Does Employee Ownership Promote More Innovation?

One of the most important aspects of entrepreneurship is its connection to innovation. When firms discover new products, processes, technologies, or ideas, those advances develop competitive advantages for the firm. Because innovation is an important part of economic growth, we want to encourage firms to organize themselves in a way that promotes innovative activity and creativity among workers, for the good of the firm and the economy.

Recent news has shown tech giant Google reorganize in an attempt to stay true to the vision of their founders. Another approach, especially for entrepreneurs, to develop a highly productive and high achieving firm is through employee-ownership. In firms that are employee-owned, stocks of the company are held by the employees and board members are at least partially elected by employees.

Employee-owned firms are theorized to have more productive workers and less turnover than firms with traditional ownership structures. If an employee owns part of the firm, they will be more likely to share their expertise, market knowledge, and other applications with research and development or another appropriate party who can make best use of the idea. Research also suggests that when employee’s compensation is tied to firm performance, workers are motivated to work harder. Policymakers have also taken an interest in employee ownership as a way to boost sagging income levels, especially for middle class households.  

A recent Economist article discussed employee ownership and the Employee Stock Ownership Plans (ESOP) that generally accompany them. While this firm structure does provide stronger motivations for workers to contribute to the success of the firm and the allure of a potential large payoff of a sale of stock, the author was careful to note there are risks and tradeoffs that employee ownership prompts. Workers at these kinds of firms need to diversify their stock holdings, not just rely on their firm stock as retirement income. Employee-ownership also leads to greater entrenchment. Swift change aimed at increasing competitiveness can be harder to institute when workers can keep underperforming management in power.

But my primary questions are:

  • Are employee-owned firms actually more innovative than traditionally owned firms?
  • Do workers who are motivated to see the firm succeed due to their personal financial gain steer their productivity into innovation?
  • Is knowledge transfer made easier through this kind of firm structure?
  • If so, what kind of results does the increase produce?

Research shows profit-sharing, which is not directly employee ownership, represents a similar level of employee engagement in the success of the firm. The firm will usually set aside some percentage of the profits and disburse them in shares to the employees. In a research paper on profit sharing and innovation, the authors studied German firms with this kind of ownership structure and found different results about different types of innovation. They found that product innovation, or the ability of a firm to make new and different products, is spurred by profit-sharing structures in their sample of firms. This differed from their results on process innovation, the improvements firms make to develop products faster and more cheaply. Process innovation was not affected by any profit-sharing structure within the firm.

When firms take efforts to align incentives of workers with the strategy of the firm, innovation does not necessarily suffer. The innovative capacity is increased in new product development, but not in improving existing products. As profit sharing and employee-ownership becomes a bigger part of policy discussions, policymakers should understand both the risks and opportunities of this firm structure, and how it affects broader economic outcomes like innovation. However, beyond just a firm structure that aligns employee incentives, firms need to implement high-performance work policies, low levels of supervision and above-market wages to get the most out of a change in ownership structure. While employee ownership is just one option for privately owned firms, and smaller ones at that, employee ownership can produce results that are socially beneficial.

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chris jackson

Chris Jackson

Chris Jackson is a research assistant in Research and Policy for the Ewing Marion Kauffman Foundation, assisting in the understanding of what policies and environments best promote entrepreneurship and education in the pursuit of economic growth.