OPINION: Part One: Employee-Owned Companies and Worker Cooperatives: a Comparison

So, are the models of employee-owned companies and workers’ cooperatives the same? Americans across the political spectrum have a misconception that employee-owned companies and worker cooperatives are alike, or at least function in similar fashion. Several websites that contribute to this fallacy include Democratic Socialists of America and MachimonWordPress. Websites like these continue to conflate employee-owned companies with worker co-ops even when the two business models have glaringly obvious differences. Worker cooperatives are businesses that are operated by the workers through democratic means. They often have very little, if any, hierarchy. On the other hand, employee-owned companies use traditional models for firms but often implement stock ownership plans to provide employees with economic incentives.(Zurer) Based on the misguided premise that both business models are similar, should be good for the worker, and perform competitively in the market, articles from all political leanings unintentionally misinform all who read them. In reality, employee-owned companies are not only distinct from worker cooperatives, but they are superior to worker cooperatives in multiple ways. These include but are not limited to structural superiority, capitalist incentives, and built-in tax advantages.

Structure is an important difference between employee-owned companies and worker cooperatives. Employee-owned companies are most commonly organized as Employee Stock Ownership Plans, otherwise known as ESOPs. Similar to a trust, ESOPs hold stock in the company on behalf of the employees, not run by the workers themselves. Conversely, worker co-ops are democracies running a business. Business decisions in worker cooperatives are collective discussions between workers in planned special meetings. All workers have a say in how the business is run. (NCEO) Conscious Company Media’s Rachel Zurer says,

“A worker cooperative is an employee-owned business in which each member or worker-owner has one equal share of the business. This also means that every worker-owner has one equal vote in the co-op, no matter their pay or seniority.” (Zurer)

Problems with this model are very clear. Without decisive leadership, any business will struggle. Allocating business decisions among all worker-owners within a democratic framework exacerbates this problem by breaking down leadership roles. Worker cooperatives are a clear example of this. As this Atlantic article lays out, problems are common with employees unable to agree on business decisions. The co-op becomes paralyzed from indecision. Larger cooperatives naturally have a worse time with this and have to depend on hierarchies. Some co-ops even have ill-considered rules that limit employee pay. According to “Cathy Co-op”

“For example, many worker co-ops have a pay-scale difference ratio that cannot be exceeded, such as Union Cab Cooperative in Madison, WI. This works by setting a company policy where, for example, the highest paid worker would not be allowed to earn more than four times the lowest paid worker. (Or whatever the co-op decides.)”

Limiting pay adds yet another set of problems: the destruction of incentives for leadership and promotion. CEOs are paid so much because they are good at what they do. Experienced and effective business leaders just aren’t going to take a huge pay cut to generously help a struggling worker cooperative. Failing to provide adequate incentive through increased pay from seniority and performance will hurt both the productivity and quality of a worker co-op’s employees. In contrast, ESOPs have no qualms about compensating their company heads appropriate with their occupation. Such practices and structural issues become evident in the cutthroat world of business. In America, there are only 300 worker cooperatives compared to over 9,000 ESOPs. (Wirtz)

As a consequence of beneficial ESOP structure, employees have an added incentive to perform well at their jobs. "Most workers report that cash incentives, stock options, ESOP[s]...motivate them to work harder..." Workers then own a stake in the company's future. In fact, an ESOP transforms the workers into capitalists who invest in themselves. Benefits the workers bring to the company are passed on to increased stock value, boosting employers’ and employees’ prospects alike. Incentives like these translate into statistically significant increases in productivity and performance. From the MinneapolisFed website, “authors suggest that average productivity could be as much as 5 percent higher at employee-owned firms.” (Wirtz) The evidence is consistent across multiple studies: productivity is higher in ESOPs than in average firms. However, America is not a good case study for worker cooperative performance as there are only 300 of them. Italy, on the other hand, had over 38,000 cooperatives as of 2006. As profits are shared between workers in a co-op, wages in a worker co-op can often used as an indicator of company performance. An Econstor.eu study mentions that wages “...of co-op workers are...more variable than the wages of workers of capitalist firms.” For extra emphasis, wages “...of the worker in capitalist firms are independent of firm-specific changes in market prices.” From this we can gather that worker cooperatives, on average, have less consistency in wages than conventional firms. Not only do capitalist firms offer more stability to workers than do worker co-ops, but according to the same study, “Co-op wages are about 14 percent lower on average.” (Pencavel) This means that worker co-ops do not even perform on par with conventional firms. Similar results from more research could be a death sentence for the worker cooperative model even with the added advantage of Italian co-op specific tax breaks.

An often left out, but important factor, is the comparatively low taxes that employee-owned businesses and ESOPs have to pay. Thanks to tax reform in 1974, ESOPs became a viable business model. According to the Minneapolis federal reserve bank, “If a sale to an ESOP entails 30 percent or more of the company, the owner can defer capital gains taxes on the sale, and sometimes avoid them altogether.” Not only are capital gains taxes avoided on stock awarded to employees, but the loans ESOPs use to buy out aforementioned stock are also tax deductible, as opposed to worker co-ops in which the workers have to provide the capital upfront. (Wirtz) Possibly the most outsized benefit for the firm itself is the exemption of federal income taxes equal to the percent of the stock held by an ESOP S-corporation. Dividends earned by employees are tax-deductible while company profits reinvested in the company are tax deductible as well. (NCEO) Next, as an added retirement bonus, “Typically, employees receive the cash value of the shares in their account upon leaving the company.” (Zurer) Benefits like this do have their drawbacks. Buying back stock from workers that are leaving can build into a large expense for firms. However, other tax benefits more than make up for that loss. Much of ESOP profitability comes from these extraordinary tax advantages. A compelling case could be made that ESOPs themselves aren’t as viable a business model without those built in tax breaks; However, in the current tax system, ESOPs are undeniably favorable for private companies. Worker cooperatives have less extensive tax concessions in America than ESOPs. (Baarda)

In conclusion, not only are employee-owned companies different, they are superior to worker cooperatives in almost every way. In employee-owned companies, wages are higher, profits are more consistent, and the conventional hierarchical structure is more conducive to higher firm performance. So will employee-owned companies become more popular in the future? That will be up to the rising generation of business owners to decide.

Next week, Part Two of this series will come out and we will be examining the arguments on whether or not worker cooperative are examples of successful socialism in a free market.