The Democratic Firm

Chapter 8: Employee Sovereignty in the Japanese Model

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Chapter 8: Employee Sovereignty in the Japanese Model

The Hegemony of the American Model

Almost all the discussion of economic reform in the transitional economies has been dominated by the American (or Anglo-American) model. The Anglo-American corporate structure is presented by Western advisors and multilateral organizations as if it was the only model. It is presented as “the” joint-stock company; anything else is viewed as an immature example that will eventually evolve into the “modern” and “fully developed” model.

One problem with this exclusive focus on “the American model” is that there is a major divergence between the reality in the large American corporations and the model. The greatest and most significant divergence is the separation of ownership and control analyzed by Adolf Berle and Gardner Means in the first third of the 20th century [1932, 1967]. The large corporations with publicly traded shares (sometimes called “public corporations” where the “public” refers to publicly traded shares instead of public or state ownership) have such widely dispersed shares that the shareholders are not able to organize together to act as a coherent decision-making unit. If dissatisfied with decisions made by the firm, each small shareholder would have to incur great costs to organize other shareholders and would stand to gain only a minuscule amount. Thus the shareholders apply the “Wall Street rule” of “voting with their feet”, i.e., selling their shares.

The voting rights attached to the common equity shares fall into disuse, and the de facto control rights over the company fall into the hands of the managers (who typically own an insignificant amount of shares). These management-dominated companies are sometimes called “managerist” companies, and they have evolved a philosophy of “managerialism” [Enteman 1993]. According to this view, the corporate managers are endowed with a “social responsibility” to balance and promote the interests of all the “stakeholders” which include the shareholders, employees, creditors, suppliers, customers, local residents, and government. By being “responsible” to everyone, the managers are in fact accountable to no one but themselves (as one can judge by considering the levels of executive compensation and benefits in the large American companies).

The American model is held up to the world as the example of an economy operating according to clearly defined property rights. Yet, we have seen the reality is quite different. One of the crucial parts of “property rights” are the control rights, and the control rights over the major corporations in America are de facto held by people based on their functional role (as the corporation’s managers), not based on their property.

Conventional economics offers no explanation of how the American economy could function so well in spite of diverging at such a crucial juncture from “the American model.” Instead conventional economics downplays the “separation of ownership and control” into the “agency problem of corporate governance” where—as in any agency situation—there might be some divergence between the desires of the principals and the decisions of the agents. And then attention is focused on how the managerial labor market and the takeover market (or market for corporate control) might function to lessen the agency problem. With such soothing discussions, one can easily forget about the fundamental divergence between “the American model” of a property-rights-based economy and the reality of the managerist corporation.

The Japanese Model

When any consideration is given to alternative non-Anglo-American models, the German model (with employee representation on the co-determination boards) or the Japanese model are usually mentioned. Since it now appears that early 21st century world economy will have the Asian economies of Japan and China as a major if not dominant part, we will focus on the Japanese model. It is fundamentally different from the Anglo-American model.
The fundamental principle underlying the Japanese model of mixed economy is anthropocentricism, or what Keisuke Itami refers to as "peoplism." Peoplism is given concrete expression in the form of employee sovereignty with the corporation, and an emphasis on the independent, land-owning farmer within agriculture. This principle is clearly different from the ideological foundations of Western capitalism, and it would be incorrect to assume that the Japanese system belongs to the same regime just because it uses market mechanisms extensively and exists side by side with a democratic political system. [Sakakibara 1993, p. 4]
Post-war Japan was the original East Asian “miracle” economy, and, in spite of the hegemony of the American model in most discussions, the Japanese model may well exert a strong direct or indirect influence on the evolution of the large enterprises in China.

Many treatments of the Japanese economy focus on the role of the state and industrial policy. However, the state does not produce the products that have so successfully blanketed the world. The Japanese firm has been the main actor in this success story. Two sides of the Japanese firm need to be considered: the external connections to other business-related firms and the internal system of corporate governance.

Much of the productive power of modern Japan is contained in the financial-industrial groupings called “keiretsu” [see Gerlach 1989]. There are vertical keiretsu dominated by one firm such as Toyota and horizontal keiretsu such as Mitsui or Mitsubishi where a large variety of industries are represented within the group. Each group has a main bank that plays the leading financial role.

In the “standard American model” of a company, the insiders (managers and workers) are agents who are supposed to answer to the “owners”, the shareholders. We have noted how the large American companies have, aided by the stock market, gained “separation” from the shareholders and a degree of managerial autonomy through a strategy of atomizing shareholdings. The insiders in large Japanese firms have gained their autonomy from the shareholders through the strategy of cross-ownership. Shares are, in effect, exchanged with business partners so that most of the shareholding will be in friendly hands. The firms are thus tied together both by business and by shareholding.

A high proportion of the holders of Japanese equity have more to gain from the other business they do with the company whose shares they hold than from profits or capital gains on the shares themselves. They are 'committed' in interest terms because they have a stake in the actual long-term growth of the company. They are committed in practical institutional terms in that they hold the shares by arrangement with the issuing company and it is hardly thinkable that they could dispose of the holding without consulting with the company's managers. [Dore 1987, p. 113]
As long as a firm is performing satisfactorily, the cross-shareholders will defer to the managers of the firm. When a firm is in distress, the main bank typically steps in with the blessings of the cross-shareholders to orchestrate the restructuring of the firm. Thus the cross-holding creates a system of contingent self-governance—insider or employee sovereignty contingent on the company staying out of financial or business distress.

When company A owns shares in company B, and company A gets into distress, then it may ask B for permission to sell the B shares to raise some needed capital. This is considered something of a disgrace and is usually accompanied by promises to buy back the shares from the market when profitability returns. If a typically unrelated shareholder would not normally ask the permission of management to sell shares in the company, then those shares are called “floating shares”. Ordinarily, only about 20-30% of the shares in the large companies are floating shares on the stock market. The remaining 70-80% of the shares are locked into the cross-holding pattern.

With over a majority of the shares stabilized in friendly hands, there is virtually no takeover market or market for corporate control in modern Japan. The very idea of a takeover is held in disrepute in Japan.
The reason Japanese think this way is not because the Japanese spiritual make-up is particularly special, but because Japanese corporations are organized as aggregate bodies of corporate employees, and in effect the buying and selling of a company takes on a semblance of buying and selling a group of human beings. [Matsumoto 1991, p. 45]
Since the War, there have been only a handful of hostile takeovers in Japan and those were in small to medium-sized companies [see Kester 1991].

In the standard Western model of a market economy, market relationships between buyers and sellers are thought of as spot or auction market transactions. If the same commodity can be purchased from another seller at a lower price, then demand switches to the lower-cost supplier. In the Japanese economy, there is the rather different notion of relational contracting [see Goldberg 1980]. It is a long-term high-trust relationship with extensive communication along many other dimensions than just price and quantity. Relational contracting extends well outside the specific keiretsu groupings. Contractual partners might even exchange shares as a symbol of the long-term relationship.

In the Western model, shareholding is by itself a relationship; it makes the shareholder an “owner” of the company. If the shareholder has some other business relationship with the company, that is considered a “conflict of interest.” The unrelated shareholder would be interested only in the pure profit of the firm (in the form of dividends or capital gains). A related shareholder would have a “divided loyalty”—some other economic interest in the firm aside from profit (e.g., salaries or the price paid for the products)—so the shareholder would not be a pure representative of the firm. Representatives of related shareholders on the board would not be “independent” directors. Related parties, such as workers, managers, suppliers, or customers, are external to the firm. The shareholders are thought of as the “members” of the firm whose interests (profit) define the goal or objective of the firm to be maximized.

In the Japanese firm, the shareholders are not sovereign. The returns on the shares have more of the characteristics of debt or preferred stock [see also Gerlach 1989, p. 157; Matsumoto 1991, p. 6; Dore 1987, p. 114].

Against this pattern as it has developed in the West, the common stock shareholder of the Japanese company is more in the position of a preferred shareholder in a Western company. Having made an investment that is at risk, the shareholder is entitled to a return on that investment. Therefore dividends are paid, but not as a percent of earnings but as a percent of the par value of shares in the company. [Abegglen and Stalk 1985, p. 184]
In the Japanese model, shareholding is usually symbolic of some other business relationship.
Unlike Western institutional shareholders, which invest largely for dividends and capital appreciation, Japanese institutional shareholders tend to be the company's business partners and associates; shareholding is the mere expression of their relationship, not the relationship itself. [Clark 1979, p. 86]
The board of directors would typically be made up of representatives of the related parties—firstly the managers and other long-term employees and then the banking and insurance partners, the main customers, and the suppliers.

The basic difference between shareholding as the relationship, and shareholding as being only symbolic of a relationship can be explained using the distinction between property rights and rights that are attached to a functional role (which are sometimes called “personal rights”). In the standard Western corporation, the control and current income rights attached to the common voting shares are considered to be property rights that may be bought and sold freely between legal parties. In the model democratic firm, the control and current income rights are personal rights attached to the functional role of working in the firm (so that the insiders would be self-governing in their work and would reap the positive and negative fruits of their labor). Board members should be representative of those who have this functional role. When a business entity is in a web of relational contracts, then the exact boundaries of the firm become vague. Thus the presence of a few representatives of relational partners on the board is broadly within the bounds of the notion of a democratic firm. The insiders are represented on the board through the presence of the senior and retired managers (although there is no formal machinery for these board members to be elected by, or held accountable to, the insiders).

Although there is some danger of oversimplification in making such a statement, the most direct description of this situation is that Japanese corporations 'are controlled by, and exist for, their employees'. Japanese corporations are thus united bodies of corporate employees. [Matsumoto 1991, p. 27]
On the basis of analyses made on control structures within Japanese corporations, Takanori Nishiyama claims that the Japanese economic system has already been transformed into a system that might called 'laborism', where corporations are under the control of workers, or, perhaps, supervisory workers. [Matsumoto 1991, p. 20]
The connection between board membership and representation of those having the functional role of being “in the firm as a community” realizes part of the basic structure of the democratic firm [see Dore 1987 for the model of the Japanese firm as a community].

If the legal shell of the joint stock company is used to package a democratic firm, then the ownership of the shares must be attached to the functional role of working in the firm. Share ownership by insiders, however, has not been an important feature in the Japanese model (or the German model where employees are represented by law on the supervisory boards independent of share ownership). While major relational partners may own corporate shares and be represented on the board, the insiders in the large Japanese firms have usually not been major shareholders. If the insider or employee sovereignty of the Japanese model is to be institutionalized in a formal corporate structure, then insider share ownership using something like the Employee Stock Ownership Plan or ESOP may well be a possibility.

Another important aspect of the Japanese model is the labor system of lifetime employment. The so-called “employment relation” becomes the ultimate example of relational contracting—the identification of the worker with the firm. High trust is developed between workers and managers by managers exercising the self-restraint to not use their power to enrich themselves and to take advantage of the workers. On their side, the workers choose to be cooperative without feeling that they are exposing themselves to being opportunistically exploited by self-aggrandizing managers. That mutual cooperativeness in the high trust management-labor relationship is the basis for the high X-efficiency of the Japanese firm [see Leibenstein’s work collected in Button 1989]. That stands in sharp contrast with the American model where managers and employees are both seen as outsiders devoted to their own self-interest who must be “monitored” by the “owners”—the unrelated (and thus absentee) shareholders—to protect “the interests of the firm.”

A simple cooperative action game (of the prisoners’ dilemma variety) can be used to illustrate the difference between a company based on low trust with individual optimization and a company based on high trust, identification with the firm, and cooperation [see Leibenstein 1984, 1987 for the best treatment of this approach to the Japanese firm]. The players A and B could be thought of as managers and workers (or as any two groups in the firm) who need to cooperate together to increase the X-efficiency of the firm.

Payoff to

Player B

Payoff to Player A, B


Not Cooperate

Payoff to


$A+1, $B+1

$A-2, $B+2

Player A

Not Cooperate

$A+2, $B-2

$A, $B

Typical Cooperative Action Game

If each player chooses the individualistic not-cooperate action, then they receive the non-cooperative payoff of $A and $B. If they cooperate, then the total results increases by (say) 2 which we assume is evenly split to arrive at the cooperative payoffs of $A+1 and $B+1. But if one party opportunistically chooses the individualistic non-cooperative option when the other party acts cooperatively, then the total result remains the same (no increase without cooperation of parties) and two units are shifted to the rent-seeking party. The strategy pair (Not Cooperate, Not Cooperate) is the dominant equilibrium solution. No matter which strategy one player chooses, it will always pay the other player to take the non-cooperative action. But that non-cooperative outcome ($A, $B) is dominated by the cooperative outcome ($A+1, $B+1) which is better for both parties.

This prisoners' dilemma-type game is a generic representation of the countless cooperative action situations that occur continuously and at every level in the complex multi-person productive operation of a firm. In each given situation, effective monitoring and enforcement might be applied at a certain cost to change the payoffs and thus assure the cooperative outcome. But this “external” neo-classical solution is hardly feasible over the countless cooperative action situations that occur in a complex team operation. The Japanese company uses the alternative “internal” solution of developing a corporate culture of cooperation that leads to a virtuous circle or high level self-reinforcing equilibrium. This cooperative culture is feasible in the Japanese company because the managers and workers are the members of the community and will reap the joint fruits of their cooperative efforts.

The following table summarizes these and many other areas of contrast between the American or Anglo-American model company and the Japanese model company [see Clark 1979, or Dore 1987 for similar tables]. It should be remembered that a comparison is made between models. As was previous noted, the large American companies function somewhat differently in practice.


Anglo-American Model Company

Japanese Model Company

Residual Claimants


Long-term member-workers


Property of shareholders

Community of members

Company board

Representatives of shareholders

Council of community elders with representatives of major related organizations (e.g., main bank)

Role of management

Agents of shareholders

Senior leaders of community

Management self-interest

Assumption of individual maximization of reputation in managerial labor market (non-cooperative strategy)

Assumption of cooperative leadership to make company prosper and maximize reputation within firm (cooperative strategy)

Monitoring of management

By board and ultimately by shareholders and market for corporate control

By management elders/peers and bank representatives on board

Role of shareholders


One of stakeholder groups along with suppliers and customers

Shareholder interest

Maximization of company profit (assumption that shareholders are normally unrelated to company)

Shareholding often symbolic of business relationship, the latter being the primary economic interest. Little attention to unrelated floating shareholders.

Transactions with related shareholders

To be controlled by independent directors or forbidden by "firewall" regulations

Normal part of relational contracting where shareholding is symbolic of business relationship


Paid-out share of profits

Quasi-fixed like dividends on preferred stock

Role of long-term workers

Contractual employees

Members of community

Worker interest

Assumption of individual maximization (non-cooperative strategy)

Assumption of cooperative action to make company prosper (cooperative strategy)

Organized worker representation

Trade union (adversary relation based on workers versus company)—your jam or my jam

Enterprise union (oppositional relation loyal to company)—our jam today or our jam tomorrow

Source of labor efficiency

Allocative efficiency based on labor mobility

X-efficiency based on labor immobility

Labor training

Responsibility of worker as it increases value on labor market—training for specific skills

Responsibility of company since immobility allows company to benefit—training for general skills

Job definition

Extensively specified job definition to limit opportunism

Job flexibility and low monitoring based on worker commitment to company

Wage determination

Rate for job determined by market

Rate determined by seniority and assessed merit

Response to secular decline

Reduce employment and other direct costs to maintain profits

Maintain employment, reduce hours, and retrain workers for new product lines

Relations to suppliers and customers

Auction market contracting based on assumption of mobility and exit leading to greater allocative efficiency

Relational contracting based on assumption of immobility and voice leading to greater X-efficiency

The Japanese company goes a long ways towards showing how a democratic firm might operate in practice. It puts to rest the idea that the Anglo-American model is the only model that can succeed in a modern economy, and it shows that a more democratic model may also be superior in terms of efficiency and competitiveness in addition to the first principles of getting the fruits of your labor and democratic self-determination.

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