Structure of the Democratic Firm

1. Structure of theDemocratic Firm David Ellerman University of California at Riverside www.ellerman.org

2. Must Workers Buy the Corporation? • When the supplier of one input to production is also the residual claimant (i.e., hires the other factors), then one must conceptually separate: • Role 1 of factor supplier, and • Role 2 of being the hiring party (residual claimant). • What is legal basis for corporation's management rights over workers: • Ownership of capital ("means of production"), or • Employment contract?

3. Answer: Employment Contract • Corporation plays both roles of capital-supplier and hiring party but it is only in hiring-party role, that corporation gets management rights over workers. • Without employment contract, corporation only has usual property-owner rights to exclude others from using one's property without consent. • That is, "ownership of means of production" only gives company right to make workers into trespassers, not employees (absent the employment contract).

4. Suppose Capital Rented Out • Keep Corporation A's ownership of capital (machines, buildings, and land) the same but suppose they are rented or leased out to another Corporation B which then supplies labor and other inputs and undertakes production. • Corporation A still has "ownership of means of production" (Role 1) but no management rights over labor using those means (machines, buildings, and land) and does not own the product that is produced. • This involves no change in ownership of the means of production, only a different set of contracts, a different hiring party.

5. Must Workers Buy Corporation A? No! • Corporation B could be a democratic firm where the legal members were the people working in it (and who previously worked in Corporation A). • What was owned in previous arrangement? • Corporation A was owned by its shareholders which is essentially the indirect ownership of the capital assets of Corporation A, e.g., machines, buildings, and land. • Corporation A's second role as hiring party (or residual claimant) was not "owned"; contracts can be made one way and then later made another way in a market, e.g., capital may hire labor and then labor may hire capital. • Workers do not need to "buy" the hiring party role; they need to turn around the contracts to make a democratic firm.

6. Fundamental Myth of "Capitalism" • The Fundamental Myth of the so-called "capitalist" system is that the management and product rights are all part of the first role, the ownership of the means of production. It's all part of the "ownership of the firm." • But no real (as opposed to imagined) "ownership" is violated by reversing the hiring contracts between the corporation A and the workers so that the management and product rights then go elsewhere (e.g., Corporation B).

7. Orthodox Econs & Marxists all buy the Myth • Even though the Fundamental Myth can be refuted by a few seconds of thought (reverse the hiring contracts), that argument is 'unavailable' to both conventional economists (not to mention legal theorists, business people, etc.) and Marxists. • The Fundamental Myth permeates economics and ordinary language where the ownership of a company (i.e., indirect ownership of capital assets) is absolutely routinely taken as "ownership of the firm" where "firm" = both of the two roles of capital owner and hiring party (residual claimant), the latter of which is not "owned".

8. Origins of Fundamental Myth • Complete agreement of Marx and orthodox economists in supporting Fundamental Myth. • Bad metaphor with medieval land ownership where landlord was Lord of land. • "It is not because he is a leader of industry that a man is a capitalist; on the contrary, he is a leader of industry because he is a capitalist. The leadership of industry is an attribute of capital, just as in feudal times the functions of general and judge were attributes of landed property." [Marx, Capital Vol. I]

9. Standard Semantic Games • Marx: Capital* = “Means of labor” + contractual role of residual claimant (e.g., using wage labor). • But then Capital* is not owned like Capital since extra contractual role (*) is not owned. • Thus Marx's name for the system, "Capitalism", is actually a misnomer based on a faulty understanding. • Orthodox economics plays same game by shifting between two meanings of "corporation": • Corporation as just ownership of capital assets in a corporate form which is owned, and • Corporation* = Corporation + Hiring party role, where the latter is a contractual role that is not owned. • Ditto for "owning a capital asset," "owning a factory," and "owning a firm."

10. Vector model of production • To see Fund. Myth in ordinary economics, let's look at a simple model of a productive opportunity. • Consider production function Q = f(K,L) • K = flow of capital services (flows of all non-human inputs) • L = flow of labor services (all human activities in the productive opportunity) • Assets and liabilities appropriated in production = (Q, –K, –L) = “whole product” or production vector • Given prices p, r, and w, the value of whole product = profit = pQ – rK – wL.

11. Fund. Myth in Capital Theory • Fund. Myth = Whole product part of capital ownership. • Hence value of (0,K,0) + (Q, –K, –L) = (Q,0, –L), namely “quasi-rent” pQ – wL in each period discounted back to be “value of capital asset” when in fact is the value of the asset plus the value of the contractual role of being the residual claimant which is not owned now or in the next n years. • “When a man buys an investment or capital-asset, he purchases the right to the series of prospective returns, which he expects to obtain from selling its output, after deducting the running expenses of obtaining that output, during the life of the asset.” [Keynes General Theory, 135]

12. Fund. Myth in Corporate Finance Theory • Standard semantic game in finance theory confusing: • Corporation as owned asset, and • Corporation* as owned asset plus unowned contractual role of undertaking production. • Corporate finance theory discounts returns to corporation* as if it was the value of the corporation. • “There, in valuing any specific machine we discount at the market rate of interest the stream of cash receipts generated by the machine; plus any scrap or terminal value of the machine; and minus the stream of cash outlays for direct labor, materials, repairs, and capital additions. The same approach, of course, can also be applied to the firm as a whole which may be thought of in this context as simply a large, composite machine.” [Miller and Modigliani Dividend Policy..., 415]

13. Fund. Myth in General Equilibrium Theory • Can pin-point property rights error in Arrow-Debreu model: ith consumer owns aij share in jth corporation but jth corporation does not “own” Yj production set. • Production sets or functions are not "owned" assets; they represent possible transformations of inputs into outputs. • Arbitrage possible in so-called “comp. eq.” with decreasing returns & positive profits since Yj not “owned.” • No competitive eq. with decreasing returns. • McKenzie was right (only constant returns) and Arrow & Debreu were wrong.

14. Summary So Far • Analysis so far is needed to see that "capital ownership" or "ownership of the means of production" is not the issue. • The key institution in mis-named "capitalism" is not private ownership of capital. • The key institution is the voluntary contract that allows the renting or hiring of workers, the employment contract. • Alternative to this "employment system" is a private property market economy with the renting of people abolished—where people must own or rent the things they use instead of the owners of things being able to rent people.

15. Abolish a Voluntary Contract? Yes, indeed! • From ancient times, the sophisticated defense of slavery was that it was based on implicit or explicit contracts—but today the self-sale contract is abolished. • From ancient times, the sophisticated defense of non-democratic govt was that it was based on an implicit or explicit contract to alienate the governance rights to a ruler—but today such a pactum subjectionis is considered invalid. A democratic constitution may only delegate, not alienate, governance rights. • From ancient times, the marriage contract extinguished any independent legal personality of the wife in favor of her being "covered" as a feme covert by the husband—but today such a coverture marriage contract is abolished.

16. History of Inalienable Rights Theory • The anti-slavery and democratic movements developed counter-arguments that such personal alienation contracts were inherently invalid and thus the rights they pretended to alienate were inalienable rights. • These arguments descend from the Reformation and Enlightenment. • Basic idea: personal alienation contracts puts a person into the legal role of a non-person (or person without adult capacity)—yet the person remains de facto a fully capacitated adult so contract is impossible. • When Law says "Obey your master" and it will count that as "fulfilling" the contract, then it is only a legalized fraud on an institutional scale.

17. Employment contract is a personal alienation contract • The employment contract is the personal alienation contract that survives in today's legal system. • It is a governance alienation contract in the workplace—the employer is not the delegate or representative of the employees. • It puts employees in the legal role of non-responsible instruments since the employees have: • no legal liability against them for the inputs they use up (i.e., the input liabilities K), and • no legal ownership of the outputs they produce (i.e., the output assets +Q).

18. Employment contract violates inalienable rights • Since "employees" remain fully capacitated de facto responsible persons, they cannot in fact fulfill a contract with alienates rights of governance and responsibility for positive (+Q) and negative (K) results of their actions. • Yet the legal systems says "Obey the employer" and that counts as "fulfilling" the contracts so then employer has the legal role of residual claimant to get whole product (Q,K,L) while the employees who rent themselves out get the rental payment for the labor commodity +L. • Moment of truth: Criminous employee is suddenly a partner with criminous working employer. Hitman's defense: "But I sold my labor!" Law then recognizes that responsible human action is non-transferable and inalienable. But that is always true.

19. Production in Employment Firm • Labor L (all who work in enterprise) de facto responsible for labor product (Q, –K,0) = (0,0,L) + (Q,–K,–L) = labor + whole product. • But under employment relation, employees only appropriate (0,0,L) as first seller. • Capital supplier with contractual role of residual claimant to net (Q,0,–L) = (0,K,0) + (Q,–K,–L).

20. Responsibility Principle Violation under Wage Labor Institutional fraud of pretending responsible human action can be bought and sold in employment contract thus allows the institutional robbery of precisely (Q,–K,–L).

21. A corporation for workplace democracy • A democratic company is not owned; • just as a democratic municipality or township is not owned. • A democratic company has members, not "owners" based on functional role of working in the firm; • just as a democratic municipality has voters based on functional role of residing in the municipality. • A democratic company can issue bonds (debt securities) but no equity shares; • just as a democratic municipality can issue municipal bonds but no equity shares.

22. Marxist/Socialist Confusions • Since Marxists and most socialists swallow the fundamental myth, they think the "solution" lies in public ownership rather than "private ownership of the means of production" (so workers are public employees). • Even Yugoslav self-management just tried to have "social ownership" rather than "state ownership"—and "social ownership" of capital assets meant workers could have no private claims on their own retained earnings.

23. Internal Capital Accounts in Democratic Firms • But rethinking the issue without the fundamental myth implies there is nothing wrong with worker-members of a democratic firm being debtors of the firm with their internal debt recorded in an internal capital account. • Workers' share of current net income and vote is entirely independent of amount in the internal capital account (which is interest-bearing like any other debt). • Mondragon industrial cooperatives developed such internal capital accounts in practice.

24. Property Rights and Personal Rights • Rights that one qualifies for by playing a certain functional role, e.g., residing within the city limits of a municipality, cannot be sold or bequeathed like property rights. • These role-attached rights are sometimes called personal rights since they attach to the person having the functional role. • A conventional corporation can be precisely compared to a democratic corporation by parsing the bundle of rights called "ownership" in the usual joint stock corporation.

25. Rights bundle in ordinary company • A. Voting rights: • A.1. Current voting rights • A.2. Future voting rights • B. Value rights: • B.1. Current net income rights, • B.2. Future net income rights, and • B.3. Net asset rights. Whole bundle is treated as alienable property rights attached to equity shares.

26. Rights bundle in democratic company • A. Voting rights: • A.1. Current voting rights = personal rights of current worker-members, • A.2. Future voting rights = personal rights of future worker-members. • B. Value rights: • B.1. Current net income rights = personal rights of current worker-members, • B.2. Future net income rights = personal rights of future worker-members, and • B.3. Net asset rights = property rights of current worker-members.

27. Normative case determines rights assignment • A. Voting rights: • A.1. Current voting rights = assigned by democratic principle to those who are governed = current worker-members, • A.2. Future voting rights = assigned by democratic principle to those governed in future = future worker-members. • B. Value rights: • B.1. Current net income rights = value of (Q,K), the fruits of labor of current worker-members so assigned by private property appropriation (responsibility) principle to current worker-members who produced it, • B.2. Future net income rights = value of (Q,K), the fruits of labor of future worker-members so assigned by private property appropriation (responsibility) principle to future worker-members who produced it, and • B.3. Net asset rights = property rights of current worker-members = value of fruits of past labor reinvested in company.

28. Summary • Democratic firm realizes the democratic principle of self-government in its assignment of voting rights to those who are governed, currently and in the future. • Democratic firm realizes the principle of private property appropriation (getting the fruits of one's labor) in the assignment of net income rights, currently and in the future. • Democratic firm with internal capital accounts recording net asset value does not force workers to sacrifice fruits of past labor reinvested in the firm.