Should Employees Participate in Corporations? A Law and Economics Perspective.

Article 20 of China’s 2023 Company Law for the first time states that one of the corporate purposes is to protect the legitimate rights and interests of employees. If a corporation’s purpose extends to its employees, then its governance structure needs to be adjusted accordingly to empower employees to express their views. Employee participation, which includes both management participation and financial participation, is one possible mechanism for adjusting the governance structure. Management participation here refers to employee participation in corporate management. Financial participation refers to employees receiving benefits from the corporation’s performance, for example via stock ownership.

Theoretical foundation of employee participation

Parties in a corporation do not always share the same interests. Shareholders may want to maximise their investment returns, managers may focus on advancing their careers, and employees may care about job security and higher salaries, etc. Employee participation can reduce such conflicts of interest by reducing information asymmetry and aligning the interests between different parties. For example, as a form of management participation, employees can elect employee representatives on corporate boards. These representatives can provide information obtained from frontline employees to the decision-making process, thus reducing the information asymmetry between different parties. Representatives can also bring employees’ opinions straight to management. Moreover, as a form of financial participation, employees can acquire corporate stocks at favourable prices, thereby aligning their interests with corporate success.

Empirical evidence (quoted in my PhD thesis) shows that employee participation enhances employees’ sense of ownership, improves their satisfaction and work efficiency, and reduces employee turnover. In addition, employee participation can enhance firm valuation, productivity, and profitability. Yet, some scholars (also quoted in my PhD thesis) claim that the impact of employee participation on employees and on firm performance is not significant. One possible reason is that employee participation only pays off when corporations continually refine their practices. However, many corporations only implement employee participation superficially or fail to refine it over time, so it may not lead to positive outcomes.

One might ask: if employee participation brings benefits to both the corporation and its employees, why do we need regulations rather than relying on voluntary adoption by corporations to ensure its implementation? When corporations and their employees negotiate the specifics of employee participation, they will face many costs. The costs include seeking information about employee participation, negotiating the implementation terms of employee participation, and ensuring that both parties will follow the agreed-upon terms. However, accessing information about employee participation can be difficult, and employees are often at a disadvantage when negotiating with the corporation, making it difficult to reach terms that satisfy both parties. As a result, employee participation may not arise spontaneously and hence may require government intervention through regulations.

The practices of China and Germany

Employee participation in China and Germany is similar in some ways, but also quite different in others. Both countries have established regulatory frameworks for management participation. However, neither China nor Germany has specific laws governing the implementation of financial participation. Compared to China, Germany has a more deeply embedded system of employee participation at the board level, where employees have fixed seats on the supervisory board and decision-making power (co-determination). The board of directors in China has decision-making power, but there are no fixed seats provided for employee representatives. Compared to Germany, China is more inclined to promote the employee stock ownership plan (ESOP) as a form of financial participation. China began to promote the ESOP in the 1980s to advance the ownership reform of state-owned enterprises (SOEs). To this day, the ESOP remains an important instrument for facilitating such reforms.

These differences result from the different political, historical, and economic backgrounds of the two countries. Employee participation in management in China originates from the socialist democratic philosophy of the Communist Party of China (CPC), which emphasises the role of workers in corporate management, particularly in SOEs. Besides, financial participation is important in advancing the development of the socialist market economy with Chinese characteristics. In China, the CPC can achieve many political and economic objectives by promoting employee participation. This reflects the CPC as the core leadership of the country. The institutional logic of management participation in Germany did not originate from socialist democracy, but rather from Bismarck’s political compromise aimed at weakening socialist influence. Moreover, Germany implemented financial participation to promote the recovery and development of its economy after World War II. Overall, employee participation in Germany is a mechanism for achieving economic democracy in corporations and is less closely tied to political ideology.

Empirical literature on employee participation in China and Germany demonstrates its positive impact on both employees and firm performance. In my PhD thesis, I also conducted an empirical study myself, of 52 Chinese state-owned enterprises listed on the Shanghai and Shenzhen stock exchanges. The results showed that the implementation of ESOP can indeed enhance the total factor productivity of enterprises, thus providing new evidence to the existing empirical literature on the positive effects of employee participation.

Looking ahead

Regulatory intervention in employee participation is not only theoretically justified but also practically feasible and can produce positive results. Other countries can draw on the experiences of China and Germany and encourage employee participation through regulation, taking their own specific circumstances into account. Examples include requiring employee representatives on corporate boards and giving tax breaks for ESOPs.