Fri, Nov 26, 2004 - Page 9 News List

Modern economy blurring the line between capital and labor

The practise of augmenting standard wage packages with stock options can help boost employee morale, but it also creates an unhealthy concentration of risks

By Robert Shiller

The traditional hostility between labor unions and the world of finance should not obscure their common interest in using financial tools in an expansive and creative way. We live in an age of financial capitalism, and the only intelligent way forward -- for unions and other workers' associations -- is for these bodies to help their members make increasingly sophisticated use of the tools of risk management.

The traditional boundaries between labor and capital are becoming blurred. For example, companies increasingly augment standard wage packages with stock options, even for rank-and-file employees. In the US, the Labor Department reports that last year, 14 percent of US workers in firms with 100 or more employees were offered stock options. Expect more such packages in the future.

The problem is, most employees do not fully understand options or stocks and do not know how to evaluate them. A recent paper by Massachusetts Institute of Technology professors Nittai Bergman and Derk Jenter suggests that management tends to award employee options when employees are excessively optimistic about the outlook for company stock -- thereby in effect opportunistically substituting overpriced options for full pay.

Unions and workers associations are the natural vehicles to monitor such behavior, but they must invest in the expertise to do so effectively. They should not stand in the way of compensation that includes stock options, or that otherwise create financial risks for their employees. But they should make sure that such programs are administered in employees' interest, because companies that encourage their employees to hold options or to invest directly in the company's stock are asking them to take on some of the company's risks.

To be sure, sharing ownership can help employee morale. But it also creates an unhealthy concentration of risks: not only the employee's job, but also his assets now depend on the company's fate. The scandal at Enron, in its final days, was that management prevented employees from selling their Enron shares while executives unloaded their own shares.

Obviously, unions need to be alert to such bad behavior. More generally, they must examine employee ownership programs both sympathetically and analytically, in order to suggest ways to hedge the risks they create.

The same is true of other financial tools. Labor unions have long pointed with satisfaction at hard-won contracts that specified a defined-benefit pension for their members. But these unions were often without the financial sophistication to judge whether the firm set aside sufficient capital to meet its commitments decades later.

In the US, union failure to represent members' interests adequately contributed to a major pension default at the Studebaker Corporation in 1963. The AFL-CIO, the United Auto Workers and the United Steel Workers then petitioned Congress -- against strong opposition from business interests -- to establish the Pension Benefit Guaranty Corporation in 1974 to insure private pensions against companies' failure to honor them.

Gradually, many countries, with prodding from their trade unions, now have some form of benefit protection plan for private pensions. The latest example is the UK, where trade unions have spurred the creation of the Pension Protection Fund, which will begin operating next year.

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