The liberal market model of finance, ownership, and governance: An evaluation of its effect on...

Asia Pacific Journal of Human Resources 2009 47(2) 133

The liberal market model of finance, ownership, andgovernance: An evaluation of its effect on labour

Andrew Pendleton*University of York, UK

This paper examines the theory and evidence of the effect of finance, ownership, andcorporate governance on labour and employment, with special reference to the so-called ‘market-outsider’ or liberal market economies. The main finance, ownership,and governance characteristics of these economies are described and brieflycompared with those in so-called co-ordinated market economies. A set ofpredictions of the impact on labour management and employment are outlined.Evidence is presented from comparative studies and from within-country studies,especially of the United Kingdom. It is found that predictions are not clearly borneout, and the paper identifies a set of factors to explain this. These include dispersedownership, the nature of corporate law, and the public visibility of listed companies.

Keywords: corporate governance, employment relations, ownership

Correspondence to: Professor Andrew Pendleton, York Management School, University ofYork, York YO10 5DD, UK; fax: + 44 1904 434163; e-mail: [email protected]

Asia Pacific Journal of Human Resources. Published by SAGE Publications (Los Angeles, London, New Delhi,Singapore and Washington DC; www.sagepublications.com) on behalf of the Australian Human ResourcesInstitute. Copyright © 2009 Australian Human Resources Institute. Volume 47(2): 133–149. [1038-4111]DOI: 10.1177/1038411109105438

* An earlier version of this paper was presented to the annual conference of the Association ofIndustrial Relations Academics in Australia and New Zealand in February 2008 and to staffand students at La Trobe University, Melbourne. I am grateful for comments on the paper byparticipants in these events, and by the editor and referees.

In the last ten years interest has been steadily mounting within industrialrelations and human resource management (HRM) in how finance, ownership,and corporate governance affect employment, industrial relations, and humanresource management. Underlying this development has been an appreciationthat ‘financialisation’ (defined broadly as ‘the globalisation of financialmarkets, the shareholder value “revolution”, and the rise of incomes fromfinancial investment’ (Stockhammer 2004, 720)) has been affecting ever-broader aspects of public and private life. There has been a growing recogni-tion that much of what happens in employment and labour relations is

substantially influenced by institutions, practices, and pressures that are some‘distance’ from direct management–employee–union interactions. Alongsidethis development, interest has been growing in the relationship betweennational ‘business systems’ and other features of national economies, such aslabour relations. Distinctions have been drawn between regime types andpatterns of employment and industrial relations.

The purpose of this paper is to consider how, why, and to what extentfinance, ownership, and corporate governance affect labour management(broadly defined), focusing on the liberal market economies in general and theUnited Kingdom in particular. We draw attention to a ‘two-systems’ modelwhich has dominated the literature to date. This model contrasts systems saidto be characterised by market forms of co-ordination between shareholdersand managers, as in the United States, the United Kingdom, Australia, andNew Zealand, and those where co-ordination through relationships betweenkey actors is more important, typically Germany and Japan. Although thiscomparative perspective has been influential, there has been growing criticismof the ‘two-worlds’ approach, focusing mainly on its inadequacies inportraying systems other than the market system. We add to this criticism byevaluating the labour relations characteristics associated with market-basedsystems. Drawing on recent comparative and within-country evidence, weassess whether the labour management predictions are borne out by theevidence.

Our review of the evidence indicates a mixed picture. While there is someevidence that is consistent with the descriptions in the ‘market model’, there isequally considerable evidence that casts doubt on the predictions found in themodel. Labour management is more complex and often more ‘benign’ toworkers than is predicted in the market model. We argue that managers havea degree of ‘strategic choice’ and autonomy from shareholders in their manage-ment of labour, contrary to the determinism in the market model. We attributethis strategic choice to key characteristics of the ownership and governancesystem including dispersed ownership of large companies. Growing concen-tration of ownership has encouraged shareholders to engage in relational moni-toring, but ownership stakes have not become sufficiently large to substantiallyshift effective power to shareholders. We also highlight the role of corporatelaw in limiting the duties of managers to shareholders, and also recentlystrengthening their obligations to other stakeholders such as labour. We then goon to suggest that managers may use their discretion to pursue labour strategiesand practices that can be beneficial to labour for a variety of reasons, includingthe desire for a quiet life. These tendencies are reinforced by public scrutiny oflisted companies and pressures for corporate social responsibility. However, wemust emphasise that not all is rosy for labour in liberal market economies likethe United Kingdom. The well-developed but relatively unregulated financialsystem has facilitated the development of new financial instruments and invest-ment practices which can be harmful for labour. An unresolved issue is the

134 Asia Pacific Journal of Human Resources 2009 47(2)

The effect of the liberal market model on labour 135

extent to which these developments, alongside periodic bouts of restructuring,cast a longer term shadow over human resource management and labourmanagement. At the time of writing (late 2008) there is growing awareness thatthey can have serious and substantial adverse effects on workers via their contri-bution to economic instability.

Several strands of literature on finance, ownership, and governance haveemerged in the last few years, of which only some focus specifically on labour.The first, and most extensive, is that in financial economics. This literature isdominated by a principal–agent perspective, with corporate governance beingviewed as the ways in which investors (predominantly shareholders) getmanagers to do what they want them to do (Shleifer and Vishny 1997). Thisliterature has not traditionally considered labour, with the obvious exception ofmanagers (executive compensation looms large in this literature). Recently,however, an interest in labour has started to emerge (e.g. Pagano and Volpin2005). A second strand is what might be called the ‘mainstream corporategovernance’ literature. This tends to focus on the institutional characteristics ofcorporate governance, such as size and composition of boards of directors,shareholder rights, codes of conduct, etc. This might be viewed as a ‘narrow’conception of corporate governance. The third strand might be referred to ascomparative political economy. This literature is notable for comparing groupsof national economic and business systems, and labour tends to be integral toanalyses in this tradition. Finally, there is an emergent literature in industrialrelations itself, drawing heavily on the political economy literature. We willconsider these latter two streams of literature in this paper.

The comparative political economy literature highlights complementar-ities between labour management systems and other components of nationalbusiness systems. Much of this literature utilises a two-systems model, high-lighting differences between one system where the co-ordination of economicactivity and actors occurs predominantly through market transactions: UnitedStates, Canada, United Kingdom, Ireland, Australia, and New Zealand; andanother where non-market based forms appear to be more important, as insome European and Asiatic economies, typically Germany and Japan.Differences in labour management between these two groups are seen to berelated to differences in the organisation of finance, ownership, and governance.The most well-known and influential strand of this literature is that of ‘varietiesof capitalism’ (Hall and Soskice 2001). Authors in this tradition contrastmarket-based (liberal market economies: LMEs) with relationship-based formsof co-ordination (co-ordinated market economies: CMEs) across various dimen-sions of corporate activity, such as relationships with labour, dealings with otherfirms, etc. These authors highlight complementarities between approaches to

The literature

finance, ownership, and governance, and approaches to labour management.As it is well put by Gourevitch and Shinn (2005, 52):

In LMEs firms coordinate through formal contracting in arm’s-lengthrelationships operating in highly competitive markets. In CMEs firmscoordinate through information sharing, repeated interactions, and long-term relationships, all sustained by institutional arrangements that make thestability of these commitments credible. In CMEs managers invest inworker training to sustain manufacturing that demands high levels of skill,and workers have incentives to engage in that training; in LMEs managersprefer flexibility and hence lack motive to invest in skills development,whilst workers lack incentives to upgrade.

The finance and ownership features of the two systems are contrasted asfollows. Stock-market listing is more widespread in market than relationaleconomies, and hence characteristics associated with market listing are morepervasive and important. The London Stock Exchange, for instance, had 3256listed firms in 2006 compared with 760 on the Deutsche Borse (Federation ofWorld Exchanges 2007), despite Germany being a larger economy. Stock-market capitalisation was around 140% of GDP in the United Kingdom andUnited States, and around 110% in Australia, in 2005 compared with under50% in Germany (World Bank 2007).1 Ownership of listed firms in marketeconomies tends to be more dispersed than among unlisted firms or amonglisted firms in relational economies. In their survey of the 20 largest firms ineach country, nearly all of the UK and US sample were widely held comparedwith 5–50% in most European countries (La Porta et al. 1999).2

In market economies ownership is typically dispersed among institutionalinvestors who maintain large and diversified portfolios of stock-market invest-ments. Banks and industrial firms typically own just a small fraction ofcompanies. Family ownership is rare among larger firms in market economies(La Porta et al. 1999). By contrast, in relational economies, bank, industrial, andfamily ownership is more widespread and extensive. A notable feature ofcountries such as Japan and Germany is interlocking ownership betweencompanies. It is sometimes said that firms in liberal market economies makemore use of equity financing while those in co-ordinatedmarket economies makegreater use of long-term bank lending, but in recent years share buybacks havemeant that net fixed capital raised via equity has tended to be larger in CMEs.3


1 New Zealand does not readily fit the LME stereotype, with the market capitalisation of listedcompanies being under 40% of GDP in 2005.2 Exceptions to this generalisation are New Zealand where most of the largest firms are notwidely held (see also Cameron 2007) and Japan where most are widely held.3 In both systems, firms rely primarily on internally generated funds.


Fundamental differences in governance are typically associated with thesedifferences in finance and governance. Shareholders in market/outsidereconomies are said to rely on market mechanisms (primarily secondary markettrading) to enforce discipline because the costs of interventionist or relationalmonitoring exceed the gains (due to free-rider problems). The value of secondarytrading in the United Kingdom and the United States is nearly double GDPcompared with about two-thirds of GDP in Germany (World Bank 2007).4 Inrelational/insider countries, owners have the power, opportunity, and pay-offsto engage in active governance characterised by continuing relationships withinvestee firms. In brief, the contrast is that between exit and voice.

In the liberal market economies, these features of ownership, finance, andgovernance are said to influence management decision-making and practicesin several ways. Governance via the secondary share market means thatmanagers are said to be at the mercy of shareholders. Because institutionalshareholders have diverse portfolios and minority stakes they are prone to exitin response to poor managerial or company performance (Hutton 1996). Someinstitutional owners are said to have short-term orientations: the structure ofthe pension fund industry in particular, whereby pension fund managerscompete for pension fund business, means that short-term financial returns oninvestment are of prime importance. The propensity to exit puts managers atthe mercy of takeovers, and hence job-loss. It is therefore in managers’ intereststo keep shareholders happy. This lack of commitment on the part of share-holders means in turn that managers find it difficult to enter into commit-ments with other stakeholders, thereby encouraging predominantly markettransactions with them. This encourages short-termism among managers, andthis is said to pervade investment decisions (Carr and Tomkins 1998), businessstrategy (Hutton 1996; Porter 1997), and R&D (Demirag 1998). The emphasison (short-term) financial returns is cascaded down firm’s organisational hier-archies, and shapes howmanagers at all levels make decisions. These pressuresfrom the market for corporate control are enhanced by the managerial labourmarket: managers do what shareholders want to preserve present and futurejob security (Fama and Jensen 1983).

Predictions

It is not difficult to see how this system of governance affects labour manage-ment. Clearly, if market pressures are strong enough, managers will be forcedto prioritise shareholder interests at the expense of others such as labour, and to

Influences on labour management in LMEs

4 Australia is somewhat lower at around 80% of GDP, while New Zealand has lower tradingactivity than major European countries (World Bank 2007).

shift risk onto labour from shareholders (Armour, Deakin, and Konzelmann2003; Froud et al. 2000; Jacoby 2005; Lazonick and O’Sullivan 2000).Furthermore, pressures for short-termism will spill over into labour manage-ment, both directly and indirectly via business strategies, making it difficult formanagers to enter into long-term binding commitments with labour.

These general observations can be translated into several specific predictions(Gospel and Pendleton 2003; Black, Gospel and Pendleton 2007). One, job tenuremay be shorter than in relational systems and it may bemore problematic to offerjob security and long-term career structures. Theremay be a greater use of contin-gent labour to minimise long-term quasi-fixed costs. There is also likely to be agreater use of contingent pay systems where employees bear some risk. Liquidstock markets will facilitate the use of stock-based compensation tools. A shiftaway from defined benefit pension systems, in which the firm rather than theemployee bears the investment risk, towards defined contribution or personalpension systems may also be observed. Two, in so far as business strategies mayfavour products and services not requiring long-term investments, there may bea tendency to depress skill levels and avoid complex patterns of work organisa-tion. All things being equal, it seems likely that there will be lower investment incontinuing training by firms, with a preference for securing trained labour on theexternal labour market as and when required. Three, in industrial relations, itmight be predicted that firms will have a higher propensity to avoid union recog-nition and collective bargaining as this may form a countervailing force to share-holder interests.Where collective bargaining does occur, decentralised forms seemlikely to be favoured so as to constrain union influence within the firm. Multi-employer bargaining seems likely to be discouraged by low levels of inter-firmco-ordination.

Evidence

In the emerging literature on finance, ownership, governance, and labour thereare two main sets of empirical evidence. The first compares labour manage-ment in liberal market economies with that in relational or co-ordinatedmarket economies. The second compares listed firms with privately ownedfirms in liberal market economies, with the expectation that stock-marketpressures will mean that labour management is ‘harsher’ in the former. Wereview each sets of literature in turn, focusing primarily but not exclusively onthe UK case.

Comparative evidence

There have been a small number of comparative attempts to empirically testwhether labour management ‘outcomes’ are related to dimensions of finance,ownership, and governance. The evidence is partially supportive but there arepronounced problems of data availability and statistical methodology. Most


studies use national ‘scores’ for various aspects of finance, ownership, governance,and labour management, and there are obvious issues of within-system compo-sition and diversity that have to be recognised. With these provisos, thefollowing findings have emerged from this literature. Average job tenure tendsto be shorter in countries where there is ownership dispersion (in listed firms),high levels of secondary trading activity, minority investor protection, and ahigh level of mergers and acquisitions activity (Black, Gospel and Pendleton2007; Hall and Gingerich 2001; Jackson 2005). There is also evidence thatdownsizing is correlated with high levels of market capitalisation (relative toGDP) and mergers and acquisitions activity (Jackson 2005). Trading activity isalso correlated with greater responsiveness of employment to the business cycleand higher activity rates (Black, Gospel and Pendleton 2008). Firm-levelcomparative data indicates that downsizing is correlated with dispersedownership of listed firms (Jackson 2005). As for wages, there is no clearevidence that finance, ownership, and governance are associated with the levelof average wages (or changes in wages), though national level data indicatesan association with pay dispersion, bargaining decentralisation (Black, Gospeland Pendleton 2007), and aggregate real wage flexibility (Black, Gospel andPendleton 2008). A recent study using OECD data indicates that growth inpay inequality has been greatest in those nations, typically market-outsidercountries, in which the growth of stock markets and stock trading has beengreatest (Sjöberg 2008). Contrary to predictions, however, provision of contin-uing training is positively associated with mergers and acquisitions activity(Sjöberg 2008). There is no evidence that provision of training is lower inLMEs. There is also no association between market capitalisation or mergersand acquisitions activity and the level of unionisation (Jackson 2005).

Overall, the results from studies of this type suggest that features typicallyfound in LMEs tend to be associated with employment ‘outcomes’ (shortertenure, downsizing, more flexibility of employment) but that there are no cleareffects on other dimensions of labour management. However, these results can atbest be viewed as suggestive. While some finance, ownership, and governancedata are available on an annual basis, most of the labour data is not, with theresult that pooled models are not feasible. Observations are therefore oftenderived from a small number of years or a single cross-section, with obviousproblems of representativeness as well as a small n. The problems ofconducting multivariate analysis are compounded by the likely inter-related-ness of both observed and unobserved components of national systems. Inother words, finance, ownership, and governance measures may be proxyingfor other aspects of national systems such as legal regimes.

Within-country evidence

Recently, there have been a number of attempts to consider the relationshipbetween finance, ownership, and governance and labour management withinmarket systems. This has been facilitated by the development of questions


about governance in national workplace surveys such as the BritishWorkplace Employment Relations Survey (see Pendleton and Deakin 2007).Clearly investigation of within-system variations in the context of two-systems models requires that important dimensions in the latter are somehowtransposed to individual countries. The most common approach has been tocompare listed against non-listed firms on the grounds that governancepressures from institutional investors in the former will generate distinctlabour management features. Alternatively, some observers have attemptedto replicate the market-outsider – relational-insider distinction using listingand shareholder involvement (Anderson et al. 2006). Another approachdistinguishes between listed firms according to the strength of shareholderorientation (Bacon and Berry 2005).

In general the evidence does not indicate that labour management is lessfavourable to labour in listed firms. Konzelmann et al. (2006), usingWERS98,find that workplaces belonging to public limited companies (PLCs)5 scoresignificantly better than other private sector firms in managerial commitmentto HRM and provision of training. Information from the employee question-naire indicates that PLCs are more likely to consult over job prospects, trainingand pay, and more likely to have made training available. Consistent withpredictions, however, PLCs are more likely to use incentive pay.

In the 2004 version of the Workplace Employment Relations Survey, thegovernance measures are refined to specifically identify workplaces belonging tostock-market listed firms. Using this data, Pendleton andGospel (2006) comparelisted and non-listed private sector workplaces, controlling for size and industrialsector. They find no significant differences in relation to contingent employment(fixed-term contracts, job security guarantees, redundancies, contracting out), orto contingent pay other than stock ownership plans. Union recognition is morelikely in listed workplaces, as is membership of an employers’ association. Thereis evidence of more employee involvement (quality teams, briefing groups) andgreater disclosure of information (on company finances). Results for training areinsignificant except that possessing an Investors in People award is more likely tobe found in listed workplaces. There is no evidence that costs and profit targetsare more likely to be found in listed workplaces but productivity targets are. Thestrongest result is that benchmarking is more likely to be found in listed work-places. In a similar vein, Pendleton and Deakin (2007) compare listed and non-listed workplaces across a range of relevant factors. They find that listedworkplaces are no more likely to emphasise profit targets though they do givemore emphasis to quality of service. Listed workplaces are no less likely to offeremployees long-term employment. However, unlike the results from Pendletonand Gospel reported above, there is some evidence that listed workplaces have ahigher probability of offering training.


5 WERS98 does not specifically identify listed companies.


Bacon and Berry (2005) compare the labour management practices offirms where clear priority is given to shareholders with those where otherstakeholders’ interests are more explicitly taken into account. They find thatfirms emphasising shareholder interests have less joint consultation but aremore likely to recognise unions. There was no consistent or clear difference inthe propensity to reduce employment or employment costs.

Overall, the quantitative evidence from within the United Kingdom doesnot indicate that labour management is ‘harsher’ in stock-market listed work-places. In some respects, labour management appears to be more ‘employeefriendly’. However, a limitation of these comparisons is that the effects of largestock markets may by so strong and pervasive that they percolate throughoutthe economy, with the result that privately held firms and workplaces have somesimilar practices to their listed counterparts. Nevertheless, the pattern of evidencepresented does not sit easily with the view that stock-market listing will haveadverse effects on labour.

In theory, the market model provides harsh discipline on those managers thatdo not deliver good corporate performance. The market for corporate controlwill ultimately displace these managers, while the managerial labour marketwill mean that future employment is difficult to secure. This model providesa highly deterministic account – managerial actions will be driven by thedictates of the market. This is the basis for claims that labours’ interests willgenerally be seen as secondary to those of shareholders in liberal marketeconomies. The evidence on labour management practices presented earlier,however, is not clearly consistent with this view.We propose that the reason forthis is that the operation of the ownership and governance system in liberalmarket economies differs somewhat from the prescriptions in the model. Thegeneral tenor of the argument is that managers have a greater degree of‘strategic choice’ vis-à-vis shareholders than is often assumed in the literatureon market-based governance. As far as labour management is concerned, thereis considerable evidence that managers in stock-market listed firms use thisautonomy to pursue more ‘enlightened’ labour and HR policies than wouldbe expected from predictions extrapolated from market models, at least formost of the time.

Ownership and monitoring

Underpinning managerial discretion in ‘market’ countries has been dispersedownership of listed firms. Contrary to the view expressed earlier that thisencourages strong, market-based governance by investors, the more traditional

Governance explanations for patterns of labourmanagement in LMEs

Berle and Means (1932) perspective appears more convincing. Dispersedownership gives managers power. Typically, most institutional investors ownless than 1 percent of stock in their investee companies. Those legal protectionsfound in ‘market’ countries to protect minority investors inhibit the potentialfor larger, institutional investors to group together in ownership coalitions,though informal coalitions are formed in exceptional situations (Black andCoffee 1994). The small ownership stakes owned by most institutional investorstends to inhibit active governance because of free-rider concerns: activist share-holders bear the costs of intervention but secure only some of the benefits. Inthese circumstances, investors might prefer to govern by exit, as the marketmodel suggests, but the evidence is not strongly consistent with this. Themarket for corporate control in the United Kingdom does not on the wholetarget poorly performing firms: rather takeovers tend to be driven by concernsto achieve synergies (Franks and Mayer 1997). The evidence also suggests thatinvestors tend to make adjustments to their ownership positions in companiesrather than to offload their stake in its entirety, at least in most cases.

Two developments in recent years add to the complexity of the functioningof the governance system. One is that institutional ownership is becomingmore concentrated. As institutional investment becomes more concentrated,and the size of stakes of the largest institutional investors becomes larger, itcan become more costly and difficult for major shareholders to divest largeproportions of their stock in routine trading. This is said to be encouraging ashift to more relational styles of corporate governance among some institutions(Pendleton and Gospel 2005), and towards longer term perspectives on the partof major investors (Waring 2005). The second development is that institutionalinvestors have been increasingly pursuing ‘alpha’ strategies (InvestmentManagers Association 2007) – that is, investors seek returns that outperformthe market as a whole. Furthermore, the desired margins over the market arebecoming larger. The combination of these two developments has an inter-esting effect on corporate governance. Corporate performance is becomingmore important to institutional investors but it is potentially costly to achievegovernance via market means because the size of their ownership stakes meansthat offloading investments in their entirety may well incur losses. At the sametime, these ownership stakes are not large enough to give investors the powerover management of block-holders. This means that investors increasinglyhave to engage in relational forms of governance, in which managers call a lotof the shots. At the same time, investors are also increasingly investing in ‘alter-native investments’ such as hedge funds, and these introduce instability intocompany performance (we return to this later)

Top executives in countries like the United Kingdom and Australia nowspend a significant part of their working time engaged in meeting investorsprivately. In Pendleton and Gospel (2005) we argue that this form of governancegives managers considerable strategic choice in managing labour. They have


superior information about managing the firm and the accepted division oflabour is that investors should not ‘micro-manage’. Given also a lack of expertiseand understanding of human resource management in companies amonginvestors, coupled possibly with the vestiges of the historical view that labourmanagement is rather vulgar, the evidence suggests that investors will generallyaccept management’s preferred approach to managing labour as long as it iscredible and consistent with business strategy (see Hendry et al. 1999). There isalso the potential for a significant conflict of interest among fund managers(Gourevitch and Shinn 2005): since many fund managers are now American-style investment banks, offering a range of corporate services to firms (includingpension fund management), conflictual approaches to management tend to bediscouraged. Institutional investors are reluctant to criticise managementsbecause they want to win business from them.

The combination of these factors means that managers typically have roomfor strategic choice in their dealings with major investors. As Deakin et al. show(2006) managers may seek to secure support of major institutional investors forsignificant changes in labour management or for social partnership arrange-ments between the firm and its employees/unions. Overall, we may concludethat ‘in contrast to the stakeholder critique, which sees managers and firms as thepassive victims of the finance and ownership system, firms may determine theirlabour strategies and seek to win investor support for them’ (Pendleton andGospel 2005, 80).

Although investors generally lack expertise on human resource manage-ment, and tend to see it as a subsidiary issue in discussions with companymanagers, there is some evidence that pension funds seek to encourage goodhuman resource management in investee companies (Hendry et al. 1999;Anderson, Marshall, and Ramsay 2007). There is also evidence that some insti-tutional investors take into account social performance, including labourrelations, when making investment decisions (Graves andWaddock 1994; Cox,Brammer, and Millington 2004). Recent legislation in the United Kingdom hasde facto encouraged pension funds to take more note of corporate social respon-sibility, including labour relations, by requiring pension funds to make theirapproach to corporate social responsibility (CSR) explicit (Pendleton andDeakin 2007). The development of a range of CSR codes of conduct withexplicit labour relations and employment components, such as the UN GlobalCompact (2008) and the OECD (2008) Guidelines for multinational enterprises,may also have assisted in creating a climate in favour of CSR. The growth ofsustainable responsible investment (SRI) seems likely to further enhancepositive approaches of investors towards HRM (Waring and Lewer 2004),though there is room for doubt on its effectiveness (given the small size of theSRI sector, the difficulties of securing long-term investment advantages, andthe tendency to focus on negative screening) (see Burgess, Lewer, and Waring2006; Haigh and Hazelton 2004).


Directors’ obligations to shareholders

Although the market model emphasises that top managers should pursueshareholder value, and that the market will enforce this priority, legal regula-tion of managerial activity is not consistent with this. Legal prescriptions ofdirectors’ duties are usually to the company not the shareholders (Deakin2005). In liberal market economies, these duties have generally been establishedthrough common law, though in the United Kingdom the Company LawReview has recently enshrined these in statute. These statutory duties includethe duty to exercise independent judgment and the duty to promote the successof the company. In exercising the latter duty in the United Kingdom, directorsare explicitly required to consider the interests of employees, the communityand the environment, and to consider the long-term consequences of theirdecisions. Similarly in Australia, directors are required to discharge their duties‘in good faith in the best interests of the corporation’.

Extensive research into the views of directors has been conducted by theCentre for Employment and Labour Relations Law at the University ofMelbourne. Their survey of around 4000 directors of Australian companies doesnot suggest that directors uniformly and faithfully pursue shareholder intereststo the detriment of those of other stakeholders. Although 44 percent of directorsranked shareholders as their number one priority, an almost equal proportionranked the company as the main priority. Employees were in the top three prior-ities (with shareholders and the company) in nearly 80 percent of cases (thoughfirst in only 7%). A majority of directors (55%) believed that acting in the bestinterest of the company meant they should balance the interests of all stake-holders. A further 38 percent believed they should act in the interests of all stake-holders for long-term shareholder benefit (Jones et al. 2007). Large proportionsof directors include improving employee morale (87%), safeguarding jobs (66%),and ensuring fair treatment (94%) as priorities.

The Melbourne team explicitly sought to test whether managerial perspec-tives differ between firms according to the salience of shareholder pressures.They found that directors in firms where there was a high salience of share-holder ‘demands’ (as measured by reports of various forms of shareholderactivity) are not more likely to increase/decrease employee numbers or wagesand bonuses during upturns or downturns. An equal proportion of firms in eachcategory described the firm’s relationship with employees as a partnership(Anderson et al. 2006). An intriguing finding is that top managers were lesslikely to describe their relationships with employees as a partnership where therewas a majority block-holder. This suggests that dispersed ownership may givemanagers more autonomy to develop good relationships with employees.

Managerial discretion and support for labour

Given these characteristics of the ownership and governance system, wepropose two explanations for the configuration of labour management



practices and characteristics identified earlier. One is that managers pursue aquiet life by looking after labour when shareholder pressure is limited. Thereis mounting evidence in support of this, primarily from the financial economicsliterature. Conqvist et al. find that managers in (Swedish) firms with dispersedownership pay both themselves and their workforces more in firms with moreconcentrated ownership. In the United States Werner, Tosi, and Gomez-Mejia(2005) find that pay for performance sensitivity is lower when ownership isdispersed. Pendleton and Gospel (2008) find that dispersed ownership in theUnited Kingdom is associated with higher pay for employees, even aftercontrolling for size. Finally, in the United States Bertrand and Mullainathan(1999, 2003) find that wages are higher, other things being equal, in those USstates with stronger takeover protection. When they have discretion (becauseof dispersed ownership or other protections from shareholders), managers maytreat their workers better for several reasons: to secure a happier and morecompliant workforce, to provide ‘shark repellents’ against takeovers (Paganoand Volpin 2005), to turn workers into ‘white knights’ to fight takeovers, tolegitimise their own high salaries (Sassalos 1995), and to promote efficiency(Pendleton and Gospel 2008).

A second reason is the public visibility of publicly listed companies. Publiccompanies are governed by more stringent and more comprehensive disclosurerequirements than private companies, and these requirements are becomingever more demanding. Even where these disclosure requirements do not dealwith labour issues specifically, the effect is to increase the visibility of the publiccorporation. In addition there is mounting scrutiny of listed companies’practices by social responsibility movements, sometimes in loose alliances withunions. The point about corporate social responsibility in this respect is not the‘depth’ of companies’ adherence to CSR or their motives for adopting it (keyissues in the literature to date), but the volume and strength of demands froma variety of sources on companies to avoid bad labour practices and in somecases to adopt good practices. Witness the significant difference between listedand unlisted companies in possession of the Investors in People ‘badge’ in theUK results mentioned earlier. Reputational issues seem to be of increasingimportance to large companies, and to large investors too (Graves andWaddock 1994). There is also some evidence that a concern for reputation isleading some companies to develop ‘employer branding’ so as to attract andretain good quality employees. These brands emphasise company commit-ments to training and employee voice.

The implication of the analysis and evidence presented here is that the ‘marketmodel’ view of how finance, ownership, and governance affect labour needs to berevised. While some evidence from comparative studies is consistent with thepredictions of themarket model (lower job tenure and greater pay inequality, for

Concluding thoughts

instance), there is a body of evidence that suggests that governance processes mayoperate rather differently from the way often described. Furthermore, labourmanagement practices are often more favourable to labour than is usuallyclaimed. We have suggested in the paper that the market model understates thedegree of relational governance and managerial strategic choice. Managers withstrategic choice may pursue ‘progressive’ HRM policies for a variety of reasonsincluding self-interest. Dispersed ownership, growing ‘lock-in’ of major institu-tional investors, and a climate in favour of corporate responsibility may allcontribute to managerial discretion. At the same time, a strong influence bearingupon managers of listed firms is public scrutiny of management practices andpressures for disclosure. This reinforces tendencies towards good labour practices.

Does this mean the ‘market model’ should be rejected? Our answer is no,but it should be substantially revised. A key question is whether the marketeconomies have distinctive characteristics which differentiate them from othereconomies as far as corporate governance and labour are concerned. Despitethe critique of the market model presented here, there are nevertheless somedistinctive features of the market model economies. First, shareholders dowield substantial power over firms in some circumstances. When firms’performance seriously deteriorates, major shareholders are capable of bandingtogether informally or tacitly to enforce speedy and severe disciplinary actionupon incumbent managers (Black and Coffee 1994). Often this is at the expenseof labour, given relatively weak labour protection in many ‘market model’economies. These events do not happen very often: a key question concernsthe extent to which these occasional events cast a shadow over managerialbehaviour in the longer term.

One of the problems with analysing the effects of finance, ownership, andgovernance on labour is that we lack a methodology for evaluating the extentof episodic, occasional, but nevertheless powerful phenomena such astakeovers. Takeovers are a cyclical phenomenon: most of the time they are rela-tively uncommon, and hostile takeovers are very uncommon. However, fromtime to time bursts of takeover activity take place, and these are especiallyfound in the ‘market model’ countries. Similar observations may be madeabout the use of novel financial instruments, arising from well-developedfinancial markets. Examples include the recent boom in private equity buy-outs and the upsurge in hedge fund activity. The latter appears to be an irritantto companies most of the time, but events since summer 2008 indicate that itcan be severely destabilising. Short-selling of company stock has driven downshare prices of target companies to the extent that rights issues have beenseverely disrupted in a couple of instances. As regards private equity, it isimportant to note that these transactions have taken place to correct the short-comings of the shareholder model of governance, including the capacity ofmanagers to treat labour ‘indulgently’. As a result these transactions havefrequently been followed by pay cuts and lay-offs, though the evidence is by nomeans clear-cut or compelling (Wright, Bacon, and Amess in press). Venture



capital (and relatively liquid capital markets) also has another role in shapinglabour management in ‘market model’ countries: by supporting the emergenceof companies in new areas of economic activity, they help to promote new waysof managing labour (free from the path dependencies found in long-established firms) which may then percolate through to ‘old economy’ firms.

So, the implication of the paper is that the ‘market model’ found in mostdiscussions of governance and labour management needs to be revised, thoughnot entirely rejected. What is clear, though, from our emphasis on managerialstrategic choice is that we need to develop a methodology for evaluating theinfluence of finance, ownership, and governance on managerial behaviour,bearing in mind that a range of other influences will also be present. To dothis, we will need to move away from the simple, abstract notion of marketsfound in the market model, as well as moving beyond the simplistic view of themanagerial–investor relationship found in agency theory

Andrew Pendleton (PhD, Bath) is professor of Human Resource Management in York ManagementSchool, University of York, UK. He has been a visiting fellow at Monash and Sydney universities. Hismain research interests are in the areas of ownership, governance, and employment relations.

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