Profit-Sharing, Labour Effort and Optimal Distributive Shares

Abstract

Government officials and social critics from both sides of the political spectrum have advocated profit-sharing and worker participation in' firm decisionmaking as a means of increasing worker productivity, job satisfaction and firm profitability. Yet profit-sharing is not a common form of firm organization, and little economic analysis has been devoted to specifying the optimal structure for a profit-sharing system. This paper makes two points about such a structure. First, it shows that game-theoretic problems associated with simple profit-sharing systems may prevent such a firm from achieving an optimum. Second, it shows how optimal profit-sharing depends upon setting correct distributive shares and upon how these shares relate to the method of profit-taking, workers' preferences and relative labour productivity. The focus of the paper will be on the relationship between the reward structure and worker behaviour on the one hand, and the ability of the firm to achieve its stated goals on the other. While the analysis will be developed for the goal of profit maximization, it follows from Markusen (1975) that the conclusions apply equally well for the goals of worker welfare maximization and output maximization. Cast in this framework, it is hoped that the paper can be easily integrated into the growing body of literature on profit-sharing developed by a number of authors including Kornai and Liptak (1962), Meade (1972, 1974), Vanek (1965, 1970), Vanek and Espinosa (1972) and Ward (1957, 1958, 1965).