Investment and Supply Effects of Industry-Indexed Bonds: The Labor Managed Firm
Universita di Roma Tor Vergata; National Bureau of Economic Research (NBER)
Stephen C. Smith
George Washington University - Department of Economics
Economic Systems, Vol. 23, No. 3
In this paper we introduce and analyze a financial instrument, termed industry-average performance bonds (IAPB), that we show offers two important advantages for labor-managed firms (LMF): reduced underinvestment, and diminished "Illyrian" supply effects. These instruments commit the LMF to pay a contractual share of value added in its industry, or otherwise index liabilities to a measure of industry conditions; we show that certain incentive compatibility problems associated with the simple firm performance bonds examined in the LMF literature to date are thereby overcome. Privately optimal use of such instruments is also shown to induce LMFs to rationally adopt a positively-sloped supply function in contrast to the classic Ward effect. Finally, it is shown that IAPBs have an effect on joint choice of investment and LMF membership similar but not identical to an exogenous reduction in risk. The bonds are also of interest to employee-owned, producer-coop, family-run and other risk-averse businesses that wish to retain managerial or internal control.
JEL Classification: P13, G32, J49, G13
Date posted: January 25, 2000