Who bears risk?

There's one aspect of the collapse of City Link that deserves more attention than it gets - that it undermines the conventional idea that firms' owners are risk-takers.

Better Capital's stake in the firm took the firm of a secured loan, which means they'll get first dibs on its residual value. Thanks to this, Jon Moulton, Better Capital's manager claims to stand to lose only £2m - which is a tiny fraction of his £170m wealth.

By contrast, many of City Link's drivers had to supply capital to the firm in the form of paying for uniforms and van livery, and are unsecured creditors who might not get back what they are owed. Many thus face a bigger loss as a share of their wealth than Mr Moulton. In this sense, it is workers rather than capitalists who are risk-takers.

This point is not, of course, specific to City Link. Most decent-sized businesses represent only a small fraction of a diversified portfolio for their capitalist owners, whereas suppliers of human capital usually have to put all their eggs into the basket of one firm; only a small minority of us have "portfolio careers" . All that stuff they teach you about the benefits of diversification applies in the real world to capital, not labour.

There are two implications of all this.

First, it means that the idea that capitalists are brave entrepreneurs who deserve big rewards for taking risk is just rubbish. As Olivier Fournout has shown, the idea of managers as heroes is an ideological construct which serves to legitimate power and rent-seeking.

Secondly, it suggests that ownership might in some cases lie in the wrong hands. Common sense tells us that those who have most skin in the game should have the biggest say simply because they have the biggest incentive to ensure that the firm succeeds. As Oliver Hart - who's hardly a raving lefty - says: "a party with an important investment or important human capital should have ownership rights." This is yet another case for worker ownership.

This in turn reminds us of a cost of inequality; sometimes, ownership is in the wrong hands simply because the most efficient owners can't afford to buy the firm.

All this poses the question: are there policy measures, other than worker ownership, which could ensure a more equitable bearing of risk?

One answer would be policies to achieve serious full employment. Full employment would allow workers to reject job offers which expose them to excessive risk, and it would mitigate human capital risk by ensuring that those who lose their jobs - and the collapse of firms is an inevitable part of capitalism - can quickly find new work.

Secondly, we need a more redistributive welfare state. The welfare state is not a scheme whereby "we" pay for "scroungers". It is instead an insurance mechanism. It is a means of pooling human capital risk; we pay premiums (tax) in good times and receive compensation in bad times when such risks (illness or redundancy) materializes. The fact that many workers suffer a massive drop in income when they lose their jobs suggests the welfare state isn't providing enough insurance.

Of course, all these ways of improving risk-bearing fall outside the Overton window. 

Comments

[Pete]

Good article.

You can also tell that private equity owners of a business don't truly have much skin in the game by their imposition of levels of leverage which no worker-owned company would ever willingly consider.

This leverage-driven tax dodge both increases the risk faced by workers and is a big part of the reason that more efficient owners of a business often can't afford to buy it.

I would therefore suggest ending the tax-deductibility of interest as a third plank of your programme.

[Matt Moore]

Interesting. A few thoughts.

The most important of which is, if you are suggesting that workers suffer from a relative inability to diversify their sources of labour income (I agree), why do you propose they also invest their capital / savings in becoming owners of the SAME firm? Surely this reduces their diversification. Only a fool or an inside trader holds shares in his employer.

"ownership is in the wrong hands simply because the most efficient owners can't afford to buy the firm." - If such an arrangement would be more efficient, why isn't lending available to enable it? Super-fragmented ownership often enacts its own costs. I don't think there is massive unexploited value here. Obviously, otherwise I would be building a business around it.

Would also love to see policies promoting full employment, though we would probably differ on the substance. In particular, minimum wages hardly seem to be designed to support such an outcome - lower average taxes on the poorest / least skilled would be better.

Agree unemployment insurance is the way forward. Especially if provided on a competitive basis, but perhaps mandatory contribution. The lack of a link from premiums / contributions to payout is what undermines this.

[An Alien Visitor]

In order to reestablish any sort of social democracy we need to readdress the policies of the neo liberal period, the systematic reduction of tax rates for the richest, the reduction in social mobility, the massive financialisation, including rising household debt.

When these are redressed then we don't have to view a minimum wage as being in conflict with full employment, for example.

The neo liberal mindset, so ingrained, need to be smashed.

[Stevenclarkesblog.wordpress.com]

What about Bob Shiller's ideas for livelihood insurance and macro markets?

If the welfare state is where goverments own shares of our human capital, can you foresee a world where such shares can be bought, sold and diversified by private entities?

[Luke]

Zero hours contracts is another risk shifting mechanism, especially if the worker can't have more than one contract (which I understand is common).

[Neil Wilson]

"Only a fool or an inside trader holds shares in his employer."

Or somebody who is self-employed, or owns their own firm. Or works at a co-operative.

ie all the best private ownership structures.

Having all your eggs in the basket is part of what makes private ownership actually work. The problem with allowing capital diversification and easy exits for capitalists is that they don't really care if the firm lives or dies.

If you remove the risk by implementing a state Job Guarantee - where *anybody* can always get a living wage by working for the public good, then you remove the risk not only of losing a job, but of everything falling apart if your worker-owned co-operative doesn't function as expected.

You could couple the Job Guarantee with significant restrictions on third party ownership of businesses - precisely because you want as much skin in the private sector game as possible.

[Neil Wilson]

"Of course, all these ways of improving risk-bearing fall outside the Overton window. "

So did most of Maggie Thatcher's policies.

She, however, didn't complain about it all the time and use it as an excuse. She just got on and moved the window by selling the vision.

[Neil Wilson]

I shall quickly point out that Thatcher's vision came straight from Hades. But sold it she did.

[An Alien Visitor]

I think the mission should be to crowd out the private sector as much as possible, because much of what they produce is total useless junk (despite what their adverts and labelling claim). Think of all the Christmas presents that have been bought and won't be used. Think of all the health remedies that don't do anything.

Crowd out the private sector and save the planet and humanity!

[dwb]

full employment... check. Then you go off the rails with the redistributive state.

ugh. No: Because of the high cost of legal advice, wealthy people have access to better contract lawyers (solicitors), which allows them to draft complex financing arrangements. The flaw here is that credit given to the firm (van livery, etc.) should have had a higher claim priority than other secured credit.

More laws only help the legal profession, and rich people will always be able to afford clever lawyers to find the loopholes.

The way to help small businesses and independent contractors is to set up services where they can obtain better legal advice. There is nothing that would have stopped these independent contractors from banding together to get better contracts. At full employment, workers have leverage.

[Bob]

What about abolishing corporation tax and requiring the company to share around 25% of the profits, or more. Combine this with requiring code termination with a worker's board. The abolition of corp tax and VAT could be funded by a Land Value Tax.

[Luis Enrique]

"the conventional idea that firms' owners are risk-takers"

Doesn't "owner" usually refer to equity holder, not providers of senior debt? Or had Better Capital somehow contrived to own the firm yet have the status of a senior creditor?

[Fred Fratter]

@Luis - That's commonly done. The PE house will take the equity but all the value will be in the senior debt that they load into the structure.

[Ben]

Really like this post. We so need to get a better deal for workers. Most employers lord it over workers.

Even as a skilled worker in tech where we have real trouble recruiting new staff and even then it takes a year to get them up to speed, it feels as though the balance of power lies with my employer by some way.

I can't imagine what it's like to be in a low skilled job where you can be replace on a whim. Even these guys should have rights and protections.

I think the shift in mortgage commitments to longer-term and the shift in job security to short term has put unprecedented stress on regular people.

On a related note a lot of risk is borne by renters. For example on leaving a rental in London I had to "compensate" the estate agency for 400 quid because although I'd left with the required notice I'd not run the full contract. They got a replacement tenant to move straight in but I was left with no option aside a protracted legal battle which for an individual isn't feasible. Heads they win tails I lose.

[Sam]

"The fact that many workers suffer a massive drop in income when they lose their jobs suggests the welfare state isn't providing enough insurance."

Not necessarily. If I consider welfare as a private insurance deal, and ask how much of my current income am I prepared to sacrifice in order to purchase an income if I become unemployed, I don't come anywhere close to assuming I should insure the full value of my current income.

We can certainly put an upper bound at the amount of pension I purchase - for surely I expect to be retired for longer and more certainly than I expect to be unemployed.

The lower bound, if we assume that I have no savings that could tide me over, would be enough to feed my family and pay the utility bills.

My personal answer would be very close to the lower bound, (or maybe lower, as I do have savings, and am pretty confident I could find a replacement job if necessary).

YMMV, but those seem to be the right numbers to begin to frame the discussion.

[John Lennar]

Why don't all of you just start a small business next week and become owners?

[John Lennar]

Apparently, according to the post, starting a business is not risky. So why not do it?

[John Lennar]

Small businesses make up 99.7% of U.S. employer firms.

[Luis Enrique]

John

this post is not about small business owners

Fred

thanks for that.

[Dave Timoney]

The aversion of owners to risk is not just a peculiarity of private equity.

Limited liability, which shields beneficial owners from the risk of management incompetence or malice, redistributes the cost of failure (via creditors) onto society at large, which means that workers end up paying for it (through downward pressure on wages and upward pressure on prices).

This may redistribute capital among certain owners, but at an aggregate level it preserves capital as a class.

[Jim]

So in the case of City Link, what would have happened to the firm had Better Capital not provided £40m in funding at that point? Would the staff have found the money? Without that cash there would have been no more firm at that point in 2013, so the staff would have all been out of a job then instead.

At the end of the day, he who pays the piper calls the tune. And if someone else gets to call the tune without paying, they will soon find the piper no longer is being paid, and there's no tune to call.

[John Lennar]

Louis or Fred,

Well then, I think it is extremely unfair to use the capitalist label.

You do not consider small business owner's capitalist and owners?

Please clearly define capitalist and owners.

If you are specifically referring to private equity/hedge funds/ investment bankers, why not just call them that and not capitalist.

At what point does a small business become one of these "capitalist" that is referred to in the post?

The post refers to "decent-sized businesses". Didn't the vast majority of these decent-sized businesses start out as small businesses?

I am from the US and I am not familiar with the companies and the specific situation above.

[John Lennar]

For example, I just looked at the US Forbes list. The top 15 on the list originally obtained their money from starting a small business.

[John Lennar]

Walmart, Microsoft, Facebook, Google, Bershire Hathaway, etc. were all started as small businesses.

So, if someone starts a small business and becomes successful, then they become on the these bad capitalist that are referred to in the post?

[Fred Fratter]

John

I think you need to go back to the original example in Chris' post. Who suffers the loss when the business fails? It could be more than one group. In the City Link case it looks like it will mainly be the workers. Is that fair? If you think it is, then fine. If it's not fair, then at some point in the business' life the simple shareholder ownership model failed. Perhaps another one would be better?

On those US business examples you give, one answer could be they become "bad" capitalists when they start creating significant negative externalities because of their size. That could apply to some of those on your list. You still have anti-trust laws in the US after all.

Fred

[Deviation From The Mean]

"Apparently, according to the post, starting a business is not risky. So why not do it?"

No, the point of the post is to say it is risky but the risk has been transferred to the workers and the owners bear little of the risk. The argument is then to say to workers, why do you put up with this state of affairs? I guess society has conditioned people to not challenge the fundamentals. The job of the left is to provide evidence such as contained in this post and make the argument that things need to change. But then there are structural barriers to setting up a business collectively that needs addressing also. You certainly can't argue that this post is wrong by saying,if the article were true then workers would simply set up businesses en masse. This is a very dishonest way to look at the issue.

To John lennar: I think most leftists regard small businesses as the most reactionary - certainly in politics and how they treat their workers. Walmart are an example who buck the trend, I suspect they have always been an appalling employer. I certainly wouldn't lump them in with Microsoft.

[Luis Enrique]

nobody (sensible) would deny that owners of small businesses are exposed to big risks (unless I suppose they are already rich). (btw I hope that the commentator above is wrong to suggest that most 'leftists' are hostile to small business owners)

This post is clearly about capitalists who are rich enough that "a decent sized business" is only a small part of their total wealth.

But once a small business has become large then the nature of the risks the owner is exposed to changes. The current owners of Walmart would certainly lose a lot of money if the firm somehow when bust, but I doubt they'd find themselves needing a soup kitchen

[Jim]

@Luis Enrique: So basically as long as a small business is just bouncing along making a living but no more, the 'owner' gets to still be the owner because there's not much wealth there, but as soon as the business makes some decent profits, the 'owner' deserves to have it taken away and given to the employees?

I'll give you an example. A friend owns a small restaurant. She's run it for 25 years nonstop, and built it up from nothing. During those 25 years at various times she's made some decent money (turning over 750K at the peak) and has invested her profits in various properties. She is now by all accounts wealthy, though still working full time in the business. If her business were to close, the employees would undoubtedly be worse off than she. Does that mean she should have her business taken away from her?

[Luis Enrique]

Jim

your comment relates to nothing I have written

[Jim]

@Luis Enrique: How so? You state that the nature of business owner risk alters at they get bigger and more successful, the implication being that as the owner's risk of financial loss from the failure of the business reduces (having already made a pile so to speak) and the employees risk remains the same, at some point the employees have more risk than the owner, and therefore deserve to have ownership of some part of the business to compensate.

Or do you not agree with the basic premise of the OP which was that the employees of City Link should have had more say in the running (and indeed ownership) of the business because their relative risk from its demise was greater than that of the outside investors?