Why U.S. Corporate Boards Don’t Include Workers

(Bloomberg Opinion) -- In Germany, it’s considered perfectly normal that half the members of corporate boards are representatives of the corporation’s employees. In the U.S., where Senator Elizabeth Warren recently proposed 40-percent worker representation, it seems like a radical idea.

Why the difference?

Those employee board seats in Germany are required by a 1976 law, and in the U.S. corporations could put worker representatives on their boards if they wanted to. So one interpretation is that the U.S. setup is the natural order of capitalism and the German one artificial. As economists Michael Jensen and William Meckling, leading proponents of the shareholders-first philosophy of corporate governance, argued of the German approach in 1979:

The fact that this system seldom arises out of voluntary arrangements among individuals strongly suggests that codetermination or industrial democracy is less efficient than the alternatives which grow up and survive in a competitive environment (i.e., one where organizational alternatives are on all fours legally).

I wrote on Friday about the origins of Germany’s system of corporate co-determination, parts of which actually did arise out of voluntary arrangements before being encoded in law. Worker participation in German industry began with and continues to be centered around works councils, employee-elected bodies that consult with management on workplace issues. The first works councils were instituted by company owners in the latter half of the 19th century; in the 1890s the German Reich began actively encouraging their creation (Kaiser Wilhelm II was a big fan) and amid wartime labor shortages in 1916 it required all but the smallest employers to set them up. The Weimar Republic made that arrangement permanent in 1920 and added a requirement for limited worker board representation in 1921. The Nazis — big surprise — shut all that down, but after World War II the works councils were revived and soon expanded their purview from the shop floor to the supervisory board.

But enough about Germany! The U.S., it turns out, also used to have entities much like works councils, which went under names like “employee representation plans,” “company unions” and just plain “industrial democracy.” They came into vogue later than in Germany, but constituted a major movement from about 1915 through 1935, when Congress put a stop to them (which doesn’t sound like what Jensen and Meckling would call a “voluntary arrangement”). I cannot claim to be an expert on this history, but I do know a lot more about it than I did a few days ago, so here goes.

In the late 1800s, as European workers joined forces in labor unions and some European employers strove to amplify workers’ voices, the U.S. remained uniquely hostile to all forms of worker organization. Part of this had to do with the individualism inherent in American culture, which was accentuated by the popularity among the nation’s intellectual elite in those days of Social Darwinism, the doctrine that in economic life as in the origin of species, the fittest survived. In “What the Social Classes Owe to Each Other,” published in 1883, Yale sociologist and leading Social Darwinist William Graham Sumner allowed that some “trades-unions” might occasionally play a constructive role in, say, advocating safer workplaces, but dismissed them generally as “an exotic and imported institution ... having been developed in England to meet English circumstances.”

Sumner wasn’t entirely wrong about that. The class consciousness that underlay the rise of the labor movement in Europe was less pronounced in a country where many industrial titans had started their careers as laborers. But there were also power dynamics that put unions, and industrial workers in general, in an especially weak position on this side of the Atlantic:

  1. Railroads and then industrial corporations got much bigger, much faster in the U.S. than in Europe, giving them a big size advantage over unions.
  2. The U.S. industrial workforce included many recent immigrants speaking lots of different languages, which made organizing hard and limited workers’ political clout.
  3. The U.S. government in those days was spectacularly corrupt, and industrialists and financiers had far more money than anyone else with which to corrupt it.

Although the courts and law enforcement remained reliably on the side of business owners and against attempts to organize workers well into the 20th century, the political and intellectual tides in the U.S. began to shift in the 1890s. The first significant business experiment in giving workers a voice in the U.S. began in that decade as well.

This occurred at Filene’s, the Boston department store, where company president Edward Filene in 1898 enlisted a committee of employees to help administer an insurance plan and medical clinic. By 1905 the employee-run Filene Cooperative Association was not only running benefit programs but also had the right to change any store rule by a two-thirds vote. The association’s arbitration board adjudicated disputes between management and workers, ruling against management 46 percent of the time, while an accountant hired by the association pored over the company’s books to make sure they were on the up and up.

Filene, who also founded the progressive think tank now known as the Century Foundation and was largely responsible for bringing credit unions to the U.S., seems to have been concerned mainly with motivating his workers and making their jobs more fulfilling. For a lot of the other company executives who started works councils in subsequent years, fending off unionization was a top priority.

The most famous works council plan was instituted in 1915 at Colorado Fuel and Iron Co., then the nation’s second-largest steelmaker. After company efforts to break a coal miners’ strike led to the notorious 1914 “Ludlow massacre,” John D. Rockefeller Jr., whose family was CFI’s biggest shareholder, turned to Canadian labor relations expert and future prime minister Mackenzie King for help. King devised a system of elected employee representation that became known as the Rockefeller Plan and was widely imitated.

The combination of wartime labor shortages and the first overtly union-friendly presidential administration led to big gains for both organized labor and works councils during World War I. Amid labor unrest in 1918, President Woodrow Wilson created the National War Labor Board to adjudicate company-labor disputes, and the board frequently pushed companies to create works councils as part of the labor deals it devised. While the pressure from Washington eased soon after that, works councils and company unions kept being formed. By 1926, according to labor historian Greg Patmore, there were 432 U.S. companies with employee representation plans covering almost 1.4 million workers. “Some were little more than advisory bodies with little or no authority,” Patmore writes. “Others had a final say over dismissals and seats on the board of directors.”

My favorite among the employee representation approaches was what became known as the Leitch Plan. Stockyard-worker-turned-business-guru John Leitch wrote an entertaining 1919 book about it, “Man to Man: The Story of Industrial Democracy,” which describes production workers electing a House of Representatives and foremen and other middle managers electing a Senate, with this legislature empowered to propose workplace changes to a cabinet composed of top management. At Goodyear Tire and Rubber Co., which seems to have implemented its plan without any help from Leitch, production workers elected both House and Senate, and in 1922 those two bodies voted workers a 15 percent pay raise, then successfully overrode a cabinet veto.

Even at the companies most enthusiastic about worker participation, though, there was still the awkward question of who really called the shots. “Capital and labor are not alike,” Leitch wrote. “They travel the same road up to the division of profits; there the road forks and we do not yet know just how the profits may reasonably be divided.” At Filene’s, younger brother Lincoln Filene finally got fed up with the way Edward was dividing the profits and united with other shareholders to seize control of the company in 1928 and merge it with the Federated Department Store chain (now Macy’s Inc.). And as the Great Depression of the 1930s began turning profits to losses at company after company, the happy compromises of the 1920s gave way to brutal pay cuts and layoffs.

The political equation changed too, as a Democratic Party committed to empowering independent trade unions — and suspicious of company unions — took power in Washington after the 1932 elections. Its first big effort, the National Industrial Recovery Act of 1933, guaranteed the right of workers to form and join unions but also allowed for the continued existence of company unions and employee representation plans. In its wake, membership in such entities rose to an all-time high of 2.5 million in 1935, compared with 3.5 million in non-company unions.

That was also the year, though, when a conservative majority on the Supreme Court struck down NIRA as unconstitutional. Congress regrouped, this time with even bigger Democratic majorities gained in the 1934 elections, and under the leadership of Senator Robert Wagner of New York pushed through a National Labor Relations Act in 1935 that was at once more carefully worded (to meet the Supreme Court’s objections) and more hard-line. With Wagner arguing that company unions made “a sham of equal bargaining power,” his legislation no longer allowed employers “to dominate or interfere with the formation or administration of any labor organization or contribute financial or other support to it.”

The Supreme Court upheld the NLRA by a 5-4 vote in 1937, and that was that. Arms-length negotiations between corporations and unions became the rule, big increases in unionization followed, and big pay increases for working Americans followed that. For a long time, labor economists and historians adjudged this to have been the right move for workers. Since the 1980s, though, revisionist scholars have been showing that some company unions actually did a pretty good job of promoting both employee well-being and company productivity. And with unions now absent from most of U.S. economic life — only 6.5 percent of private-sector workers belonged to one in 2017 — the lack of any kind of organized worker representation today is glaring.

That’s not to say we’ve returned to late-1800s conditions. Federal laws and regulations that didn’t exist then now protect employees against workplace dangers, discrimination and lots of other bad things. Lots of corporations offer extensive employee benefits, and many encourage some level of rank-and-file involvement in decision-making. But if that company-organized involvement leads to discussions of working conditions or pay, it risks violating the NLRA’s ban on company unions.

In 1994, a commission appointed by Commerce Secretary Ron Brown and Labor Secretary Robert Reich recommended that Congress revisit the NLRA to provide a safe harbor for employee involvement programs. The next year, the Republican-majority House and Senate did just that with the Teamwork for Employees and Managers Act of 1995, but in the face of opposition from organized labor, President Bill Clinton (Brown’s and Reich’s boss), vetoed it.

This would seem to have gotten us pretty far from the question of why American corporate boards generally don’t include worker representatives. But I think there is a connection. Union officials have occasionally gotten seats on corporate boards in the U.S.: United Automobile Workers presidents Douglas Fraser and then Owen Bieber served on Chrysler’s board from 1980 to 1991 after Fraser’s lobbying helped Chrysler secure a government bailout in 1979-1980, and after the bailout of 2008-2009 the Chrysler and General Motors boards each included a representative of the UAW Retiree Medical Benefits Trust, which happened to have become the companies’ biggest shareholder. Union and government-employee pension funds have also occasionally used their clout as shareholders to pressure managements that they see as anti-worker. And employee stock ownership plans and worker cooperatives (which got a boost from new legislation enacted this month) both give workers a say as owners.

But all of these seem quite different from the German setup, where rank-and-file workers are expected to be involved in company governance from the shop floor (or bank branch or research and development center) to the boardroom. What Warren has now proposed can be seen as a sort of very high level employee involvement program. Even if it doesn’t go anywhere (and I’m guessing it won’t, at least not any time soon), perhaps it can restart the discussion over whether we shouldn’t be encouraging other kinds of employee input too.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”

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