1. Governance of the Stakeholders’ Firm Vicente Salas Fumás University of Zaragoza

2. Outline Motivation of the Paper and Research Questions The Basic Model Main Results Conclusions

3. Motivation: New Firm “Transition from the “Old Firm” (shareholders oriented) to the “New Firm” (stakeholder oriented). Why?- Ethical and social responsibility reasons - Economic reasons: change in strategic assets; from physical capital (embedded in machinery and equipment) to knowledge (embedded in people and organization). - Governance of the new firm has to account for new reality.

4. Motivation: Governance Choices World of Incomplete Contracts: Governance forms: Hierarchical, Balanced, Trilateral (Williamson, Kreps) Old firm: Hierarchical; shareholders hold residual decision rights New Firm: Hierarchical; workers hold decision rights? Balanced; co-determination workers and shareholders?Trilateral, board as trustees?

5. Basic Model Joint production workers and shareholders. Two productive resources, physical capital and knowledge. Investment in knowledge is non contractible and can be transaction specific Product sold to the market; Bertrand competition (customers as stakeholders) Decision on who finances the investment in knowledge, workers or shareholders

6. Basic Model Time 0 Time 1 Time 2 Time 3 ------------------------------------------------------------------------------------------------------------------------------ Parties decide who Decision on the amount Parties agree on the Market competition finances the investment invested in physical and terms of the allocates wealth in human capital human capital transaction (resource created between allocation and rent consumers and sharing between producers. workers and shareholders) Figure 1.- Timing of contracting and investment decisions

7. Competition Time 3 V=F(K,H)= Value in terms of willingness to pay by consumers ; c= cost; K, Physical capital, H, Human capital Vb, cb, value and cost for the competing firm P, Pb, prices of the two firms Equilibrium condition, V-P* = Vb-Pb*=Vb –cb =Wb if V-c=W>Wb P* = V-Vb+cb, Profit =P*-c= (V-c)-(Vb-cb) = W-Wb Profitb= 0 Consumer surplus = V-P*= Wb

8. Main Results Proposition 1.- The Bertrand competition model determines an equilibrium solution where our reference firm, which creates more wealth than firm “b” by assumption, obtains a rent equal to the difference between wealth created by the firm and wealth created by the competing one, R* = W* – W b. At the same equilibrium solution consumers get a surplus, CS*, equal to the wealth created by the alternative choice, CS*=W b.

9. Main Results Time 1, 2 Pay off at t=2 G(K*, H*) = K* + (1-  ) (F(K*,H*) – K* – H*-W b ) S(K*,H*) = H* +  ( F(K*,H*) – K* – H*-W b ) Pay off t=1 if Shareholders finance B(K*,H*) = G(K*,H*) – K* – H* = (1-  ) (F(K*,H*) – K* – H*-W b ) – H* Pay off t=1 if Workers finance SN(K*,H*) = H* +  ( F(K*,H*) – K* – H*-W b ) – H*

10. Main Results Time 0.- Proposition 2.- Shareholders’ finance of both physical and human capital imply under investment in the two forms of capital and lower total welfare, compared with first best results, except in the particular cases of  = = 0. Proposition 3. – The solution where workers finance investment in human capital and shareholders finance investment in human capital implies under investment of the two forms of capital and lower welfare, compared with first best results, except for values of the parameters,  = 1 or =1. Proposition 4. - Wealth created is maximized if workers finance human capital invested when  c = (1- )/(2- ) and shareholders finance the investment otherwise.

11. Employability 1 1 Bargaining Power 1/2 Optimal worker finance Optimal shareholder finance Combinations of parameter that determine the second best optimal Investment decisions on human capital from the condition  (  - )/(2- )

12. Shareholders interest in empowering workers Proposition 5.- When shareholder finance the investment in human capital the profit maximizing value of the empowerment parameter is zero. If workers finance the investment shareholders prefer nil empowerment of workers if human capital is general, and positive empowerment if human capital is specific. Proposition 6. - When shareholders finance the investment in human capital they prefer minimum worker employability, =0. When workers finance the investment shareholders prefer positive but less than full employability, except for he particular case when they hold all bargaining power,  =0, where they will choose =1. Specificity and competitive advantage

13. Conclusions Governance alternatives Hierarchical : Control of the firm by knowledge workers faces inefficient risk allocation problem; Control of the firm by shareholders who finance all investments faces an appropriation problem and under investment in all productive assets. Efficiency of shareholders control and finance increases as knowledge becomes more firm specific and workers have less bargaining power.

14. Conclusions Bilateral : Shareholders willing to empower workers if the later finance investment in embedded knowledge; second best optimal. Empowerment of workers increases as human capital is more firm specific. Shareholders may prefer employability than empowerment to create incentives for workers investing in human capital, but it may lower competitive advantage.

15. Conclusions Trilateral : The Board of Directors as a Board of Trustees faces a motivation problem: how to create incentives for total welfare maximization? Worth to study since there is room for wealth creation