Sunday 20 March 2011

I nearly stopped on reading on the very second page...

I was sent a copy of Beyond The Corporation to review. To cut a long story short, having read to the very end (which took me over a week - I'm a fast reader but it's a slow read in equal and opposite measure) and understood what he trying to say (even though he never really says it), I agree with his argument, but he gets off to a bad start on pages 1 and 2:

My ancestor's achievement made him very rich, and also be brought a lot of wealth to his descendants. People who own paper mills are well off, and during my childhood we did not lack for money. If you own the mill, you ad your children and your children's children will receive all the wealth created by the endless hard work of the employees.

You don't have to do anything: it is simply given to you, it is yours by legal right, even if you have nothing to do with the mill and have never contributed anything to its success, and even if for generations your family has invested no new money in the business, other than some of what the business itself generates through the work of the employees.


Woah! What does he overlook here?

1. The owners of the mill are subject to all the rules and regulations and are e.g. at the mercy of some EU Directive which might be brought in to prevent 'intensive water use' in the same way as they have shut down a lot of 'carbon intensive' heavy industry.

2. The employees do get a lot of the 'wealth' generated by the business, as they are paid market wages (and I fail to see how wages can be anything other than market rates, or else they'd go elsewhere) which are usually about three-quarters of the net profits of the business after about half of the total income is lost in taxation.

3. What the owners/shareholders actually get is not "all the wealth", it's about a quarter of post-tax income, and is a mixture of:
a) rents (whether on the land and buildings the business owns or on patents etc);
b) return on capital invested (in the sense of 'the money tied up in all the machinery') and
c) the 'super profits' generated from 'economies of scale' or 'synergies' or 'good will' or a 'dominant market position'.

a) can easily be removed from the equation by taxing it (whether you call it Business Rates or Land Value Tax or charging for the special protection given to the owners of patents). The ridiculous salaries which CEOs pay themselves come out of (a) and (c) of course, they are not robbing from the employees so much as robbing from the shareholders.

b) everything has to be financed somehow, and in the book he explains that there is no harm in the providers of finance for the physical or intellectual investment being paid interest (he explains that the a lot of employee buy-outs are financed by bank loans if the employees themselves don't have enough spare cash).
-------------------------------------------------
So really, it's only item (c) that we need to think about.

To answer the question of to whom these really belong we have to ask "Who creates them?" and that is the tricky bit - no individual can really be said to create them but they are there, and as a rule 'everything has to belong to somebody'.

4. One person on his own cannot just become a shelf-stacker in a supermarket, the supermarket has to be there first. And this shelf-stacker is paid a market wage of £12,000 a year, but by combining and co-ordinating the efforts of all the drivers, shelf-stackers, check out girls, cleaners, product designers and store managers, the 'supermarket' (as an abstract entity) generates profits well in excess of all these salaries.

The way I understand it, his argument is that the economy works far better if those 'super profits' are shared firstly between the providers of the actual money invested (as interest) and the remainder between all the employees. Over time, any well run business is self-financing, so over time, an employee-owned business would generate sufficient 'super profits' to repay any loans it has taken out to buy the business (see 3 b) above) and it becomes 100% employee-owned.

5. So the shelf-stacker would end up being paid his £12,000 basic wage for work done and would receive a few thousand pounds extra as 'profit share'. For example, Tesco's profit after tax divided by the number of employees appears to be about £5,000. In the later chapters, where the book gets very technical (my favourite chapters), he explains that employees could/should be encouraged to roll up this profit share within the business, as a quasi-cash account earning interest, as insurance against unemployment and for their retirement.

6. This would leave the shareholders with nothing, of course - but who are those shareholders? By and large they will be people working for other shareholder-owned businesses, who have spare cash left over after paying off their mortgages and who are saving up for their retirement by buying shares in other shareholder-owned businesses and hoping to keep some of the £5,000 'super profits' generated by employees elsewhere.

7. So the whole 'capital market discipline' is actually a hugely expensive and inefficient way of churning money round (with plenty being creamed off by 'the City') with everybody trying to enslave everybody else. He points out that even though all the individuals working for a supermarket might not know much about the bigger picture of running a supermarket, they certainly know a lot more about it than small shareholders, pension fund trustees, investment managers and the like, so by and large, employee-owned businesses are run far better than ones owned by people with no involvement in the business.

8. "Aha!", I hear the audience shout, "If this were true, how come so few businesses are owned by their employees? Why don't they spontaneously come into existence?"

That's the sad bit of the story and where you have to un-learn a lot of what you have previously been taught as Gospel, and to which I will return over the next few days and weeks. To give you a clue, it's got to do with the confusion between current wealth created by a business in the year (which is fairly stable) and the net present value of all the 'super profits' to be created in future, i.e. the market capitalisation (which can fluctuate wildly).

32 comments:

chefdave said...

Bugger, I just typed I long, detailed post but my Blogger account deleted it when I signed in. Annoying.

Here's the crux: LVT would implement a sort of organic profit-share. As the surplus would increase in line with productivity LVT & a CD would incentivise hard work and a more efficient allocation of resources. Currently the system uses productivity against workers because it raises their costs via the land market. This is not good for working people.

Lola said...

Pt. 8. A lot of businesses are owned by their employees. In pretty well all small business the owner also works in the business, often doing real work.

Lola said...

This question has exercised me too. Who does create the super profits? I have usually fallen back on the old saw that 'an entrepreneur brings together the resources of land, labour and capital to make a profit'. In other words the super profit is paid to the organiser. The bloke that sees the opportunity and decides to try and capitalise upon it.

Mind you that does not answer the question for less entrepreurial businesses, generally large and mature.

Perhaps the trend is that as a business grows one involves the staff more in ownership. ever heard of the Estate Agents 'Jackson Stopps and Staff? I think Mr J-S had this same idea.

It's been in my mind because I want to improve my exit plan and improve the business. Curiously I ended up with ownership (or at the very least a profit share) going to not only the staff but also the clients. A move to a form of mutuality - which'd be pretty novel for a retail FS business, but in many ways a natural development. But, and it's a Big But, I want the money out I've invested - or some form of reward for its use and do I deserve some payment for making it all happen in the first place, for 'organising' it?

Mark Wadsworth said...

CD, yes, this is like a microcosm of Georgism within the boundaries of each business:

Super profits = land rents
Shareholders = land owners
Employees = citizens.

But while all (or nearly all) citizens contribute to land values in some way, it's only people involved in a specific business who contribute to its value.

L, yes, with very small businesses or one or two partners, the distinction between 'owner' and 'employee' is irrelevant (which highlights how artificial it is).

And fair play to the original entrepreneur who gets the whole thing rolling, he did take the risk, most of them fail and the lucky few get the reward.

The reason the employee-ownership model doesn't catch on is that the original owner of the business thinks (not unreasonably) "I'd rather sell the NPV of the future super-profits, i.e. the share capital, than just be repaid my accumulated capital account with interest out of profits each each year" and of course the stockbrokers, advisors and accountants etc are all advising him to do it this way.

The fact that the up front windfall gain to the retiring business founder is far less than the future benefit to the business, its employees and customers etc. does not enter into the retiring founder's calculation. So it's a question of splitting the difference somehow.

Tim Almond said...

That's a grossly simplistic view of a family business, that it's a magic pot of cash that keeps delivering money ad infinitum.

What happens to that paper company when we're all using Kindles to get our news and books, and write notes on laptops (already do this)?

I said when I first saw blogging start to take off that the only thing to do with a newspaper business was to find a sucker to take it off your hands, and I feel similarly about paper. OK, there's a business for paper, but with more and more electronic communication, paper's going to get more and more niche (do kids even still send handwritten lovenotes or just text now)?

Mark Wadsworth said...

JT, indeed.

A good example of this is when the founders of Tipp-Ex sold the business in 1997, the old owners cashed in mightily and the new owners got stuffed.

Deniro said...

point 2 "3/4 of the net profits"
useful for analysis to note that, that is better than a owner/employee patnership with profits split 50/50.

Mark Wadsworth said...

Den, and your point is..? Give me an example.

Bayard said...

Well, I haven't read the book, but what the author is proposing sounds very much like what Robert Townsend was proposing in his book "Up The Organisation" published in 1970. I read it when I was at college and it's a damn good read.

Deniro said...

I'm simply noting that you are saying that the employees earnings are 3/4 of the profits and the owner's earnings are 1/4 of the profits. If each employee were treated as an equal partner with the owner they would get 1/2 not 3/4 of what their parnership generated.

JJ said...

@chefdave

Do all your comments long or short in Word, then copy and paste. If you don't save your word document, make sure you don't delete it until your comment is published.

You can of course type your comment and then right click, copy, and save on your clipboard ready to paste.

Mark Wadsworth said...

B, this book isn't a damn good read, but as the author owned said paper mill and sold it to his employees, at least he walked the walk.

Den, whoever recommended some mathematical formula where 'the owners' (however defined) as a group get exactly half and employees (however defined) as a group get the other half? That sounds a bit mad to me.

JJ, I sometimes do the right-click, copy and paste. If the original comment fails and it won't paste it again, then somebody up there is telling you to get on with something else.

Deniro said...

If you employed somebody and the result of the arrangement resulted in profit of £1000 , what would you pay them.

Bayard said...

Robert Townsend practiced what he preached, too. He was a successful businessman first and author second.

AntiCitizenOne said...

>If you employed somebody and the result of the arrangement resulted in profit of £1000 , what would you pay them.

If you employ someone then you normally agree to a fixed amount up-front. The split should depend on the going rate for the task asked.

So if 5 Currency-Units of employee time resulted in 1000 CUs of profit then the split should be 5-995. After all If you hadn't been there that 1000CU profit wouldn't exist at all and your employee would also be 5CUs worse off.

Deniro said...

AntiCitizenOne
So you think the split should be 5-995 . Actually as Mark pointed out the Split is 750-250. Employees get a better deal than people think.

TheFatBigot said...

Re point 6: "who are those shareholders?"

You said:"By and large they will be people working for other shareholder-owned businesses, who have spare cash left over after paying off their mortgages and who are saving up for their retirement by buying shares in other shareholder-owned businesses".

Yes, but that only describes them as individuals it does not define them as shareholders.

Shareholders can only buy (i) newly issued shares or (ii) existing shares. The first option requires the purchaser of new shares to put new cash into the business and take a risk, the second option involved the transfer of existing shares which necessarily represent the cash someone previously risked by putting it into the business.

In either event each shareholder represents what each share represents, namely an element of capital which the business is still using to generate the added value from which employees are paid.

If you are going to turn a company incorporated by shares into some sort of worker co-operative, the capital injected by the original shareholders must be repaid or confiscated. If the latter option is not part of the plan, the shareholders do not end up with nothing, they must have their capital repaid - that capital now being represented by the market value of their shares (with or without artificial or "super" profits).

A business established using borrowed money can be entirely self-financing over time, but part of the deal is that the capital sums loaned must be repaid together with interest until such time as they are repaid. The same applies to turning a company with shares into a workers' co-op.

It is wholly artificial to look at Tesco's annual profits and say they could result in each employee receiving £5,000. That is to look at only one side of the equation. The £5k-per-employee currently being received by shareholders is the price the company (or, if you prefer, each employee) is paying for the use of someone else's money. By all means buy-out the shareholders as you would pay-back the capital on a loan when a business is estalished by that sort of funding, but don't pretend employees could receive an extra £5k a year unless and until the capital is repaid.

I know not what return Tesco shareholders get. Say it's 5%. That means the capital used to maintain the business represents £100,000 per employee. That paints a rather different picture from saying shareholders' profits equate to £5,000 per employee.

The irony is that what you seem to be supporting here is the exact opposite of your essential case for LVT.

I'll leave that teaser with you and, if I have any energy left after Monday's golf, might add an explanatory offering at my sparsely occupied blog.

Anonymous said...

Hi MarkW,

Not sure whether what this guy says is so 'revolutionary'. Employees of public listed companies can buy as much of their own company as they want but many just wait for their stock option to mature and sell them and then spend the money.

When Russian gave their citizens free shares, the shares got sold shortly after.

If a Management-employee buy out business go bust, I am wondering who should pick up the tap.

And of course family business are subjected to market competitions and it is hardly 'have to do nothing' - otherwise the businesses tend to go bust (how many paper mills are their around in the UK today)?

What employees and citizens need is financial education, or at the minimum, the lesson on compound interest.

Mark Wadsworth said...

TFB, thanks for that summary of the world how we are taught to see it, which is a mixture of 'things that are true' and 'things which are untrue', for example you say:

"That means the capital used [by Tesco] to maintain the business represents £100,000 per employee."

Tesco's net assets are £14 billion, which divided by 500,000 employes = £28,000 per employee.

Take it from me, this is exactly the same as LVT, but on a much smaller scale.

Anon, who said it was revolutionary? He's just saying that 'things are a bit better' if done that way.

Bayard said...

"The way I understand it, his argument is that the economy works far better if those 'super profits' are shared firstly between the providers of the actual money invested (as interest) and the remainder between all the employees."

What about the the providers of the actual money invested as share capital (as dividends)? People seem to be forgetting that, before everyone's money was tied up in ridiculously expensive housing, business start-ups were financed through share capital, not loans from banks.

AFAICR, the system Robert Townsend advocates is that employees take part of their renumeration as shares. Where the shares come from, I can't remember, but probably they are bought from the existing shareholders, as TFB suggests. It appears that MR Erdal didn't have to do this, as he owned all the shares already. Thus, although RT doesn't suggest that all the shares are owned by the employees, he makes the point that by having employee shareholders, it prevents the senior executives cheating the shareholders as pont 3. a) and automatically enrols the employees in a profit-share scheme.

Mark Wadsworth said...

B: "What about the the providers of the actual money invested as share capital (as dividends)? People seem to be forgetting that, before everyone's money was tied up in ridiculously expensive housing, business start-ups were financed through share capital, not loans from banks."

Not really true - 90% of finance in businesses is either money borrowed (loans, bonds) or retained profits. A small part is the original founder's share capital.

Of course the people who provide the finance should be rewarded - it's called interest, the rate which depends on the length of time it's committed and the associated risk. That's the same either way.

It's easier to

a) Forget all about companies limited by shares (where there can be a wild disparity between total assets employed and market capitalisation; and a complete disconnet between 'employees' and 'owners') and

b) To assume that the business is run as a limited liability partnership (which has the same balance sheet but no concept of market capitalisation; and where all longer serving or permanent employees are members).

James Higham said...

The employees do get a lot of the 'wealth' generated by the business, as they are paid market wages (and I fail to see how wages can be anything other than market rates, or else they'd go elsewhere) which are usually about three-quarters of the net profits of the business after about half of the total income is lost in taxation.

This point in particular agreed - goes without saying almost.

Lola said...

Isn't this about 'risk'? Most people don't like 'risk'. They prefer to be employees, at what they perceive is low risk. They have a job. Plus most people don't innovate, or rather they don't have the confidence to innovate.

If someone is prepared to take a risk and to innovate they will expect a bigger pay off. Combine that with organising something to happen and the extra reward seems equitable to me.

But, I agree with MW. Salaries commanded by what are on average, average managers of large companies are almost totally unjustified. This is especially so in financial services generally, where to be frank nearly everyone is overpaid (except me, obviously).

In order to motivate and retain good people you need to have some form of engagement, or connection with the success - or failure - of the business, over and above/below your pay, the 'turning up money'. Many bad employers just pay 'turning up money' and consequently their people just 'turn up'. They waste their employees time. The employees waste the employers time.

So, in essence I am with this bloke, but I want my premium for entrepreneurialism.

Mark Wadsworth said...

L, again, for sure, the original founder is a special case, but it's easiest to imagine this as a partnership, where each subsequent generation of employees or bosses is in the same position as the founder; they are encouraged to/forced to constantly innovate to keep things moving as it is their own partners' capital which they are risking.

He addresses the point that "employees like low risk" in the book, and says words to the effect of "If you were just a humble employee of Woolworth's plc and it goes bust, you end up with no job, nothing. If you'd been a partner in Woolworth's LLP, worst case you end up with no job, nothing. How is the former better than the latter? But in the latter case, it's quite possible that the partners would have innovated their way out of trouble, or even pulled the plug a year or two earlier to keep as much of their capital as possible"

Bayard said...

"Not really true - 90% of finance in businesses is either money borrowed (loans, bonds) or retained profits. A small part is the original founder's share capital"

This may be true now, but it wasn't always the case. Not only that, but it is generally bad for the economy to have commerce financed by loans. Those providing the loan are taking considerably less risk than shareholders and they don't care whether the business sinks or swims, so long as they get their money back. I'm with the Muslims on this one. However, over the last fifty years, as the nation's spare capital has been concentrated in the banks, so we have come to assume it normal that the primary source of business capital is from loan and bonds.

"Of course the people who provide the finance should be rewarded - it's called interest, "

Yes, but it would be better for everyone concerned if it was called dividends. It is the lack of interested shareholders that leads to poor management and the most interested shareholders are employees

Mark Wadsworth said...

B: "... it would be better for everyone concerned if it was called dividends.

It is the lack of interested shareholders that leads to poor management and the most interested shareholders are employees."


That's his basic point. The most interested 'shareholders' are those closest to the business, i.e. the employees/partners. With an LLP rather than a Ltd structure, there is no need to artificially split up the income into 'wages', 'interest' and 'dividends', it's all 'profit share' (however calculated - and the profit share calculation in an LLP can closely mirror these three broad categories).

People would then focus on maximising profits and bickering over how it is to be split up is a secondary issue. But what they would not worry about any more is 'the share price' because there wouldn't be one.

So if your employee's 'profit share' (i.e. 'dividends') falls from £5,000 last year to £3,000 this year, you are a bit miffed, but you haven't got £2,000 poorer, you have still got £3,000 richer.

With a plc, seeing as share prices are largely a function of net profits, if the profits of a plc go down from £5 million to £3 million, the market capitalisation goes down from (say) £50 million to £30 million - but is this a real loss of £20 million? And if it's not a real loss of £20 million, was the £50 million a real gain (i.e. real wealth) in the first place?

AntiCitizenOne said...

It would work a lot better if transfer taxes were replaced with an LVT on Land Rights and IP rights.

Lola said...

MW -

Para 1. Yes of course - that's competition for you.

Para 2. Well, yes. Employees get all sorts of preferential 'benefits' to shield them from such notional risk. Partners do not. In my experience a lot of people like all them benefits, and don't like the chance of failure, or rather they can't be arsed with the potential for gain if they get involved.

Mark Wadsworth said...

AC!, yes, I mentioned that in the post.

L, agreed. But somebody has to bear the risks. Better for people involved in the business to risk getting a smaller bonus (or a small cut in salary) than for third parties acting via intermediaries to risk losing half or all the money they have given to somebody else (and probably not to the business itself).

Lola said...

MW - Sorry don't follow you...

TheFatBigot said...

"90% of finance in businesses is either money borrowed (loans, bonds) or retained profits. A small part is the original founder's share capital."

At what stage in the life of the business is this the case?

When it first starts 100% is received from the subscribers to shares. Assets bought from that money might be used as security for borrowings, but without that security the borrowing would not be possible. It is artificial to say that money borrowed against assets acquired using share capital is a separate source of finance because it isn't, it is a derivative form of finance.

Over time the par value of issued shares will become a smaller and smaller proportion of the capital value of a successful company but par value is irrelevant. The company received the par value and used it. It could pay it back if it wanted to. For so long as it uses it, shares values will represent the current value of the initial par value. For a successful company that is far more than par, for a flop it is nil.

In the case of a successful company, retained profits and the ability to borrow are diect consequences of the company using the original share capital. It makes no sense to freeze the value of that injection of funds at par when the value of each pound injected has increased.

Retained profits are not independent of subscribed capital they are the result of subscribed capital. Borrowings are, likewise, only possible because someone somewhere was prepared to risk injectng money that has been used by the company in such a way that it is now in a position to borrow.

The 90% of business finance that is not directly subscribed by original shareholders is dependent on and derived from businesses retaining and using the money subscribed for shares. You cannot divorce the two.

Mark Wadsworth said...

TFB, thanks again for the boring recital of the world and how we are supposed to see it. I know all that stuff. It is my job.

Now tell me, as a former barrister, do you think that the barristering profession would work better somehow if all the barristers in a chambers merged into a full partnership, and then if that partnership merged with other barrister partnerships to form a limited company, which ended up being a quoted plc?

Are the few banks which are still run as partnerships better or worse run that the banks which are plc's?