Works Councils: An Agency Perspective *
Comites de empresa na Europa: uma analise desde o modelo de agencia
Works councils are an important component of the industrial relations in Germany and the European Commission has, recently, implemented mandatory laws to foster European Works Councils within multinational firms based in States Members (European Commission, 2002). Moreover, the fall in private sector unionism in the United States and United Kingdom have renewed the interest on workplace representation, where works councils are the most salient institutions (Weil, 2003). However, a series of corporate scandals involving works councils in Germany has generated some scepticism about the role of these institutions within organizations. (1) In spite of the relevance of works councils on the firm performance and workers' welfare, our understanding of the strategic behaviour of elected works councils is not complete.
This paper investigates the role of works councils in a simple agency framework in which works councils are supposed to monitor manager's information on behalf of the workforce. Managers may have an interest to make workers believe that the firm is facing low performance in order to extract additional effort which is ex-ante non contractible (Hart, 1983, 1995). In this situation works councils are supposed to provide workers with audited information about the real state of the firm (Freeman and Lazear, 1995). However, works councils are independent agents who might pursue their private interest. As economic theory recognizes different levels of a firm's hierarchy may use private information opportunistically, possibly through coalitions against other levels of the hierarchy (Tirole, 1986). Particularly, works councils and management (i.e. the most informed parties) may form coalitions to misreport the real situation of the firm. So, if collusion is an issue on workplace representation workers must find a way to incentivize their representatives in order to align works councils' interest with workforce's goals.
The initial framework of this paper considers that employees can incentivize works councils through contingent monetary payments. Workers can give monetary transfers to the works councils to deter potential collusive behaviour with other members of the firm (management). In states of nature where workers can be expropriated by potential coalitions, they should pay higher compensations to councillors (Tirole, 1986). Collusion makes contingent payments costly and reduces workers' payoff. It generates a negative effect on the workers' willingness to implement workplace representation in firms where deter collusion is very costly. In other words, works councils as a representative institution with valuable private information should be compensated with salaries that take into account their auditing tasks and which should not be necessary setting at the same level of wages for a regular worker.
The second part of the paper considers a more realistic view of works councils, in which explicit monetary incentives for works councils are often unfeasible. Then, elections are the only mechanisms that constituents have to influence councilors in which they re-elect their worker's representatives contingent on first period outcomes and councilor's reported information. Additionally, if works councils are heterogeneous in their preferences for management's monetary transfers the election process should take into account the likelihood to have non-congruent works councils within the potential candidates. Particularly, workers face representatives that may or may not have congruent interests with them, in the sense that a congruent councilor dislikes management's monetary transfers (i.e. bribes). When only congruent councilors are elected a fixed wage equal to the wage of the employees is enough to recommend the worker's preferred action. However, when there are non- congruent councilors they should receive a compensation that takes into account potential bribes from management.
When councilors are well compensated for their representative activities they would face an inter-temporal trade-off between accepting management's transfers at first period and losing rents at the second period. Elections as the only mechanism to discipline works councils increase costs of entering on collusive behaviour with management. When benefits of being in office are large enough representatives will try to behave in the employees' interest. The employees' capacity to deter collusion with an election mechanism hinges on two conditions: first, at least the benefits of being in office (salary) should be public information (transparency); second, monitoring tasks that have been delegated to works councils should not have big gap on effort, thus means works councils should not be involved in personnel reforms in which effort has large impact on firm performance. The last condition implies that under costly employment reforms employees' welfare would be higher with other mechanism that representative participation (i.e direct participation or referendum).
Finally, since councilors' compensation should increase with how much they weight management's transfers, we can compare monetary incentives with election mechanism. Since workers cannot set up councilor's compensation contingent on the state of nature, it reduces the workers' capacity to punish councilors with hidden information in some states of nature. This implies that the negative effect of non-congruent councilors under election on the workers willingness to implement works councils is larger than the same effect under contingent monetary transfers' case.
The paper proceeds as follows: Section two discusses the background of the problem and the related literature. Section three states the model and the benchmark of a firm without workplace representation. Section four studies the case where workers can give contingent monetary transfer and studies the effect of potential collusion on the implementation of works councils. Section five studies the case of elected work councils, in which workers can incentivize their representatives through elections. Section 6 discusses results in the context of European industrial relations. Section 7 concludes.
2 Background and Previous Literature
Several european countries have laws and institutions concerning with employees' involvement and participation at workplace. In addition, the European Commission has implemented mandatory laws to foster European Works Councils through multinational firms. These laws give information and codetermination rights about financial and personnel issues like employment decisions, new production process and investment projects that affect the workforce. Legislation across countries differs with respect to works councils' objectives and rights, but a common element is that those committees possess rights to be informed about the firm's financial situation, which is relevant to personnel policies at workplace. Works Council's objective, often specified in legislation, is to foster labour and management cooperation with the goal of increasing the performance of the firm and protecting the interest of the labour workforce. Summing up, councilors should monitor manager's financial information, communicate the gathered information, and recommend it if is the case, new personnel practices to workforce contingent on this information (Annex A.3 presents a comparative table about laws on workplace representation for a group of European countries).
In continental Europe, particularly in German where works councils have been viewed as essential part on the corporate governance and industrial relations, governments and firms consider that works councils should reduce conflicts related to employment policies between management and employees by improving communication and cooperation among parties. Although works councils are bounded to employees through elections, they are called to create peace and cooperation within organization (Roger and Streeck, 1995). However, recent scandals involving the German corporate culture have generated skepticism on the role of those institutions. Recently, works councils' leaders and personnel management in big German companies have been involved on allegations of bribes and corruption in the implementation of employment policies. The most well documented case with effects not only on the corporation but also on German politics has happened at the largest European carmaker Volkswagen, where the leader of works councils was found guilty of accepting management 'bribes' to support certain aspects of corporate employment policies.
In spite of the fact that works councils play a relevant role on corporate governance and the European Commission has encouraged state members to implement European Works Councils, our understanding of the strategic behaviour of representatives is not complete. In this paper, we offer a new perspective in which employees' representatives are independent and informed agents who might pursue their private goals and are constrained by their concerns to be re-elected. The paper tries to answer important questions concerning industrial and labour relations: What are the consequences of workplace representation on the welfare of the workforce?
Both theory and empirical literature assume that works councils behave in the workers' interest. However, works councils have valuable information that they might use in their own goals. Then, given the widespread use of worker representatives and the recent directives of the European Community it is relevant to have a better understanding of the incentives of these agents within organizations. Works councils may be tempted to form coalitions with management and audit unpopular employment policies against employees' interest, as recent scandals in Volkswagen Corporation have shown. The potential coalitions between...