Mandated Works Councils and Firm Performance: Labor Productivity and Personnel Turnover in German Establishments

Frick, Bernd; Möller, Iris Article Mandated Works Councils and Firm Performance: Labor Productivity and Personnel Turnover in German Establishments Schmollers Jahrbuch – Zeitschrift für Wirtschafts- und Sozialwissenschaften. Journal of Applied Social Science Studies Provided in Cooperation with: Duncker & Humblot, Berlin Suggested Citation: Frick, Bernd; Möller, Iris (2003) : Mandated Works Councils and Firm Performance: Labor Productivity and Personnel Turnover in German Establishments, Schmollers Jahrbuch – Zeitschrift für Wirtschafts- und Sozialwissenschaften. Journal of Applied Social Science Studies, ISSN 1865-5742, Duncker & Humblot, Berlin, Vol. 123, Iss. 3, pp. 423-454, https://doi.org/10.3790/schm.123.3.423 This Version is available at: https://hdl.handle.net/10419/292064 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Schmollers Jahrbuch 123 (2003), 423-454 Duncker & Humblot, Berlin Mandated Works Councils and Firm Performance: Labor Productivity and Personnel Turnover in German Establishments* By Bernd Frick and Iris Möller Abstract Traditionally, works councils have been viewed by most economists as welfare redu cing cartels that inhibit firms from allocating their resources efficiently. This view has been challenged recently: To the extent that a works council can convince a firm's em ployees to accept decisions and measures that seem to violate their interests, mandated codetermination is likely to overcome the problems inherent in a "prisoner's dilemma" situation, where credible commitments are impossible to be made without the support of an exogenously implemented institution. This latter view is supported by the evidence presented in the empirical part of the paper: First, a review of the literature on the influence of works councils on investments in "intangible assets" suggests that concentrating on investments in physical capital, on productivity, profitability, investments, and some other easy to measure indicators of firm performance may lead to a considerable underestimation of the positive effects of mandated works councils. Second, the presence of a works council has a positive and statistically significant influence on labor productivity as well as a significantly nega tive influence on personnel turnover in German frrms. The respective coefficients indi cate that these effects are in some cases quite large and that they differ considerably between industry and service sectors as well as between East and West German firms. Zusammenfassung Die theoretische Diskussion der wirtschaftlichen Folgen rechtlich autorisierter Ar beitnehmervertretungen ist durch zwei weitgehend inkompatible Sichtweisen charakte risiert: Auf der einen Seite wird argumentiert, dass Mitbestimmung der Arbeitnehmer aufgrund einer Veränderung der Anreizstrukturen zu Effizienzverlusten führen, die Kos ten der Etablierung und Koordination von Arbeitsverhältnissen erhöhen und die Mög lichkeiten der Arbeitnehmer zu opportunistischem Verhalten verbessern kann. Dem steht die gleichermaßen plausible Vermutung gegenüber, dass Mitbestimmung durch * We wish to thank two anonymous referees for their comments and suggestions. Any remaining errors or omissions are, of course, our own. Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 424 Bernd Frick and Iris Möller eine Verbesserung des Informationsflusses die Kooperations- und Kompromissbereit schaft der Beschäftigten erhöht, die Kanalisierung innerbetrieblicher Konflikte erleich tert, die Wahrscheinlichkeit opportunistischen Verhaltens reduziert und damit die Quali tät der Arbeitsbeziehungen verbessert. Ungeachtet ihrer Defizite ist die verfügbare empirische Evidenz sehr viel eher mit der letztgenannten Hypothese kompatibel: So zeigt eine entsprechende Auswertung der Daten des IAB-Betriebspanels deutlich, dass Betriebsräte einen positiven Einfluss auf betriebliche Investitionen in "intangible assets" (wie z.B. die Stabilisierung individuel ler Beschäftigungsverhältnisse) haben. Zum anderen wird deutlich, dass die Existenz einer kollektiven Arbeitnehmervertretung unter sonst gleichen Bedingungen mit einer signifikant höheren Bruttowertschöpfung einhergeht. JEL Classification: M5, 15 1. lntroduction The recent political debate about the now enacted reform of the German "Works Constitution Act" as wen as the discussion initiated by the "co-deter mination cmnmission" (jointly founded by the Hans-Boeckler Foundation and the Bertelsmann Foundation 1) has led to an unprecedented increase in the pub lic interest regarding the relative impact of alternative forms of worker partici pation on firm performance. Moreover, the academic discussion by labor and personnel economists has been spurred by a number of different, though clo sely related developments: • The increasing globalization of product and labor markets has led to a resur gence in academic interests regarding the German system of industrial rela tions. On the one band it has been agued that it may have to surrender to the pressures of competition. On the other band, it has been argued that its spe cific idiosyncrasies (like the influence of large banks and the existence of mandated works councils) may be a source of competitive advantage that is unlikely to be eradicated by globalization. Although most of the arguments discussed in this context are wen known in the meantime, it is interesting to see how the formerly incompatible theoretical positions seem to have con verged recently. • The availability of two large and representative firm panels has fostered empirical analyses that have been impossible to conduct before. So far, especially the "Hannover Firm Panel" has been used extensively to docu ment the influence of mandated works councils on various dimensions of firm performance. Although the works of Addison, Schnabel and Wagner (1998, 1999, 2001) as well as Jirjahn (1998) represent state ofthe art econo m(etr)ics, they leave some of the crucial questions unanswered: 1 For the results of their work see Streeck and Kluge (1999) as well as Frick, Kluge and Streeck (1999). Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 425 • None of the studies quoted above controls for the capital stock of the firms in the sample. This may cause an "omitted variable bias" if capital intensity and the existence of a works council are correlated. Moreover, the fact that the data is confined to manufacturing firms from Lower Sax ony raises the question whether the findings can be generalized to other parts of the country and/or to service firms. Finally, since the West Ger man system of industrial relations has -in the eyes of many critics -been forced upon the East German economy it is worth a separate investigation whether the influence of works councils on firm performance differs be tween the two parts of the country. • The main finding of most of the research -other things equal, the exis tence of a works council has no positive influence on the performance of firms (positive effects on labor productivity and personnel turnover are compensated by a negative influence on profits) - is problematic for at least one reason: Most authors exclusively deal with investments in phy sical capital, thereby neglecting investments in human and organizational capital which, in turn, may be of paramount importance for the works councils. If this were true, the findings presented so far may lead to in adequate policy implications. Our contribution to the growing body of literature has three different goals: First, we want to review the theoretical arguments that have been raised in the most recent discussion. In this context we show that the formerly incompatible positions have converged to a considerable extent (section 2). Second, we pre sent the findings of different production function estimates that have been aug mented by variables such as, inter alia, the existence of a works council (sec tion 3). Our estimates use data from two years of the !AB-Panel (1998 and 2000). We then look at the impact of works councils on a specific dimension of firms' investments in human and organizational capital, namely personnel tumover (section 4). Our estimates not only distinguish between East and West German firms but also between manufacturing and service firms in each part of the country. We conclude with a summary of our main findings and some implications for further research (section 5). 2. Works Councils: Welfare Reducing Cartels or Efficiency Enhancing lnstitutions? Assuming that ownership accompanied by secure property rights is the most effective institution for providing individuals with incentives to create, main tain and improve assets, it is maintained that it is also essential that the resi dual rights of control, i.e. the rights to make any decisions conceming an as set's use, are exclusively controlled by a single party. The economic impor tance of residual control follows from the difficulty of writing contracts that Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 426 Bernd Frick and Iris Möller specify all the control rights. This would be possible only if the parties to a contract were able to foresee all future developments and could therefore agree on and enforce a complete contract, i.e. one that specifies what each party has to do in every relevant eventuality at every future date and how the resulting income in each such event should be divided. However, complete contracts are generally impossible for transactions of any significant complex ity that occur over a period of more than just a few days: "Complete contracting requires freely imagining all the myriad contingencies that rnight arise during the contract term, costlessly determining the appropriate actions and division of income to take in each contingency, describing all these verbally with enough precision that the terms of the contract are clear, arriving at an agreement on these terms, and doing all this so that the parties to the contract are motivated to follow its terms" (Milgrom and Roberts 1992: 289). Due to the individuals' bounded rationality, informational deficits and in formational asymmetries contracts are necessarily incomplete. Consequently, arrangements that leave all control rights that are not otherwise assigned to a single party ( eliminating the need to negotiate and reach agreement for every unanticipated development) may result in significant cost advantages. While the notion of ownership as residual control is relatively clear for a simple asset, it gets increasingly fuzzy when applied to a (large) firm. Decisions by the owner or the management may be especially controversial when not only the physical capital of the firm, but also the human capital of the employees is affected. Jensen and Meckling (1976, 1979) for example suggest that when the party having residual control rights is also entitled to receive the residual retums, then the residual decisions made tend to be efficient ones. More specifically, they argue that in a firm, where the workers receive contractually agreed upon fixed wages in exchange for the effort they supply, the residual clai mant will, just by pursuing his own interests and maximizing his retums, make efficient decisions. Under these assumptions, a redistribution of control rights will necessarily lead to an inefficient resource allocation, because those who bear the residual risks are not the only party to decide on the use of the firm's assets. These arguments, in turn, form the basis of their market oriented case against mandated codeterrnination published already more than twenty years ago: "If codetermination is beneficial to both stockholders and labor, why do we need laws which force firms to engage in it? Surely, they would do so voluntarily. The fact that stockholders must be forced by law to accept codeterrnination is the best evidence we have that they are adversely affected by it" (Jensen und Meckling 1979: 474). More recently, this orthodox position has been challenged by a number of economists -be it proponents or critics of property rights theory2. First, it has Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 427 been argued that decisions made by the residual claimant may not always be efficient: If only part of the costs of a decision accrue to the party making the decision, then that party will find it in its interest to ignore some of the exter nal effects, sometimes leading to inefficient decisions. If, for example, effi cient production requires that workers invest in firm-specific skills, then insti tutions that protect their investments make them more likely to invest in ac quiring those ski11s3• Alchian (1984) and Furubotn (1985, 1988) have argued that in a world of informational asymmetries between self-interested employ ers and employees, and the risk of post-contractual opportunism, effective co operation may be advantageous to both parties4• In this context they empha size the importance of firm specific skills and investments: "Workers who undertake durable reliance investments commit themselves to the firm for some time into the future and are, therefore, vulnerable. The distribution of the firm's quasi-rents and the value of the labor assets can be affected by the behavior of other members of the coalition. Hence, the possibility exists that worker-investors, if unprotected by institutional or contractual safeguards, may be exploited and suffer serious economic injury" (Furubotn 1988: 167). 2 This does not imply, however, that this position has not also been defended quite forcefully. See for example Hart (1995: 686) who argues that "if companies function better when there are worker representatives on the board, then it will be in the interest of the company's founders to put worker representatives on the board -no govemment intervention is required". He explicitly rejects the "externality argument" by suggesting that firms create many types of extemalities and that it is therefore far from clear that mandating worker representatives will encourage finns to intemalize the right ones. 3 See also Dilger, Frick and Speckbacher (1999), Frick, Speckbacher and Wentges (1999) as well as Berthold and Stettes (2001). 4 More recently, this argument has been further developed by Rajan and Zingales (1998, 2001). They define the firm not as a "nexus of contracts", but as a "nexus of specific investments". Thus, their model (building on an approach developed by Gross man and Hart (1986)) is similar to the one developed by Aoki (1984: 119), who defines the finn as "an enduring combination of firm-specific resources". In the Rajan and Zin gales model, the firm requires a physical asset that is specific to the enterprise and two individuals. The total productivity is maximized if both individuals make specific in vestments in human capital. But each individual must have access to the physical asset to be able to specialize. If either individual fails to specialize, he can be substituted by an unspecialized outsider without loss of total productivity. Moreover, Rajan and Zin gales distinguish between "ownership" and "power". In their model, ownership of the enterprise gives the owner the right to exclude other individuals from access to the physical asset and the right to sell the physical asset to a third party. These rights give the owner significant power in bargaining over the eventual distribution of the jointly produced rents. However, participants can also acquire power in another way: Invest ment by either individual in firm-specific human capital gives the individual bargaining power, because due to his investment there will be more rents to share if he stays in the coalition (see also Blair 1999). In this sense, codetermination may be interpreted as part of an institutional arrangement designed to protect the investments of workers. Zingales (1998: 497) terms such arrangements a "complex set of constraints that shape the ex post bargaining over the quasi-rents generated over the course of the relationship" (see also Williamson 1985 as well as Alchian and Woodward 1988). Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 428 Bernd Frick and Iris Möller Thus, if workers are not protected by institutional or contractual safeguards against opportunistic behavior of other members of the coalition, they will either be unwilling to invest in the acquisition of firm specific skills or may risk serious economic loss in the case of dismissal. In a situation, where not all of the coalition-specific resources are owned by a single party, codetermina tion is likely to be a govemance structure that is capable of dealing with max imizing agents with conflicting interests. Irrespective of this generally favor able view of voluntary codetermination, legal intervention by the state is un equivocally rejected: "(E)fforts by govemments to ... reshape the firm have not led to particularly desir able results. The approach taken has emphasized the "political" aspect of the firm and the importance of corporate govemance while failing to give much attention to broader economic issues and to the relation between the firm's total property-rights structure and its performance. By granting workers major control rights without re gard to their actual investment position in the firm, state programs have violated an important rule for ensuring rational allocation -namely, the rule that those making decisions should bear the füll costs of the decisions they make. This defect, together with the costly system used to apportion the firm's quasi rents between workers and stockholders, means that the orthodox co-determined firm does not possess a truly efficient organizational structure" (Furubotn 1988: 178). Second, this view has in the meantime been challenged by, among others, Freeman and Lazear (1995), who argue that codetermination is likely to be underprovided by the market5• Cooperative solutions of the prisoner's dilem ma are unlikely to occur as long as there is no exogenous regulation by some third party. However, although mandated works councils have the potential to foster an increase in the joint surplus, firms are most likely to oppose them: "(l)nstitutions that give workers power in enterprises affect the distribution as well as amount of joint surplus. The greater the power of works councils, the greater will be workers' share of the economic rent. If councils increase the rent going to workers by more than they increase total rent, firms will oppose them. lt is better to have a quarter slice of a 12-inch pie than an eighth slice of a 16-inch pie" (Freeman and Lazear 1995: 29). s Accordingly, Levine and Tyson (1990) argue that in a typical prisoner's dilemma, all firms would benefit if they introduced worker participation. However, since codeter mined firms needed -among other things - a compressed wage structure to encourage group cohesiveness and dismissal protection to lengthen the time horizon of workers, they would be at a competitive disadvantage. The reason is that traditional firms will motivate their employees through fear of dismissal and a sharply differentiated wage structure. lt is highly unlikely that under such circumstances a participative equilibrium will emerge. The viability of a single codetermined firm will be threatened by adverse selection (it will attract the less motivated job-seekers) and an extemality (its best work ers will be poached by traditional frrms which can pay more). Hence, the market will be biased systematically against codetermined workplaces and the economy will be locked in a socially sub-optimal position. Mandated codetermination could overcome this di lemma by requiring all frrms to introduce participatory machinery. Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 429 This argument is supported by Sadowski, Junkes und Lindenthal (1999: 9), who emphasize that in distributional conflicts about contractually unprotected quasi-rents, it is at least optirnistic, if not naive, to expect an efficient volun tary agreement about the firm's constitution. A selfish rational agent will al ways prefer a constitution that strengthens his absolute position in ex post bar gaining, even if this is detrimental to the firm value. Thus, one cannot expect an efficient constitution of the corporation as a result of a bargaining process between co-specialized investors. Hence, the fact that firms do not offer code termination rights voluntarily to their workers is only a necessary, but not a sufficient condition of the assumed inefficiency of mandated rights to informa tion, consultation, and decision making (see also Roberts and van den Steen 2001). Given these seerningly incompatible positions, theory offers no definitive guidance as to the likely effects of mandated codeterrnination. The beneficial and detrimental effects must be demonstrated empirically. Tue theoretical ar guments presented so far can be summarized in two competing testable hy potheses: H1: Codetermination leads to an inefficient allocation of resources by changing the incentive structure of the owners of the firm. Moreover, it is likely to increase the costs of coordination and to increase the probability of worker opportunism (by behaviors such as delaying or even "blocking" decisions that are in the inter ests of the owners). H2: Codetermination fosters communication, increases the employees' readiness to accept management's decisions and reduces the probability of conflict and opportunistic behavior. Thus, it is likely to lead to better labor relations within the firm. The following two sections contribute to the existing literature by offering some new evidence. While section 3 analyzes the impact of mandated works councils on labor productivity, section 4 presents selected findings regarding the influence of works councils on firms' investments in human and organiza tional capital. As it turns out, the evidence seems to be compatible with the "performance enhancing-hypothesis" rather than the competing "cartel-hy pothesis". However, due to specific econometric problems that have not been solved yet (see section 5), the empirical relevance of the latter hypothesis can not be ruled out entirely. 3. Works Councils and Labor Productivity Until recently, the number of studies analyzing the influence of works coun cils on firm performance was rather low and their quality poor. With the avail ability of different firm panels, the situation has changed quite dramatically; the number of studies has been -and still is - increasing rapidly and the more Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 430 Bernd Frick and Iris Möller recent studies suffer less from metbodological problems tban tbe ones tbat bave been publisbed until tbe mid and late 1990s6. Tbe more recent studies bave used a variety of measures, including productivity levels and growtb, financial performance and profitability, investment in researcb and develop ment and job generation. According to tbe estimates, bowever, works councils seem to bave no clear cut consequences for firm performance: On tbe one band, the presence of a works council bas -otber tbings equal - a significantly positive influence on labor productivity, but a significantly negative impact on profitability. On tbe otber band, works councils do not bave an influence on investment bebavior and / or on innovations (neitber on product nor process innovations) 7• To date, only few empirical studies bave been able to control for the capital stock of the companies in tbe samples used8• Tbus, most available studies are unable to rule out tbe possibility tbat it is capital intensity ratber tban tbe pre sence of a works council tbat fosters tbe economic performance. To overcome tbis methodological problem we use the 6th and the 8th wave of the !AB-Panel for firms located in West Germany and tbe 3rd and tbe 5th wave from East Germany (tbe data is from 1998 and 2000 respectively, see Kölling 2000). Our estimates are based on sample sizes tbat vary between sligbtly less than 700 (service firms in East Germany in tbe year 2000) and sligbtly more tban 2.600 (all West German firms in 2000). In 1998 as well as in 2000, the respondents in the sample firms bave been asked bow mucb money bad been spent in tbe previous year to replace used capital goods. Assuming tbat tbe amounts recently spent are bigbly correlated witb the capital stock, we estimate different types of production functions (Cobb-Douglas, CES and Translog) witb value added as our dependent vari able. Besides information on capital and workers employed, tbe production function estimates include a wide range of variables identified as (potential) determinants of firm performance: Apart from a works council and a profit sbaring-dummy our augmented production function estimates include the per centage of qualified employees, two dummy variables indicating wbetber tbe firm invested in new communication or computer tecbnologies ("process inno vation") or brougbt new products and/ or services to the market ("product in novation") witbin tbe last two years. Moreover, we include indicators measur ing the percentage of sales exported, wbetber tbe firm employed any appren- 6 For a recent overview -including a distinction between three different phases of economics research -see Addison, Schnabel and Wagner (2003). Studies that have been published prior to 1997 are also summarized by Frick (1995, 1997b). 7 See Addison, Schnabel and Wagner (1996, 1998, 1999, 2001); Addison, Siebert, Wagner and Wei (2000), Dilger (2002), Hübler and Jirjahn (2002, 2003), Jirjahn (2003) and Schank, Schnabel and Wagner (2002). s To the best of our knowledge the only notable exception is FitzRoy and Kraft (1987, 1990). Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 f f 1 u.) u.) Ta ble 4: Works Councils and Personnel Policies of German Firms Author(s) Sample / Data Type and Indicator(s) of Personnel Policy Voluntary and Involuntary Tumover Addison, Schnabel and Hannover Firm Panel* Hires, Departures Wagner (1998, 1999, and Labour Tumover 2001) Addison, Siebert, Hannover Firm Panel Net Employment Change Wagner and Wei (2000) Beckmann and !AB-Panel** Churning Rate Bellmann (2002) Dilger (2002) NIFA-Panel*** Personnel Turnover, Departures and Hires per 100 Employees Frick (1996a, 1996b, Representative Sample Dismissals and Quits 1997a) of West German Firms per 100 Employees (n > 1.600, mid 1980s)**** Hires per 100 Employees Gerlach, Hübler and Hannover Firm Panel Coefficient of Variation Meyer (2001) of the Size of the Workforce * ** *** **** See Brand, Carstensen, Gerlach and Klodt (1996) for a description. See Kölling (2000) for a description. See Widmaier (2001) for a description. See Büchtemann and Höland (1989) for a description. Indicator( s) of Codetermination Presence of a Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council; Type ofWorks Council Presence of a Works Council Presence of a Works Council Effects of Codetermination Significantly negative ( all firms); not significant in firms with 21-100 employees Not significant Significantly negative Significantly negative Significantly negative Significantly negative Not significant Significantly negative 8. � t fr 8. � s ;.o g, .i:,. w -...J OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 J 1 u.) 1 u.) Ta ble 4 continued Kraft (1986) Schmidtke and Backes-Gellner (2002) Backes-Gellner, Frick and Sadowski (1995, 1997) Jirjahn (1998); Gerlach and Jirjahn (2001) Zwick (2002) Bellmann (2003) Boockmann and Hagen (2001); Hagen and Boockmann (2002) Small Sample of Large Manufacturing Firms (n = 62, late 1970s) !AB-Panel Representative Sample of West German Firms Hannover Firm Panel !AB-Panel !AB-Panel !AB-Panel Labour Tumover as Perceived by Management (Dummy "High" vs. "Low") Vacancies per 100 Academics, Skilled White-Collar Employees and Skilled Blue-Collar Workers Initial and Further Training Percentage of Apprentices Among Workforce; Retention Rate of Apprentices after Completion of Training Probability of Further Training Per-Capita Expenditures for Further Training Per-Capita Expenditures for Further Training Special Groups of Employees Probability of Employing Subcontractors Percentage of Subcontractors Percentage of Fixed-Term Contracts Percentage of Subcontractors Percentage of Freelance Work Presence of a Works Council; Participation Index Presence of a Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council Not significant Significantly negative Not significant Not significant Significantly negative Not significant Not significant Significantly positive Significantly positive Significantly positive Significantly positive Significantly positive Significantly positive Not significant Not significant .j:>. w 00 "!'.! ::i. [ o: ;:::: OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 f f 1 u.) u.) Ta ble 4 continued Düll and Ellguth !AB-Panel Percentage of Fixed-Term Presence of Significantly positive (1999) Contracts a Works Council Significantly negative Percentage of "Marginal" Employment Relationships Frick (1992, 1994); Representative Sample Compliance with the Handi- Presence of Significantly positive Frick and Sadowski from Firm Register in capped Act13 a Works Council (1995); Sadowski and Rhineland-Palatinate Dismissals of Disabled Behaviour of the Significantly positive Frick (1990, 1992) Employees Works Council (in with respect to probsupport of employee) ability of reinstatement Fringe Benefits Bellmann and Frick !AB-Panel Voluntary Pension Plan Presence of Significantly positive (1999); Operated by Employer a Works Council Frick (2000) Number of Benefits Provided Significantly positive Schnabel and Wagner Hannover Firm Panel Voluntary Pension Plan Presence of Significantly positive (1999) Operated by Employer a Works Council Labour Costs, Flexible Staffing Arrangements and High Performance Work Practices Addison, Schnabel and Hannover Firm Panel Per-Capita Wages Presence of Significantly positive Wagner (1998, 1999, a Works Council (all firms as well as 2001) firms with 21-100 employees) Bellmann and Kohaut !AB-Panel Per-Capita Wages Presence of Significantly positive (1999) a Works Council in East German firms only 13 Measured by the percentage of the workforce officially recognized as "severely disabled" according to the German "Handicapped Act" of 1974. 8. � t fr 8. � s ;.o g, .i:,. w \0 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 J 1 u.) 1 u.) Ta ble 4 continued Dilger (2002) Frick (2002) Gold (1999) Hübler and Jirjahn (2003) Jirjahn (1998); Jirjahn and Klodt (1998) Schank (2001) NIFA-Panel Flexible Working Hours NIFA-Panel Number of "High Performance Work Practices" Hannover Firm Panel Probability of "High Labour Costs" and "Excessive Staff Size" Hannover Panel Per-Capita Wages Hannover Panel Per-Capita Wages !AB-Panel Per-Capita Wages Presence of a Works Council; Type of Works Council Presence of a Works Council; Positive Evaluation of Works Council by Management Level of Activities and Type of Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council Presence of a Works Council Significantly positive Not significant Significantly positive Significantly positive Significantly positive Significantly positive, but higher in firms not covered by a collective agreement as compared to those in the covered sector Significantly positive Significantly positive ! "!'.! ::i. [ o: ;:::: OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 441 In order to maximize worker effort, loyalty and motivation, firms usually im plement specific incentive mechanisms to avoid opportunistic behavior. Since the deposition of bonds or "entrance fees" is neither feasible nor legally en forceable, workers are initially paid less than their marginal product, but even tually are paid a wage exceeding their marginal product. Over the expected te nure with the firm workers receive an expected present value of compensation equal to the present value oftheir productivity (see Lazear 1979, 1981). Work ers whose productivity is below a certain minimum can be immediately dis missed, thereby loosing their rent of staying with the firm. In an "institutional vacuum", firms prefer rather steep wage profiles in order to dismiss workers by the time their wage rate equals their marginal product, because at this point the firm can maximize its "dismissal profit". In a perfectly competitive labor mar ket, however, such opportunistic behavior severely damages the firm's reputa tion as an honest employer. In the long run, such firms will face considerable problems in recruiting qualified and loyal personnel -except in the case they offer flatter age-earnings profiles, which, in turn, increase the probability of worker opportunism because in the latter case the opportunity costs of being dismissed are significantly lower than in the case of steep profiles14. While the payment of seniority wages creates a kind of dependency on the part of workers, the same is true for firms, because the fixed costs of recruiting and training workers have to be amortized during the course of the individual employment relationship. Especially in the case of the most productive work ers this amortization is permanently endangered, because those workers can - due to their sector specific skills and knowledge -change employers without any severe depreciation of their human capital. At the same time, firms are - irrespective of legal constraints -usually able to dismiss the less productive workers first, if workforce reductions become unavoidable, i.e. due to a reduc tion in product demand. There is ample evidence that workers who voluntarily resign from their last employment relationship are more productive than those who had been dismissed: In their new jobs, they have on average much higher returns on their human capital than laid-off workers, although the respective rates had been nearly identical prior to the job change (see Gerlach and Schasse 1991). In the latter group those who had lost their job due to a plant closure did not experience lasting reductions in their returns to human capital while those who were dismissed for personal reasons incurred substantial losses that could not be compensated even in the long run ( see Gibbons and Katz 1991). Since firms usually have some discretion with respect to whom to dismiss, the market obviously infers that workers dismissed due to plant clo sures are on average of high quality while those who had been dismissed indi vidually are of low quality. 14 Firms that pay seniority wages are indeed more successful in economic terms than otherwise identical firms which do not consider tenure as an important determinant of the development of individual wages and salaries (see Kühl 1995). Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 442 Bernd Frick and Iris Möller In the absence of legally enforceable codetermination rights, workers are less willing to invest in the acquisition of firm specific human capital than otherwise observationally equivalent workers who are protected by exogenous regulations against an expropriation of their quasi-rents due to unjust dismis sals (see Alchian 1984)15• This kind of "uncooperative" behavior is likely to cause disturbances in the production process and to inhibit the transfer of firm specific skills and knowledge from the incumbent to the new employees. The most likely result of a lack of worker participation is, therefore, an increase in non-wage labor costs due to an increase in voluntary tumover. Since the labor market's transparency is rather limited, the reputation mechanism is unlikely to guarantee that firms always remain "honest" and never dismiss workers in order to expropriate their quasi-rents (see Sadowski 1988). Thus, from the worker's point of view seniority wages lack a self-enforcing mechanism that inhibits employer opportunism. The more widespread seniority wages become and the steeper the age-eamings profiles are, the more the demand for institu tional safeguards to reduce employer opportunism will increase16: "Once a bond is posted, a firm has a strong incentive to label a worker a shirker and to claim his bond. Unless, as is likely in practice, third parties can be relied on to determine whether a worker has shirked, workers will only be willing to post bonds if they are convinced that the firm will not take them under false pretence. Workers should trust firms not to falsely expropriate bonds so long as the bond is smaller than the value to the firm of maintaining its reputation as an employer. When workers are uncertain of the trustworthiness of firms, they are unlikely to be willing to post bonds" (Dickens et al. 1990: 165). If neither the reputation mechanism nor the extent of relation-specific in vestments are sufficient conditions to suspend employer opportunism, the question arises whether and to what extent mandated codetermination is likely (or even indispensable) to improve the quality of plant-level labor relations and the functioning of firm-intemal labor markets. Thus, to the extent that works councils serve as "collective information agencies" whose main task is the reduction of information asyillilletries between management and work force, they form an important part of a micro-corporatist arrangement, de- 15 In his Nobel lecture, Becker (1993: 394) explicitly states that "firm-specific in vestments produce rents that must be shared between employers and employees, a shar ing process that is vulnerable to "opportunistic" behavior because each side may try to extract most of the rent after investments are in place". 16 The hypothesis that the reputation mechanism cannot rule out employer opportu nism is supported by two empirical observations: On the one hand, the risk of being dismissed increases c.p. with the worker's age and irrespective of the presence or ab sence of mandated job protection legislation (see Farber 1993 for the USA and Frick 1994 for Germany). On the other hand, more than 50% of all dismissals occur in a minority of only 10% of all firms, which nevertheless survive in the market (see Frick 1997a). This finding seems to be stable across countries and occurs in growing as well as in shrinking companies. Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 443 signed to overcome the prisoner's dilemma situation which is characteristic for labor relations. Since on the one band, management is usually better in formed about the financial situation of the enterprise, it can systematically try to pretend that the situation is worse than it actually is in order to achieve a redistribution of quasi-rents which is more in its favor. The works council's task, therefore, is to ascertain the "true" reduction of the marginal product of labor and/ or to make sure that the initial distribution of the quasi-rent is re tained (see Freeman and Lazear 1995)17. On the other band, workers represen tatives' are usually better informed about the productivity and motivation of individual employees than is management. This information, in turn, can be valuable to management not only in the case of dismissals, but also when se lecting workers for further training, etc. This information is likely to be very reliable, because the works council's interest in a maximization of the joint surplus to be distributed is unlikely to conflict with management's interest in profit maximization18. Contrary to the unions in the US and Great Britain, works councils in Ger man firms have a de jure rather strong position with regard to dismissals, im plying that employment protection in the latter country has a strong collective component. According to § 1 of the Dismissal Protection Act of 1969, dismis sals must not be "socially unwarranted". This means that they must be jus tified in terms of either the conduct of the individual employee or the opera tional requirements of the enterprise (for an overview, see Birk 1993)19• Prior consultation with the works council is a prerequisite for the validity of any dismissal (§§ 102-103 Works Constitution Act). The works council must be informed within one week, and has one week in which to respond to an ordin ary dismissal. In cases of extraordinary dismissal, i.e. severe misconduct, the works council must be informed immediately and has three days in which to object to the dismissal. The works council may either give its consent, remain silent, express its misgivings, or even lodge a formal contradiction. If the works council objects to the dismissal, the employee generally has a claim to continued employment pending a judicial decision or until a settlement has been reached. 11 There is ample evidence that German works councils adequately fulfill this task: In a large number of recent cases they supported management in its attempt to reduce labor costs by either separating parts of the enterprise from the mother company (although this usually results in more or less severe income losses), by renouncing to fringe benefits in order to increase investments or by extending the number of weekly working hours. The most prominent example, however, was the works council's ap proval to introduce the four-day working week at Volkswagen. 1s This is to be expected as least as long as the firm's personnel policy does not threaten the stability of the dominant coalition among the workforce, i.e. the qualified, middle-aged employees with long tenure (see Sadowski 1985). 19 These regulations explicitly exclude small firms with less than six employees, and employees who have not yet completed a minimum probationary period of six months. Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 444 Bernd Frick and Iris Möller Special procedures are applicable to collective dismissals, depending on the number of employees affected, and on the size of the firm. In general, employ ers must inform and consult the works council, communicating, inter alia, the reasons for the proposed dismissals, the timetable for their implementation, and the number of employees affected. Both the employees affected, and also the works council, may contest collective dismissals on grounds of improper criteria used for the selection of employees to be laid off. In firms with more than 20 employees the employer must, at the request of the works council, negotiate a social plan. Until recently there was little empirical evidence on whether works councils do indeed influence employers' dismissal (and em ployees' quit) decisions. Therefore, the question is to what extent works coun cils act as "safeguards" against employer opportunism and as "protectors" of employees' quasi-rents by reducing dismissals as well as voluntary resigna tions. If the works councils fulfill their constituents' expectations, the relative number of dismissals and resignations ( dismissals and resignations per 100 employees) should be significantly lower in firms with a works council than in enterprises without plant-level representation. Using the 5th and the 8th wave of the !AB-Panel to calculate the respective figures it tums out that, first, the rate of (in-)voluntary tumover is indeed significantly higher in the latter as compared to the former type of firms. Second, the observed pattem is more or less identical in East and West Ger man firms as well as in firms located in the second and tertiary sectors (see Table 5). Table 5 Personnel Turnover in East and West German Firms* Seetor East German Firms All Firms Firms with Firms without Works Council Works Council All Firms 13,0 8,5 17,3 lndustry 13,7 9,2 16,3 Services 12,7 8,2 18,2 West German Firms All Firms 12,1 9,4 15,7 Industry 10,2 8,5 13,2 Services 13,1 10,0 16,8 * Number of hires and departures per 100 employees during the first six months of the year 2000 in finns with five and more workers. Source: !AB-Panel, Wave 8 from West Gennany and wave 5 from East Germany. Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 445 In order to analyze the impact of works councils on personnel tumover we follow an approach suggested by Hübler and Jirjahn (2003) who distinguish not only between firms with and without a works council but also between firms that are members of an employers' organization and those who are not. Our estimates reveal that in firms with a works council personnel tumover is significantly lower than in firms without a plant-level interest representation. This effect is more pronounced in firms that have to obey to one or more col lective agreements, suggesting that management attitudes also play a role in reducing tumover (see Table 6). At the same time, however, it appears that the existence of a works council is of paramount importance. These findings, however, are only a necessary, but not a sufficient condition for the proposed "intemal efficiency" (see Aoki 1984) of the German Works Constitution. At first sight they are even supportive of the conflicting view, that codetermination is one of the main reasons for the "inflexibility" of Ger man firms when facing the need to adjust the workforce. lt is, therefore, neces sary to show that the works councils not only take into consideration the qua si-rents of the insiders, but also the interests of the firm as well as those of the (unemployed) outsiders. Additional estimates (not presented here) show that works councils neither oppose dismissals in contracting firms nor prevent re cruitments in expanding firms (see Frick 1997a). If, as has been pointed out by several critics, the works councils unilaterally favor the interests of the incumbent workforce, we should observe the follow ing (see Frick 1997a: 254-260): In shrinking firms with a works council the percentage of younger and/ or qualified workers should be disproportionately high among the leavers if the works councils actually favor those with long tenure and reduced opportunities on the extemal labor market. This, in turn, would be detrimental to the firm's economic performance, because in the long run it is left with its less productive workers, putting it at a competitive disad vantage compared to otherwise identical firms without a works council. In shrinking firms without a works council, the percentage of older and/or less qualified workers should be disproportionately high among the leavers, be cause of the firm's interest in retaining its most productive employees. The respective estimates show that the presence or absence of a works council does not have any influence on the qualification structure of those who leave or stay in the case of inevitable workforce reductions. Apart from the above mentioned differences in the tumover rates of firms with and without a works council, it is still possible that the presence of a plant-level interest representation severely restricts the firm's ability to react to technical progress or to changes in product demand. If this were the case, the standard deviation of the number of dismissals should be much smaller in firms with a works council than in otherwise identical firms without a works council. However, looking at the relative concentration of dismissals in Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 446 Bernd Frick and Iris Möller Ta ble 6 The Separate Impact of Works Councils and Collective Agreements on Personnel Turnover in East and West German Firms (2000)1 Variable/ Firms B SE E T East German Firms MBR/MTV2 ---0,3682 0,0674 -5,46*** MBR/OTV3 ---0,1701 0,0830 -2,05** OBR/MTV4 -0,1165 0,0497 -2,35** West German Firms MBR/MTV -0,2752 0,0463 -5,95*** MBR/OTV -0,1946 0,0661 -2,94*** OBR/MTV -0,1671 0,0400 -4,18*** Industry (East Germany) MBR/MTV ---0,2708 0,0877 -3,09*** MBR/OTV ---0,1916 0,1048 -1,83* OBR/MTV ---0,0404 0,0631 -0,64+ lndustry (West Germany) MBR/MTV ---0,2553 0,0623 -4,10*** MBR/OTV ---0,1640 0,0866 -1,89* OBR/MTV ---0,1939 0,0608 -3,19*** Services (East Germany) MBR/MTV ---0,5471 0,1079 -5,07*** MBR/OTV ---0,1246 0,1344 -0,93+ OBR/MTV ---0,2771 0,0808 -3,35*** Services (West Germany) MBR/MTV ---0,3005 0,0707 -4,25*** MBR/OTV ---0,2396 0,1017 -2,36** OBR/MTV ---0,1557 0,0531 -2,93*** + not significant; * p < .10; ** p < .05; *** p < .01. 1 Dependent variable is log odds of personnel turnover (ln(pt/(1 -pt)). For additional controls see tables 1 -2. The füll results are available from the authors upon regnest. 2 MBR/MTV: with works council, with collective agreement 3 MBR/OTV: with works council, no collective agreement 4 OBR/MTV: no works council, with collective agreement (reference category OBR/ OTV: no works council, no collective agreement). expanding as well as in contracting firms with and without a works council, it appears that the respective Gini-coefficients are nearly identical and that the Lorenz-curves intersect twice in both cases. In shrinking firms with a works council, the coefficient value is 0,635; in firms without a works council it is Schmollers Jahrbuch 123 (2003) 3 OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.123.3.423 | Generated on 2023-04-04 12:32:21 Mandated Works Councils and Firm Performance 453 -(2003), Produktivitätswirkungen betrieblicher Mitbestimmung -Welchen Einfluss haben Betriebsrat und Taritbindung? Zeitschrift für Betriebswirtschaft 63, Ergän zungsheft 4, 63 -85. Jirjahn, U. / Klodt, Th. (1998), Betriebliche Determinanten der Lohnhöhe, in: K. Ger lach/O. Hübler/W. Meyer (eds.): Ökonomische Analysen betrieblicher Strukturen und Entwicklungen, Frankfurt/M: Campus, 91-115. -(1999), Lohnhöhe, industrielle Beziehungen und Produktmärkte, in: L. Bellmann/ S. Kohaut/M. 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