The displeasure is mutual

As the UK government strives to boost productivity, Julian Le Grand looks at the performance of mutuals and asks whether they could become more prevalent

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Mutuals are companies that are owned and controlled by their users or, more commonly, by employees – with the retailer John Lewis being perhaps Britain’s best-known example of an employee-owned mutual. The UK has recently seen the development of so-called public service mutuals: groups of public-sector workers who spin out of that sector and form independent partnerships that contract with government to provide public services ranging from community health to forestry management. In Europe, Mondragon is a famous federation of employee-owned companies in the Basque region of Spain. Northern Italy and France also have some workers’ co-operatives, although most are tiny (10 people or fewer).

There is an interesting fact concerning all these kinds of mutuals. Evidence collected by the economist Gregory Dow and others suggests that employee-led mutuals have higher productivity than comparable private-sector, profit-making companies in the same area. They also generate greater satisfaction from their customers, show greater resilience in the face of economic downturns and have higher staff morale.

Employees at a mutual have a strong incentive to do their job well and to maximise the return they get for their efforts

Why are they so successful? The principal reason relates to employee incentives. All employees at a mutual have a strong incentive to do their job well and to maximise the return they get for their efforts. In a shareholder-owned company, although employees are rewarded for doing their job, part of the return from their efforts goes to shareholders – leading to a reduced incentive to go the extra mile.

Another reason often cited for the success of mutuals concerns the sense of greater freedom and autonomy that the employees feel. These feelings encourage them to work hard, to be innovative and – a factor often crucial to improving productivity – to be keen to supply information to management to improve production processes.

Why are mutuals rare?

But, if mutuals are so successful, why are there so few of them? We live in a competitive world and one might think that, with all these competitive advantages – especially in terms of productivity – mutuals would be the dominant form of economic organisation. Yet in the UK co-ops of any kind comprise less than 1% of all companies. The dominant form in most western countries by far is the shareholder-owned company, with mutuals way down the list.

Economists and other social scientists have put forward theories to explain the relative rarity of mutuals. Most of these can be grouped under the heading of the problem of ‘collective choice’. Essentially, this refers to the difficulties for decision-making faced by any group of people where there is no clear hierarchy. In mutuals, the necessary decisions for managing or developing the organisation are taken by the employees collectively in some way. This may not be too difficult if the number of employees is small, because the necessary deliberations will take less time and there will be fewer interests that need to be met. But the problems are obviously much greater for large organisations.

Still, it is unlikely that this fully explains the rarity of mutuals. Shareholder-owned companies often have a multiplicity of different shareholders and do not seem to suffer from these problems. One reason for this is that they tend to have a clear hierarchy in which a few senior executives take decisions designed to maximise shareholder value, which their subordinates are required to execute. But there is also far less diversity of interests among shareholders than among employees of a large company. Most of the former are primarily interested in maximising shareholder value.

In mutuals, however, decision-makers can come from across the organisation and may have very different views on the appropriate strategy and how to implement it. An example is what is often termed the ‘horizon problem’ for investment decisions. Workers who only envisage staying in the company for a short time before moving on will be less inclined to vote for the re-investment of profits than their more committed contemporaries, especially if the investments concerned have longer-term pay-offs.

The funding dilemma

The issue of investment draws attention to what, in my view, is the chief problem facing mutuals: the difficulty of raising capital. Capitalism is called that for a reason. Small companies need capital to grow and large ones need capital to replace their depreciated capital stock, to maintain their position or to grow even larger. The invention of the limited liability company in the nineteenth century gave companies a remarkably easy way to raise capital without incurring huge debts: issuing shares.

There will need to be some form of government policy intervention to address the problem of access to flexible capital

This permitted companies to draw on large pools of capital that were not available from banks or other lending institutions. Although debt may on occasion be cheaper than equity (because it attracts tax breaks and lenders only want to be repaid, not to see stellar returns), equity capital has the key advantage of flexibility. It comes with no fixed interest payments or repayment schedules – just dividend payments whose amounts and timing can be decided by company managers.

But there is a fundamental challenge when it comes to funding a mutual’s capital requirements from either debt or equity: it means relinquishing a measure of control over the organisation, either to lenders, who will require repayment schedules to be met, or to shareholders.

Losing control flies against the whole point of an employee-controlled organisation. Mutuals occasionally offer a minority stake to shareholders or offer non-voting shares, but, in practice, few are willing to take up such offers. The result is that most mutuals, despite their competitive advantages in the market place, start small and remain so.

Why policy change is needed

The UK government is intent on increasing economic growth through raising productivity throughout the economy. The productivity advantages of employee ownership suggest that encouraging the growth of employee-owned mutuals could be a good way of achieving this aim. But there will need to be some form of policy intervention to address the problem of access to flexible capital. Otherwise, despite their productivity advantages, employee-owned mutuals will remain a minority form of business organisation.

Julian Le Grand is Professor of Social Policy at the Marshall Institute of the London School of Economics. He has advised several UK governments on choice and competition in the public sector and the development of public service mutuals