Codetermination and the Modern Theory of the Firm: A Property-Rights Analysis

Abstract

During the postwar period, state-sponsored codetermination programs have become increasingly important and, by now, are firmly established in most countries of Western Europe. Conventional wisdom suggests that this growth of reform legislation is part of a broad social movement designed to advance industrial democracy and enlarge the power of labor to influence corporate policy. Certainly, there is no doubt that significant institutional change has taken place. But since reorganization has been motivated more by political considerations than by any fundamental rethinking of the theory of the firm, questions still exist concerning the effects the new system may have on economic behavior. There are, in fact, serious doubts about the efficiency of mandatory codetermination. Various writers have suggested that the type of codetermination legislation found in Europe may force firms to adopt organizational structure that would not be selected voluntarily by wealthWhen workers finance firm-specific investments, they supply one part of the total capital stock needed by the firm for production. It is arguable, then, that worker-investors should be regarded as equity holders and be granted control and income rights in the enterprise. This article seeks to explain the property-rights structure that such a firm must possess to be efficient, and to determine the conditions under which this organizational form is likely to emerge under a voluntary contracting process. Compared to a legally mandated codetermined firm of the European type, the voluntary variant shows clear superiority; specifically, it tends to promote productivity-enhancing incentives, relatively lower transaction costs, and a more rational allocation of risk. * Special thanks go to Armen Alchian, who has provided encouragement, advice, and key ideas concerning the nature of the firm. The article was written during my residence at the Center for the Study of the New Institutional Economics, University of the Saarland, West Germany, 1985. Financial assistance was received from the Deutsche Forschungsgemeinschaft and is gratefully acknowledged.