9780815709022

Chapter One

MARGARET M. BLAIR

THOMAS A. KOCHAN

Introduction

Large publicly traded corporations have been the dominant organizational form in the U.S. economy throughout most of the twentieth century. But as we move into the twenty-first century, this organizational form appears to be undergoing substantial changes, and its dominance in the economy is being challenged by a variety of alternative forms, including partnerships, closely held corporations, joint ventures, venture capital firms, and virtual organizations. Furthermore, even within firms that retain the legal form of the publicly traded corporation, significant changes appear to be taking place in the way production is organized, and in the terms of the relationships between corporations and their employees.

The changes taking place, while poorly understood, seem to involve a paradox: on the one hand, the economic value added by corporations and other productive enterprises appears to be increasingly dependent on inputs other than physical capital. By the end of 1998, the book value of property, plant, and equipment in the publicly traded corporate sector represented only 31 percent of the total value of the long-term financial claims on nonfinancial corporations (the sum of the book value of their long-term debt, plus the market value of their equity). This compares with 83 percent just twenty years earlier, in 1978. The excess of market value over book value is, as best we understand, driven by a massive increase in the importance of intangible assets, including things like patents, copyrights, and brand names, but also including many very poorly understood assets such as organizational capital, reputational capital, and importantly, human capital--the knowledge, skills, ideas, and commitment of the employees.

Even as human capital and organizational capital are growing in importance as a source of value in many firms, however, organizational forms and employment relationships appear to be changing in ways that tend to undermine loyalty and commitment and encourage mobility by employees. Financial market institutions have become more influential in the governance of corporations, and labor unions have become less influential. Prevailing ideology in academic and policy circles stresses that shareholders are the owners of corporations, that the economic purpose of corporations is to maximize value for shareholders, and that employees are employed at will. Temporary work and contract work are rising, and job security seems to be declining.

Are these trends consistent in ways that we do not understand, ways that contradict accepted theory and wisdom? Are the new employment relationships and organizational forms that are emerging able to harness the ideas and skills of the people who are actually doing the work as well as or better than the old forms? Or is the corporate sector eating its seed corn in some sense--getting a temporary boost in earnings by cutting payrolls and contracting out more work but failing to make the necessary new investments in training and building a committed and innovative work force?

As of early 1999, the slashing and downsizing that made headlines in the mid-1990s appeared, on the surface, at least, not to have hurt overall economic performance in the United States. Indeed, some observers have argued that the downsizing and restructuring of the 1980s and early 1990s were at least partly responsible for the strong economic performance of the late 1990s. Corporate equity values (as captured by, say, the Wilshire 5000, a very broad-based stock index) more than tripled in the nine years from 1989 to the end of 1998. Although unemployment rose during the recession of the early 1990s, and declined only slowly throughout the subsequent expansion, by the end of 1998 it had fallen to 4.3 percent, a thirty-year low. Gross domestic product rose slowly but steadily in the 1990s, with growth averaging somewhat more than 2.5 percent a year in real terms from 1989 through 1998 (including the recession year of 1991). Nonetheless, labor continues to be squeezed, with average hourly earnings for production workers (in inflation-adjusted terms) at the end of 1998 still below what they had been in 1968, and average weekly earnings (also in inflation-adjusted terms) still below what they had been in 1962.

Unanswered Puzzles

Were the changes going on in employment relationships and in the corporate sector generally responsible for, or at least partially responsible for, the strong overall performance of the economy? Or is the economy performing well for other reasons, in spite of the changes in the terms of the relationship between companies and their employees? And how are these changes related, if at all, to the continuing pressure on low-income workers? The essays in this book will not definitively answer these questions, but they shed light on some aspects of the questions.

Job Stability

Charles Schultze begins the book by evaluating the extent to which job stability has been declining for American workers. Schultze finds a modest decrease in job attachment for the overall labor force since the late 1970s, but finds that some subgroups of the work force have experienced much greater loss in job stability than others. For women and young men, for example, average job tenure has not declined, while for mature male workers, average job tenure has declined by 25 to 30 percent. Moreover, Schultze notes a modest reduction in retention rates (the proportion of workers with a given level of tenure who can expect to continue at their current jobs for some period of time longer, say, two more years (the two-year retention rate), or four more years (the four-year retention rate). If the decline in retention rates persists in the years ahead, Schultze notes, it will drag down average tenure further as the current cohort of workers ages. Schultze also found that the displacement rate (adjusted for cyclical fluctuations in the overall unemployment rate) for wage and salary workers in private nonfarm jobs drifted up from the early 1980s through 1993-94 but then fell back in 1995-96 to almost their original level (figure 2-1).

Schultze further found that the cost of displacement for long-tenured workers is large. He cited estimates from one well-known study of mass layoffs in the first half of the 1980s that the present value of the lifetime earnings loss for displaced workers with six or more years of tenure would average (after conversion to 1998 wage levels) about $115,000. To evaluate the potential lifetime losses to workers with more substantial tenure, he used estimates generated by other researchers of how rapidly wages typically rise with tenure and labor market experience to simulate the path of future wages for laid-off workers over the remainder of their working lives. He then compares that path to the wage path that similar workers in other firms who were not laid off could expect over the same time span. He estimated that male workers with eleven to twenty years of tenure, who are laid off through no fault of their own, suffer a cumulative loss of earning power that on average has a present value of about $155,000. Just as the wage premium earned by workers with long tenure is rarely recognized as part of the wealth created by their corporate employers, the substantial losses in earning power experienced by laid-off workers is rarely counted against the gains that shareholders enjoy from corporate restructuring.

Workers who lose their jobs when productivity and wages are growing rapidly across the economy, and then find employment in new full-time jobs, can expect to experience wage increases that will enable most of them to recoup their absolute losses (even if not their relative losses) in no more than five to six years. But, according to Schultze, when wages are stagnant--as they were for twenty years prior to 1996--many laid-off workers with substantial tenure may still not have recovered their former absolute standard of living after ten or even fifteen years. Hence the downsizing and restructuring that occurred in the 1980s and early 1990s may have been especially devastating because it disproportionately affected long-tenured male workers (who had been relatively well insulated from layoffs in previous eras), a group for whom the costs of job loss were especially large.

Historical Perspective

Peter Cappelli provides a sweeping review of the history of employment relationships, noting that the changes we are witnessing today, that appear to be moving work arrangements away from internal labor market systems toward more market-mediated systems, have their precedent in systems that were common in the nineteenth century and early twentieth century. In the 1800s, he notes, it was common in many industries for merchants to arrange for craftspeople working with their own equipment in their own homes to manufacture certain goods, especially textiles and shoes, according to orders placed by the merchants. The merchant would bring them the raw materials and come back later for the finished product. This system, referred to by economic historians as the putting-out system, bears a remarkable resemblance to the system used by some companies today who hire independent consultants (writers, programmers, graphic artists, and bookkeepers, for example) who work out of their own homes and provide services or deliver finished products to the firm. The advantages of the putting-out system for merchants were its flexibility and reduced fixed costs--exactly the same advantages cited today by companies who lay off their formerly permanent full-time employees and ask them to work as contractors. Of course, from the point of view of the employee, the fixed costs and the risks have not gone away. They have just been shifted from the company to the employee-contractor.

Similarly, just as merchants who used the putting-out system complained of quality control and reliability problems, critics of outsourcing arrangements today note exactly these same problems. The putting-out system eventually gave way to the inside-contracting system (precisely because of the quality-control and reliability problems, some historians say), in which the entrepreneur provided the factory, a power source, and raw materials, but hired contractors to come in, sometimes with their own equipment, hire their own workers, and take responsibility for some entire piece of the production process. Cappelli notes that the modern-day counterpart to these arrangements includes vendor-on-premises arrangements, such as Xerox operating an on-site copy center inside a larger organization. Cappelli cites data indicating that as many as 50 percent of manufacturing employees in the United States in the late 1800s were employed by inside contractors.

The inside-contractor system had problems too, however. Historians writing about manufacturing at the end of the nineteenth century noted frequent complaints by factory owners about the lack of control they had over workers and their difficulty in providing incentives for contractors to meet the quality standards of the factory owners. As a consequence, factory owners had to monitor their contractors closely, which proved costly. Factory owners also discovered that once the inside contractors had figured out how to organize the work flow, and had set up the equipment, the owners could readily duplicate this arrangement and hire foremen to supervise the workers at a much lower cost. In other words, once the knowledge about how to set up the work had been transferred to the factory owners, the factory owners discovered they did not have to continue paying the contractors for this specialized knowledge. Around the turn of the century, then, factory owners began rapidly replacing their inside contractors by foremen, and the contractor's employees by direct employees of the company. Nonetheless, for several decades after this transition, workers were still much more connected to their foremen than they were to their company, and turnover rates for industrial workers, especially unskilled workers, may have been as high as 150 percent a year in the early 1900s. This was partly a consequence of voluntary quits, but foremen were notorious for exploiting queues of workers at the factory gate in order to drive workers harder by threatening to fire them.

Scholars of the period have noted that where work was done by skilled craftspeople, rather than by unskilled workers on an assembly line, high turnover was not necessarily disruptive to organizations. In fact, it appears that turnover may have helped to speed up the spread of new knowledge. Similar observations are being made today about how the mobile culture of Silicon Valley has substantial economic benefits in speeding the transfer of knowledge from one firm to another.

It was the introduction of assembly-line-based mass production techniques, and the scientific management techniques that came along with it, that led companies to have an interest in long-term relationships with employees. Assembly lines required workers to learn skills that were very specific to their role in the production process, which in turn made on-the-job training much more important and thereby raised the economic returns to tenure. Companies began developing institutional arrangements, employment practices, and incentive systems to encourage employees to stay around, and the turnover rate in the industrial sector fell dramatically in the 1920s. Among the institutional arrangements that came out of this era was the managerial hierarchy--and the managerial class came to have the greatest job security. By the 1920s, most of the features of what we now recognize as internal labor market systems were in place. During the Great Depression, the huge surplus of unemployed workers caused some companies to shift back somewhat toward the drive system, but the labor shortages during World War II brought back internal labor markets as the dominant system. By 1970, labor market scholars estimate that 80 percent of workers in the United States had jobs with features characteristic of internal labor markets.

Since the 1980s, Cappelli argues, however, there has been a fairly dramatic shift back toward organizing production in ways that look much more like the old inside-contracting systems. Cappelli does not offer any data to quantify this shift, but he notes a variety of ways in which employment relationships are becoming more market mediated, in the sense that traditional bureaucratic employment structures are weakening, and employment is more likely to be based on a short-term, contractual relationship, and shaped by individualized incentives and pressures from outside labor markets. Cappelli does not tell us what percentage of workers now work under short-term or project-oriented contracts, rather than as permanent employees, but Schultze's evidence suggests that long-term relationships are still quite important, and, importantly, that the returns to tenure have not declined in the 1990s relative to the 1980s.

The key question of course is whether the internal labor market model adopted by most large corporations by the middle part of the twentieth century represented "progress," and hence that a shift back by the corporate sector in the direction of a market-mediated model would constitute a regression. Alternatively, internal labor markets and market-mediated relationships may simply represent alternative models, with each having its advantages and disadvantages in different environments. The internal labor market model may not, in fact, be a clearly superior model for all times and places, while the market-mediated model may have advantages for the information-based economy that we do not yet fully understand. He leaves for further research, however, the question of what developments, in technology or in the business environment, for example, might explain and justify a shift back toward more market-mediated relationships at the end of the century.

Discussant James Baron accepts Cappelli's premise that corporations are dividing up work in ways that entail greater organizational specialization, and more use of contractors, as firms focus on what have been called their core competencies. But, he notes, "It is much less clear how these trends affect the nature of work and employment." While it is true that huge firms are emerging that specialize in contract work, or consulting work, or short-term project work, these firms do not themselves necessarily rely on temporary or contract workers. In fact, many such firms have prospered by relying on high-commitment, training-intensive approaches to human resource management. This view is supported by Schultze's observation that, while large, high-profile companies in manufacturing have gone through extensive downsizings in the past fifteen years, other firms in the nonmanufacturing sectors have grown fast enough to more than make up for the losses of manufacturing employment. Baron suggests that these trends complicate the problem of determining whether an employment relationship should be regarded as market-mediated or not. He suggests that the concept of "market mediation" in employment markets needs to be defined more precisely, in several different dimensions, and that, once this is done, more careful research is needed to evaluate the extent to which employment relationships today are in fact more or less market mediated than they have been in other eras.

Changes on the Shop Floor

Eileen Appelbaum and Peter Berg examine the changes that are taking place in shop floor organization, documenting, for example, the trend in some firms for supervisors to be eliminated and decisionmaking activities to be pushed down to front-line workers. The trend they document may provide one explanation for why the aggregate data show that job stability has declined for middle-aged men (who have traditionally filled many of the supervisor slots) but not so much for other kinds of workers.

Appelbaum and Berg undertake a detailed analysis of evolving approaches to shop floor organization, documenting in three industries many of the changes that business consultants and manufacturing experts have been talking about for the past decade. They note that new information technologies, combined with a growing emphasis on quality and on-time delivery as tools of competition, are making it much more attractive for firms to adopt workplace practices in which front-line workers are actively involved in information gathering and decisionmaking--tasks traditionally thought to be management tasks. These authors surveyed more than 4,000 employees in thirty-nine plants, in the steel, apparel, and medical electronic instruments and imaging industries to learn whether, and the extent to which, such changes are actually happening, and whether employees in more participatory settings are also more likely to have some portion of their pay tied to firm performance.

Although the Appelbaum and Berg sample is admittedly a biased one (drawn from firms that agreed to cooperate in the study), it covers significant portions of the firms in the three industries studied. A consistent finding, among all of the plants surveyed, was the recognition by plant managers of a need to adopt work organization and human resource practices that engage the capabilities of their employees in decisions about production and in quality improvements. Some of the plants surveyed are industry leaders in this regard, some are in a process of transition, and some recognize the need to change but are uncertain how to go about it or what specific workplace practices really pay off in their industries.

The authors found that in the plants they studied, horizontal information flows were often at least as important as, if not more important than, vertical flows between front-line workers and supervisors, that the tasks of monitoring and coordination were rapidly being shifted to front-line workers, that hierarchies were being flattened, and that the number of supervisors was being reduced. They also found that, where front-line workers have expanded responsibilities for problem solving and coordination of productive activities, they are also much more likely to have some portion of their pay (although generally only a very small portion) contingent on firm performance, through profit sharing and various kinds of group incentive pay, such as production or quality bonuses. These findings contradict the predictions of economic theorists who have stressed the free-rider problem with group incentives and the importance of vertical relationships between principals and agents, and who have argued that individual performance incentives would be much more effective than group incentives.

Appelbaum and Berg offer an intriguing interpretation of their finding about the importance of horizontal interactions and group incentives. They note that profit sharing and group incentives may be effective more because of their symbolic value than their intrinsic value. "It is the recognition of workers as stakeholders in the firm, and not the size of the incentive, that is significant and that provides incentives for workers to expend appropriate levels of discretionary effort," they suggest.

Discussant Kathryn Shaw notes that the Appelbaum and Berg results raise questions about what, exactly, is driving the changes that are taking place in workplace organization. Is it just that new information technology is available that makes flexible workplaces more possible, or could it also be true that workers in general have higher skills today than they did in the past, and employers are trying to make greater use of these skills? Or is it something else?

Role of Technological Change

Timothy Bresnahan, Eric Brynjolfsson, and Lorin Hitt provide some insight into these questions in their chapter. These authors examine the technological changes that are taking place in many workplaces, particularly those driven by or accompanying the spread of computer technologies. They argue that organizational changes that shift authority and decisionmaking activities downward and outward are complementary to the use of new information technologies, and they present data consistent with this analysis. Moreover, they argue that these organizational changes, together with increased use of computer technology, are jointly complementary with increased employee skill levels, measured in a number of dimensions.

Bresnahan and coauthors argue that information technology is transforming the workplace because employers who use information technology usually coinvent new approaches to workplace organization and new product and service offerings. Information technology and the organizational coinventions together change the mix of skills that employers demand. Specifically, employers may substitute computers for low-skill work while at the same time increasing their demand for workers with certain cognitive and social skills. They support their argument with firm-level data linking several indicators of information technology use, workplace organization, and the demand for skilled labor.

They find that information technology use is correlated with arrangements that call for broader job responsibilities for line workers, more decentralized decisionmaking, and more self-managed teams. In turn, they find that both information technology and these new organizational arrangements are correlated with worker skill, measured in a variety of ways. Significantly, they find that firms that attempt to implement only one of the three types of changes, without the other two, turn out to be less productive than firms that invest in all of the complements. And, in some cases, they turn out to be less productive even than firms that invest in none of the complements. The results highlight the importance of organizational changes accompanying advances in information technology in the changing demand for workers with different skill levels.

The evidence marshaled by these authors, then, provides evidence in support of one of the most prominent explanations that have been offered for the growing disparity in incomes. This is the theory that technological change in the past few decades has been "skill-biased," meaning that it has simultaneously increased the demand for skilled workers, even as it has reduced the demand for low-skilled workers.

Discussant Gary Burtless notes, however, that the results from Bresnahan and coauthors are based on data drawn almost exclusively from large corporations, and he questions whether they tell us much about trends in smaller and mid-sized companies. The latter account for a growing percentage of the nation's employment. Moreover, Burtless points out that firms that introduce new information technology might not only change the way that they produce goods and services within the firm, they may also change their decisions about whether to make or buy inputs, and in particular, they might, as Cappelli suggests they are doing, contract out more extensively to smaller producers. Hence a study that looks only at what is happening in 400 or so large companies may not be very revealing about the aggregate demand for skilled and unskilled workers. In fact, there is considerable evidence that employment has declined in the largest companies, and that those companies are now buying such services as office cleaning, cafeteria operations, photocopying services, and guard services rather than hiring their own employees to perform these functions. These changes would reduce the direct demand by these companies for low-skilled workers, but they would not necessarily reduce the aggregate demand for low-skilled workers. Rather, they would shift that demand from large corporations to smaller, specialized contractors.

Meanwhile, the contractors that do hire the low-skilled workers may tend to pay those workers less than the large firm would have paid, because the large firms have historically favored flat, paternalistic pay structures. Burtless then argues that, even if it is correct that technological change is encouraging a skill-biased reorganization in large corporations, this is not the whole story. We must still look toward factors such as the weakening of unions, the lowering of trade barriers, and the increased flow of immigrants for a complete explanation of why large corporate employers could get away with the contracting-out strategies that they are adopting.

Employee Sharing in Decisionmaking and Returns

Since at least the 1920s, theorists, policy analysts, and advocates have argued that corporations should be restructured as employee-owned firms in order to strengthen the voice of employees in the workplace and provide greater protection for their interests. But other theorists and policy analysts have argued, for a variety of reasons, that employee-owned firms would not be efficient. Moreover, the latter group has argued that if employee-owned firms were really more efficient, there would be gains for people who organize firms in that way, and we should therefore see more of them. Two of the chapters in this volume look at empirical evidence about when and why firms are organized in ways that give employees ownership-type claims and responsibilities, and how such firms fare relative to firms organized as standard, widely traded corporations.

Avner Ben-Ner, W. Allen Burns, Greg Dow, and Louis Putterman ask why firms might choose ownership structures or management systems in which employees participate directly in decisionmaking or in financial returns. The authors have constructed a unique data set providing organizational detail about hundreds of private and publicly traded firms in Minnesota. The data include information about whether those firms have employee stock ownership plans (ESOPs) or profit-sharing plans, as well as about human resource practices in the firm (especially those associated with employee involvement in decisionmaking), and the nature of the technology used by the firm (such as the degree of complexity of the tasks that are performed by individual workers and how interdependent the tasks are). The authors were also able to obtain employment information for firms in their sample, such as the number of employees, and the average wages and tenure of their employees, as well as information about the capital intensity and riskiness of the industries in which the firms operate.

The authors found evidence that greater task complexity leads to higher levels of worker participation in decisionmaking. But task complexity is not necessarily associated with worker participation in financial returns (through profit sharing or share ownership). Worker participation in financial returns, by contrast, seemed to be most strongly associated with high average worker tenure and high wages. Although it is not clear which is cause and which is effect in the latter finding, the results suggest that the two different types of participation may serve different functions and may therefore be chosen in different circumstances. They also suggest that information and coordination problems may be at least as important in driving the choice of organizational form, if not more so, than the incentive problems that have been stressed in much of the theoretical literature.

The authors find little support for several widely repeated theories in the literature on worker-managed firms that purport to explain why worker-managed firms and other forms of worker participation in decisionmaking and in financial returns are not more common. In particular, theorists have speculated that workers would not want to share in financial returns because they are likely to be more risk averse than outside investors. Other theorists have argued that if a firm uses a high level of specialized assets in production, than the firm would have trouble getting outside debt financing. Hence it would have to rely more heavily on equity financing, and since workers would tend to be more wealth constrained, most of this financing would have to come from outside equity investors. Moreover, if the assets of the firm are highly specific, outsiders who financed those investments would want to be sure that workers are intensively monitored to be sure that they do not misuse or abuse those assets. All of these factors argue against worker participation in management or in financial returns in firms with substantial firm-specific physical assets. Ben-Ner and coauthors find, to the contrary, that, in their sample, firms with high levels of physical asset specificity were more likely to have ESOPs and more likely to use workplace practices that include employee involvement in decisionmaking than firms with lower levels of asset specificity. Like the result about task complexity, this result could be explained by appealing to information and coordination problems with specific assets: if employees who use highly idiosyncratic assets have better information than their managers do about how to use those assets optimally, then it might be more efficient for managers to delegate decisionmaking authority to them, despite the potential negative incentive effects of giving employees decision rights. The negative incentive effects of delegating decisions can then be counteracted to some extent by also giving employees a share in the financial returns.

(Continues...)

Introduction	p. 1
Has Job Security Eroded for American Workers?	p. 28
Market-Mediated Employment: The Historical Context	p. 66
Comment	p. 90
High-Performance Work Systems: Giving Workers a Stake	p. 102
Comment	p. 138
Technology, Organization, and the Demand for Skilled Labor	p. 145
Comment	p. 185
Employee Ownership: An Empirical Exploration	p. 194
Comment	p. 233
Employee Ownership: An Unstable Form or a Stabilizing Force?	p. 241
Comment	p. 289
Ownership, Incentives, and Control in New Biotechnology Firms	p. 299
Comment	p. 327
Measuring Corporate Investments in Human Capital	p. 334
Comment	p. 370
Contributors	p. 383
Index	p. 385
Table of Contents provided by Syndetics. All Rights Reserved.

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The New Relationship Human Capital in the American Corporation

0815709021

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