Ownership structure, value of the firm, and the bargaining power of the manager.

• Author: Mercuro, Nicholas

1. Introduction

   In their seminal article, Michael Jensen and William Meckling developed a theory of the corporate ownership structure that took into account "the trade-offs available to the entrepreneur-manager between inside and outside equity and debt" |5, 312~. Jensen and Meckling concentrated on the principal-agent problem and the agency costs that arise from the introduction of outside equity into the firm. This was done without any consideration of what effects such an action might have had on the bargaining power of the owner-manager in negotiating wages with the current employees of the firm.

   Several years later Masahiko Aoki |1; 2, 61-91~ introduced a model of the firm that emphasized "its aspect as a quasi-permanent organization of stockholders and employees" |1, 600~. He asserted that as a result of their association with the firm, the employees acquire skills and knowledge that, when combined with the physical assets supplied by the stockholders, can produce some economic gains--the so-called organizational rent. Such rents would not be possible through the employment of external factors of production (such as workers that have no knowledge of the workings of the firm). The organizational rent can be produced only through the cooperation of the stockholders (supplying the physical assets) and the existing employees. As such, the situation is tantamount to a two-person cooperative game, and the question becomes, how then is the organizational rent to be distributed between stockholders and employees. Aoki proposed that the solution to this particular distribution problem could be accomplished by use of a bargaining process attributed to Frederik Zeuthen and John Harsanyi that leads to the Nash bargaining solution.

   Implicit in Aoki's analysis was that all equity was outside equity. Therefore, no attention was given to how alternative ownership structures of the firm affect (1) the bargaining power of the manager and (2) the distribution of the organizational rent. One could start out with an owner-managed firm and examine the distribution of the organizational rent under such an ownership structure. It would then be important to understand how the introduction of outside equity into the firm a la Jensen and Meckling, would affect, if at all, the distribution of the organizational rent.

   This paper demonstrates that the introduction of outside equity into a heretofore owner-managed firm increases the bargaining power of a risk averse owner-manager. As a result, the employees' share in the organizational rent will decrease, which will in turn lead to an increase in the value of the firm.

   Section II of this paper introduces a simple model of the firm that makes possible the explicit derivation of the organizational rent from the existing market conditions. In addition, section II sets the stage for the bargaining process that determines the distribution of the organizational rent between stockholders and skilled workers. This process takes the form of negotiations for the determination of a wage rate for skilled workers (and, therefore, the capitalized value of the firm).

   A solution to the bargaining problem is derived in section III. Thereafter in section IV, we conclude with an examination of the introduction of outside equity, its effects on the manager's bargaining power and, through that, its effects on the equilibrium of the bargaining process and the value of the firm.

   An appendix, available directly from the authors, contains an explicit derivation of the bargaining power of management and skilled workers and the more technical derivations and mathematical proofs.

2. The Model

   We consider a firm that at period t faces a set of outstanding orders for its product, quantity |q.sub.t~. The orders that are filled must be filled at the unit price |p.sub.t~, announced at the end of last period. The manager must decide on what quantity q to produce (q |is less than or equal to~ |q.sub.t~) at the given price. For purposes of simplicity, we assume away the possibility of negative inventories (i.e., backlogging) or positive inventories, so that unfilled orders represent lost sales.(1)

   To introduce the concept of what Aoki |1~ refers to as organizational rent, we make three assumptions.

   ASSUMPTION 1. Workers, through their association with the firm for at least one period, acquire skills and knowledge that are firm-specific. These workers are referred to as skilled workers.

   ASSUMPTION 2. At period t the firm can retain either all or none of the |N.sub.t-l~ skilled workers.

   ASSUMPTION 3. Given |p.sub.t~ and |q.sub.t~, if skilled workers are paid the same wage rate as unskilled workers, |w.sub.0~, the firm's choice to retain all of its |N.sub.t-1~ skilled workers is both (a) feasible (i.e., with the possible addition of unskilled workers will enable the firm to fill its outstanding orders) and (b) uniquely optimal.

   With the above assumptions we can now describe how the organizational rent arises. First, assume that the firm chooses to retain all of its skilled workers and those workers accept the same wage as unskilled workers, |w.sub.0~. The profits under this optimal policy (Assumption 3) are:

   |Mathematical Expression Omitted~

   where |C.sup.*~(|q.sub.t~;|w.sub.0~) denotes the cost function under this assumption. If the firm chooses the alternative and employs only unskilled workers, its profits will be maximized at some output |q.sub.t~(|q.sub.t~ |is less than or equal to~ |q.sub.t~) and they will be equal to

   |Mathematical Expression Omitted~

   where |C.sup.0~(|q.sub.t~;|w.sub.0~) denotes the cost function when only unskilled workers are employed. Then,

   |Mathematical Expression Omitted~

   represents the organizational rent that would result from the cooperation of the skilled workers with the firm in period t. By Assumption 3, ||pi~.sub.t~ |is greater than~ 0.

   Clearly, the potential for organizational rent offers benefits to both, the owners of the firm (higher profits and consequently an increase in the firm's capitalized value) and to skilled workers (higher wage income). But this rent is only earned if management and skilled workers cooperate by agreeing on how it will be distributed. It is on this distribution problem that we turn our attention now.

   Given a discount rate r, let |V.sup.0~ denote the capitalized value of the firm if only unskilled workers are used and hence no...