Is employee profit-sharing a win-win?

When theory meets the real world, things get a bit complicated

Is employee profit-sharing a win-win?

Having employees act as owners of the company for which they work should be a no-brainer. It is, in theory, the perfect employee benefit, as the employee wins and the employer gains, too, through increased company productivity. It also should please those who call for capitalism to be reinvented in some form, as what could be more democratic than employees profiting from their efforts? And all this should be true whether employees are part of an employee share ownership plan (ESOP) or a profit-sharing plan.

Of course, when theory meets the real world, things get a bit more complicated. A survey done in the year 2000 by Richard Long of the University of Saskatchewan of Canadian CEOs showed almost 100 percent agreement that profit-sharing was good for their companies, promoted loyalty, and increased job satisfaction. CEOs were in less agreement about its effects on employee absenteeism, and were split between “positive contribution” and “no contribution” on its role in the company’s stock performance.

But are, or were, CEOs correct in their assessment? A more comprehensive study has just been published by Elio Nimier-David of the University of Chicago, with David Thesmar of MIT and David Sraer at Berkeley, titled “The Effects of Mandatory Profit-Sharing on Workers and Firms: Evidence from France.” It seeks to answer two questions: 1. Does this program actually benefit employees, or are firms merely substituting profit-sharing for normal wages? 2. Does this promote firm productivity? France is a useful example, as the government passed a law in 1967 requiring all firms with more than 100 employees (reduced to 50 employees in 1991) to distribute a share of their excess profits (defined as profits above five percent of book equity) to employees. This formula, which is effectively a significant tax on profits, as well as its implementation for more than 50 years, make for a rich data set to examine.

Along the way the authors made some interesting discoveries. Pre-1991, there was more than the usual “bunching” of firms reporting between 95 and 99 employees, which was under the 100-employee threshold for mandated profit-sharing. This bunching completely disappeared after the threshold was changed in 1991. The authors thus reject the idea that profit-sharing is perceived by all employers as a benefit to their companies.

Workers do benefit from profit-sharing. The authors concluded that for firms with positive excess profits, employees had a 1.8 percent increase in their total compensation (wages+ profit-sharing). About three-quarters of this increase came at the expense of the owners of the firm, with the rest being paid for by the government in the form of lower corporate income tax, as profit-sharing reduces the corporate income tax base.

As to the second question, involving firm productivity, the authors found no productivity gains. They tried hard and used several different measures and looked for any increase above one percent over non-profit-sharing firms, yet found nothing. “We obtain consistent findings across all measures: profit-sharing leads to a precisely estimated zero effect on productivity,” noted the authors.

They also looked at other factors that have been cited by other researchers as a benefit of profit-sharing, including reduced sick leaves and the probability of working extra hours. They found no effect on these measures. Finally, to those researchers who often say that much profit-sharing comes to too small an amount to change employee behaviour, they note that in this case, “the requirement to share profits represents a transfer to employees of about 10.5% of firm’s pre-tax income” – a not-insignificant amount of money.

Profit-sharing has benefits. Employees benefit, though the results are not equal. Workers at the lower end of the skill distribution list do not see their base salary reduced (due to minimum wage thresholds) and thus benefit fully from profit-sharing, whereas employees at the higher end show a decline in their base wages, leaving total compensation unchanged. Just don’t think that this is a panacea to increase productivity in your company.

Jim Helik is a contributing author to the Managing High Net Worth and the Commodities as Investments courses published by CSI Global Education. He is also one of the first holders in Canada of the Human Resource Management Professional designation from the Society for Human Resource Management.