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Workers’ Participation in the Income Risks of the Firm

The fundamental basis of profit-sharing implies workers’ foregoing part of their wages in the sense that, from a relatively secure income, they are acquiring a claim to a share in the uncertain future profits of the firm. In doing so, workers only undertake an additional risk if the participation is arranged for a future time-period for which reliable estimates of the firm’s profitability are still unavailable. Only in this case of ex-ante participation (under uncertainty), can one expect that ex-post income advantage results on the average in the form of a remuneration for the risk undertaken.

If profit-sharing is linked to the contract of employment it would imply for the firms that, in the case of risk occurring, workers also accept direct liability. Since part of the remuneration of workers in profit-sharing represents a contingent claim the worker must forego some of his labour income if the firm does not yield any profits. Given that human capital is directly used as a source of residual income it certainly follows that from the outset the workers’ liability is limited to a portion of their current income. In contrast to the case where human capital is used as a collateral for obtaining credit the abolition of this limitation on liability would require specific institutional regulations, such as agreements on obligatory additional payments by workers or permission to carry forward losses. The obligation to make additional payments would again tie the shift in risk-taking to capital assets, whereas the carrying forward of losses would spread the direct liability of human capital over several time periods.

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The likelihood of risk-diversification, however, seems small if profit- sharing is linked to the employment of workers. The limits of worker risk-taking would possibly soon be reached if the workers were to share in the risk of a single firm, the expected profitability of which would determine the workers’ employment prospects. The fact that firms pursue extensive policies to spread risk does not basically resolve the contradiction. The workers themselves could introduce a non-market system of risk allocation by establishing a common investment fund whereby profit-sharing in different firms are pooled — collective profit- sharing. In principle, they can achieve a similar degree of risk-mixture as capital owners by diversifying their individual portfolios. In view of the extent of risk-transfer and the resulting impact on workers’ income it would be important to practice a collective type of profit-sharing. Only in this way can any substantial improvement in risk-allocation be expected.

Is profit-sharing more advantageous than raising credit on human capital? If profit-sharing is built in the contract of employment the •workers’ profit-sharing as well as risk-participation cease when employment is terminated. A worker when made redundant, need no longer feel liable for the income risks of the firm. If he terminates the work contract himself he cannot continue participating in the firm’s profit. It is essential from the workers’ point of view that this constitutes an additional and limiting effect on liability. The inclusion of profit-sharing in the workers’ contract is similar to a risk-participation contract having an escape clause. Corresponding risk participation on the basis of credit raised against human capital would have to grant workers the right to free themselves at any time from further liability. This type of contract, not subject to long term notice would be unthinkable on the capital market where the sellers of risky assets always have to absorb possible losses. Besides, banks have to fear that workers would be tempted to participate in projects which are too risky.

The situation is different when workers share income risks with the firms in which they are employed. Workers’ profit-sharing is, in principle, not individually tailored. Similar to a collective wage agreement profit-sharing, not based on individual decisions, represents for the individual worker a collective agreement. Although the worker may terminate his work contract individually he has no opportunity, in anticipating his decision to leave the firm, to influence the design of a profit-sharing scheme which is subject to a collective agreement.

The workers’ option of leaving the firm may not jeopardize liability in a profit-sharing scheme as seriously as it appears at first sight. If profit expectations deteriorate, then workers may become more interested in seeking alternative employment while at the same time the firm might also have a growing interest in creating redundancies in order to save fixed labour costs. But in a direct risk-participation scheme both parties would be pursuing the same interests of either trying to avoid liability or rescinding the contract. A clash of interest occurs only when the workers’ reaction to a reduction in profitability exceeds the mutual interest of the firm in creating redundancies. This response is unlikely to be excessive since the worker will compare the costs of searching for new employment to the minimum fixed wage which he can get by remaining in his old firm. Thus, the liabilitv of the workers is still assured. A fairly balanced ratio between the fixed wage and the share in profits could ensure that less mobile workers do not have to carry too much liability.

Problems would not, of course, arise when favourable profits are expected. In this situation workers’ mobility has no limited effect on liability. Then the workers’ termination of their contract of employment and thus of their commitment to future liability doe$ not usually lead to a contraction in the overall level of liability for the firm because departing workers can be replaced on the same conditions. One can also conceive that the problems of, mobility would diminish in importance if profit-sharing is linked to a fund into which dividends flow. This would redirect the interest of the worker away from the single firm’s profit to the profit performance of the group comprising the fund.

It would be apparent from the foregoing that on the whole direct profit-sharing of workers permits a higher degree of risk-transfer than do schemes for raising credit on human capital which are feasible on the capital markets. Looking at it slightly differently, profit-sharing facilitates the transferring of risk on better conditions than can be offered by banks. Any advantage accruing to the workers is essentially a consequence of their readiness to take on additional income risks. It does not arise through redistribution which ignores market forces. It can also manifest itself in the reduction of unemployment risk which is a serious threat and burden to the workers as it has more than economic implications.


Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.