The Evolving Diversity of Enterprise Ownership and Governance
by Laixiang Sun
There is a widespread belief that the only efficient ownership structure for a market economy is one in which firms are owned by private investors and that the existence of well-defined personalized property rights is a basic precondition for the proper functioning of a market economy. This perspective is based on the view that the placement of property under the exclusive control of private owners makes them liable for the consequences of bad decisions, but entitled to the rewards of good ones, and thus more willing to motivate managers and workers.
Searching for a New Paradigm
However, in reality there has been a rich diversity in ownership structures even in those bastions of the free market economy, the United States and Western Europe. In the developed world, employee-owned firms have been widespread in the service professions including law, accounting, investment banking and medicine. Employee stock ownership is also spreading in the industrial sector. Institutional investors have become the dominant shareholders of large publicly traded corporations. Farmer-owned producer co-operatives dominate the markets for basic agricultural products. Mutual companies owned by their policyholders sell half of all life insurance and a quarter of all property and liability insurance in the developed world.
These facts indicate that the conventional perspective on the ownership issue is descriptively narrow. The claim that private investors should own the firm is not the logical consequence of free markets and free enterprise. We need to examine the emergence of unconventional enterprise ownership and governance structures across economies, and search for a new paradigm on the ownership and governance of firms. WIDER’s research project ‘Property Rights Regimes, Microeconomic Incentives and Development’ addresses these concerns and seeks to advance the debate.
Existing Assets versus Growth Opportunities
Provided that it has opportunities to grow, an enterprise should focus on cost minimization, that is minimizing the sum of all costs including organization costs and transaction costs. This leaves open the important question of how, at the firm’s inception, the enterprise should attach growth opportunities to the assets it has. Moreover, from a dynamic perspective, the key to success is to build a web of specific investments around one or more critical resources that are most closely linked to the best growth opportunities. This suggests that the role of the ownership and governance system is to ensure that the power to make decisions is allocated to the people with the best opportunities.
Following this perspective, we can say that in a traditional capital-intensive and vertically integrated enterprise, highly specialized inanimate assets—ranging from plant and machinery to world famous brand names—represent the most critical resource for future growth.
The human capital of employees is largely tied to these assets and outside opportunities for this highly specific human capital are rare. The boundaries of this type of enterprise are clear-cut and represented by the ownership of its unique assets.
Joint Ownership in Silicon Valley
In modern human-capital-intensive firms like those in Silicon Valley, the critical resource for future growth lies with the trinity consisting of the entrepreneur’s professional human capital, the firm’s inanimate assets, and a web of information encapsulation and sharing arrangements. As a consequence their property rights arrangements have complex elements of ‘joint-ownership’ with the provision of bilateral option rights. That is, a cluster of the venture capitalists (VCs) have the rights to exercise an exit option against the entrepreneurs’ interest in bad times (liquidation rights); and the entrepreneurs’ rights to the issued options are vested contingent on subsequent performance. In terms of control rights, there is typically a shifting arrangement across their components. If the firm performs poorly, the VCs obtain full control. As the firm’s performance improves, the entrepreneur retains/obtains more control rights. If the firm performs very well, the VCs retain their cash flow rights, but relinquish most of their control and liquidation rights.
Adaptive Efficiency in Transition Economies
In reforming state-owned enterprises (SOEs) and township-village enterprises (TVEs) in a transition economy such as China, the critical resource for future growth lies not only with existing assets and the human capital of entrepreneurs, but also with the web of interorganizational relationships (Guanxi). This web of relationships represents the firm’s organizational and social capital. It is capable of mobilizing scarce resources from more than one existing channel, supplying an elastic contract mechanism to facilitate continuity and efficient adaptation, and thereby reducing uncertainty. This web has been closely tied to the government system and in the early stage of the Chinese reforms it was fully embedded within the old universal government system. That is the reason why joint-ownership in China has involved local government as one of the key partners. The crucial question arising here is: can this web be used to facilitate market development in general, and to set up new bases for the emergence of new market organizations and institutions in particular? Recent development suggests that, on balance, the answer is ‘yes’.
For an enterprise to be dynamically efficient, its organizational structure (mainly ownership and governance) must be adaptively efficient. It must be able and willing to find new and creative solutions in order to overcome shortages of resources and other social/economic bottlenecks. If one path does not work, it must be able and willing to initiate organizational responses to try new paths until successful outcomes are achieved. Similarly, for an economy to be dynamically efficient its institutions must be adaptively efficient. Adaptively efficient social institutions are capable of providing economic and political flexibility for organisations and people to adapt to new opportunities. They must provide incentives for the acquisition of knowledge and learning, induce innovation, and encourage risk taking and creative activities. They must also encourage experiment and eliminate errors in a world of uncertainty, where no one knows the correct solution to the problems we confront. In brief, transition economies need transitional institutional arrangements that are adaptively efficient. In this light, the transition process could be quite long.
Laixiang Sun is a WIDER research fellow and director of the research project ‘Property Rights Regimes, Microeconomic Incentives and Development’. He is also affiliated with the Centre for Financial and Management Studies (CeFiMS, School of Oriental and African Studies) at the University of London, the International Institute for Applied Systems Analysis (IIASA) in Laxenburg, Austria, and the Guanghua School of Management at Peking University in Beijing, China.