No End in Sight For The History of Corporate Law: The Case of Employee Participation in Corporate Governance

Journal of Corporate Law Studies
ISSN: 1473-5970 (Print) 1757-8426 (Online) Journal homepage: http://www.tandfonline.com/loi/rcls20
No End in Sight for the History of Corporate Law:

The Case of Employee Participation in Corporate
Governance
David Kershaw
To cite this article: David Kershaw (2002) No End in Sight for the History of Corporate Law: The
Case of Employee Participation in Corporate Governance, Journal of Corporate Law Studies, 2:1,
34-81
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34 Journal of Corporate Law Studies  
NO END IN SIGHT FOR THE HISTORY OF CORPORATE LAW:

THE CASE OF EMPLOYEE PARTICIPATION IN CORPORATE
GOVERNANCE
DAVID KERSHAW*
This article contests the claim made by Professors Hansmann and Kraakman that the end of
history in corporate law has been reached and that this evolutionary last stop has no place for
employees in corporate governance. The article analyses the theoretical foundations of this
claim, namely Professor Williamson’s transaction cost account of board control and
Professor Hansmann’s governance cost account of when worker ownership works and fails.
It argues that while both costs place constraints on the form of efficient economic organiza-
tion, neither cost can explain the absence of hybrid institutions, both real and imaginary, that
would be both transaction and governance cost efficient and allow for employee participation
in corporate governance. Accordingly, this article submits that if the end of history for corpo-
rate law has arrived, its identification is fortuitous, as the claim lacks theoretical support.
A. I NTRODUCTION
Economic booms can be depressing times for those interested in alternative forms
of corporate governance and organization. During the economic good times it is
counterintuitive to modify what seems to be working. As part of the infrastructure
of economic growth, corporate governance regimes that exist in the “leading econ-
omy” of the times are lauded as the efficient facilitators of economic success. As
Germany and Japan rose in the 1980s what was different about them was attrac-
tive to scholars who saw in exotic governance regimes solutions to US problems.
In the 1990s as America excelled, the interest in foreign exotica disappeared. The
very governance regimes that were previously perceived as the cause of success
were now presented as the source of inflexibility and failure.
One available interpretation of recent economic developments is that scholars
who have long maintained that, over the long run, the market generates efficient
solutions to corporate governance problems have been vindicated. Proponents of
this position offer an analogy with biological natural selection. The market over
* Associate, Shearman & Sterling, New York. SJD 2000, Harvard University; LLM 1992, Harvard
University; LLB 1990, University of Warwick (davidkershaw@post.harvard.edu). I would like to
thank David Kennedy, Duncan Kennedy, Bo Rutledge, Bill Bratton, Joe McCahery and Harald
Halbhuber for their encouragement and comments on earlier drafts of this Article. Special thanks
go to Marlies Braun for her comments, support and inspiration.
  Journal of Corporate Law Studies 35
time evolves to produce the most cost effective solution to the problems of eco-
nomic organization. Those rules, structures and institutions which are not as cost
effective, as efficient, as their peers will die out as the firms that employ them either
fail, defeated by their competitors, or dispose of them when they become aware
that if they do not then failure is inevitable. This is a longstanding and familiar
claim dating back to Milton Friedman and Armen Alchian.1 A claim that was
forcefully revived by Easterbrook and Fischel2 in the early 1990s. Easterbrook and
Fischel argued, for example, that “the more sophisticated and rapid the process of
natural selection the more informative the survival of a practice or institution.”3
That is, a deregulated market environment is likely to generate the most cost effec-
tive corporate governance arrangements. Accordingly, as the market is given freer
reign in the United States than in any other advanced economy, the governance
regimes one finds in the United States are, from an efficiency perspective, as good
as it is likely to get.
The recent success of the US economy and the accompanying hyperbole about
productivity, growth and a “new paradigm” have injected renewed confidence
into this evolution to efficiency claim,4 resulting, almost inevitably, in the proposi-
tion that we have reached a moment in the economic history of advanced
economies that is, or will come to be recognized as, the end of history for corpo-
rate law. A moment in which we should rejoice in the rejection of alternative cor-
porate governance regimes and recognize that governance regimes that deviate
from the US standard model5 are not efficient and liable to hold back corporations
and economies. In a recent article entitled The End of History for Corporate Law,
Professors Hansmann and Kraakman opine that:
“The standard model earned its position as the dominant model of the large corporation
by out-competing during the post World War II period the three alternative models of
1 For a more detailed account of the process see M Friedman, “The Methodology of Positive
Economics” in Essays in Positive Economics (Chicago, Chicago University Press, 1953); AA Alchian,
“Uncertainty, Evolution and Economic Theory” (1950) 58 Journal of Political Economy 211; RR Nelson
and SG Winter, An Evolutionary Theory Of Economic Change (Cambridge, Harvard University Press,
1982).
2 FH Easterbrook and DR Fischel, The Economic Structure Of Corporate Law (Cambridge, Harvard
University Press, 1991).
3 Ibid. at 356.
4 For a discussion of the “evolution to efficiency” claim see MJ Roe, “Chaos and Evolution in Law and
Economics” (1996) 109 Harvard Law Review 641.
5
H Hansmann and R Kraakman, “The End of History for Corporate Law” (2001) 89 Georgetown Law
Journal 439 at 443: “The principal elements of this emerging consensus are that ultimate control over
the corporation should rest with the shareholder class; the managers of the corporation should be
charged with the obligation to manage the corporation in the interests of the shareholders; other cor-
porate constituencies such as creditors, employees, suppliers and customers, should have their inter-
ests protected by contractual and regulatory means rather than through participation in corporate
governance; non controlling shareholders should receive strong protection from exploitation at the
hands of controlling shareholders and the market value of the publicly traded corporation’s shares is
the principal measure of its shareholder’s interest.”
36 No End in Sight for the History of Corporate Law  .   
corporate governance: the managerialist model, the labour orientated model and the
state orientated model.”6
They predict that “as equity markets evolve in Europe and throughout the devel-
oped world, the ideological and competitive attractions of the standard model will
become indisputable.”7
A central aspect of this corporate epiphany is that it is not efficient to involve
labour in a firm’s strategic decision making. Hansmann and Kraakman argue
that:
“The growing view today is that meaningful direct worker voting participation in cor-
porate affairs tends to produce inefficient decisions, paralysis or weak boards, and that
these costs are likely to exceed any potential benefits that worker participation might
bring.”8
Labour should not have a role in corporate governance rather it should sepa-
rately negotiate with the firm to contractually determine its rights, roles and enti-
tlements.9 The evolutionary or end of history intuition is that as the vast majority
of US corporations do not allow labour to play a strategic role in corporate
governance, such a role is inefficient. Complementing and supporting this intu-
ition is a body of legal economic theory that provides a sophisticated account of
why in efficiency terms labour strategic participation or worker ownership does
not work. Accordingly, in the contemporary scholarly environment, an argument
made in favour of employee strategic participation is necessarily operating outside
of the efficiency paradigm. As the lessons of history and efficiency analysis excludes
labour from the corporate board or corporate ownership, such an argument must
elevate another value or concern above that of efficiency.10 The maker of such an
argument is understood to be willing to sacrifice the size of the economic pie at the
alter of an alternative value system, for example a conception of social justice or
democracy. Scholars who promote alternative institutional arrangements do not,
according to this stifling consensus, take efficiency seriously.
This article is motivated by an opposition to this consensus. It accepts that cor-
porate law and economics’ only concern when considering and fashioning govern-
ance regimes should be efficiency, understood as looking for rules and structures
6
Ibid. at 468.
7
Ibid. at 468.
8
Ibid. at 446.
9
Ibid. at 442: “The most efficacious legal mechanism for protecting the interests of non shareholder
constituencies – or at least all constituencies other than creditors – lie outside of corporate law. For
workers this includes the law of labor contracting, pension law, health and safety law and anti-dis-
crimination law.”
10 Indeed, corporate legal arguments in favor of employee participation regularly engage efficiency yet
defer to other values, for example, a conception of social justice or the intrinsic benefits of democ-
ratic participation. See, for example, K Greenfield, “The Place of Workers in Corporate Law”
(1998) 39 Boston College Law Review 283; KE Klare, “Workplace Democracy and Market
Reconstruction: An Agenda for Legal Reform” (1988) 38 Catholic University Law Review 1.
that maximize shareholder value by minimizing the costs of organizing economic

activity through the corporate form, in particular by minimizing the costs of
raising capital, the costs of decision making and the costs associated with the sep-
aration of ownership and control. However, it is this article’s underlying premise
that organizational efficiency is much more flexible than currently believed and
that the pursuit of shareholder value can accommodate considerable institutional
variation, even an employee role in strategic participation.11
This article challenges the claim that the US model of corporate governance is
the victor at the end of the corporate form’s historical passage. It does so by tak-
ing issue with the established theoretical foundation of corporate law and eco-
nomics’ claim that employee strategic participation in and/or ownership of the
firm is in most instances inefficient. This theoretical foundation is found in the
seminal work of Oliver Williamson and Henry Hansmann who provide in large
part complementary accounts of the comparative costs of investor and employee
ownership and governance. In a nutshell, Williamson’s transaction cost account of
board control argues that if a firm relies on equity capital from outside investors to
fund its activities then the cost of that capital will be prohibitively expensive unless
the investors, and only the investors, receive the right to appoint board members
who will protect their interests.12 According to Williamson, in a competitive mar-
ket place the logic of the capital markets will pressurize worker owned firms to sell
the right to control their firm. Failure to do so will lead to considerable competi-
tive disadvantage. In contrast, Henry Hansmann argues that worker ownership
and employee strategic participation are likely to result in failure because of the
associated increase in governance costs, that is costs incurred in the decision
making process. As worker’s interests are more heterogeneous than say investor’s
interests, companies owned by their workers or in which workers participate in
decision making will incur higher governance costs.13
Through a close reading of Williamson’s and Hansmann’s claims, this article
will demonstrate that the end of history claim is premature. The transaction costs
involved in raising capital or the governance costs incurred when owners have
heterogeneous interests do not alone explain the limited success of worker owner-
ship or the scarcity of employee board representation. Transaction cost and
governance cost analysis are useful and informative tools that teach us about the
11
The flip side of this is that if efficiency alone cannot account for contemporary institutional arrange-
ments then other explanatory variables must necessarily be taken into account in determining the
path of corporate legal history.
12
See OE Williamson, The Economic Institutions of Capitalism (New York, Free Press, 1985) (hereinafter
Williamson, Economic Institutions); OE Williamson, The Mechanisms of Governance (Oxford University
Press, 1996) (hereinafter Williamson, Governance); O Williamson, “Corporate Governance” (1984)
93 Yale Law Journal 1197 (1984) (hereinafter Williamson, Corporate Governance).
13
See H Hansmann, “When Does Worker Ownership Work? ESOPs, Law Firms, Codetermination
and Economic Democracy” (1990) 99 Yale Law Journal 1749 (hereinafter Hansmann, Worker
Ownership); H Hansmann, The Ownership Of Enterprise (Cambridge, Harvard University Press, 1996)
(hereinafter Hansmann, Ownership).
cost constraints imposed upon the nature of corporate law and organizational
form. However, these costs have not led us to an efficient end point, rather they
place boundaries on institutional experimentation. Within these boundaries we
have hardly begun to play.
B. O LIVER W ILLIAMSON : A TRANSACTION COST ACCOUNT

OF THE EVOLUTION OF THE BOARD
Section B looks at Professor Williamson’s transaction cost explanation of why an

investor-controlled board is the logical, endogenous product of a competitive mar-
ket place in which the firms that effectively economize on transaction costs prevail
and survive. It begins with an introduction to the analytical framework and vocab-
ulary of Williamson’s transaction cost economics and then offers a two pronged
critique of its logic. First, transaction cost economics’ analytical framework
requires that investments in the firm by different constituencies must be catego-
rized as more or less firm-specific. However, in Williamson’s transaction cost
account of the board, his conclusions are propelled by a contestable designation of
the firm specificity of labour and equity investments. Second, the transaction cost
logic that an investor elected board is necessary to protect exposed equity invest-
ments veils a serious consideration of the nature of the actual safeguards which the
board provides to equity investors.
1. Transaction costs
Transacting in the market place is not costless. At every stage of a transaction costs
may be incurred. Such costs may distort the nature and structure of the transac-
tion or prevent its completion, for example, if it is too costly to define and enforce
property rights or if one party cannot guarantee the other’s performance, the par-
ties may not enter into the transaction. A variety of mechanisms are available for
reducing these costs including, among others, law and its enforcement, forms of
economic cooperation, including the firm, and cultural and behavioural norms.14
Transaction cost economics maintains that the familiar US corporate institu-
tions are the evolutionary product of the market’s selection of the institutions which
have minimized transaction costs. It provides an analytical framework to identify
the role played by transaction costs in organizational evolution. Central to this
framework is its claim to bring a more nuanced account of human nature to eco-
nomic analysis. It rejects the understanding offered by neo-classical economics that
economic actors are rational utility maximizers. According to transaction cost eco-
nomics, economic actors act through bounded rationality and are prone to behave
14
See generally DC North, Institutions, Institutional Change and Economic Performance (Cambridge
University Press, 1990) regarding the economic benefits of reducing transaction costs.
opportunistically. Bounded rationality assumes that whilst economic actors are

rational there are limits to a person’s cognitive capacity to consider in advance the
possibility and uncertainty of life and to address such uncertainty through complex
contracts. Opportunism assumes that, given the opportunity, people often mislead
and cheat on their contractual partners for their personal benefit.
The other central concept of transaction cost economics is asset/firm-
specificity: the costs associated with opportunism and bounded rationality are par-
ticularly acute in relation to a transaction that involves one party making an asset
or firm-specific investment whose value is dependent upon the continuation of the
contractual relationship or the continued existence of the firm. The potential ex-
post threat of a contracting party to stop making or buying a product, or of an
employer to end an employment relationship may lead an investor to refrain ex-
ante from making an investment because she knows the investment could be
expropriated. In inadequate simplicity,15 this leads to a version of the following
scenario: if a party (A) is asked to make a firm-specific investment whose value will
be substantially diminished if the relationship breaks down, and if A does not trust
the other party or know whether or not he will act opportunistically then, if it is
not possible to write an adequately complex contract, A will not enter into the
transaction unless he receives a protective price premium or unless the other party
offers a safeguard in the form of a hostage or credible commitment of some sort that
removes or diminishes the possibility of opportunism and thereby reduces the risk.
2. The logic of investor ownership: the efficient distribution of board

control
Employees’ participation in their firm’s strategic decisions is unusual; worker
ownership of enterprise quite rare.16 The limited employee role in firm govern-
ance has been explained in terms of, among others, capital’s power against
labour’s weakness,17 labour’s risk aversion to excessive firm-specific exposure,18
15
See further Williamson, Governance; Williamson, Economic Institutions; OE Williamson, Markets and
Hierarchies: Analysis and Antitrust Implications (New York, Free Press, 1975); OE Williamson and SG
Winter (ed.), The Nature Of The Firm: Origins, Evolution and Development (Oxford University Press, 1993).
16
See generally JP Bonin and L Putterman, Economics of Cooperation and the Labor Managed Economy (New
York, Harwood, 1987). Note that whilst employee stock ownership plans have led to considerable
employee ownership of residual income rights in the firms in which employees work, in the vast
majority of instances this has not led to empowering workers by providing them with a role, or rep-
resentative role, in strategic decision making. See further, D Kershaw, Constrained Evolution: A Critique
of the Efficiency of Survival in Law and Economics (SJD Thesis, Harvard University, 2000).
17
S Marglin, “What Bosses Do? The Origins and Functions of Hierarchy in Capitalist Production”
(1974) 6 Review of Radical Political Economics 33.
18
L Putterman, “Ownership and The Nature of the Firm”, in The Economic Nature of the Firm,
L Putterman and RS Krozner (eds) (Cambridge University Press, 1996) 361 at 369 noting that,
“control by production workers is relatively rare, presumably due to workers limited wealth and the
high cost of them not diversifying it.” See also, A Hyde, “In Defense of Employee Ownership”
(1992) 67 Chicago-Kent Law Review 159.
worker wealth constraints,19 and, more recently, the costs of decision making
when there are employee representatives on the board of directors.20 Williamson,
however, accounts for this phenomenon in terms of transaction cost efficiency.21
A number of constituencies who contract with the firm make or have the poten-
tial to make firm-specific investments, these include employees, managers, equity
investors and suppliers. Governance structures are devised to incentivize invest-
ments by providing those constituencies with safeguards against the opportunistic
expropriation of their firm-specific investments. To explain the need for and the
costs of failing to adapt appropriate governance structures, Williamson offers his
Node analysis (see figure 1).22 A party at Node A is not required to make an
asset/firm-specific investment and market contracting suffices. A party who is
asked to make a firm-specific investment but who receives no safeguard is at Node
B. As this investment is exposed to opportunistic expropriation, the party at Node
B will only make this investment if she receives a risk premium (p-). A party at
Node C is required to make an asset/firm-specific investment and has received a
safeguard to protect that investment, accordingly she demands no risk premium.23
A(p)
B(p–)
k=0
s=0
p– > pˆ
k>0
s>0 C(pˆ)
Fig. 1: Williamson’s Node Analysis
Through devising and employing safeguards the costs of contracting are econ-
omized. However, note that rather than provide a safeguard, it may be efficient to
19 See S Bowles and H Gintis, “The Revenge of Homo Economicus: Contested Exchange and the
Revival of Political Economy” (1993) 7(1) Journal of Economic Perspectives 83 at 93.
20 See infra Section C.
21 See Williamson, Economic Institutions at 298–325. Parts of this chapter were first published in
Williamson, Corporate Governance, supra at n. 12. See also, Williamson, Governance at 171–194;
219–249; 307–319.
22 Williamson, Economic Institutions at 32–35.
23 This diagram is taken from Williamson, Economic Institutions at 33. Where K is the level of asset-speci-
ficity, S is the level of safeguard, P is the price without asset-specificity, P- is the price when there is
asset-specificity but no safeguard and P^ is the price when an asset-specific investment is made with
a safeguard.
pay a risk premium to one party and allocate a safeguard to another if the avail-
able safeguards are limited. Furthermore, there is no determinate relationship
between a particular safeguard and a particular firm-specific investment or
investor. Nor does the extent of firm-specificity determine who gets which safe-
guard. The answer to the question which safeguard should be used in relation to
which constituency depends upon what is the efficient allocation of the available
safeguards. If constituency A can only be incentivized to make the investment
through safeguard Y but constituency B could be incentivized through Y or Z,
then constituency A will receive the Y safeguard. However, assuming that the
value of each party’s investment is identical, if only safeguard Y can effectively
safeguard either A or B, the safeguard will be awarded to the constituency
that would demand the highest risk premium for making the unsafeguarded
investment.
In corporate governance there are various examples of safeguards for employee
or investor firm-specific investments, including golden parachutes, poison pills and
control over the board of directors. The central problem in the context of
employee and investor relationships to the firm is who should have the right to
control and appoint the board. Williamson argues that, as labour’s investments are
either not firm-specific or can be incentivized through safeguards that do not pro-
vide board participation or control rights, employees are situated at either Node
A or at Node C without board representation. In contrast, the firm’s relationship
to equity investors is difficult to perfect. Shareholders purchase a claim on the
firm’s future positive net cash flows and are concerned that the firm act to maxi-
mize those cash flows. However, it is neither possible nor desirable to contractu-
ally specify what the firm should do in the future. Furthermore, equity investors
have no direct claim to the firm’s assets and they stand at the back of the liquida-
tion queue. Therefore, the right to appoint and control the board of directors
offers a safeguard that can protect shareholder interests when the firm meets the
future, without restricting management’s hand. There is no other safeguard which
would incentivize equity investment while reducing the risk premium (the cost of
the firm’s capital). Without equity investor control of the board, for example, if
non-voting shares are issued, the firm’s cost of equity capital would be much
higher. Accordingly, investor voting and control rights “evolves as a way by which
to reduce the cost of capital for projects that involve limited redeployability.”24
This section aims to blur this evolutionary logic. It does so in three steps. First,
it asks whether labour’s investment is ever non firm-specific. Second, the claim
that labour can be adequately safeguarded without voting board representation
begs an account of the adequacy of these alternative safeguards. This section
argues that the safeguards which Williamson identifies are hardly safeguards at all.
Third, Williamson asks the reader to join with him in an intellectual leap of faith:
24 Williamson, Governance at 185.

from the observation that the board may act as a safeguard for equity investors to
the claim that the board must be awarded only to equity. This leap vaults the ques-
tion what is it about the operation of the board that provides equity investors with
a safeguard? The answer to this question does not, as a matter of “logic,”25 lead to
a board appointed and controlled only by equity investors.
2.1. The firm specificity of human capital

Williamson argues that labour may be situated at either Node A (non firm-specific)
or Node B (firm-specific). He does not define or offer examples of Node A employ-
ees, referring merely to workers with “general purpose skills and knowledge;” that
is, workers possessing basic skills for tasks that do not relate specifically to the
nature of the firm’s activities and competencies. He notes that such workers “can
quit and be replaced without productive loss to either worker or firm.”26 However,
in the workplace, although there may be many Node A workers it seems unlikely
that any of the jobs which they do are necessarily situated at Node A. Most jobs
requiring general purpose skills provide scope for productivity enhancing, firm-
specific investment from the employee. A profit motivated firm would want to
encourage such firm-specific investment by providing either the appropriate safe-
guards or a risk premium.
In defence of this Node A designation, Williamson submits that “workers
located at Node A have the least concern over expropriation.”27 Presumably, as
they are not concerned they would not demand a risk premium. However, relying
upon “concern over expropriation” to determine Node designation is flawed.
First, concern over expropriation is a function of perception.28 A “general purpose
skills and knowledge” worker in an environment of high unemployment and with
experience of prior expropriation may be most concerned about expropriation.
Second, whatever the level of firm-specificity, within the transaction cost frame, that
investment must be paid for or safeguarded. Of course, the extent of the invest-
ment and the perception of its specificity will determine the amount of risk pre-
mium and may, therefore, affect the allocation of the available safeguards.
However, the fact that an employee’s premium is lower than another’s does not
render the firm-specific investment non firm-specific. Accordingly, while the
25
Williamson, Economic Institutions at 323–324.
26
Williamson acknowledges that this is an “oversimplification” as he assumes that the employee can
find further employment and that there are no transition costs. Williamson, Economic Institutions at
302 n. 22.
27
Williamson, Corporate Governance supra at n. 12 at 1207.
28
On transaction costs and perception see M Chapman and PJ Buckley, “Markets, Transaction Costs,
Economists and Social Anthropologists” in JG Carrier (eds), The Meanings of Markets: The Free Market
In Western Culture (Oxford, Berg, 1997) at 225–250. They conclude that transaction costs do not exist
of themselves rather they are the product of “local perceptions, local structures of knowledge, spe-
cific understandings, native definitions of reality” (at 246).
extent of worker firm-specific investment will vary, all employees are at Node B
without a safeguard and at Node C if safeguarded.
To place a large section of employees in the Node A box is rhetorically loaded.
There are three coded messages. First, as a matter of transaction cost logic, if the
board is a safeguard and Node A workers do not require a safeguard, then they
require no relationship to the board. Many workers are thereby easily excluded
from the board representation race. Second, it functions subtly to support the posi-
tion outlined below that Node B employees should not be safeguarded through the
board. If many workers cannot have board representation then it would not be
practical to grant any workers board representation. How would we decide which
workers could be represented? Wouldn’t this be extremely divisive? Third, this
separation of Node A and B workers also functions to present equity as the fitting
suitor to the board as, without a safeguard, it is always and entirely at Node B.29
Some employees, Williamson acknowledges, will be at Node B and, unless
governance safeguards are crafted, they will not make efficient investments without
higher compensation (a risk premium). From a contractarian perspective, these
safeguards will be crafted through contractual trial and error, whereby employers
have an incentive to offer compensation and contractual terms and safeguards that
in part respond to employees’ interests in order to attract employees and cost effec-
tively incentivize employee productivity. Williamson notes that “efficiency pur-
poses will be served by crafting specialized bilateral governance structures that are
responsive to the needs of the firm at the contracting nexus.”30 However, central to
the transaction cost analysis of corporate governance is the notion that there may
be a limited number of appropriate safeguards for a particular type of investment.
If there is no effective safeguard or if the effective safeguard is efficiently allocated
to another investor, then contracting may efficiently employ no safeguards.
Accordingly, if workers are situated at a safeguarded Node C then the nature of
these safeguards must be specified. Williamson does so briefly in the law review ver-
sion of his theory of board control. As employee safeguards he identifies “grievance
machinery and associated job structures—ports of entry, promotion ladders bump-
ing and so forth.” 31 He also suggests that, although rarely seen in practice, a non-
voting board observer appointed by Node B workers could act as a safeguard.32
However, it is unclear that any of these “existing” safeguards are in fact safeguards
against opportunistic expropriation of employees’ firm-specific investments.33
29
See further text to nn. 41–68.
30
Williamson, Economic Institutions at 303.
31
Williamson, Corporate Governance supra at n. 12 at 1208.
32
Williamson, Governance at 314 referring to the possibility of “observer status . . . to permit their spe-
cialized advice and/or to satisfy their informational needs.”
33
See further, MM Blair, “Firm Specific Human Capital and Theories of the Firm” in MM Blair and
MJ Roe (eds), Employees and Corporate Governance (Washington, D.C., Brookings Institute, 1999), dis-
cussing labor economists’ analysis of human capital and noting that “In general, the lesson from
labor theory has been that employee investments in firm-specific human capital cannot be well pro-
tected by explicit and complete contracts” (at 63).
Absent collective bargaining agreements,34 grievance structures, promotion lad-

ders etc. may be unilaterally terminated or altered, legitimate expectations denied.
With or without collective bargaining agreements, the firm may act opportunisti-
cally towards an employee to encourage him to leave without the firm incurring
severance pay or pension obligations.35 Indeed, Williamson’s own analysis makes
this point. He argues that golden parachutes that allow managers to trigger large
severance payments if the firm is taken over, are necessary because new manage-
ment could act in ways which changed the conditions of employment or force the
manager to leave “of his own accord” without severance pay, thereby expropriat-
ing a manager’s investment. For example, they could “give demeaning assign-
ments to incumbent management.” As noted above, the employee safeguards he
mentions seem prone to similar opportunistic behaviour. However, employees, in
contrast to senior management, rarely benefit from golden parachutes. Observer
board presence suffers from similar flaws: worker observer status on the board
facilitates bargaining, flexibility and trust but offers no real safeguard against the
opportunistic exploitation of this trust. An information gathering observer may
ensure that the employees receive their Node B value, but it does not safeguard
their investment from opportunistic management, new or old. The observer board
presence may facilitate a Node B investment, but it is not a governance structure
that lowers the risk premium and moves an investor towards Node C.
Williamson does not provide an adequate account of the efficient safeguarding
of employee firm-specific investments. The safeguards he identifies are not real.
The question that beckons is would employee board representation qualify as a
transaction cost safeguard for labour firm-specific investment. Williamson fails to
address this. He argues that to provide a constituency located at Node C with
board representation would be to provide two bites at the corporate apple.36
34
Note that “the percentage of private sector employees in unionized workplaces has declined from
nearly 37% in 1953 to less than 12% today.” M Barenberg, “Democracy and Domination in the
Law of Workplace Cooperation: From Bureaucratic to Flexible Production” (1994) 94 Columbia Law
Review 753 at 756, citing DG Blanchflower and RB Freeman, “Unionism in the United States and
Other Advanced OECD Countries” (1992) 31 Industrial Relations 56.
35
Stone makes a similar point when she argues that Williamson relies upon an inaccurate description
of industrial democracy in offering these safeguards: “[Williamson] focuses on the ideology and
rhetoric of industrial pluralism and its promise to create a privatized mini democracy within the
workplace, but ignores the fact that this promise never materialized,” K Van Wezel Stone, “Labor
and the Corporate Structure: Changing Conceptions and Emerging Possibilities” (1998) 55
University of Chicago Law Review 73 at 158. Given the inadequacy of the industrial pluralistic frame-
work , she claims these safeguards are illusory. However, Williamson does not in fact, as Stone sug-
gests, argue that this industrial pluralistic framework “permits unions to protect the investment of
workers adequately.” He would claim that the contractual process with or without unions would, if
it is efficient to do so, introduce adequate safeguards or provide for a risk premium. Stone’s focus
upon industrial democracy does, however, reveal Williamson’s implicit reliance upon collective bar-
gaining, as the “safeguards” to which he refers are more effective, have more bite, when introduced
through collective bargaining machinery.
36
Williamson, Governance at 314, noting that “in effect broad participation on the board invites two
bites at the apple (get your full entitlement at the contractual interface; get more in the distribution
of the residual).”
Indeed, if firm-specific labour is located at Node C it makes no sense to discuss

board representation. However, when labour’s “safeguards” are revealed as illu-
sory, labour returns to Node B and the issue of board voting representation as a
safeguard for employee firm-specific investment must be reconsidered. Clearly,
such representation would provide effective protection from managerial oppor-
tunism. Managers would have to answer to worker representatives on the board
for opportunistic expropriation of employee firm-specific investments. Such action
could endanger their managerial position and, accordingly, they would be wary of
such behaviour. Williamson himself, when discussing management, suggests that
if available safeguards are inadequate, then board representation may be appro-
priate. He notes, inter alia,37 that “management’s participation may help to
safeguard the employment relation between management and the firm—an
important function given the inadequacy of formal procedures for grievance.”38 If
inadequate safeguards for management justify a board presence, then why not for
other employees with similarly inadequate safeguards?39
However, the argument that if labour’s safeguards are inadequate then labour
should be safeguarded by board representation does not correctly employ
transaction cost analysis. It assumes a determinate relationship between an
unsafeguarded firm-specific investor and board representation. That is, it assumes
that to reveal that an investor’s safeguards are illusory projects that investor
towards the board. However, within the transaction cost framework that does not
37
Williamson, Economic Institutions at 317. He also offers other justifications for management board
presence, for example, it permits the board to observe the managers decision making process and
managerial presence brings informational advantages.
38
Williamson, Economic Institutions at 317.
39
Progressive scholars following Katherine Stone, have used this move. Stone, supra at n. 35, argues
that “if the current bargaining is not an adequate bilateral scheme to protect firm-specific invest-
ments of workers then by Williamson’s criteria there is a compelling case for expanded labor particip-
ation on corporate boards.” MA O’Connor, “The Human Capital Era: Re-conceptualizing
Corporate Law To Facilitate Labor Management Cooperation” (1993) 78 Cornell Law Review 899 at
917. At 941 she also notes that: “Williamson emphasizes that parties have incentives to adopt govern-
ance mechanisms that mitigate the threat of opportunism. Thus firms using participatory shop floor
practices have the incentive to implement codetermination in order to reduce the wages necessary to com-
pensate workers for the costs of opportunism” [emphasis added]. MM Blair, Ownership and Control:
Rethinking Corporate Governance For the Twenty First Century (Washington, D.C., Brookings Institute, 1995)
makes a similar argument. She notes at 240 that “where employees or other stakeholders have sig-
nificant specialized investments at risk, their rights and obligations as owners should be formalized
through compensation schemes, organizational forms, or other arrangements that place significant
amounts of the company’s equity under the control of the at risk stakeholders and that assign con-
trol responsibilities commensurate with their equity stake in the group.” Jai Chandrasekhar, in a
review of Blair’s book counters that “if workers have already bargained for payment for their special
skills [DK—e.g., firm-specific investment] . . . claiming a share of control and equity as compensa-
tion for the same skills is double dipping.” JK Chandrasekhar, “Book note: Worker Empowerment
Through Corporate Law?” (1996) 105 Yale Law Journal 1707 at 1711. See also L Putterman,
“Corporate Governance, Risk Bearing and Economic Power: A comment on Recent Work by
Oliver Williamson” (1987) 143 Journal of Institutional and Theoretical Economics [Zeitschrift Für die
gesamte Staatswissenschaft] 422 at 427–428 assuming that the logic of Williamson’s claim collapses
upon the demonstration that labor makes firm-specific investments.
necessarily follow. Rather, the relevant concern is with the efficient fit between
governance structures and the attributes (and related costs) of the various invest-
ing parties.40 Therefore, it may be cost effective for the firm to incentivize human
firm-specific investment through other non-board safeguards or by offering no
safeguards and paying the risk premium through higher wages, profit-related
bonuses etc. This will be the case where the allocation of the board safeguard to a
different constituency is efficient because other mechanisms are not available to
accommodate that constituency’s risk concerns and the failure to do so would
result in an overall higher risk premium. The progressive path from unsafe-
guarded employee firm-specific investment to board representation may, there-
fore, be interrupted by a more efficient distribution of this safeguard. Accordingly,
if Williamson’s claim about the necessity of awarding the board to equity investors
is correct, his inadequate analysis of labour safeguarding is of no consequence.
2.2. Dividing the prize: safeguarding equity investments

Williamson argues that debt and equity are governance structures that correspond
to the firm-specificity of the investment for which capital is required. Debt will be
used to finance non firm-specific investment as the creditor can safeguard her
exposure by using the investment as collateral. As the investment is non firm-
specific it can, if necessary (if the company defaults on the loan or the firm goes
bankrupt), be sold or employed elsewhere without significant depreciation in
value. However, a firm–specific investment is worth considerably less elsewhere (if
the firm goes bankrupt or defaults on the loan) than to the firm making the invest-
ment. Accordingly, the investment is insufficient collateral for a loan. A creditor
averse to this increased risk will demand a higher return on the debt (a risk pre-
mium) and the company’s cost of capital will rise. In such a situation equity may
be cost effectively employed. However, equity financing, Williamson argues, is a
highly exposed firm-specific investment which if unsafeguarded is situated at Node
B:41 equity is not safeguarded by complex contracts, security in individual assets
40
Williamson, Governance at 311 noting that “The main hypothesis out of which transaction costs
worked is this: align transactions, which differ in their attributes with governance structures which
differ in their costs and competences in a discriminating (mainly, transaction cost economizing)
way.”
41
See generally, E Warren and JL Westbrook, The Law of Debtors and Creditors: Text, Cases and Problems
(4th ed., Gaithersburg, Aspen Law & Business, 2001). Williamson, Economic Institutions at 304, notes
that “. . . the productive assets of suppliers of . . . labor . . . normally remain in the supplier’s pos-
session. If located at Node A the suppliers can costlessly re-deploy their assets to productive advan-
tage.” This separation of workers into Nodes A and B allows Williamson to present equity
investments as more firm-specific than employee investments: “suppliers of finance bear a unique
relationship to the firm” as their investment is “always located at K>0 [i.e., firm-specific]” [empha-
sis added] and whilst “the whole of [equity’s] investment is placed at hazard,” workers and other
constituencies will always walk away with something and some of them [relying on the labor Node
A designation] may redeploy their assets “costlessly.” However, it is very rare that stockholders lose
all their investment, and employees never leave a firm with all their productive assets/human
and on bankruptcy other claims have priority over common stock.42 Equity
investors will demand an expensive risk premium if required to invest at Node B.
To reduce the cost of their capital, they require a safeguard. Awarding the board
of directors to equity investors is a safeguard mechanism which moves these
investors towards Node C.43 For Williamson, the board is a dual control mecha-
nism: shareholders have the “the ability to exercise contingent control by concen-
trating votes and taking over the board of directors,”44 and the board controls and
reviews management.45 By lowering their risk premium in exchange for the power
to appoint and remove the board, shareholders pay for control.46 Thus, the board
of directors, as equity safeguard, “arises endogenously.”47 The logic of cost econ-
omizing, not the contingencies and paths of history, the myopia of normalcy or the
maintenance of power, explains this relationship of the outside investors to the
board of directors.48 Accordingly, once a firm, including a fully employee owned
firm, requires firm-specific investment, the costs of capital will propel the firm to
relinquish control over the board to equity investors.49 Failure to do so will impair
competitiveness, resulting in conversion or failure.
However, as detailed below, this governance logic is not simply the logic of eco-
nomics, it is also the product of Williamson’s analytical framework. That is, the
multifaceted implications of the economic forces that Williamson correctly identi-
fies are flattened through the conceptual logic and language of the transaction cost
framework. The logic works as follows: as (a) equity investments are more firm-
specific and more exposed than the investments made by other constituencies50 and
(b) the board is the only safeguard that can move these investors to Node C, from
an efficiency perspective the board must be awarded to the shareholders and only
to the shareholders. The board, as a safeguard, is understood as a prize and as in
any competition there is only one first prize and one winner. No one shares the
first prize, certainly never with anyone who is not as deserving. The transaction
cost competition is presented as follows: the constituency that best fits into the
transaction cost concept of firm-specificity wins the board. However, understand-
ing the board and control over the board in these terms is not the dictat of
capital. Clearly, much of this capital is tied to and is dependent upon the firm’s routines, culture,
technology, products, customers, politics etc. When the employee leaves or the company disap-
pears, a considerable fraction of what makes that employee’s human capital work is lost. Of course
much is redeployable, once a person can use Microsoft Word 2000 he can always use it. However,
whether an employee or shareholder would leave firm failure with more or less is hardly self-
evident. In addition, as noted previously, the extent to which a labor investment is perceived to be
firm-specific and exposed is a function of the perspective of the investor, his experiences and hori-
zons. An employee with prior experience of uncompensated expropriation, limited opportunities
to use his investment elsewhere and whose attachment to community does not allow him to move
away, will see his investment as highly firm-specific and exposed.
42 Williamson, Economic Institutions at 304.
43 Williamson notes that the board of directors becomes a “safeguard against expropriation and egre-
gious mismanagement.” Ibid. at 305.
44 Williamson, Governance at 245 referring to “the critical attribute of equity.”
45 Williamson, Economic Institutions at 305.
efficiency rather the product of transaction cost economics’ conceptual structure

and vocabulary. The board should not be seen as a prize but as a range of prizes.
Closer attention to the nature of the board safeguard and what protections share-
holders actually pay for, reveals that efficiency is not so demanding, and that the
board may be shared.
Since Berle and Means51 it has become widely accepted that the shareholders’
ability to exercise control over the board of directors and management is highly
constrained. There are two specific problems of control. First, the ability of the
board of directors, consisting of internal and external directors, to exercise effec-
tive control over management, and second, the ability of shareholders to act to
ensure that the board of directors and management act in the shareholders’ inter-
ests. Inside directors, i.e., management, have informational, knowledge and learn-
ing by doing advantages that render external supervision by external directors
very difficult. Outside, “independent” directors, through their direct or indirect
dependency on management and through management’s control over the distrib-
ution and presentation of information52 are steered in the management’s pre-
ferred direction. Furthermore, shareholders are weakly positioned to sanction an
ineffectual or incompetent board. The ability to exercise control over the board of
directors is severely limited as the costs of mounting a proxy fight far exceed the
46
Apparently confirming Williamson’s safeguard claim, it seems that shareholders do in fact pay for
the right to vote. Analysis by Lease, McConnel and Mikkelson in 1983 into the price of dual class
shares which were identical in all respects apart from their voting rights, revealed a premium of
between 3.79% and 6.95% for the voting shares. Whilst they identified an anomaly whereby supe-
rior voting shares actually traded at a discount of 1.17%, the weight of the evidence suggests that
providing shareholders with voting rights offers a cost of capital saving. It is important to note that
these discounts do not correspond to the discounts that would be imposed if only employees con-
trolled the board. For reasons outlined below the discount would most likely be larger. However, as
outlined below institutional variation can accommodate a board role for investors and employees
that alleviates cost of capital inefficiencies. RC Lease, JJ McConnell and WH Mikkelson, “The
Market Value of Control in Publicly Traded Corporations” (1983) 11 Journal of Financial Economics
439. See also H Levy, “Economic Evaluation of Voting Power of Common Stock” (1983) 38 Journal
Finance 79.
47 Ibid. at 306.
48 Williamson, Economic Institutions at 323–324 noting that “Upon realizing that this is a very inefficient
result, the workers who are organizing the enterprise thereupon invent a new general purpose safe-
guard, name it the board of directors. Upon recognizing that expropriation hazards are thereby
reduced, the suppliers of equity capital lower their terms of participation to p^. They thus become
the “owners” of the enterprise. Not by history but by logic does this result materialize” [emphasis added].
49 Note that Williamson argues that in such a situation equity is cheaper than debt as (a) it does not
increase the level of debt, thereby decreasing the risk of bankruptcy and (b) because of the board
safeguard.
50 See n. 41.
51 AA. Berle and GC Means, The Modern Corporation and Private Property (New Brunswick, Transaction
Publishers, 1991).
52 MC Jenson, “The Modern Industrial Revolution, Exit, and the Failure of Internal Control
Systems” (1993) 48 Journal of Finance 866 at 864 noting that “. . . the CEO almost always determines
the agenda and information given to the board. This limitation on information severely hinders the
ability of even highly talented board members to contribute effectively to the monitoring and eval-
uation of the CEO and the company strategy.”
benefits to individual shareholders.53 The collective action problem54 generated

by broad dispersion of ownership means that most of the time no one acts, no one
turns up to meetings,55 shareholders simply sign the proxy cards sent out by the
board and rubber stamp the board’s and therefore management’s direction and
action. Even large institutional investors take limited holdings in individual
companies.56 Accordingly, they too remain deterred by the cost and free rider
problems of proxy action57 as well as by the reputational implications of anti-
management activity.58 Most of the time whether a shareholder can vote or not is
largely irrelevant. In effect, through director capture and shareholder inactivity,
the management appoints the board. Only in theory are the shareholders
“awarded the board.”
If this is the case, then why would an investor pay a premium for this ineffectual
vote/board safeguard? It seems that there are three reasons for paying a premium
for the board safeguard which relate both directly to the actual voting rights them-
selves and indirectly to what the possession of the vote disallows. First, although
free riding and collective action problems may inhibit effective exercise of control
over the board and management, crisis circumstances may arise which trigger or
motivate shareholder action to control egregious activity or to take emergency
action.59 In the individual firm context it is unlikely that such action is cost effec-
tive; however, it may be deemed cost effective particularly by institutions that feel
that action to discipline management is appropriate as “a matter of principle”, or
“to set an example”. It may be rare, but proxy actions do and can remove inef-
fective and incompetent management.60 The vote, which allows participation in
such a crisis, is clearly a safeguard, albeit an extremely attenuated one. The share-
holders here participate in defining the boundaries of the space in which the board
and management can act in ways that fail to maximize shareholder value. The
vote perhaps allows shareholders to contribute to the moral and ethical parame-
ters of business. The other key determinants of the nature and extent of this space
are the level of efficiency of the markets for corporate control, additional capital,
53 FH Easterbrook and DR Fischel, supra at n. 2 at 78.

54 See generally, M Olson, The Logic of Collective Action (Cambridge, Harvard University Press, 1965).
55 WA Klein and JM Ramseyer, Business Associations: Agency, Partnerships and Corporations: Cases and
Materials (2nd Ed) (Westbury, Foundation Press, 1994) at 491 noting that “despite the potential
importance of actions taken at shareholder meetings, few shareholders of public corporations actu-
ally attend them.”
56 See BS Black and JC Coffee, “Hail Britannia? Institutional Investor Behavior Under Limited
Regulation” (1994) 92 Michigan Law Review 1997 at 2001.
57
See JC Coffee, “Book Review, ‘Investor Capitalism: How Money Mangers Are Changing The face
of Corporate America, by Michael Useem’ ” (1997) 95 Michigan Law Review 1970.
58
Black and Coffee, supra at n. 56 at 2060 noting that “. . . a reputation as a troublemaker is some-
thing to be devoutly wished on one’s competitors and avoided for oneself.”
59
FH Easterbrook and DR Fischel, supra at n. 2 at 66 note that “voting rarely serves any function
except in extremis.”
60
See for example, Black and Coffee, supra at n. 56 documenting the proxy action spearheaded by
Norwich Union in the UK to remove the board of directors of Tace PLC.
products and management, and the fiduciary duties owed to the firm together with
the practical mechanisms that assist their enforcement such as auditing, account-
ing standards, litigation etc.
Second, and related to the first factor, is that although the board and manage-
ment may fairly be understood as adrift from shareholder control, the fact that the
theoretical rather than effective power of the vote belongs to shareholders means
that management and the board will prioritise shareholder interests above those
of other corporate constituencies.61 This is not a concern where crisis voting, the
market mechanism or fiduciary duties adequately control managerial self interest,
shirking and incompetence; however, it remains a concern for those board deci-
sions protected from review by the business judgement rule, or that are not suffi-
ciently inefficient62 or self interested to trigger a market mechanism or principled
shareholder action. The fact that the directors and management do not rely (in
theory) on any other constituency to keep their jobs provides equity investors with
comfort that where markets, fiduciary duties and principled disgust do not reach,
management will be looking towards shareholders’ interests even if at times they
may be acting in their own. By awarding the board to equity investors, the primary
incentive structure within the boundaries of unsanctioned board decision making
is limited to the interplay of managerial self interest and shareholder value.
Third, is the ability of voting rights to attract a tender premium. Giving share-
holders the vote facilitates the operation of the market for corporate control.
Depending upon the provisions of a corporation’s charter and the state of its incor-
poration’s corporate law, a certain percentage of shares with voting rights must be
obtained in order to gain control of the corporation, replace management, merge
the company etc. Investors purchasing voting stock do so in anticipation that they
may attract a tender premium at some point in time when a tender offer is made
or a merger proposed. This would suggest that the voting premium fluctuates as a
positive function of the efficiency and level of corporate control activity in the mar-
ket as a whole and in particular industrial sectors. It seems likely that the intro-
duction and use of innovative protective mechanisms such as poison pills, ESOPs,
and the regulation of takeovers would lower the vote premium. This third factor
pushes in the opposite direction to the second factor outlined above. As the effi-
ciency and the level of activity of the market for corporate control increases, these
tender premiums will increase; however, the premium paid for a second factor
61
Hansmann, Ownership at 69 makes a similar point when he argues that “The advantage to the
investors in a widely held business corporation from being owners rather than simply dealing with
the firm through market contracting as mere lenders, may be in large part just that their ownership
assures them that the firm’s management is not serving some other class of owners with interests
contrary to that of the investors.”
62
On the scope for inefficient behavior due to market failure see LA Bebchuk, “The Debate on
Contractual Freedom in Corporate Law” (1989) 89 Columbia Law Review 1395; SG Winter,
“Economic Natural Selection and the Theory of the Firm” (1964) Yale Economic Essays 225.
safeguard will decrease as the scope for non-shareholder value action by manage-
ment decreases.
There are, therefore, cost of capital implications of awarding the vote to equity
investors, but they are rather different and more complex than Williamson claims.
However, the imagery of his idea is simpler and easier to follow: equity investors
receive voting control over an institution that acts to protect their firm-specific
investment which they pay for by reducing the cost of supplying their capital. In
this contractual frame, equity investors have paid for the ability to decide who on
the board makes the decisions and, through the vote, can sanction directors who
fail to act to protect their investment. Accordingly, no one else should have that
right without paying the equity investor for it. In this frame, if other constituencies
received voting representation on the board of directors this would increase the
risk for the shareholders,63 diminish the value of the shareholder’s vote and would
increase the cost of equity capital. However, if the above account of why equity
investors reduce the cost of capital is correct, then the shareholder does not pay for
this simplistic image of control central to Williamson’s endogeny. Furthermore, if
institutions can be devised which mirror the actual safeguards which the board
provides equity investors whilst introducing other constituencies to the board, then
the presence of those constituencies should not affect the firm’s cost of capital and,
at least in these transaction cost terms, should not inhibit the efficiency of such a corpo-
rate form.
Corporate governance structures that allow for employee board representation
while providing the first and third factor safeguards detailed above are easily envi-
sioned; the second factor creates more difficulties. Investors in a 100% (residual
income) investor-owned firm could be given voting rights to elect a majority of the
board and the power, through simple majority, to remove the whole board. The
remaining board seats would be allocated to employee representatives. The char-
ter could also provide that the previous directors or a limited percentage thereof,
or perhaps only internal directors (management and employee), could not be re-
appointed if removed by the shareholders. Management would be appointed and
removed by simple majority. Major investment and policy decisions would require
simple majority. The charter and/or the relevant state incorporation statute
would need to provide for majority board and shareholder resolutions to approve
a change of control transaction. The directors and management would owe
fiduciary duties to the corporation, and in certain circumstances, directly to share-
holders but not to any other constituency. The familiar practical entourage which
facilitates the enforcement of fiduciary duties, including, shareholder derivative
suits, auditing, and insider trading rules would remain effective.
63 Williamson, Governance at 314 noting that “. . . such protective powers as it [the board ] possesses are
compromised by inviting broad participation on the board . . . confronted with added risk those who
are the natural residual claimants in the nexus of contracts will adjust the terms under which they
contract adversely.”
Such a simple structure would allow shareholders to act in a crisis or to act “on
a matter of principle” or “to set an example” by wiping the board clean. The
ability of such action to contribute to the definition of the outer limits of ethical
business activity would be unaffected. The shareholder vote in such a structure
would be identical to its role in a 100% equity investor-voting firm. The reality
under both structures is that control through voting is profoundly attenuated;
however, on rare occasions, the shareholders have the ability to act and define the
parameters of abuse and incompetence. Whether investors receive votes to
appoint a majority of the board and general board dismissal rights or 100% vot-
ing rights, the actual safeguard vis á vis the first factor is identical. Similarly, if
majority board and shareholder resolutions are required to accept a tender offer,
then the market for corporate control is not subject to any additional restriction.
Any successful bidder would be able to remove the whole board and exercise
majority control. Any cost of capital benefit received as a result of anticipated ten-
der premiums would be unaffected. Accordingly, under the first and third factors,
such a structure would allow for considerable employee voting rights without hav-
ing transaction cost of capital implications.
The second factor is more complex and problematic. In the unincentivized
space discussed above where the market mechanism, fiduciary duties and crisis
voting do not constrain shirking and self-interested behaviour, the introduction
of non-shareholder voting clearly alters the incentive/interest structures and the
value of the shareholder’s safeguard. Therefore, simple employee voting repre-
sentation, where the employees have no residual or quasi-residual interest, would
have an adverse effect on the firm’s cost of capital. Although with majority
investor board representation the board could ensure that most of the time only
shareholder maximizing decisions were made, in practice different
incentives/interests (employee welfare incentives) would be introduced to the
board as the investor’s directors would not always agree or act as a unit. In addi-
tion, in relation to any decisions that require super majority vote, the employee
representatives could hold up the board and use this possibility to exert influence
in areas where they do not have the ability to hold up decision making. The sec-
ond factor safeguard in the alternative governance model set out above, while
not removed, would be undermined. However, the extent to which this safe-
guard is devalued is a function of the lack of alignment of incentives/interests. At
one extreme are employees who have only fixed wage, salary and funded pen-
sion claims on the firm. But even these employees have types of residual interest:
their investments in the firm and the surrounding community are dependent on
the success and longevity of the company. Other non-shareholding residual
interests may be introduced which further align the incentives/interests, for
example, profit and performance related pay. In Germany the incentives of non-
owner workers are further aligned with equity investors as their pension entitle-
ments are often not fully funded. Accordingly, they retain an interest in the
success and profitability of the firm until long after they have left the firm’s
employ. Moving towards ownership, stock options and stock bonuses on attain-
ing certain targets further align interests. ESOPs and defined contribution pen-
sion plans that take major shares in the members’ firms operate effectively to
align interests so long as the share of ESOP or pension ownership is substantial.64
As the incentive structure moves towards employee/equity alignment the second
factor cost of capital implications of employee representation are reduced. To the
extent that employee/shareholder interests are not aligned through residual and
quasi-residual interests, institutions are available that could align the employee
representatives’ interests. For example, the employee representatives could
receive remuneration on a profit related basis.65 A more draconian measure
could provide a committee of independent directors with the power to dismiss
employee representatives where all independent directors and a super majority
of all non-employee board members deem an employee representative to be con-
sistently acting partially and to the detriment of shareholder value.
In addition, the extent to which misalignment could detrimentally affect the
firm’s cost of capital is, as noted above, a function of the effectiveness of external
control mechanisms, in particular, on the level of competitiveness in the corporate
control, product, capital and managerial markets. Interestingly, the negative sec-
ond factor cost of capital implications of employee representation are reduced as
these markets become more effective. Therefore, perhaps slightly counter intu-
itively, an effective market for corporate control unhindered by anti-takeover
defences and anti-takeover statutes may be more conducive to employee strategic
representation.66
If the costs of capital benefits to the firm of awarding the board to equity can be
obtained through governance and ownership structures that facilitate employee
representation, then it is unclear why efficiency demands that the board and the
64
However, as the recent collapse of ENRON reveals, an employee’s failure to diversify may have
disastrous implications for such employee’s retirement plans. Interestingly, the response to ENRON
has not been to require that employees’ undiversified interests are protected by governance mech-
anisms. However, there appears to be a strong case for this. Employees with considerable (in per-
sonal rather than absolute terms) residual firm interests are likely to serve as powerful and informed
board members who could prevent or at least inhibit the abuses of power and discretion that appear
to have taken place at ENRON. Further, such employee representatives with limited, but person-
ally valuable stakes in the company, are less likely to fall foul of the temptations of “independent”
directorships.
65
However, note that this could undermine the disciplinary value of informed employee representa-
tives.
66
If an effective market for corporate control mitigates some of the negative transaction cost of capital
implications of labor board representation, then labor’s presumptive opposition to pro-investor
takeover regulation, as seen, for example, by the recent German labor movement’s opposition to
the EU’s proposed 13th Directive on Company Law Concerning Takeovers, may be misplaced (see,
for example, “Germany Acts to Limit Hostile Takeovers” July 11, 2001, Financial Times). If an active
market for corporate control is a mechanism to align investors’ interests in shareholder value with
labor’s interest in board representation, then combining pro-investor takeover regulation with reg-
ulation securing co-determination rights may be a more beneficial strategy than outright opposition
to such takeover regulation.
power to elect the board must be entirely awarded to equity investors. The trans-
action cost story of evolution fails to demonstrate “endogeny.”
The board as safeguard need not, at least in transaction cost of capital terms, all
belong to equity investors. Accordingly, the analysis of labour firm-specific invest-
ments and safeguards is freed to consider a relationship to the board that can effi-
ciently accommodate shareholder and employee safeguard requirements. There is
no transaction cost of capital efficiency basis for excluding, and there appears to
be an efficiency (safeguard) case for providing,67 a form of board representation
for employees to safeguard their oft unsafeguarded firm-specific investments.68
C. H ENRY H ANSMANN ’ S THEORY OF GOVERNANCE COSTS
Section C explores Professor Henry Hansmann’s governance cost explanation of

why worker ownership does not work and of the rarer instances when it is suc-
cessfully employed. Hansmann’s argument has crystallized into accepted learning
within the corporate legal academy, and as such is a central factor in Hansmann’s
and Kraakman’s claim that at the end of corporate legal history there is no place for
labour in corporate governance. It is this Article’s contention that this pillar of the
evolutionary/historical claim has suspect efficiency foundations. However, as with
any construction, if one builds on top of such foundations it becomes increasingly
difficult to see the flaws below. This section attempts to reveal those flaws. It does
so by taking issue with the way in which Hansmann produces a governance cost
conforming organizational reality. As this reality is shown to be a function of
Hansmann’s perspective and of the internal imperative of his cost claim itself,
governance costs are demoted from a cause to a consideration. Section C demon-
strates that outside of the constraints of Hansmann’s viewpoint, many familiar and
imaginable alternative institutions would facilitate employee strategic particip-
ation without necessarily increasing the governance cost burden.69 Hansmann’s
analysis does not provide theoretical support for the end of corporate history claim,
rather it highlights one cost factor that has moulded and placed constraints upon
the structure of US corporate governance.
67 See text to nn. 26–40.

68 For other cost accounts which attempt to explain why labor should be excluded from board repre-
sentation see, for example, SM Bainbridge, “Participatory Management Within a Theory of the
Firm” (1996) 21 Iowa Journal of Corporation Law 657 and MC Jenson and WH Meckling, “Rights and
Production Functions: An Application to Labor Managed Firms and Codetermination” (1979)
52(4) Journal of Business 469.
69 Although, of course, that does not exclude the possibility that such institutions may be inefficient as
a result of other cost factors.
1. Distinguishing costs
For Hansmann, as for Williamson, our familiar organizational landscape is the
product of the market’s selection of the more efficient alternatives. Market
selection may “operate quite slowly,” but “over the long run cost minimizing
forms of organization will come to dominate most industries.”70 Hansmann’s
ambitious project sets out to understand existing economic institutions, the sur-
vivors, in cost terms.71 He asks what are the key cost factors that have shaped cor-
porate institutional evolution and what do these cost factors tell us about the
viability of alternative institutional forms. This article focuses on one aspect of his
project, namely the explanation of when worker ownership works and why. The
ownership of enterprise by its employees is unusual in Western economic settings.
However, although limited, the US and Europe provide examples of where
employee ownership has survived if not flourished. Hansmann sets out to explain
the cost conditions of the survival of worker ownership and the cost determinants
of its frequent failure.
Hansmann teaches us about the complexity of the cost implications of
organization. Where other scholars, such as Williamson, have often focused on
a particular cost to explain the failure of worker ownership, for example the cost
of the firm’s capital,72 in the first instance at least, Hansmann attempts an all-
encompassing cost analysis. Under the rubrics of the “costs of market contracting”
and the “costs of ownership” he considers the costs of monitoring workers, that is
the costs of discouraging shirking and incentivizing work;73 the costs of lock in,
that is the costs of incentivizing and safeguarding firm-specific investment by
workers;74 the costs of information and communication, that is the costs of obtain-
ing and accessing information about work processes, problems and solutions;75 the
costs of raising capital for firm-specific investment;76 the agency costs of ensuring
70 Hansmann, Ownership at 22–23. In Hansmann, Worker Ownership at 1756, Hansmann notes that
“to be sure we should not exaggerate the effectiveness of market selection. Self conscious invention
and diffusion of new organizational forms can be a very gradual process; relatively inefficient firms
may be weeded out by market forces only slowly.”
71 Hansmann, Worker Ownership at 1755, noting that “in a free enterprise economy the market
should select efficient organizational forms. Two forces push in this direction. First, entrepreneurs
and owners have a financial incentive to organize and reorganize in ways that are relatively efficient.
Second, competition in the market will put less efficient organizational forms at a disadvantage and
those forms will consequently have a smaller chance of surviving. In the analysis that follows, sur-
vivorship will therefore be employed as an important index of the relative efficiency of alternative
organizational forms and of worker ownership in particular.”
72 See Section B.
73 Hansmann, Worker Ownership at 1761–1763.
74 Ibid. at 1764–1775.
75 Ibid. at 1764–1768. Here I refer to the cost factors he raises under the headings “Strategic Behavior
in Bargaining”, “Communication of worker preferences” and “Responsiveness to average versus
marginal worker preferences.”
76 Ibid. at 1771–1772.
that management acts in the interests of the firm’s shareholders,77 and the costs of
organizational governance, namely the costs of making strategic and operational
decisions within the firm.78
From this cost complexity emerges Hansmann’s central and causal cost factor:
the costs of governance.79 Political and economic institutions provide mechanisms
for making decisions. These decision making mechanisms incur costs, these costs
are governance costs. Decision making costs include, in particular, (1) process costs:
the investment required to make informed decisions and the time spent and wasted
in search of consensus over key and contentious business issues, (2) the costs of mak-
ing inefficient decisions when median preferences substantially differ from average
preferences and majority voting results in the adoption of median preferences,80
and (3) the costs of not being able to make an efficient maximizing decision, to
implement corporate strategy or to quickly respond and adapt to external changes
where the institutional structure facilitates hold up and minority rent seeking.
In assessing these costs, Hansmann is particularly concerned with the charac-
teristics of those who own the firm.81 His key claim is that the costs of governance
are a function of the degree of homogeneity/heterogeneity of the interests of the
owners of the firm.82 This seems intuitively correct: the more interests that are
articulated, expressed and pursued, the more time spent and the greater the costs
incurred in making a decision and the greater the likelihood that some potentially
efficient decisions will be blocked. Therefore, a central factor in determining
whether a firm constituency can efficiently participate in decision making (i.e., to
participate without incurring prohibitive governance costs) is the extent to which
the interests of the members of that constituency are heterogeneous.
77 Ibid. at 1768–1769.
78 Ibid. at 1779–1783. In this section I use governance costs to refer to the costs of making collective
decisions and the costs of making poor and inefficient decisions. I realize that Hansmann defines the
term “governance costs” more broadly to also include “the costs of monitoring managers”
(Hansmann, Ownership at 21). I do not refer to the costs of monitoring managers when I refer to
“governance costs.”
79
Ibid. at 1783: “A survey of the types of firms in which worker ownership has succeeded suggests
strongly that the costs of governance associated with collective decision making are extremely
important in determining where worker ownership is viable and how it is organized. In fact these costs
go far in explaining the large residual in the existing pattern of worker ownership that remains unexplained by the other
costs and benefits of worker ownership” [emphasis added]. While Hansmann has popularized governance
cost concerns within corporate law, in economics both Kenneth Arrow (see Bainbridge, supra at n.
68) and Jenson and Meckling ( Jenson and Meckling, supra at n. 68) have considered the importance
of such costs before him. See also A Ben-Ner, “The Life Cycle of Worker Owned Firms in Market
Economies: A Theoretical Analysis” (1998) 10 Journal of Economic Behavior and Organization 287 at 298.
80 Hansmann, Ownership at 40.
81 For Hansmann, “a firm’s owners . . . are those persons who share two formal rights: the rights to
control the firm and the rights to appropriate the firm’s profits and residual earnings” (Hansmann,
Ownership at 11).
82 Hansmann, Ownership at 40 noting that “The costs of collective decision making can be negligible
. . . as long as the owners have highly homogeneous interests”; “The costs of collective decision are
then the additional costs that result from heterogeneity of interests among the owners.”
Hansmann contends that investor ownership is particularly conducive to low

costs of governance83 because although investors’ interests may differ, their pri-
mary shared interest is in the maximization of the value of the firm’s earnings. In
addition, the market fosters investor interest homogeneity as investors choose
stocks that fit their return, horizon, risk, taxation and liquidity profiles. In contrast,
while employees may share relatively homogeneous interests, particularly where all
firm employees perform similar functions, in the majority of firms employees will
perform different tasks, have varied education and skill levels, career prospects,
pay scales, levels of firm-specific investment etc. Accordingly, if heterogeneity of
owner interest is the key determinant of governance costs, then employee particip-
ation in strategic decision making is likely to result in burdensome costs of govern-
ance.84 Hansmann’s lesson for scholars and activists interested in encouraging
employee ownership and involvement in enterprise is that it is viable only if the
interests of those employees are relatively homogeneous. Widespread investor
ownership and limited employee ownership and the predominant failure to
enfranchise employee stock owners under employee stock ownership plans85 is,
accordingly, the product of efficient economizing on governance costs. Many his-
torical and contemporary attempts at employee ownership have not survived and
will not survive because ownership by employees who have heterogeneous inter-
ests is not governance cost efficient.86
2. The authority of reality

Hansmann’s inquiry is into the fit of cost theory with economic reality, i.e., which
of the identified cost factors most persuasively explain the forms of ownership and
corporate governance evident in contemporary western economies.87 Without the
“reality” of the success and failures of various experiments with worker ownership
and participation, the organizational analyst has a set of cost factors, for example,
83
Hansmann, Ownership at 40 noting that “the costs of collective decision making can be negligible in
large corporations in which ownership is widely shared and hence agency costs are large, as long as
the owners have highly homogenous interests.”
84
Hansmann, Ownership at 119 noting that “The evidence suggests, however, that with a heteroge-
neous work force direct employee control of the firm brings substantial costs—costs that are gener-
ally large enough to outweigh the benefits that employee ownership otherwise offers.”
85
See P Rooney, “Worker Participation in Employee Owned Firms” (1988) 22 Journal of Economic
Issues 451 noting that “Perhaps contrary to expectations, this study found very little worker particip-
ation in employee owned firms, even in majority owned firms.”
86
Hansmann, Ownership at 119 noting that “for the present it seems most reasonable to predict that
successful instances of employee ownership will be largely confined to firms with highly homoge-
neous classes of employee owners.”
87
Hansmann, Worker Ownership at 1754–1755 noting that “worker ownership offers a number of
important efficiency advantages . . . however, these advantages correlate poorly with the observed
distribution of worker ownership”. “. . . the principle costs . . . to worker ownership . . . whilst clearly
significant in explaining the observed distribution of worker ownership, are less important than has
commonly been supposed and in any case are insufficient to explain the existing distribution of
worker owned firms.”
governance costs, costs of capital, costs of worker lock-in etc., but limited means by
which to weigh the relevance or importance of those costs to the efficient evolu-
tion of organization and to assess the trade offs between costs or the balance of cost
savings against cost burdens. The arbitrary prioritisation of a particular cost could
determine whether you are a radical or an apologist: to prioritise the costs lost in
failing to incentive worker firm-specific investment could lead to worker strategic
representation; to prioritise the cost of capital implications of not granting board
representation to outside investors may privilege the relationship between the
board and the investor. In the absence of an arbiter of, or criteria to determine,
the weight and importance of each cost, there is neither solid opposition nor sup-
port for the priority of any of these cost factors. Without an arbiter, the analysis of
the cost implications of organization is at Figure 2 below. Such an arbiter is avail-
able in the real world of institutional survivors.
G C L M A
Fig. 2
G Costs of Governance
C Communication, information, efficient preference costs
L Lock in costs
M Employee monitoring costs
A Managerial agency costs
Of central importance to Hansmann’s argument that the viability of employee

ownership is a function of the level of employee homogeneity/heterogeneity is the
example of the law firm. Indeed, the law firm, presented as the most widespread
example of employee ownership, is the keystone to his account. Service firms and,
in particular, small-to-medium-sized law practices88 provide an example of an
industry which, almost exclusively, utilizes a form of employee ownership and
employee economic democracy.89 Without the law firm Hansmann’s claims
88
Given the increasing presence of large multi-national professional service firms, it is important to
note that this is not the image of the service professional or the law firm upon which Hansmann
relies. Rather his concern is with the “small scale professional firm.” While clearly aware of the
growth of law firms, he notes that “the firms in which employee ownership is found are, like law
firms, often small enough to permit the use of highly participatory forms of direct democracy”
(Hansmann, Ownership at 98).
89
H Hansmann, “A General Theory of Ownership” Unpublished Manuscript (1986), quoted in
Williamson, Governance at 314 noting that “The only important industry in the United States in
which worker owned firms are clearly the dominant form of organization are the service industries
such as law, accounting, investment banking and management consultancy.”
would seemed forced and unconvincing.90 The law firm balances the scales,
explicitly and implicitly attributing weight to the various cost factors. For example,
monitoring workers may be an important cost factor, but how important can it be
when the industries in which monitoring is likely to be particularly problematic
and the costs thereof very high, for example, in manufacturing industry, are not
the industries where worker ownership is found.91 On the contrary, the industries
where monitoring is straightforward and the costs thereof low, for example, in law
firms, worker ownership is commonplace. Similarly, lawyers, whose skills and
learning are readily re-deployable, have limited firm-specific capital as compared
to employees in industrial firms, but such firms remain predominantly investor-
owned whereas law firms are employee-owned.92 Further, the information, bar-
gaining and communication problems within law firms are, Hansmann argues, far
less acute than those in investor-owned firms. Accordingly, courtesy of the law firm
as the representative of “worker ownership”, these costs are deemed inconsequen-
tial in determining the success and distribution of worker ownership.93 When one
turns to the costs of governance, law firms shout out in favour of the governance-
costs savings of homogeneous employee interests. Whereas investor-owned firms
generally have a more heterogeneous employee constituency and save costs by
making investors owners, service professionals have relatively homogeneous inter-
ests. For example, most lawyers in small firms perform similar tasks. Whilst they
are specialized to some degree, they deal with the same institutions, the same
information base and share similar incentives. Accordingly, the costs of employee
90
Hansmann refers to and uses other examples of worker ownership, for example, the Pacific
Northwest plywood cooperatives and taxi and transportation companies. However, service profes-
sionals and, in particular, law firms are the dominant aspect of his reality. In assessing the determi-
native role of a particular cost in forming the institutional structure of reality, the law firm is always
given center stage. For example, when considering the costs of monitoring workers he notes that “in
the service professions, where worker ownership is the norm, the productivity of individual workers
can . . . be monitored rather closely . . . lawyers in corporate law firms commonly document the use
of their time in intervals of six to ten minutes” (Hansmann, Worker Ownership at 1762). On worker
lock-in, cooperatives are referenced but law firms engaged in detail (ibid. at 1765). On strategic
behavior in bargaining, he looks only to law firms: “in the types of firms in which worker ownership
is common, the potential asymmetry of information between managers and workers seems relatively
low. Consider for example professionals of partnerships such as law firms” (ibid. at 1766). On
governance costs he looks first to law firms: “the partners of a law firm, for example, are all lawyers
of roughly equal skill who work more or less independently of each other” (ibid. at 1783). In
Ownership his summary of the benefits of worker ownership refers only to “the small scale profes-
sional service firms where employee ownership is most common” (at 75).
91
Hansmann, Worker Ownership at 1761–1763. Setting aside free riding concerns, the incentives of
ownership would reduce the costs of monitoring workers. Accordingly, industries where these costs
are high would obtain more such cost savings from worker ownership. As in these industries worker
ownership is rare, Hansmann concludes that the explanatory value of this cost is minimal.
92
Ibid. at 1765.
93
Ownership incentives would reduce the information, bargaining and communication costs because
in many instances the workers as owners would benefit from the release of that information.
Accordingly, industries where these costs are high would obtain more such cost savings from worker
ownership.
governance in law firms are low and employee ownership in the legal industry is
viable. Courtesy of the real in the guise of the law firm, the importance of the
various cost factors is structured as per Figure 3 below. From the original set of cost
considerations, only governance costs as a function of homogeneity of owner inter-
est clearly explains why law firms are employee-owned and most other firms are
not. Therefore, it follows that unless the workforce has largely homogeneous
interests, to advocate employee ownership or strategic participatory work prac-
tices is not advisable as they are destined to incur burdensome governance costs
and, in the absence of artificial supports, result in failure or reversion to investor
ownership.
M A
C L
G
Fig. 3.
3. Through the looking glass: tailoring corporate reality to theory

This section argues that in order to elevate governance costs as the factor that
explains the survival of certain types of worker ownership and the failure of oth-
ers, the landscape of firm success and failure must be tailored accordingly.
Hansmann’s descriptions of the organizational structures which provide authority
for the theory of governance costs are not independent, objective accounts of these
organizations but rather they are accounts that are a product of the governance
cost lens. Replacing the implicit claim that organizational reality and cost theory
are independent of each other with the proposition that the former is the product
of the latter, reinstates Figure 2 and its unfortunate lack of clarity.
This section focuses on three aspects of the production of a governance cost
conforming organizational reality. First, it examines the way in which images of
direct and representative democracy are deployed in Hansmann’s texts to elevate
heterogeneous owner interests as the cause of governance costs and to avoid a
comparison of like with like, namely representative worker owned structures with
representative investor owned structures. Second, this section examines how the
choice of label for an unusual organization operates to present that organization
in a way that fits with the cost claim. Third, this section details how Hansmann’s
economic reality is formed and marked by the governance cost claim’s internal
imperative: if a surviving/successful institution has owners with heterogeneous
interests, that institution must prevent the expression of those interests otherwise
it could not have survived.
3.1. The illusion of direct participation

Stereotypical and utopian images of worker ownership often depict small scale
industry in which each worker plays both a productive and decision making role.
All decisions being reached following thorough consideration and discussion of all
issues by all firm members. In fact, however, worker ownership could take many
forms, more or less democratic. Hansmann does not rely upon the easy target of a
utopian caricature of worker ownership, as others have done. 94 In the introduc-
tion to the costs of collective governance, Hansmann informs his reader that,
depending upon the size of the firm, the collective choice mechanism employed by
worker owners could take a direct or representative form, the latter usually resem-
bling the institutional arrangements used by investor owners. In Hansmann’s
work, the direct/representative dichotomy does not explicitly structure the analy-
sis of worker and investor ownership. However, his discussion of the sources of
governance costs and the comparison of the governance costs of worker and
investor ownership subtly invokes this dichotomy. The governance costs of het-
erogeneous interest worker ownership are attached to images of direct democracy
whilst, unsurprisingly, representative economic democracy provides the backdrop
to a discussion of the governance costs of homogeneous interest investor owner-
ship. I stress that this account is not explicitly structured by the labels direct and
indirect or participatory and representative, rather that they silently underpin the
discussion. These latent attachments operate to render the different governance
cost implications of investor and worker governance and their respective viability,
or lack thereof, persuasive. Without these attachments the reader would be far less
willing to accept the proposition that worker ownership rarely works because
worker’s interests are normally too heterogeneous.
At the level of direct democracy the governance cost proposition seems persua-
sive. The more members actively involved in a directly governed polity or firm and
the more diverse their concerns and interests, the more expensive the process of
decision making becomes. In a direct democracy these costs seem to be a direct
function of the number of members and the homogeneity of the interests of those
members: more members with diverse interests result in more and lengthier dis-
cussion, more conflict, more hold up etc. However, it does not follow that repres-
entative democracy is subject to a similar relationship between costs, numbers and
homogeneity of interest. A consideration of numbers makes this clear. While rep-
resentative governance may introduce other costs following from the separation of
ownership and control, as soon as representation is introduced a subsequent
increase in the number of owners will not necessarily increase governance costs. It
may do so, in extremely attenuated form, if the increased numbers of owners
results in a larger representative body/board. By implicitly attaching the concept
94
Making this criticism of Williamson, see L Putterman, “On Some Recent Explanations of Why
Capital Hires Labor” (1984) 22 Economic Inquiry 171 at 177–178.
of worker ownership to direct democracy, Hansmann allows the readily available

direct democracy-governance cost relationship to infect all forms of worker own-
ership.
In the discussion of the sources of governance costs Hansmann describes poten-
tial conflicts amongst workers, for example, over relative wage and investment pol-
icy. He notes that the level of such conflict is likely to be a function of the extent of
the division of labour and how the age and size of the share ownership of the mem-
bers will exacerbate such conflicts of interest. He argues that such heterogeneity of
interest creates space for “active disagreement” [emphasis added]. 95 Hansmann feeds
the differences in worker opinion and interest directly into disagreement and con-
flict in decision making: “the more participants in a collective choice mechanism
disagree the more costly the mechanism is likely to be.”96 Implicitly he presents
employees as direct participants in the decision making process. He does not dis-
cuss how employee representatives in a representative governance structure could
respond to, foster, mediate or alleviate such conflicts and the resulting costs. When
he discusses the inefficiencies that can arise when majority voting chooses the
median rather than the average preferences, he is not concerned with the election
of representatives but rather with the voting of preferences in relation to particu-
lar decisions,97 i.e., direct employee control of strategic decisions. This ineffi-
ciency, he notes, is more likely to arise when some individuals, read employees,
“are better situated”98 to participate than others. However, in a representative
structure, the better situated participants would not have an advantage over other
participants; rather they would represent the less able and disadvantaged partici-
pants. Finally, Hansmann argues that if workers are to exercise their control rights:
“they may need to invest considerable time and effort in obtaining knowledge about the
firm and about other worker’s preferences and in attending the meetings and other activ-
ities necessary to reach and implement effective collective decisions.”99
However, only a direct participant would have to acquire such information and
find the time to attend meetings etc., as representation efficiently relieves princi-
pals from such demands. Clearly, underpinning this discussion of the costs of
governance is an understanding that worker ownership involves direct economic
democracy.
This discussion of the governance costs of worker ownership is actually a dis-
cussion of the governance costs of direct worker democracy although Hansmann
does not explicitly identify it as such. Absent an account of the governance costs of
representative worker democracy, the reader (a) implicitly links worker ownership
with direct democracy and (b) readily accepts the claim that all forms of worker
95
Hansmann, Worker Ownership at 1780; Hansmann, Ownership at 90.
96
Hansmann, Worker Ownership at 1781.
97
98
Ibid. at 1781.
99
Ibid. at 1781.
ownership incur high governance costs even though only one form of worker own-
ership (direct democracy) has been considered.
Hansmann’s “comparison” of the governance costs of “investor owned
firms”100 focuses upon the investors’ shared interest, namely the maximization of
the net present value of the corporation.101 Their shared/homogeneous interests
make the resolution of conflict easier and less costly,102 even where “numerous
investors share ownership in the firm.”103 In the Ownership of Enterprise, the discus-
sion of the costs of governance follows immediately after a detailed analysis of the
agency costs of dispersed shareholdings and of the investor’s inability to control
the firms they own.104 The idea of representative shareholder democracy clearly
structures the governance cost discussion. Subsequent references to voting in the
investor ownership context do not mean an active role in strategic decision mak-
ing (in contrast to the understanding of voting in the employee ownership discus-
sion) but rather voting the board and controlling representative structures.105
Indeed, to state the obvious, in the corporate legal arena, any discussion of the
modern corporation where “numerous investors share ownership” takes it as given
that representative, not direct, governance is employed. Crucially, it is this shadow
of representation that allows Hansmann to persuasively foreground investor
homogeneity as the key factor attenuating governance costs, whereas the very
fact of representative, in contrast to direct, governance structures seems central
to controlling the costs of governance even in the largely homogeneous investor
ownership setting.
To compare institutional like with like, an account of widespread investor own-
ership in a direct democracy setting is required. Even if we assume that investment
vehicles are adequate proxies for “the investor”, conflict confusion and delay
would abound if investors were required to make strategic decisions. Investment
decisions and profit maximization are rarely clear single paths.106 Judgment,
interpretation and assessment are required, disagreement a corollary thereof
even for a set of investors who share similar risk and investment profiles. As the
number of investors expands, the scope for disagreement about profit maximiza-
tion increases. Some would be informed others less informed, some capable of
100
The subtitle to Hansmann, Worker Ownership, Part V (B) at 1782, is “Comparison with Investor
Owned Firms” highlighting the fact that although Part V (A) at 1780 was entitled the “Sources of
the Costs,” in fact it is an account of worker (direct) governance.
101
Ibid. at 1782. Hansmann, Ownership at 62 noting that “Investor Owned firms have the important
advantage that their owners generally share a single well defined objective: to maximize the net
present value of the firms earnings.”
102
Hansmann, Ownership at 62 noting that “The costs of collective decision making are thus relatively
low for investor owned firms.”
103
104
Hansmann, Ownership at 57–62.
105
Ibid. at 63.
106
Ibid. at 65 noting that “once uncertainty is introduced it would be surprising if shareholder opin-
ions did not differ on which course will maximize share value.”
participation others less so. The median decision of the informed and uninformed
may not proxy to the average preference or the value maximizing preference. The
costs of direct investor governance where there is widespread ownership would
expand exponentially and be unworkable.
Consideration of the governance costs of direct decision making by investors
when ownership is diffuse thrusts the institutional structure of representative
governance as the central mechanism in controlling governance costs into the
spotlight. Representative structures reduce governance costs, although the extent
to which they do so is a function of the adaptation of the form of representation to
context. Cost reduction by means of representative governance may be a function
of, inter alia, the following factors: representation limits the number of authorized
voices and links these voices to a shared explicit goal/duty–profit; it distances deci-
sion making from an emotional attachment to interest, facilitating compromise
and consensus and it may allow the decision maker to see more clearly the par-
tiality of interest; and it allows individuals to specialize in governance thereby
reducing time, information gathering and collective action costs. Furthermore, the
representative body’s delegation to full-time management is likely to reduce the
costs of governance as with time, knowledge and information control advantages,
managers can largely control decision making.107 The costs of collective decision
making are contained because the corollary of delegation to management is that
the part time non-executive directors are not in a position to make well informed,
considered decisions and, therefore, they readily defer to management. As most of
the time the external board members do not make an independent decision, the
costs of governance are minimal. From this perspective, the investor represent-
ative board is governance cost efficient because it fails as a control mechanism.
Any account that argues that governance costs as a function of owner interest
homogeneity renders employee ownership unworkable and investor ownership
workable, must explain exactly how the relationship between interest homogene-
ity and representative structures render worker representative governance more
expensive than investor representative governance. For example, if, as explained
above, delegation to full time management in an investor representative setting
reduces governance costs, then perhaps employee representation will increase
these costs by making the board a more effective control mechanism. As an
employee representative is likely to share many of the knowledge advantages of
management and will be more able to detect misinformation than external part-
time directors, the presence of an employee director could lead to the board’s
increased awareness of options, disagreement and conflict/expression of interest
and, accordingly, to increased costs of governance. Facetiously stated, employee
107
JH Choper, JC Coffee, RJ Gilson, Cases and Materials on Corporations (4th ed., Boston; Little, Brown,
1995) noting at 7 that “in normal circumstances, social norms time constraints and informational
imbalances all result in a tendency for the board to be dominated by the chief executive.” See MC
Jenson, supra at n. 52.
representation may not work because it makes the board work. However, in his
general discussion of the theory of governance costs, Hansmann fails to provide an
explanation of why heterogeneity of employee interest increases the costs of rep-
resentative governance.
Absent a specific account of the governance costs of representative employee
ownership, we cannot assume that the costs of employee ownership are high
because the costs of direct employee ownership are high, just as we do not (and
Hansmann does not) assume that the governance costs of investor ownership are
high because widespread investor direct governance would incur prohibitive
governance costs.
3.2. Partners as workers: who owns the law firm?

As noted above, the law firm, as a proxy for the employee-owned firm, operates to
organize the weight and priority of the costs responsible for the evolution of board
membership and control. Hansmann abstracts from the law firm to the concept of
worker ownership and in so doing expropriates aspects of legal practice as pre-
conditions for worker ownership. Indeed, if the law firm is the worker-owned firm,
as Hansmann contends, then the logic of his governance cost claim is compelling
given that the owners of law firms do, on the whole, have homogenous interests.
On reading Hansmann’s analysis for the first time, the notion that the law firm
is the archetypal employee/worker owned firm is unsettling. The label appears
both appropriate and inappropriate. Law firms are owned by people who work at
the firm. The equity partners of a law firm have a residual claim on the firm’s earn-
ings and all participate in strategic decision making. Many of the non-owner
employees will, following a period of employment, either leave or become
employee-owners. Therefore, worker ownership seems an appropriate label. On
the other hand, the clear majority of a law firm’s workers have no investor-like
residual claim and have no input into strategic decision making. This includes not
only lawyer non-owners (associates, trainees) but also secretaries, as well as
employees who work in reception, mail room, information technology support,
maintenance, bills and accounting, library, catering, cleaning etc. Many of these
employees are not transitory employees, rather they stay with the firm for much of
their working lives. If a worker-owned firm is a firm in which a large number of
the workers have residual claims and a decision making role, then the label
appears to be inapposite. From this viewpoint, the law firm seems to fit into other
corporate boxes. For example, one could describe it as an unlimited liability108
investor-owned close corporation: it has a limited number of investors who, as in
108 This characterization ignores the fact that law firm partners may in some jurisdictions be able to
limit their liability through limited liability partnerships. See, for example, the New York Limited
Liability Partnership Act.
many close corporations, also work full time at the firm and enter into employ-
ment relationships with other lawyers and support staff, and a considerable major-
ity of employees are not investors in the firm. Accordingly, if law firms provide an
example of worker ownership then so do many close corporations. However, it
would seem odd to rely on close corporations where only a few of the employees
are owners to identify the conditions under which employee ownership is success-
ful. This sense of lack of fit seems to relate to the percentage of the workforce who
owns the firm. Hansmann also shares this sense. In an endnote in the Ownership of
Enterprise, when discussing the 1980’s management buyouts, he notes that whilst
these firms may be employee-owned they “do not provide much evidence con-
cerning the viability of employee ownership” because “typically only a very small
number of managers participate in the ownership of these firms and these owners
come from a fairly narrow stratum of the firm’s employees.”109 Arguably, as only
a small number of employees participate in ownership of the law firm, it too does
not “provide much evidence concerning the viability of employee ownership.”110
If we reject the claim that the law firm is a proxy for worker ownership, then
what does the law firm teach us about the costs of organization and when it is pos-
sible for employees to play a role in strategic participation? The law firm is a firm
in which a limited number of persons have residual interests and control the firm.
These persons invest limited financial capital and considerable human capital.
The owners generally have shared interests and incentives. When the firm is rela-
tively small, the partners all participate in decision making and share management
responsibilities amongst themselves. As the firm increases in size, management is
often hired and representative decision making structures such as managing part-
ners, partnership councils and executive committees are introduced, limiting deci-
sion making activity and attenuating conflict. If these short points about law firms
are accurate, then it seems that small law firms teach us in the first instance about
the problems of direct democratic decision making in organizations, i.e., a limited
number of individuals can participate directly in decision making. Too many par-
ticipants impose excessive costs and necessitate the introduction of representative
structures. Perhaps, the law firm teaches us that homogeneity of interest may allow
a greater number of participants before the costs of direct democracy get too high.
That is, homogeneity of interest may indeed allow a slightly larger membership of
a direct economic democracy. But even in law firms the limits of direct particip-
ation are quickly reached and representative structures are introduced. In
summary, law firms contain may lessons about how employee ownership can be
made to work by adjusting representative structures to the context and growth of
109 Hansmann, Ownership at 105 n. 49.

110 Blasi and Kruse, for example, “reserve the term employee owned for a corporation that is more
than 51% owned by its employees . . . such a firm must include most of its employees broadly rep-
resented.” JR Blasi and DL Kruse, The New Owners: The Mass Emergence of Employee Ownership In Public
Companies and What it Means to American Business (New York, Harper, 1991) at 7.
a firm. However, its lessons are found in the development of its institutional struc-
tures not in the nature of its owners’ interests.
3.3. Labelling the exotic: Spanish cooperatives and German co-determination

Although unusual, large scale industrial worker ownership with representative
decision making structures is not unknown to either US or European economies.
Successful cooperatives exist in Spain, Italy and England. Germany and Austria
have mandatory codetermination provisions. Firms in the United States have
been bought by their employees through ESOPs, and although most ESOPs have
failed to pass through voting rights and/or provide employees with a role in
governance, a few have done so.111 Many of these firms and co-operatives are gov-
erned with or owned by employees with highly heterogeneous interests, yet they
are successful. Apparently the costs of governance in these firms has not prohib-
ited their success or survival. Accordingly, they represent a problem for
Hansmann’s governance cost account of organizational evolution. If the costs of
governance can be institutionally attenuated, then these costs cannot explain why
worker owned firms with adaptive representative structures do not abound.
Accordingly, if a firm is successful and is wholly or in part owned or controlled by
employees with heterogeneous interests, then an additional factor must be present
to distinguish or marginalize this institution from the governance cost rule.
Hansmann provides these factors in the guise of the conceptual boxes of control,
non profit, culture and subsidy.112
3.3(a) Spanish cooperatives

Mondragon is a successful grouping of industrial cooperatives based in the Basque
region of Spain.113 Established in 1959, the co-operative group has grown to be
the eighth largest industrial group in Spain, with 120 companies and 42,000
employees. The Group consists of three sectors: financial, industrial and distribu-
tion. The industrial sector consists of seven sub-sectors producing a range of
111 See generally Blasi and Kruse, ibid.

112 I shall not address subsidy in any detail here. It functions very simply: if an institution’s existence
can be linked to direct or indirect subsidies its institutionally efficiency is immediately problem-
atized. The label “subsidy” legitimizes the rejection of and failure to even consider certain institu-
tional forms. Cooperatives in France and Italy are dismissed by Hansmann following his revelation
that they attract government subsidies, see Hansmann, Worker Ownership at 1794–1796.
113 See generally, www.mondragon.mcc.es for detailed information on the co-operative’s philosophy,
group structure, operations, and financials. See further, K Bradley and A Gelb, “Motivation and
Control in the Mondragon Experiment” (1983) British Journal of Industrial Relations 212; WF Whyte
and KK Whyte, Making Mondragon: The Growth and Dynamics of the Worker Cooperative Complex (Ithaca,
ILR Press, 1988) (hereinafter Making Mondragon). WF Whyte, “The Mondragon Cooperatives in
1976 and 1998” (1999) 52 Industrial and Labor Relations Review at 478.
products from household goods to engineering and capital goods.114 Membership

of the co-operative is open to any worker115 upon payment of a capital contribu-
tion of approximately $7,800.116 All members of a cooperative firm receive one
vote which they may exercise at the firm’s General Assembly. The General
Assembly is charged with, inter alia, appointing the Governing Council which
consists of between three to twelve members depending on the size of the firm.
The Governing Council is the “representative managing and governing body of
the co-operative,”117 responsible, in conjunction with the sub group executives
(see below), for the appointment, dismissal and monitoring of management.118
Each co-operative firm is part of an umbrella co-operative governance structure
containing two additional levels, namely the sub-group and group levels. The sub-
group level119 is organized on a product basis and is responsible for strategic co-
ordination and management supervision of individual co-operatives within the
sub-group. A General Assembly of delegates from sub-group firms elect a Sub-
Group Council which in turn appoints a Director General as chief executive of the
sub-group. The Director General is responsible for monitoring the management
of each sub-group firm. She may, for example, instruct an individual co-
operative’s Governing Council to remove and replace management. At the group
level, the supreme body of the co-operative is the Co-operative Congress consist-
ing of up to a maximum of 650 delegates from member co-operatives. This
Congress delegates power to a Standing Committee of 18 members designed
to supervise the top executive body, the General Council. The General Council
consists of the vice presidents of the nine divisions/sub groups and an elected
president. The General Council is responsible for the strategic development, co-
ordination and monitoring of the group as a whole.
At the individual co-operative level, the cooperatives generally do not exceed
500 employees (worker members). Worker-members have both residual claims on
the firm’s profits and voting rights. However, these residual and voting rights are
restricted. For instance, up to 70% of the firm’s net profits are placed in retirement
accounts for the workers which cannot be drawn upon until retirement;120 20% is
114
The seven industrial sectors are: automotive; components; construction; industrial equipment;
household; engineering and capital goods, and machine tools.
115
Article 1 of the “Basic Principles” of Mondragon Corporacion Cooperativa is entitled “Open
Admission” and states that “The Mondragon Co-operative Experience is open to all men and
women who accept the Basic Principles and can prove themselves professionally capable of doing
the jobs we were able to create. Therefore there is no discrimination of any type for religious, polit-
ical, ethnic or sexual reasons.”
116
In 2002 the contribution was PTS 1,500,000 ($7,800 as of 2/27/2002).
117
Article V, Participatory Management, of Mondragon’s Basic Principles.
118
The Governing Council can dismiss management at the request of the Director General of the
respective sub-group. In addition, the Mondragon cooperative bank retains the right to replace the
management or to take over the running of the cooperative itself.
119
There are nine sub-groups, consisting of the financial and the distribution subgroup and the seven
industrial divisions.
120
The co-operative may issue a dividend of up to 70% of the firm’s profits which is then placed in
the employees individual capital accounts.
transferred to a collective account used to support other Mondragon firms, new

projects and research and development, and approximately 10% is allocated to
co-operative educational and cultural projects. As noted above, worker-members
have one member one vote voting rights. Members not only elect their represen-
tatives on the Governing Council, but also vote on the co-operative’s general
policies and strategy and must approve changes in the firm’s statutes and every-
thing that involves a “substantial modification in the economic, organizational or
functional structure of the co-operative.”121 Regarding the role of workers in the
General Assembly, Whyte and Whyte in their study of Mondragon note that “in
Mondragon all major policy changes are subject to final decision by a majority
vote of the members. Our studies of FAGOR’s painful readjustments in the 1980s
make it clear that the worker members do not simply rubber stamp the proposals
of management and the Governing Councils.”122
At first glance Mondragon seems to present a problem for Hansmann’s claim as
it provides an example of employee ownership in industrial co-operatives where
the employees have heterogeneous interests. Hansmann employs three strategies
to downplay the potential significance of Mondragon for his thesis. First, and most
importantly, Mondragon does not affect the homogeneity of employee interest
thesis as, given the “substantial attenuation” of “rights to control and to particip-
ation in earnings,” Mondragon is not really worker ownership. The implicit logic
of this move is that Mondragon survives because in the absence of control and
influence, heterogeneity of member interest cannot be expressed and, accordingly,
the costs of governance are kept in abeyance. Second, as Mondragon is not “really
worker owned”, Hansmann suggests that it resembles the non-profit, particularly
the private university, run on behalf of its workers but not by its workers. The third
strategy is to marginalize Mondragon through an appeal to the cultural specificity
of its worker-members.
(i) Attenuating Control. Hansmann’s analysis of Mondragon foregrounds the insti-

tutional constraints placed upon residual income interests and control rights. As
the indicia of ownership are attenuated, Hansmann stresses that Mondragon
“cannot really be said to be fully owned by their workers” and that it does not
demonstrate that “full ownership of a large firm with a heterogeneous labour
force can be successfully placed in the hands of its workers” [emphasis
added]. Accordingly, Mondragon is not a “successful case of full worker ownership”
[emphasis added]. The underlying argument is that “the substantive limitations
that the Mondragon system imposes on the decisions workers can make,”123 lim-
its the extent to which the members’ heterogeneous interests can be expressed.
This seems logical, as the extent to which a heterogeneous interest work force can
121 Article V, Participatory Management, of Mondragon’s Basic Principles.

122 Whyte and Whyte, Making Mondragon at 210.
123 Ibid. at 1791–92.
increase the costs of governance must be a function of whether the workers can
influentially express their concerns and interests. If the costs of governance were a
function of heterogeneity of owner’s interests regardless of whether or not those
interests could be expressed through mechanisms of control and influence, then
clearly Hansmann’s thesis would perish facing Mondragon. However, within this
expression of interest analytical framework, Mondragon, Hansmann submits,
does not counter the cost of governance thesis 124 and demonstrates only that it
may be possible (efficient) to run such a company not by the workers but “on behalf
of the workers.”
The owners have attenuated control. They vote annually at meetings to appoint
the board but in practice have limited capacity to exercise any influence, rather
they simply follow management’s direction. The owner’s ability to replace man-
agement, if dissatisfied with their performance, is limited as the costs of acting to
remove the management far exceed the benefits to any one individual share-
holder. Similarly the costs of organizing collective action inhibit, in all but the
gravest of circumstances, any collective action. This, arguably, is a description of
investor ownership. A Mondragon worker-member would be similarly con-
strained. However, she would benefit from certain “control” advantages as against
an outside investor. First, she would have a considerable information advantage
over an investor. As Hansmann notes later in his analysis, it is likely that a GM
worker will be “in a position to act more thoughtfully in electing directors than are
most of that firm’s public shareholders.”125 Such an advantage means that the
Mondragon worker-member is in a position to vote more intelligently and effec-
tively. An intelligent and informed vote is a more influential vote. Second, the abil-
ity to organize collectively is less costly when all the voters are geographically
proximate, i.e., they work in the same plant, eat in the same cafeteria, live in the
same town. Third, control is also not simply a function of when you vote and what
you can do with that vote. When you work at and own a firm, the expectation that
you will be listened to and that notice will be taken of what you say increases. Non-
voting institutional mechanisms can facilitate information exchange, communica-
tion and influence. Mondragon cooperatives, for example, make use of Social
Councils. They are not, as Hansmann, claims, powerless mechanisms which
compensate members for ineffective control of the cooperative’s governing coun-
cil.126 Rather the Social Council forms an integral part of an institutional matrix
through which influence and control is exercised by worker-members. Consider,
124
Hansmann, Worker Ownership at 1793–1794 noting that “Indeed, the Mondragon experience is
consistent with the general pattern which we have already observed: successful cases of full worker
ownership (as opposed to the attenuated form of worker ownership found at Mondragon) remain
largely confined to small firms in which a highly participatory form of democracy is feasible, and
in which the members are highly homogeneous.”
125
Hansmann, Worker Ownership at 1806. Hansmann, Ownership at 115.
126
Hansmann, Worker Ownership at 1791, noting that “in apparent recognition that the electoral mech-
anisms provide at best a highly attenuated means for workers to influence management, each firm
has a social council.”
for example, the Basic Principles of the Mondragon Co-operatives which, in

Article V, describe the Social Council as “an advisory and consultative body”
whose responsibilities include the “drawing up of proposals and reports to be
adopted by the governing bodies . . . and channelling initiatives on the part of
members to the governing and management bodies.” In their study of Mondragon
Co-operatives, Whyte and Whyte note “an increasing tendency for members of
Social Councils to become involved in evaluating and criticizing the business
performance of management.”127
Given this reassessment of control and influence at Mondragon, the problem
for Hansmann’s thesis must be restated: if the costs of governance in investor
owned firms are low because of investor homogeneity of interest rather than
because of the institutional attenuation of governance costs, then in firms where
worker owners with heterogeneous interests exert as much or more control than
investor owners typically do, one would expect governance costs to be prohibitive
and for that institution to survive only for a limited period of time. However,
Mondragon continues to prosper, survive and expand.
(ii) Mondragon as Non-Profit. Once designated “not fully owned” by worker mem-
bers, Mondragon tempts other conceptual comparisons. Hansmann suggests a
resemblance to the non-profit, managed on behalf of but not by the workers. More
particularly, he suggests a resemblance to the private university that may intervene
in the activities of its largely independent schools. A non-profit “by definition has
no owners—that is persons who share in both control and residual earnings.”128
This label/comparison has several effects. First, it generates the impression that
Mondragon is a marginal or idiosyncratic institution because although non-prof-
its are widely employed in market economies they are rarely employed by pro-
ductive competitive enterprise. Second, the label of non-profit implies that it may
experience acute efficiency problems in particular agency costs and capital access
difficulties. Third the label implies that there may be a non-commercial factor
involved in the company’s existence and survival as non-profits are often moti-
vated and cost problems controlled through an altruistic commitment of some
sort.
In coming to terms with something that is unusual we understandably attempt
to place “the unusual” into boxes with which we are familiar. In so doing “the
unusual,” in this case the Mondragon Cooperatives, cannot speak for itself and is
flattened. However, what is particularly revealing is the box that the observer
127 Whyte and Whyte, Making Mondragon at 214. However, this is clearly not always the case: Whyte
and case also note that some worker-members criticize the social council for “simply rubber stamp-
ing the decisions of management.” On the interdependence of institutions that facilitate particip-
ation, O’Connor, supra at n. 39 at 937 when considering the role of German work councils, notes
that “codetermination enhances the effectiveness of these work councils by providing labor repre-
sentatives with the opportunity to attend board meetings and review firm documents.”
128 Hansmann, Ownership at 208.
chooses which reveals little about the object but much about the observer. Among
others, Mondragon may be presented in terms of the corporate boxes of the non-
profit or the investor owned corporation. It has elements of a non-profit with up
to 10% of profits going into cultural and educational projects. The workers have
a claim on the net-profits of the company but no claim to an alienable capital
share; they have the right to vote for the members of the governing council but
very limited formal rights of control or to insist on any particular policy, for exam-
ple, wage policy. Although worker members have the right to approximately 70%
of the profits of the cooperative while employed at the cooperative, they are not
shareholders as we know them. Furthermore, as the co-operative’s group bank
has considerable power over the cooperatives, which does not correspond to an
identifiable shareholding, this encourages comparisons with the non-profit private
university, for example, Harvard.129
Alternatively, we could describe Mondragon in investor ownership terms:
members are owners of the firm with control rights which are in fact less attenu-
ated than under dispersed investor ownership. Identical to the financial claims
attached to shares, the workers as a constituency130 have a right to 70% of the firm’s
future earnings. The limits placed upon the alienability of these profits could be
compared to the lack of access to a pension fund or an ESOP entitlement until
retirement age; the absence of an alienable share compared to the formal and
practical restrictions to which the sale of close corporation shares are often subject.
The bank’s power to exert considerable control and change the management
could, instead of resembling a non profit private university, just as well remind us
of a German universal bank, acting through proxy on behalf of large sharehold-
ings, or an institutional investor that passes through the votes131 but which retains
the right to vote the shares in certain circumstances. The 20% of the profits dis-
tributed to the collective account could be seen as a dividend paid on a 20% non-
voting shareholding held by the cooperative as a whole; the 10% of the profits
distributed to educational purposes could be seen as corporate gifts.
The point here is that Mondragon fits none of these boxes. However, the con-
cepts through which an observer attempts to understand the reality of Mondragon
determine whether this institutional arrangement offers innovative ways of
attenuating the costs of worker control which could be replicated or whether it
represents an anomalous if interesting institution that should remain firmly on the
129
The Cooperative Bank retains the right to replace management.
130
This “as a constituency” argument resembles Williamson’s understanding of shareholders. In
Economic Institutions at 304, he argues that in understanding the bilateral contract between firm and
shareholder, the focus upon the possibility of individual shareholder exit is a fallacy of composition
as shareholders “are the only voluntary constituency whose relationship to the firm does not come
up for renewal.” For the purposes of understanding their exposure and to avoid this fallacy of com-
position, he argues that we should look at shareholders as a constituency.
131
A defined contribution pension plan, for instance, may provide for pass through voting. See
SJ Stabile, “Pension Plan Investments in Employer Securities: More is Not Always Better” (1998)
15 Yale Journal on Regulation 61.
margins. By suggesting that Mondragon resembles the non-profit and the private
university, Hansmann encourages the reader to leave Mondragon on the shelf.
(iii) Cultural Specificity. Finally, Hansmann notes that we should be cautious about
replicating Mondragon because of the “ethnic homogeneity, insularity and low
mobility of the Basque population from which the Mondragon system draws its
workforce.” The cultural homogeneity of this region may, he implicitly suggests,
function to reduce the problems arising from the heterogeneity of worker interests
in multi-task industrial cooperatives. The message is that cultural homogeneity
may reduce the level of heterogeneity of interest that one would expect to find in a
manufacturing corporation, but in the absence of such a tight knit community and
culture, interest heterogeneity and, therefore, governance costs would be too high.
Douglas North has taught us that culture as informal constraint is a mechanism
of economizing on transaction costs.132 Similarly, cultural homogeneity will assist
in attenuating the costs arising from the heterogeneous interests of workers, by
perhaps encouraging workers to focus more on the group’s goals and interests
rather than on their own. However, culture should be seen as one mechanism of
attenuating those costs together with more formal institutional structures and con-
straints. While specific cultural conditions may indeed burden replication of a par-
ticular institutional set, formal institutions can adapt to a different cultural setting
in order to both attenuate governance costs and to incentivize a cultural setting
that can assist that attenuation.
3.3(b) German co-determination

German companies have a two tier board governance structure: the management
board (Vorstand) and the supervisory board (Aufsichtsrat). The management board is
responsible for managing and representing the company;133 the supervisory board
is required to supervise the management board and to appoint and, if necessary,
remove the management board.134 German co-determination provides for
employee representation on the supervisory board for public and private compa-
nies. For example, in a public/stock corporation (Aktiengesellschaft ) with over 2000
employees the workers may elect up to half of the supervisory board.135
Management, wage earners and salaried employees must have at least one rep-
resentative on the supervisory board.136
132
See generally, DC North, supra at n. 14.
133
Section 76(1) Stock Corporation Act (Aktiengesetz).
134
Sections 84(1), 90 and 111 Stock Corporation Act.
135
Section 1 Co-determination Act (Mitbestimmungsgessetz (1976)). See generally, U Hüffer, Aktiengesetz
(Munich, Beck, 1997). For limited liability companies (GmbH) with between 500–2000 employees,
the employees must appoint up to a third of the supervisory board’s representatives (Labor
Management Relations Act 1952 (Betriebsverfassungsgesetz) 52 paragraph 76). See generally,
A Baumbach et al., GmbH-Gesetz (Munich, Beck, 1996).
136
Section 15(2) Co-determination Act.
German co-determination does not involve worker ownership. Employee

participation on the supervisory board is not dependent upon an equity stake in
the company. However, as Hansmann points out, the distinction between
participation and ownership is not clear cut. Employees do have long term inter-
ests in the firm’s success, not merely to provide them with employment and to
ensure the viability of their communities but also because the limited funding of
their pensions means that their retirement income is dependent on the firm’s suc-
cess many years after they have left the firm’s employ. Hansmann notes that this
does not make the workers residual claimants but rather long term creditors; how-
ever, it does operate to align investor and employee interests.
While co-determination does not involve ownership, it represents a serious
problem for Hansmann’s thesis. If heterogeneous interest employee governance is
costly, then German co-determination should be even more expensive, as
employee decision makers have only quasi ownership incentives. However,
German co-determination does not seem to have inhibited the success of many
German firms or the German economy. Indeed, according to some accounts, such
institutional structures are partly responsible for West Germany’s success in incen-
tivizing high value, high skill production.137 Capital and heterogeneous labour
interests apparently exercise control over the company in a way that has not
generated prohibitive costs of governance.
Hansmann’s brief encounter with and dismissal of co-determination employs
three arguments. The first is to focus upon the fact that capital retains control, the
second is to rely upon the supervisory board’s limited governance role, and the
third is to describe employee supervisory board representation as merely an infor-
mational presence. He presents German codetermination as a practical denial of
employee control and influence.
(i) Capital’s Control. Hansmann accurately notes that although employees may
appoint 50% of the supervisory board, the casting vote in deadlock is held by the
investor appointed chair,138 and that, as management also has representation on
the supervisory board, the voting dynamics clearly favour the investor. He argues
that in a situation of conflict capital can ensure that the efficient decision is
made.139 Effectively, this is a claim that the costs of governance can be attenuated
so long as capital has the casting vote. However if this is correct, governance cost
efficiency would not be seriously problematized in firms where employee owners
held and elected up to half the board seats so long as investor owners retained
137 W Streeck, Social Institutions and Economic Performance Studies of Industrial Relations in Advanced Capitalist
Economies (London, Sage, 1992).
138 Section 27 Co-determination Act. This section provides in the first instance that the supervisory
board elects the chairman by a two-thirds majority. If the appointment is not thereby made then
the shareholders appoint the chairman and the employees the deputy chairman. Section 29(2) Co-
determination Act provides that in the event of a tie the chair shall have the casting vote.
139 Hansmann, Ownership at 111–112.
majority control. Governance costs from this perspective would only explain the
absence of worker majority ownership and majority board representation.
(ii) The Influence of the Supervisory Board. Hansmann argues that supervisory boards
have a very limited strategic role and impact on a firm’s decision making process
which continues to be dominated by shareholder interests.140 He argues that the
supervisory board is “distant from all but the broadest decisions of policy.”141
Accordingly, co-determination is of limited concern for his thesis as workers are
introduced into an institution that makes few strategic decisions. Indeed, the sep-
aration of powers theory underpinning a dual board supports Hansmann’s posi-
tion. The supervisory board is not designed to be involved directly in the
management of the company. Section 76 of the German Stock Corporation Act
provides that the “management board is to manage the company under its own
responsibility.”142 The supervisory board merely appoints the management and
supervises their activity.143 In contrast to the Anglo-American board of directors,
the German supervisory board is in theory not involved in directing the affairs of
the company. However, although the German Stock Corporation Act is based on
the division of managerial and supervisory roles of the two boards, in fact the Act
itself provides for a limited strategic role for the supervisory board. First, the abil-
ity to appoint and reappoint the managers of the corporation provides consider-
able scope to set out the parameters of firm strategic development. The choice of
management is clearly central to the direction of the company’s development and
the ability to refuse to reappoint or to remove144 management is an incentive for
management to conform to the supervisory board’s expectations. Second, section
111(4) of the Act provides that the articles of incorporation or the supervisory
board may determine that specific types of transaction may be entered into only
140
Ibid. at 112.
141
Ibid. at 112.
142
Translated in M Peltzer and AG Hickinbotham, German Stock Corporation and Co-determination Act
(Cologne, O. Schmidt, 1999).
143
J Böhm, Der Einfluss der Banken auf Grossunternehmen (Hamburg, Steuer-und Wirtschaftsverlag, 1992)
[The Influence of Banks on Large Enterprise] noting at 170 that “of central importance for the
Stock Corporation is the statutory distribution of competences between the management board,
the supervisory board and the general meeting. The management board manages the company
under its own responsibility, the supervisory board elects and supervises the management board”
[my translation].
144 The supervisory board has the power to remove a member of the management board for cause:
“ein wichtiger Grund” (section 84(3) Stock Corporation Act). MJ Roe, “Some Differences in
Corporate Structure in Germany, Japan and the United States” (1993) 102 Yale Law Journal, 1927
at 1942, notes that the supervisory board does not have the power to remove a manager “at will.”
In practice, however, the supervisory board has considerable, effectively “at will,” discretion.
Cause does not require fault. A lack of trust in the business judgment of the manager in question
would be sufficient. Furthermore, the appeal process available to the manager takes such a long
period of time (at least 3–4 years) that in reality it provides no remedy to the manager and no lim-
itation on the board’s actions. See Peltzer and Hickinbotham, supra at n. 142 at 13.
with the supervisory board’s consent. Although of diminishing importance,145

today this provision provides the supervisory board with direct strategic control of
certain major company decisions, for example, large property transactions, major
investments and participation in other companies.146
Moving away from the statutory distribution of powers and responsibilities, it
appears that, in practice, the supervisory board’s strategic role is much enhanced.
As might be expected from an institution that has the power of managerial
appointment, reappointment and removal, the clear statutory boundaries become
rather blurred in the actual practice of governance.147 For the manager to secure
her job and reappointment she must take account of the interests and opinions of
the members of the supervisory board. As a corollary thereof, it seems that
managers will ensure that the supervisory board members are consulted and that
their perspectives are taken into account in strategic decision making.148 A survey
carried out by Knut Bleicher in 1987 revealed that the members of supervisory
boards considered that they were actively involved in the management of the com-
pany and, in particular, in determining the future investment plans of the com-
pany.149 Jürgen Böhm argues that “investment decisions involve such close
working cooperation between the management board and the supervisory board
that practically we should speak of a joint investment policy.”150 Perhaps it could
be argued that the actual decision making role of the supervisory board is in prac-
tice constrained as the board usually meets only four to six times a year. However,
it seems that in addition to these formal meetings the management board and the
145
According to German commentators this provision is of limited importance today. It is unclear
whether this is as a result of investor reaction to co-determination (see, M Kittner, R Köstler,
U Zachert, Aufsichtsratspraxis (Cologne, Bund, 1995) [Supervisory Board Practice] at 68 and Peltzer
and Hickenbotham, ibid. at 18) or to the increasing complexity of modern business life (see
D Hoffman, Der Aufsichtsrat: Ein Handbuch für die Praxis (Munich, Beck, 1994) [The Supervisory
Board: A Practice Handbook] at 73–75). However, in practice the management board still requires
supervisory board consent for a range of important transactions.
146
Böhm, supra at n. 143 noting at 171–172 that “the catalog of measures which the supervisory board
reserves for its consent, normally comprise of the purchase, the sale and encumbering of property
and buildings; the erection and renovation of buildings and the expansion of machine plant; the
taking of debt and the granting of guarantees to the extent that they exceed a specific amount; the
granting of general powers of attorney and prokura as well as the appointment and termination of
employees to the extent that their salary exceeds a certain order of magnitude; the establishment
and dissolution of branches; important changes in the production program and production reor-
ganization; the purchase and sale of shareholdings and patents to the extent that they are con-
nected with highly risky transactions” [my translation].
147
Böhm, ibid. at 174, noting that “In practice the first impression of a clear separation of competences
. . . loses its clarity” [my translation].
148 Böhm, ibid. at 175, noting that “De facto, through its participation in the pre decision preparation,
the supervisory board is integrated into the decision making process of the management of the
company” [my translation].
149 K Bleicher, Der Aufsichtsrat im Wandel (Gütersloh, Bertelsmann, 1987) [The Supervisory Board in
Transition]. 60% of the supervisory board members surveyed by Bleicher believed that they were
in a very strong position to influence the management of the company. Only 9% of those surveyed
believed that they exercised minimal decision making influence.
supervisory board are in regular informal contact.151 Therefore, attention to

supervisory board practice reveals that this board is involved in much more than
merely “the broadest decisions of policy” and that co-determination introduces
worker representatives into an institution with a degree of strategic power very
similar to that of the external directors on the Anglo-American board of direc-
tors.152
(iii) More than Information. Hansmann argues that the real value to employees of
supervisory board representation is access to reliable information. However, he
goes further than this, blurring ought with is, and argues that employee represen-
tation on the supervisory board has performed merely an informational role.153
This claim dovetails with his observation that decision making is dominated by
shareholder interests and that the supervisory board plays a minimal role in deci-
sion making. In the absence of effective control and influence, in merely using
board membership to obtain and verify information, the costs that are latent in the
heterogeneity of worker interests remain dormant. Accordingly, Hansmann’s
governance costs and homogeneity claim is unaffected by co-determination as
its operation in practice does not result in the realization of the costs which it
150
Böhm, supra at n. 143 at 177 referring to E Gutenberg, Unternehmensführung (Weisbaden,
Betriebswirtschaftsverlag, 1962) [my translation].
151
See Böhm, ibid at 179–181.
152
On a comparative note, arguably the supervisory board member’s strategic power is greater than
that of external Anglo-American directors. Mark Roe, for example, notes that in Germany
“Managers still have the upper hand, but the tilt is not nearly as pro managerial as it has histori-
cally been in the United States” (Roe, supra at n. 144 at 1945). Although commentators lament the
weakness of the board (see Kittner et al, supra at n. 145 at 72, noting that the shareholder repre-
sentatives on the supervisory board are often in effect appointed by the management board; E
Schleffer, “Der Aufsichtsrat—Nützlich oder Überflüssig?” [The Supervisory Board—Useful or
Superfluous?] Zeitschrift für Unternehmens-und Gesellschaftsrecht 1/1993 at 65 calling for a more atten-
tive, skilled and active supervisory board), there are good reasons to see the supervisory board
members as less captured that the members of the Anglo-American board. First, German univer-
sal banks through their own shareholdings or through proxies which they exercise on behalf of
other shareholders, are relatively powerful as against the management board. Through the votes
at their disposal they can often control the general meeting which appoints the supervisory board’s
shareholder representatives. Accordingly, the shareholder representatives look to the banks rather
than management to keep their jobs. Second, clearly the worker representatives do not have to look
to management to maintain their position and may have access to knowledge and information
advantages that external Anglo-American directors do not. Third, it seems that the supervisory
board members often meet informally prior to the actual supervisory board meeting to address
conflicts and strategy (see Schleffer, ibid. at 73).
153
Hansmann, Worker Ownership at 1803 noting that “In short the primary effect of codetermina-
tion has arguably been just to provide workers with some informational seats on the board of direc-
tors.” Hansmann, Ownership at 112 noting that “The worker representatives to the supervisory
board arguably play a largely informational role, providing a credible source of information from
the firm to the workers . . . and indeed both these systems may be little different from the regimes
imposed in the Scandinavian countries and elsewhere, under which workers have the right to have
only one to three members on the board—enough to serve as informational conduits but not
enough to exercise meaningful control.”
theoretically threatens. However, this informational role claim is both unpersua-

sive and inaccurate. While the informational safeguard provided by employee
supervisory board representation may be essential to German industrial relations
and economic success, it is not accurate to describe it as merely informational. As
noted above, the supervisory board has, in effect, the power to review policy deci-
sions and to remove and appoint management. As Bainbridge notes in rejecting a
purely monitoring understanding of the role of the board “the power to review is
in a very real sense the power to decide.”154 Accordingly, “allowing employee rep-
resentatives to participate in reviewing managerial decisions thus inevitably trans-
fers some aliquot of the ultimate decision making authority within the firm to those
representatives.”155 Worker representatives under co-determination, therefore,
exercise influence and control. As in an Anglo-American board, this may be con-
strained through management’s control of information and self-interest but the
potential for effective influence exists.156
4. Controlling governance costs through institutional design

Hansmann’s claim that governance costs explain the limited existence of worker
ownership is not sustainable. The argument is de-stabilized by attention to the way
in which the economic reality on which he relies is constructed and presented. The
level of governance costs is not simply a function of the level of homogeneity of
owner interest but of the institutional mechanisms which can be adapted to the
context of governance, of which the degree of homogeneity of interest is but one
part. Indeed, briefly in The Ownership of Enterprise Hansmann seems to move
towards such a position. In asking what constitutes homogeneity of interest, he
notes that public choice theory demonstrates that even minimal heterogeneity can
lead to irresolvable conflict.157 He suggests that in fact “culture and institutions
place important limitations on the range of voting outcomes.” However, his
understanding of the institutional attenuation of governance costs consists simply
of cutting off the owner’s control supply, by constraining “the available range of
choices”158: silent ownership, without control and influence. What this article has
sought to demonstrate is that stripped of the framework through which Hansmann
has interpreted institutional events, “anomalies” such as Mondragon, and co-
determination can be seen as examples of institutional mechanisms which
facilitate employee control and influence whilst attenuating governance costs.
Through this frame, co-determination and Mondragon can be re-interpreted not
154
Bainbridge, supra at n. 68 at 724.
155
Ibid. at 724.
156
Consider, for example, BMW’s supervisory board’s (and the employee representatives’) role in the
selection of its CEO in February 1999.
157
He cites G Kramer, “On a Class of Equilibrium Conditions for Majority Rule” (1973) 41
Econometrica 285.
158
Hansmann, Ownership at 98.
as examples of firms in which the costs of governance are kept in abeyance through
the attenuation of control and influence; rather they are successful institutional
mutations that, given the heterogeneity of employee interests, limit governance
costs whilst facilitating influence and control. In these terms it makes little sense to
argue that governance costs as a function of owner interest heterogeneity explain
when worker ownership works and when it does not. If institutional adaptation
can control these costs without simply cutting off the expression of interest and
perspective, then these costs alone cannot explain the limited role of employees in
strategic governance in advanced western economies.
However, the failure of heterogeneity of owner interest to account for the path
of institutional evolution does not retire governance costs from institutional eco-
nomics. On the contrary, it is clear that the heterogeneity of owner’s interests may
generate costs. However, such costs may be attenuated through representative
institutional design. The institutional mechanisms revealed by Mondragon and
co-determination are merely elements of a larger set of imaginable institutional
structures which could attenuate the costs of governance of representative worker
ownership whilst facilitating employee influence and control. The task of the insti-
tutional economist is to assemble and devise institutional forms that can disable the
governance costs which may be threatened as a consequence of employee strate-
gic representation. 159
159
Unfortunately there is no scope in this article to develop these ideas about institutional design. The
focus of an institutional solution would be to diminish the possibility of interest polarization on the
board. In this regard, it would not make sense to facilitate the attachment of particular directors to
defined interest groups in the firm. In addition, the corporation’s rules and structure must disin-
centivize interest group seeking activity and incentivize profit motivated decision making. The fol-
lowing are two outline examples of institutional mechanisms for firms with employee strategic
representation:
• Innovative use of independent directors appointed by an appointments committee. For instance,
an independent directors committee could be given powers of censure or multiple voting rights
when employee representatives are deemed to be acting in a partisan fashion and not in the
interests of shareholder value. Alternatively independent directors could be appointed with the
intention of mediating conflict. Such mechanisms would disincentivize hold up, conflict and rent
seeking.
• Imagine institutional investment vehicles providing pass through voting rights to employees suf-
ficient to elect a number of designated directors (given that institutional investors usually take
only limited holdings in any one company, an investor mediating institution may be necessary
to collect and organize the pass through votes of several investors). The institutional investors
would retain sufficient voting rights to elect a representative to ensure that the employee rep-
resentatives acted in the interests of shareholder value. If following failure of the employee rep-
resentatives to so act, the institutional investor sold these shares the employees would lose their
rights of representation. This would generate incentives for the employee representatives to
exercise their influence and decision-making power in the pursuit of profit, which would con-
tain governance costs.
D. C ONCLUSION
If the end of the twentieth century represented the end of history for corporate law
and the end of the road for labour’s aspirations to participate in corporate govern-
ance, then these end points have been fortuitously identified as they lack persua-
sive theoretical support.
Williamson has demonstrated that burdensome costs will be incurred if equity’s
interests are not safeguarded through certain board protections. However, he has
not demonstrated that safeguarding these interests requires excluding employees
from board representation. From a transaction cost of capital perspective, the
board safeguard can be designed to protect equity’s risk exposure while facilitat-
ing employee input in the firm’s strategic decision making. Hansmann’s work
reveals that owners with heterogeneous interests may impose prohibitive costs on
strategic decision making. However, there is no direct link between the level of het-
erogeneity of owners’ interests and the level of governance costs. As demonstrated
by this article, institutions can mediate the relationship between heterogeneity and
governance costs and thereby control governance costs. Indeed, a closer look at
German co-determination and the Mondragon co-operatives reveal examples of
institutions that facilitate employee input in governance while containing the costs
that the expression of heterogeneous interests clearly threaten. Again, as with the
transaction costs of capital, there is considerable institutional room to involve
employees in corporate governance while avoiding the negative governance cost
implications thereof.
Williamson and Hansmann have identified cost factors that have moulded cor-
porate governance but they have not, in any unilateral sense, identified the cost fac-
tors that have been the evolutionary driving force behind US and foreign
institutional arrangements. Cost factors such as transaction or governance costs
rarely demand a single path, although they do restrict the number of paths that can
be taken. It is clearly conceivable that at some point further research into the cost
implications of employee strategic participation will block all but one path, which
could be the path to where we are now. However, Williamson and Hansmann’s
analyses of labour’s role in corporate governance have not brought the discipline to
this resting place. Accordingly, it remains equally conceivable that efficiency has no
clear end point in an imperfect world with imperfect markets and that other factors,
for example, corporate and management culture, may have to be reconsidered as
the arbiters of a choice set created by the selection of such imperfect markets.
The end of history for corporate law claim is premature. As this article has demon-
strated, at least as regards labour’s participation in corporate governance, it is a
claim that does not have theoretical support. As suggested in the introduction, it
seems that it is a claim which is riding the wave of the recent economic good times
in the United States. It would be an error to mistake a transitory economic boom,
aspirations to a new economic paradigm or satisfaction that America is once again
in the economic lead for an economic theory. Arguably, proponents of the end of
history for corporate law claim make this mistake.
If efficiency is, as surely few would contest, the starting point of organizational
analysis then, if the end of history for corporate law claim is correct, scholars interested
in institutional experimentation and devising a mechanism through which
employees can participate in their firm’s strategic decisions should switch off their
computers. However, if, as this article submits, the theoretical supports for the
claim are suspect then it is too soon to shut down. Surely, given the gravity of the
claim’s implications, the discipline should demand a solid foundation before it
enthrones the status quo and turns off the power to its institutional imagination.

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Journal of Corporate Law Studies

ISSN: 1473-5970 (Print) 1757-8426 (Online) Journal homepage: http://www.tandfonline.com/loi/rcls20

No End in Sight for the History of Corporate Law:

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NO END IN SIGHT FOR THE HISTORY OF CORPORATE LAW:

that maximize shareholder value by minimizing the costs of organizing economic

B. O LIVER W ILLIAMSON : A TRANSACTION COST ACCOUNT

Section B looks at Professor Williamson’s transaction cost explanation of why an

opportunistically. Bounded rationality assumes that whilst economic actors are

2. The logic of investor ownership: the efficient distribution of board

Fig. 1: Williamson’s Node Analysis

24 Williamson, Governance at 185.

2.1. The firm specificity of human capital

Absent collective bargaining agreements,34 grievance structures, promotion lad-

Indeed, if firm-specific labour is located at Node C it makes no sense to discuss

2.2. Dividing the prize: safeguarding equity investments

efficiency rather the product of transaction cost economics’ conceptual structure

benefits to individual shareholders.53 The collective action problem54 generated

53 FH Easterbrook and DR Fischel, supra at n. 2 at 78.

C. H ENRY H ANSMANN ’ S THEORY OF GOVERNANCE COSTS

Section C explores Professor Henry Hansmann’s governance cost explanation of

67 See text to nn. 26–40.

Hansmann contends that investor ownership is particularly conducive to low

2. The authority of reality

Of central importance to Hansmann’s argument that the viability of employee

3. Through the looking glass: tailoring corporate reality to theory

3.1. The illusion of direct participation

of worker ownership to direct democracy, Hansmann allows the readily available

3.2. Partners as workers: who owns the law firm?

109 Hansmann, Ownership at 105 n. 49.

3.3. Labelling the exotic: Spanish cooperatives and German co-determination

3.3(a) Spanish cooperatives

111 See generally Blasi and Kruse, ibid.

products from household goods to engineering and capital goods.114 Membership

transferred to a collective account used to support other Mondragon firms, new

(i) Attenuating Control. Hansmann’s analysis of Mondragon foregrounds the insti-

121 Article V, Participatory Management, of Mondragon’s Basic Principles.

for example, the Basic Principles of the Mondragon Co-operatives which, in

3.3(b) German co-determination

German co-determination does not involve worker ownership. Employee

with the supervisory board’s consent. Although of diminishing importance,145

supervisory board are in regular informal contact.151 Therefore, attention to

theoretically threatens. However, this informational role claim is both unpersua-

4. Controlling governance costs through institutional design

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