, and investment decisions than will corporate managers whose current compensation and future prospects are directly tied to the performance of the firms they manage, as reflected in stock prices. It is current compensation that is often used as a monitor of union effectiveness. And union leaders who cannot extract current wages and benefits from employers will fall under the wrath of their members.
Political Influence of Organized Labor
Unions have been adept at influencing the political process in support of legislation that increases their control over business decisions. There are two explanations for their political influence. One, members of labor unions are intensely concerned about short-run wages and fringe benefits. Such narrowly focused groups are more easily organized and generally are more politically effective than are groups with more diverse interests. Two, political action is best when an organized self-interest is able to disguise itself with the rhetoric of a noble cause. This is particularly evident in labor unions that work under the guise of struggling for the well-being of workers. But higher wages in the union sector tend to depress wages in the nonunion sector, so it is easy to see that union workers’ gains come at the expense of nonunion workers. Thus the real battle that unions wage is not against business but rather against nonunion workers, who often would be willing to work for less than the union scale.
Unions have effectively been able to project the image, however, that they are dedicated to the protection of workers’ rights against the arbitrary so-called power of big business. Union-supported legislation that restricts the discretion of capital owners or corporate management is often politically popular because it is perceived as a justifiable means of curtailing exploitative business practices. This may explain the political appeal of minimum wage laws, maximum hour restrictions, and other legislation that limits the ability of employers to negotiate with employees.
Unions also have been active in support of political measure to restrict corporate practices that serve to motivate corporate managers to concentrate on the long run. For example, takeovers, mergers, stock options, and bonuses provide important incentives for management to consider the future consequences of current decisions. Another example is a corporate arrangement call "golden parachutes" where corporate executives are compensated if their jobs are terminated as a result of a takeover or merger. It is argues that this type of arrangement provides incentives for corporate executives to take risks in line with what their diversified shareholders would consider appropriate and not to fight takeovers that would be in the shareholders’ interests.
Union myopia will affect future productivity in at least two ways. First, in anticipation of a union’s negative impact on the return to capital, one would predict that the projected equity value of a newly unionized firm, or one threatened with unionization, will fall. Second, in those industries in which union power is strongest, one would expect that wage demands eventually will reduce the industry’s competitiveness and, in the absence of government bailouts and protections, push it into serious decline.
The filing of a union election petition and the results of that action can impose significant costs on a firm. Based on data from 1962 to 1980, a successful union drive against a firm lowered the firm’s stock by 3.84 percent. According to Professors Richard Ruback and Martin Zimmerman, even the threat of unionization in the form of an unsuccessful union effort resulted in a 1.32 percent decline in the firm’s stock price.
The reduction in returns to current and potential investors reduces an industry’s investment appeal. Hence, capital formation will be retarded by the effects of unionization. Also, lower profitability in union firms will hamper the internal market for capital, a very important source of efficiency within firms.
One way to reduce the burden of union wage demands is by substituting capital for labor. And, indeed, once can be sure that the ratio of capital to labor will, over time, increase in response to excessive wage requirements. Whether this substitution will motivate an absolute increase in the amount of capital isn’t clear a priori. But, even if the amount of capital in the industry actually increases, it will be the result of a union-induced distortion in the capital labor mix that will reduce both the efficiency of the industry and its ability to compete.
The union myopia that motivates excessive wage demand has been detrimental to the long-run well being of all interests in the economy — consumers, providers of capital, and employees alike. But this economically destructive shortsightedness is the completely predictable consequence of political action that increases the power of unions over business decisions and over the allocation of business profits. Political attempts to rescue unions from the plight in which they find themselves — attempts which ordinarily involve granting them yet more power and imposing still more restrictions on business decisions — will prove just as self-defeating in the long run as have previous attempts.
Labor unions already have given worker representatives more control over business decisions than most people realize. This control has hampered the ability of business management to pursue long-run goals through far-sighted and productive investment commitments. Private business concerns may not give the future the weight that, in some ideal world, would be considered appropriate. But a realistic assessment of the motivations driving labor union activity leads to the unmistakable conclusion that giving more control over business decisions to labor unions will shorten the planning horizon of business firms.
As long as owners and managers of private businesses are free to allocate revenues among shareholders, employees, and capital investment in response to market forces, decisions will be made that promote capital formation and lead to long-run economic growth. Unfortunately, government regulation of labor relations has increasingly diminished businesses’ (and therefore consumers’) control over decisions relevant to capital investment, and passed that control to union officials. As a result, government has shortened the planning horizon of business decisions, allowed excessive wages to be substituted for capital formation, and reduced the long-run competitive vitality of major sectors of the U.S. economy.
Dwight R. Lee is the Ramsey Professor of Economics at the University of Georgia, Athens. Robert L. Sexton is Associate Professor of Economics at Pepperdine University. The authors would like to acknowledge the helpful comments of Gary Galles on an earlier draft of this paper.