Introduction

In the Modern Corporation and Private Property, Berle and Means (1932) examined the manifestations of the effective separation of ownership and control in the modern corporation and for the succeeding half-century, property rights in the profit-making firm have become increasingly attenuated. According to many, this process has been accompanied by corresponding evidence of the deleterious effect on both internal economic efficiency (and profit), particularly when the firm is subjected to political control and there is a lessened incentive to capture economic rents either in the form of improved operating efficiency or by way of influencing, through rent seeking, the political control environment (Crain and Zardkooki, 1980).

Economic performance has been particularly poor in many nationalized or State-owned enterprises (SOEs) in both advanced industrial and developing countries. In response, there has been a worldwide movement aimed at privatizing many of these industries and in fundamentally changing the conventional modes of governing agricultural, industrial as well as government enterprise subject to varying conditions of public ownership and control. In addition to full or partial divestment of government ownership, privatization is aimed at increased opportunities for private supply and finance of goods and services (which may have many essential public characteristics) and, where appropriate, to clarify relationships between the economic and political spheres relating to control of enterprises.

Even in advanced capitalist societies, however, privatization

often meets with political resistance and conflicting value systems. In many countries there are, for example, strong corporatist systems that seek to closely integrate the economic and political spheres through representation and the cooperative interaction of interest groups. There are also political pressures for widening the processes of industrial democracy through co-determination and increased worker's participation in decision-making within the enterprise.

Against this background of worldwide socioeconomic conflict over the control of enterprise, this paper sets forth a demand revealing approach to governance that would: (i) protect enter- prises against unwarranted interventions that seek, for example, to redistribute wealth within the enterprise or to some other segment of society and (ii) motivate cooperative interaction -- with workers, for example -- so as to increase enterprise wealth as well as total producer and consumer surplus.

The paper suggests the general applicability of the demand revealing approach to enterprise governance in a wide variety of socioeconomic settings. These include: (i) problems of enterprise regulation and labor relations in countries such as the United States where there has been a tendency to separate the economic and political spheres and (ii) where the value system favors their integration (corporatist socioeconomic environments in Latin America, Japan, and much of Western Europe).

In addition, the paper considers the specific applicability of the demand revealing approach to the governance of state or "mixed" enterprises and the process of privatizing these enter- prises, particularly in developing countires. State enterprises in developing countries share many problems exhibited by regulated and nationalized enterprises in the more advanced industrial societies. They often face, for example, conflicting demands and objectives imposed by "plural principals" in diverse government ministeries and agencies. Moreover, there are those who are often resistant to a clarification of the relationship between the economic and political spheres. These political difficulties are often compounded by economic ones, such as thin and imperfect securities and capital markets (and the lack of buyers) which make difficult any full-blown program of government divestment of its ownership. (Cowan, 1986) In the context of these political and economic difficulties, demand revealing techniques can be particularly useful not only for resolving inherent conflicts in the separation of ownership and control (which impede a process of partial divestment and private ownership) but dealing with more fundamental problems of the relationship between the State and the economy.

The paper is part of a larger study of privatization alter- natives and possible avenues of demand revealing experimentation that might be appropriate for bilateral/multi-lateral donor organizations and host governments in developing countries. Even though its specific focus is upon the demand revealing governance of "mixed" for-profit enterprise, involving joint government and

private ownership, the approach outlined here is broadly applicable to a wide range of "mixed" and regulated enterprises including our own public, for-profit corporations in the United States. Indeed, the general approach has been developed as a result of my long experience with dealing with government regulation of enterprise, by multiple regulatory agencies in the United States, and many of the examples of the demand revealing approach outlined herein are the outgrowth of a need for a control mechanism for the oversight of our own state regulatory apparatus in the United States. For this reason, the papers gives particular attention to the efficient regulation of "mixed" or regulated enterprises through a demand revealing approach that was recently noted in a report to U.S. Federal Agencies by the U.S. Office of Management and Budget (OMB, 1983). That report, concerned with intra-enterprise (government) decision-making regarding the acquisition of information technology, also noted that the demand revealing approach could be used to "ensure that an inefficient regulatory requirement is not imposed on the private sector." This paper expands upon this idea, with reference to its applicability to a demand revealing "regulatory" or "enterprise budget" for the governance of "mixed" or regulated enterprises in a variety of institutional settings.

The paper is also concerned with intra-firm political governance. In the absence of efficient capital markets, and particularly where the government is a shareholder, there is need for more attention to the formal decision, or voting, rules which are used to govern the enterprise. Indeed, the paper returns to the basic problem of the separation of ownership and control elaborated by Berle and Means to show how a demand revealing approach would satisfactorily come to grips with the problem. The demand revealing approach would be particularly useful where markets are thin in enterprise securities or other instruments and where shareholders are limited in their ability to "vote with their feet." Also, when the government is a major participant or when there is likely to be a significant asymmetry in the distribution of voter preferences, such that the assumption that the median voter will choose an efficient outcome for all, the demand revealing approach elaborated herein could generate truly superior results.

The paper is also concerned with intra-firm political governance of the enterprise by those other than shareholders -- for example through "one-man, one vote" as proposed by many proponents of industrial democracy or through corporalist approaches that rely on informal rules of enterprise governance. Also in the absence of formal voting, the collective bargaining process in advanced capitalist societies appears to yield outcomes somewhere between those that would result from the choices of a pure profit making

firm (PMF) and that of a labor managed firm (LMF) seeking to maximize income per worker. In such cases, the demand revealing approach might improve the overall welfare of both labor and owners relative to the collective bargaining outcome. The approach may be of interest in other advanced capitalist societies as an alternative to "democratic socialist" modes of enterprise governance as well as in many developing countries where governments are considering turning over their money-losing state enterprises to workers in hopes that labor-managed enterprises could achieve more fruitful results, at least in the short-run.

For these reasons, the paper focuses considerable attention on new approaches to demand-revealing labor-management forms of governance that would be superior to bargaining and avoid the often calamitous outcomes from access to formal decision rules of the majoritarian variety within the enterprise. Moreover, the demand revealing procedures can induce cooperation in the production of firm-specific organizational rents or intra- organizational public goods not easily achieved in the absence of such rules through conventional labor-management approaches. The paper is organized as follows: Section I introduces the demand revealing approach with reference to an example of intra- enterprise project investment decision-making contained in the OMB report and which is further elaborated at Appendix A. I then demonstrate how this approach could be applied to shareholder governance within an enterprise, with specific reference to the specific legal conundrums surrounding the separation of ownership and control, and one legal case in particular, contained in the classic treatise of Berle and Means.

Section II then expands on this approach with reference to the governance of "mixed" and regulated enterprises as well as with ancillary issues related to the process of privatization of state enterprise. The paper deals first with the simplier case of "mixed" government/private enterprise where there is goal congruence concerning value (profit) maximization between the government and joint equity partners. I then turn to the more complex problem of goal divergence and elaborate the demand revealing approach to a "regulatory" or "enterprise budget" that would have more effective discipline regarding enterprise interventions by the government as well as the revelation of the true opportunity cost of those interventions by private shareholders or joing equity partners in the firm.

In Section III, I turn to the demand revealing governance of enterprise by labor and shareholders. In this section, I give considerable attention to the demand revealing approach to a producer cooperative or labor-managed firm because this pure case assists in understanding the implications of the demand revealing approach as well as its operation within the more complex setting of joint utility maximization between labor and shareholders and the inducement of cooperative interaction in the maximization of joint organizational rents. The conclusion to the article focuses on demand revealing approaches to trade and industrial policy where the government or governments become a party to the interaction in the attempt to encourage efficient patterns of market adjustment and economic change within an open worldwide trading system.

An important aspect of the demand revealing approach highlighted in both the paper and the appendix is the role of a person or persons who is given significant power to make distributional decisions in the form of wealth transfers among shareholders and between shareholders and the government and workers. Although the basic criterion guiding these allocations is the long-revered benefits received principle of public finance, its particular application to the enterprise may raise new and interesting controversies for students of the new incentive or demand revealing mechanisms as well as practitioners, seeking to improve enterprise performance in developed and developing countries alike.

I. The Demand Revealing Approach to Enterprise Governance

Demand relevation has been called a "new and superior principle for making collective choices" (Clarke, 1971; Tideman and Tullock, 1976) that would appear to have wide applicability to political and economic decision-making in a wide variety of circumstances, and for rationalizing, in each circumstance, the interface between the political and economic spheres.

In addition to intra-enterprise decision-making within the Federal establishment (OMB, 1983) and other applications referenced at Appendix A, the technique was recently suggested as a means of improving group decision-making in the governance of housing cooperatives in developing countries (Free Zone Authority, 1985) and as a means of regulating public utilities through franchising or contracting out (Clarke, 1980; Tozzi and Clarke, 1983).

The DR rule gives to any participant in a decision the right to change an outcome -- from what would happen in absence of that person's (group's) participation -- to the person's (group's) preferred outcome by paying a penalty equal to the cost to others of changing the outcome. As demonstrated at Appendix A (OMB, 1983), the penalty motivates each participant to represent their preferences truthfully and accurately. The Appendix provides an example of a binary decision whether or not to invest in a $10 million project where the costs have been equally divided among five participants. The net reported benefits (in millions) and penalties are as follows:

Option A (Status Quo) Option B (Invest) Penalty

Party l $0m $1.0m $0.5m

Party 2 0 0 0

Party 3 0.5 0 0

Party 4 0 1.0 0.5

Party 5 1.0 0 0

Under the decision rule, Option B would be selected -- the net benefits of Option B ($0.5m) are greater than the net benefits of doing nothing (Option A). However, if either Party 1 or Party 4 had abstained from "voting", the remaining members of the group would have preferred Option A. Because their "votes" swung the outcome, Parties l and 4 are subjected to penalties (of $0.5m eacn under the demand revealing process).

In this example, these penalties (which Tideman and Tullock, 1976 call Clarke taxes) are also larger than net benefits received (i.e. $1.0 million in total penalties and $0.5 in net benefits). Appendix B also provides a further example (of an approximate zero sum game) which has been given extensive treatment in the literature (see Ferejohn, Forstythe and Noll, 1979 and Clarke "Comment" in the same volume) where the penalties are very high (i.e. fourteen times the net benefits received).

In this paper, following also Tullock in a forthcoming paper (1986), I point to the fact that high Clarke taxes are not a disadvantage but rather a positive advantage in that they prevent welfare reducing or rent-seeking redistributions of wealth within the firm or any other political organization in the society. As Tullock observes, "this high Clarke tax (penalty) in many transfers is a positive advantage, as it prevents transfers with no social value from being carried out ... and in other cases where it doesn't prevent such transfers, it at least reduces them."

Also, there has been a tendency to ignore the second essential aspect of the demand revealing approach to which I now turn in elaborating the DR approach to enterprise governance.

In addition to the demand revealing decision rule, the second requirement for enterprise governance requires someone, called here a cost share allocator, whose function is to allocate "shares" and "costs" so as to minimize the incidence of any penalties. This person's remuneration would then be inversely related to the amount of any penalties. For example, in the OMB example at Appendix A, we assume that the $10 million in project costs had been allocated equally ($2 million each) among the five parties. The result is $l million in penalties because these costs were not allocated in proportion to benefits received. With an allocation of $1 million more in project costs to Parties l and 4 and $l million less to Parties 3 and 5, there would have been unanimity in the decision to undertake the project -- which is a close call, since, as noted above, the total net benefits are only $.5 million or only 5% of total project costs.

Within the enterprise, the cost allocator also seeks to avoid close calls, which resemble zero-sum games, especially those which tend to resemble simple redistributions of income or economic rents within the enterprise. He encourages the consideration of alternatives with high net payoffs or positive sum games, which also reduces the likelihood of coalitions, a problem that also arises only if penalties are anticipated to arise in a demand revealing decision.

Of course, if the parties to a coalition have knowledge the cost allocator lacks, side arrangements (e.g. mutual cost reallocation

among the parties)would be preferred to coalitions for reasons that have been treated extensively in the demand revealing liter-

ature (Clarke, 1980). For purposes here, suffice to say that all the parties, including the cost allocator, seek to minimize or eliminate these potential penalties since they must otherwise flow outside the firm in order to keep the incentives correct.

Note also, as before, that the potential for high penalties provide safeguards against rent seeking redistributions or transfers which I will emphasize in the examples to follow as a means of guarding against both external intrusions (i.e., from the government) and within the enterprise itself. Where a decision will disadvantage some participant (as in the case of pure redistribution), there is also the motivation (as illus- trated above) resulting from the penalty to find some

appropriate allocation of costs or a superior alternative that will reduce or eliminate the penalty. In this way, demand revelation can divert activities and resources from zero-sum games designed to "divide the pie" toward positive sum games to increase its size.

The reader should also consider the likely real world behavior of actors that are subject to DR rules. They would continue to devote resources to favorably affecting their share of the distribution in terms of the allocation of costs or shares of output and to extent that this process results in unanimity, there would be no need for formal DR procedures. However, the presence of the DR rule will fundamentally change participant behavior by ensuring that once the distribution is determined by the cost share allocator, they are motivated to act truthfully in bringing to bear as much relevant information as is efficient in achieving the most effective collective outcome.

To demonstrate first the importance of such a principle in avoidance of rent seeking and the protection of property rights as well as to further illustrate the demand revealing approach for the purposes considered here, we might begin with basic problems of the separation of ownership and control in the pure profit-making enterprise. In this context, it is useful to consider the specific problems and legal conundrums -- one case of arbitrary redistribution in particular -- contained in Book II ("Regrouping of Rights") in Berle and Means. 1/

This leading case related to a corporate charter providing for Class A and Class B stock. The Class A common was redeemable at $32.50 per share, was entitled to be paid $25.00 on liquidation in preference to Class B; and was entitled to receive a preferred dividend (non-cumulative) at the rate of $1.50 per share. After this dividend, Class B was entitled to receive dividends at the rate of $1.50 per share; and thereafter the investors were permitted to declare dividends at the rate of not more than 50 cents per share per annum to the holders of both classes. If excess income was to be distributed thereafter, it must be distributed so that the holders of Class B shares should receive four times the dividend declared on the Class A.

The Standard Gas and Electric Company owned the great majority of the Class B shares which carried the sole voting rights. They proposed an amendment to the effect that, whenever Class A and Class B stock had each received dividends of $1.50 per share,

all dividends should be declares share and share alike between the two classes; and likewise the permission to redeem Class A stock $32.50 per share was eliminated. Obviously, this cut down the participation of Class B stock.

A dissenting holder of Class B filed a bill to restrain the passing of the amendment but the Court allowed it, in part because the overwhelming majority of Class B shares (that is, Standard Gas and Electric, was prepared to accept it) and this would permit additional capital to be obtained by the issuance of Class A stock (which the corporate management insisted was in the best interest of the corporation).

Suppose the disadvantaged stockholders had access to a demand revealing regime? Under such a regime, anyone affected by a decision can express their preferences (even the non-voting Class A stockholders) which in this case we assume are repre- sented by Standard Gas. The Class B stockholders are also assumed to have a "watchdog" representative on the Board of Directors that represents their interests. In this case, they could have appealed to the Board (or watchdog) and the share- allocator for a demand revealing vote on the proposal. Prior to such a vote, the Class B stockholders would request that the share-allocator make a determination of the comparative net benefits of the proposal among shareholders and allocate costs or adjustments in shares so as to minimize the possible incidence of penalties.

As illustrated below, let us assume that the share allocator (not knowing the incidence of net benefits exactly) makes a reallocation that would require the transfer of $40 million (or $4 per share) to Class B stockholders. However, the dissenting holders, who have 10 million shares, believe they will be dis- advantaged relative to the status quo by more than that amount, say $5 share. Standard Gas, on the other hand, believes that overall corporate benefits of the amendment exceed $50 million by a (net) amount of $10 million and in consequence, the result of a simple demand revealing vote with (w) and without (w/o) the compensating $40 million transfer would be as follows:

Status Quo Pass Amendment Penalty

w w/o w/o w w/o w

Standard Gas 0 0 $60m $20m $50m 10m

Class B (all) $50m $10m 0 0 0 0

If we assume that Class B holders were voting as a bloc (i.e. they had a representative on the Board of Directors who exercised

their proxies for all shares), the result in a penalty of $10 million in addition to the $40 million transfer to Class B holders. However, in order to keep the incentives to reveal preferences truthfully, the amount of the penalty cannot accrue to the Class B holders. Instead, it must be transferred outside the enterprise.

However, in lieu of the proposed amendment, suppose that an alternative amendment was presented to simply issue more Class A stock with some alternative distribution of dividends that would not significantly lessen the participation of Class B holders. The 10 million shares not held by Standard Gas are also assumed to be equally distributed among the holders so that the result of a demand revealing vote would have been as follows:

Alternative

Status Quo 1 2 Penalties

Individual 1 $.lm $ 0 $.3m 0

Other Class B Holders 9.9m 0 29.7m 0

Standard Gas 0 20m 10 m 0

Total $10m $20m $40m

In this case, the demand revealing regime has motivated the search for a solution that will achieve the basic purpose of the Standard Gas capitalization plan without significant dilution and adverse effects on Class B shareholders.

Also, the individual Class B holders are not "pivotal" in the sense that they do not individually determine the outcomes (i.e. each of the other Class B holders, if similarly situated to individual one would not be penalized).

The result is an improved capitalization plan for the enterprise in that it maximizes the sum of the utilities (preferences) for all participants (in the absence of some other alternative that would generate a higher sum of preferences). Note also that even

in the simpler case where penalties are generated, the welfare of the enterprise is improved (in the absence of the preferred alternative 2 or the information about Class B preferences, in which case a $50 million transfer would have eliminated the penalties and created shareholder/corporate unanimity.

As has been suggested in this case and demonstrated in the literature, penalties are also rarely incurred when the number of individual voters is reasonably large -- say on the order of 50 to 100 persons. For enterprise decision making in the real world, however, one would expect that DR voting would be centered in a limited to a smaller number of members, perhaps larger than the usual number of directors on the Board (perhaps because of the special interests of particular groups) but not so large as to eliminate the possibility of incentive taxes.

The use of the share-allocator who exercises significant control (power) over the distribution of rents within the firm also leads

to questions of "Qui regarder a allacatuer" in that somebody other than the Board may be necessary for determining what agenda items can be resolved through the DR procedures and for evaluating the performance of the allocator. These functions, for example, might be lodged with an independent body of trustees

who appoint the allocator and review that person's cost/share allocational decisions in conformance with benefits received criteria. This oversight responsibility may be particularly important in those cases considered in the following section where the enterprise must bear certain social responsibilities and both the allocator or trustees are charged with determining, for example, the level of subsidy which will be given the corporation for discharging these responsibilities.

In this regard, the demand revealing approach may suggest itself as a means of encouraging shareholder and equity participation in the process of divestment (of a government-owned enterprise) where the government may continue, at the end of the divestment process, to retain either majority or minority control. In the past, however, even minority control has created problems in that stockholders fear government ownership of the "golden shares" -- that is majority shares that bear specified rights of voting control. Such an arrangement may not be attractive to prospective equity holders, however, since the government has -- and may well exercise -- the option of exerting control over management decision-making. Also, many of the situations of interest in this paper require an active involvement by the government or some representative thereof in a gradual program of reducing government ownership while encouraging private investment. The program requires numerous sequential decisions concerning the optimum pace of government divestment. As will be shown, this is part of a more general problem of how to determine the appropriate mix of government ownership and private equity when capital and securities markets are thin or otherwise undeveloped and imperfect (Mintz, 1983).

In addition to implementing a pure program of privatization (so as to correct for capital market imperfections), the demand revealing approach to enterprise governance also provides a means of balancing conflicting objectives when, for example, government seeks to achieve social objectives other than the correction or capital or related market imperfections impeding the maximization of enterprise value or profits. The difficulty of achieving a viable program of divestment in such circum- stances is, of course, demonstrated by our own experience in the U.S. -- with the privatization, for example, of rail passenger and freight service. In the following section we focus expli- citly on how the procedure could be used to reconcile divergent goals such as balancing the interests of private shareholders (and the government's interest in expanding private equity participation) while meeting mandated social objectives such a maintenance of subsidized rail passenger and freight services.

II. Privatization and The Demand Revealing Governance of Mixed Enterprise

For purely private enterprises, operating in efficient capital and securities markets and immune from coalitions of workers and collective bargaining, the "new and superior" demand revealing approach might generate results truly superior to traditional governance and management decision-making approaches only in limited circumstances. However, as instanced by the previous example of traditional shareholder governance, a minority may often be surprised by the moves of a majority or the management and wish it had a more effective "voice" other than the "exit" alternative. This "voice" is what demand revelation provides.

To the extent that major capitalization decisions of the type elucidated by Berle and Means create potential adverse impacts on particular shareholder groups, demand revealing procedures could provide a means of affording safeguards that have not been adequate available through existing legal and regulatory means. The procedures might, for example, be made available whenever a capitalization plan involves a change in the charter of the corporation for purposes of altering the capitalization structure.

In addition, there may be cases where the risk preferences of shareholders are sufficiently diverse that demand revealing procedures would provide a useful means of resolving conflicts over the investment practices of enterprises that have the essential objective of maximizing enterprise value or profit. Recent literature has demonstrated that significant problems of achieving shareholder unanimity can arise even in the pure

profit making firm (PMF) of advanced capitalist societies where there are reasonably efficient capital and securities markets (Grossman and Stiglitz, 1977). These problems are evidenced, for example, by the existence of closed end mutual funds that sell at substantial discounts below the value of the corporations represented in their portfolios.

The problems of unanimity, we argue, are compounded when (1.) the enterprise operates under conditions where there is substan- tial risk or uncertainty and where capital markets are very thin or imperfect (as in many developing countries). They are further

exacerbated when (2.) the objective of value maximization is constrained by problems of how to divide quasi-rents or profits/ losses between shareholders and workers under conditions that are applicable to European-style co-determination and Japanese- style labor management (Aoki, Mizyazaki, 1980, 1982, 1984).

Finally, we face (3.) problems associated with conflicts over the objective of value maximization as, for example, when the government intervenes with regulatory controls or through its direct ownership interest, to impose its separate objectives upon the enterprise.

While issues of co-determination are dealt with in Section I.B., I consider here the first and third of the above problems which seem the most pertinent to the process of privatization in developing countries. These involve the transition toward private ownership with imperfect (or non-existent) capital markets and the problem of the exercise by government of controls that conflict with the value maximization objectives.

1. Privatization and Goal Congruence with Imperfect Capital Markets.

Let us begin by assuming a situation where the government undertakes the process of privatization and divestment with the sole objective of maximizating the net present value of the enterprise. However, within nonexistent securities markets, it will be difficult to create condition of widely dispersed shareholdership where enterprise goals of value maximization can be pursued with shareholders that reasonably unanimous with respect to enterprise objectives. Initial investment may be confined to a small group of equity holders who can afford to operate in an environment of substantial political economic risk or uncertainty. For the initial group of investors and to encourage future investors, it would be particularly helpful to have decision procedures that would protect these investors from capitalization decisions by the government majority that would dilute their relative position and for protecting them against inappropriate governmental interventions.

With respect to, first, the objective of maximizing enterprise value where we assume goal congruence with the government, Mintz (1983) has demonstrated not only that imperfect and thin capital and securities markets create a problem of transition to full private ownership, but that these conditions create a sound case for essentially permanent minority ownership. This participation

will create a higher value for the firm that could otherwise be obtained by private shareholders without access to reasonably efficient market for trading in securities.

Mintz has also demonstrated, through a theoretical programming model, how the optimum level of government equity participation in risk sharing might be determined and also that attainment of this optimum requires some degree of government planning and prescription over capitalization and investment decisions due to the almost certain lack of shareholder unanimity regarding these decisions.

Even where government were to forego planning of the "market socialist" genre to seek to make, for example, equal marginal productivities of capital everywhere, there exist the more practical problems of how to get from here to there in a program of gradual divestment of government ownershop over time.

A demand revealing approach would essentially overcome such difficulties in and might have a managed program of partial divestiture where the mutual objective of both the government and private shareholders is to maximize the (net present) value of the enterprise. As indicated above, the procedures would be especially useful in protecting the interests of an initial minority group of shareholders. They would also serve to reconcile differences between the government and equity holders regarding the timing of, and the financial terms governing, subsequent public offerings from the government's portfolio.

Since the nature of the demand revealing approach to making these basically similar to the Standard Gas and Electric case described above, I will not further elaborate with concrete specific examples here. Instead, I will turn to the question regarding the circumstances under which demand revelation would be a superior decision-making procedure -- in contrast to say rule by management (dictatorship) or more conventional voting procedures (i.e. majority rule).

The classic work on this question (Buchanan and Tullock, 1962) addresses this question in the context of minimizing all the revelant costs, including decision-making costs and the welfare or external costs of making wrong decisions or, say, using the decision procedure (i.e. voting) to make redistributions that

will reduce the overall welfare of the affected parties. Zusman (1983) has in turn approached the question of this collective choice perspective by looking at the political decision rules of enterprises that are also constrained by the degree to which members can "vote with their feet" by selling shares (as in a perfectly efficient capital market). In looking specifically at the political decision rules of cooperatives, Zusman has focused on the selection of financial ratios such as the optimum equity liquidation and loan repayment rules for the members of a cooperative.

Zusman observes that while we might rely on the median voter result to determine the optimum liquidation/repayment ratio, this will depend on a symmetrical distribution of shareholder voter preferences such that the median voter should choose the optimum ratio.

In turn, Zusman suggests this (the median voter result) may be too restrictive an assumption and that we might better rely on professional management within the cooperative to make a distribution free pareto optimal choice of parameters (DFPO) -- "distribution free" in that the choice of the optimum will not be distorted by an assymmetrical distribution of voter preferences. Zusman's approach, which includes the use of lump sum transfers,, is closely related to the role of the share allocator elaborated in this paper. However, here, the demand revealing approach would better ensure choice of the optimum when management lacks the necessary information about shareholder preferences. 2/

In addition to the governance of a wide range of enterprises, including cooperatives (which will be treated in a later paper), the demand revealing approach would appear to have particular relevance to the process of privatizing state-owned enterprises. It would, for example, likely encourage equity participation that might not otherwise be forthcoming in a divestment program and would ensure agreement on a "satisfactory" set of divestment decisions over the course of the program. Where the share allocator is performing well, these satisfactory decisions will approach an equilibrium which we will define for purposes here as an unanimity result - that is, if a demand revealing vote were taken, there would be no penalty or Clarke taxes. 2/

The demand revealing approach is thus a means of, in part, ensuring that a value maximizing program of privatization and divestment will match performance and implementation with intentions. Where government implementation departs from this announced goal, the equity holders have a means of protecting their interests and to, in effect, maintain goal congruence with the government. Second, the procedure provides a means of re- conciling conflict that grow out of differences in expectations and risk preferences. For example, the government may differ with the equity holders over specific investment decisions because it wishes to take a more conservative posture than that favored by the initial equity holders or there may be different expectations over the implementation over some announced public policy (e.g. removal of price controls affecting the firm) such that the equity holders prefer to defer further government divestment until realization of these favorable changes is reflected in the value paid for the additional capital.

These differences can be easily resolved through the DR approach where the share allocator adjusts the relative positions of the government and the equity holders by, for example, reducing the share value of the private investors relative to the government if the risky investment is undertaken or, in the case where the government wishes to proceed with additional capitalization, reducing its position relative to the private investors. If this is successful, the most efficient decisions will be selected (always) and we will have a perfect DR equilibrium (zero penalty taxes).

Overall, the approach would appear to provide a strong degree of superiority over traditional voting when the government is a participant in the ownership and control of the enterprise, in which case there is some likelihood that the median voter result (e.g. symmetry in the distribution of voter preferences) will be violated. This will be particularly true when there is a divergence of goals, between the government and private shareholders, over value (profit) maximization and there is need for a decision-making mechanism to strike a balance between profit-maximization and the pursuit of other enterprise goals.

2. Privatization with Goal Divergence: The Regulatory or Enterprise Budget

This more difficult problem of the divergence of goals between the government and private shareholders also bears on thorny problems of the regulation of enterprise in the U.S. and other developed countries as well as U.S. experiences in establishing and setting objectives for quasi-government, for-profit corpora- tions that seek to maximize profits while meeting conflicting

social and economic objectives (e.g. the maintenance of subsidized rial service under the aegis of Amtrak and Conrail). In this regard, Medoff (1983) has provided an excellent chronicle of the dilemmas posed by conflicting Congressional guidance in these attempts at privatization a chronicle, which is also instructive of the intensity of the struggle over the composition of public and private membership (ownership and control) in these corporations over a period of some fifteen years. In more recent years, the struggle has led to some degree of unanimity over the desirability of complete privatization as instanced by the sale of U.S. Government interests in Conrail as part of a merger with private railroad enterprise.

However, in the context of observing the U.S. experience with mixed enterprise over the years, I have developed the concept of a DR approach that would not only effectively bypassing contentious issues of public/private ownership and voting control, but also provide a useful means of determining the appropriate level of subsidy when, for example, the for-profit firm is subjected to public requirements for the provision of essential services. In the role of cost allocator, the individual charged with minimizing the incidence of penalties would determine what additional costs associated with a given mandate would be appropriately charged to the government's account. Again, the cost allocator seeks to determine what subsidy would command unanimity (i.e. a DR equilibrium) between the government and private shareholders, so as to minimize penalties. If he is wrong, the expression of shareholder preferences will, of course, specify the true opportunity cost to the firm of the mandated requirement. The government must then determine whether the benefits of the mandated requirement are sufficient to outweigh these opportunity costs in which case it could cast a demand revealing vole to provide the subsidized service. In this case, the government's payment consist of both the level of subsidy initial specified by the cost allocator (which accrues to the benefit of the private shareholders) and a penalty payment to reflect the true opportunity costs expressed by these shareholders.

The approach suggested here effectively implements an idea first advanced by Portney and Sonstalie (1983) who pointed to difficulties posed by efforts to quantify the costs, much less the benefits, of government regulation. Why not, argued Portney and Sonstalie, have the affected firm identify the true social opportunity costs through demand revealing procedures, which it is motivated to do truthfully and accurately? The government can then determine whether or not to implement the regulation depending on its perception of benefits in relation to these revealed costs.

The major departure here is a procedure by which the penalties or Clarke taxes are minimized by having the share allocator make an initial determination of the estimated costs of the inter- vention and to the extent the estimate is incorrect, an additional penalty may be incurred. In addition, and in a manner similar to the Standard Gas case, the affected firm is motivated to seek alternative less costly means of compliance that may be more cost-beneficial relative to the precise intervention proposed by the government.

An example of how such an approach would work with reference to labor market interventions within an enterprise is the following case of occupational safety and health (OSHA) regulation in the U.S. Using the DR approach suggested by Duncan and Stafford (1980) for determining compensation usage differentials within the enterprise (which I further elaborate in the following Section B), let us assume that management and labor can have access to the DR procedure for determining the appropriate "public good" level of working conditions, including safety and health, conditions within the enterprise. The government, however, seeks to ensure a satisfactory set of standards starting with those that appear to be broadly applicable across many similar enterprises. For illustrative purposes in this paper, we might take the standards of noise and vibration (NV) in the workplace either promulgated by OSHA (CFR or the ILO 1984).

The demand revealing approach to determining the optimum standard is as follows:

First, the share allocator requests that the firm (i.e. management and labor within the firm) to specify their preferred alternative in terms of voluntary compliance which may not meet many of the specifications of the NV standard but involves much less costly production adjustments that would, in fact, be preferred by workers (particularly if they are compensated by wage differentials of the type elaborated in Section B). With the two standards, let us assume that the share allocator can also specify the subsidy or compensation that would be received by the firm if it complied with the government mandated NV standard. This is illustrated by the following Case A where we assume that the allocator believes that a $1 million subsidy or trnsfer would make the firm indifferent between its own or the government's standard, when, in fact, a perfect estimate of the needed subsidy would be $1.5 million.

Case A: Government Mandatory Standard Preferred

The result of a demand revealing vote with (w) and without (w/o) a compensating $l million transfer would be as follows:

Voluntary Mandatory Penalty

w w/o w w/o w w/o

Firm $.5m $l.5m 0 0 0 0

Regulator 0 0 $1.0m $2.0 $.5m $l.0

In this case, the firm would prefer the voluntary to the mandatory standard by that amount $l.5 million but the government's estimate of benefits (say, $2 million) exceeds these opportunity costs to the firm. In this case, the mandated standard would be implemented and the government would pay $l million in subsidy plus $.5 million in penalty taxes.

If alternatively, the government's estimate of benefits was less than $1.5 million, then the result (after the proposed transfer contingent on choice of the mandated standard) would be selection of the voluntary approach with a payment of up to $.5 million. As illustrated in the following Case B where the government's estimate of benefits is precisely $1 million, the result would be zero penalty taxes. Here, the allocator has estimated a subsidy that achieves a perfect DR equilibrium (zero penalties).

Case B: Firm Voluntary Standard Preferred

The alternative result with (w) and without (w/o) the $1 million transfer would be:

Voluntary Mandatory Penalty

w w/o w w/o w w/o

Firm $.5m $l.5m 0 0 $.5m 0

Regulator 0 0 0 $1.0 0 0

As shown by Clarke (1980) and others, this approach could be easily implemented where the government seeks to impose requirements (say, for pollution control) where the firm may be viewed as having to right to a subsidy (because it has a zero

right of pollution). The procedure, however, works in basically the same fashion except that the firm is essentially buying its way out of the regulation and pays explicit compensation to the government as well as a penalty when the allocator fails to find the optimum level of explicit compensation.

This approach to the regulatory control of industry might be especially appropriate where the firm is subject to multiple regulation from many sources and where the cumulative opportunity costs of these interventions are unknown and cannot be controlled through traditional means of government oversight.

A DR approach to effective government oversight would be through a "regulatory budget" of a rather non-traditional kind where OSHA and other regulatory agencies have a certain amount of society's resources to expend so as to maximize the benefits of regulatory interventions. Under those constraints, say where OSHA's share of the regulatory budget is say X% of some amount Y, it must determine whether the social benefits outweigh the cost in the affected firm relative to some other intervention. Where it believes that internal decision-making is sufficient to arrive at a satisfactory standard, and implementation of the mandated standard involves expenditures of $1.5 million from its regulatory budget ($1 million in subsidy and $.5 million in penalties) as illustrated in the Case A, it might choose not to intervene ( as in Case B) -- or it may choose to intervene elsewhere.

The idea of a DR regulatory budget presented here, which grows out of the difficulty of controlling multiple regulatory inter- ventions, might be naturally extended to the formulation of "public enterprise budgets" in countries seeking both to privatize their state enterprises and rationalize their methods of controlling these industries.

Countries which are making advances in the art of privatization are, for example, establishing divisions of public enterprise in the relevant ministries or separate units in key oversight ministries to evaluate the comparative performance of their state enterprises vis a vis private entities in the same industry. (Clarke, 1985)

The idea of a state enterprise budget is to extend such efforts by incorporating the DR approach that has been outlined have with reference to U.S. experience with privatization of transportation and social regulation of workplace standards. To implement such an approach, the roles of the share allocator and the trustees in each individual state enterprise are, of course, somewhat broadened in that they are seeking not only to make

independent judgements of relative benefits and costs among shareholder groups but also with respect to the government's interest in pursuing economic and social objectives other than value maximization.

For the enterprises that are subject to government intervention, the central bureau for state enterprises would have to both (i) justify individual subsidies to the firms when it permits government representatives or enterprise Boards of Directors to force decision that conflict with value maximization, and (ii) pay any penalty taxes that result from DR decisions over and above the amounts of the subsidy. By these means, we would expect that the overall level of intervention would be subject to a reasonable degree of control in that these resources compete with other scarce resources in the general budget of the government.

For individual firms, some knowledge of the level of government intervention would also improve the position of equity investors in cases where they are uncertain as to the level of penalties that might be generated when the allocator does not determine the perfect level of subsidy from given interventions. As Clarke (1980) has shown, there are also ways to "fine tune" the DR approach so as to make the expected level of penalty (or Clarke) taxes equal to zero. For example, the share allocator might bid for his right by the expected future amount of future penalty taxes offset by the actual incidence of penalties such that the participants in the system are not disadvantaged by the prospect of resources flowing out of the firm as the result of DR decisions. In terms of the applications outlined here, this means that shareholders are compensated ex ante for expected future penalty taxes that might arise from government partici- pation that will conflict with shareholder objectives of not value maximization.

In terms of the applications to be discussed in the following section on co-determination and labor-management relations, this might work as follows: an outside organization assisting in the privatization effort (i.e. A.I.D.) or a special unit of the host government (in cases where the government has no objective other than maximizing the value of the firm) would establish beforehand, in conjunction with the compensation arrangement for the share allocator, the amount of estimated penalty taxes. This will be essentially transferred to those in the firm participating in DR decisions. Any penalty taxes, however, that result from DR decisions would flow out of the firm to the outside organization or independent government unit, with the overall result that the participants are not disadvantaged through use of a mechanism that might be viewed as a waste of resources from their own private point of view.

3. Privatization, Contract Theory and the Demand Revealing Illyrian Firm

This section considers demand revealing contractual structures that will enlarge the economic pie for enterprise participants and the rest of society. The problems here are not so much, as before, in the protection of the enterprise or particular groups in it from external redistributive interventions and rent-seeking but rather how to use demand revelation to maximize total economic rent (e.g. total producer and consumer surplus).

We will consider first the maximization of producer surplus within the enterprise where there are costs of transacting and of search and mobility, imperfect information, as well as non-traded firm specific factors of production that can be combined to produce increases in organizational rent. Therefore, in the presence of these costs and firm-specific factors, we ask how can demand revealing mechanisms be used to structure contracts that will enhance overall enterprise performance from the standpoint of both enterprise participants and the rest of society. We conclude with some techniques, in particular that of an "enterprise adjustment budget" for encouraging efficient labor market adjustments as part of the process of privatization and for coping, more generally, with economic change.

The essential new element in the demand revealing approach is the treatment of the participatory interests of those repre- senting, say, producers or consumers. Unlike previous approaches

to participation, including the one-person, one-vote decision rules of many proponents of industrial democracy (see Clayre, et. al., 1980), the DR alternative permits effective participation by almost anyone wishing to abide by the DR decision rule and the decisions of the cost share allocator. This means (i) paying costs in relation to the allocator's perception of benefits received, and (ii) additional penalties when one's DR participation changes the results that would otherwise occur in the absence of that participation.

As indicated in the discussion to follow, there are many circum- stances when a pure profit-making enterprise might wish to enter into contractual arrangements that would substitute DR procedures

for other ways of maintaining contractual arrangements with the labor force. The incentive for use of such arrangements would appear to increase the extent to which management must rely on the labor force for information (for example, with respect to investment opportunities) and to the extent that worker's exercise substantial control (i.e. the degree to which the enterprise is a labor managed firm or producer's cooperative).

The reference to the Illyrian firm also suggests the potential relevance of the DR approach to solving a wide range of problems identified in the literature on labor-managed enterprises that have often focused largely on the Yugoslavian model. The Illyrian model (Ward, 1968; Miyasaki, 1983) contrasts often differing economists' perceptions of market socialism with the reality to be found in real-world socialist, worker-managed economies of the Yugoslav type. In relation to the wide-ranging Illyrian (LMF) literature, this paper revisits that firm from a DR perspective concerned with both efficient capital and labor markets.

Under such circumstances, the Illyrian firm (LMF) tends to dissolve to a membership of one (Miyasaki, 1984b). However, the process of getting from here to there in the absence of efficient capital and labor markets is the essential problem for which the DR approach can often provide powerful techniques for resolving. In this section, we will deal explicitly with the labor market side of the equation, focusing particularly of DR techniques for promoting efficient contracts in the labor market.

In this regard, we turn first to two strands of literature regarding the theory of labor management relations that suggest the need for demand revealing mechanisms to address certain public goods problems within the workplace. The first is concerned with distributions within the firm that result in compensations to workers that exceed some competitively determined level (e.g. union vs. nonunion differentials in the same industry or similar firms). Duncan and Stafford (1980) have focused on this phenomenon, with a particular emphasis on wage differentials which compensate for individual or flexible work schedules or an individual workplace. The result is assembly line or other production processes which involve greater interdependencies among workers and between workers and a larger capital stock per worker. Many of these working conditions are public goods, particularly in an imperfect mobility environment involving search and moving costs by management or workers in tailoring work and compensation to individual preferences and enterprise requirements. In such circumstances, Duncan and Stafford emphasized the potential applicability and the economic value of a demand revealing mechanism that will determine the optimum shared working conditions and that will maximize profits subject to reservation utilities (or preferences of the workers). "Note also that whether workers are 'in control' or whether we have a 'company union', there will be incentives to run some type of demand revealing mechanism (median voter, Clarke tax) to maximize the size of the pie to be redistributed (Duncan and Stafford, 1980, p. 360 who also point to cases where workers will want an effective demand revealing mechanism involving the size of the

labor pool and other distributional decisions involving not simply those between workers and management, but workers as well).

A specific example of the applicability of the Duncan and Stafford approach is with reference to the OSHA example in Section I. An external regulatory intervention can be completely internalized (within the enterprise) where workers are assumed to have reasonable information and where there is some mechanism for making joint decisions between management and labor. In this case, the optimum result might be a decision to adopt a voluntary set of safety standards (such as the wearing of ear protective devices) that would also involve a $1 million compensation adjustment to workers (Case B) in lieu of some more capital intensive technology associated with mandatory NV standards applicable to other workplaces where technological adjustments may be less costly to implement.

The demand revealing approach could also be utilized in the structuring of cooperative efforts by management and labor to create organizational rents that increase the value of the firm over what could be achieved in the absence of a cooperative effort.

However, as has been emphasized in an internal bargaining literature that focuses on efficient contracts to elicit these results (Aoki, 1980; Miyazaki, 1984a) the nature of the decisions

in terms of value maximization will be very different depending on the relative economic power of the actors. To the extent that bargaining power favors management, we will get value maximizing decisions that approximate those of the profit-making firm (PMF). At the other end of the spectrum, we get results more in accord with the expected utility maximization of worker welfare (income per worker) instanced by the literature on the labor managed firm (LMF) in Ward, Vanek, Mead and others.

As Mitazaki's (1984a) model has suggested we can look at the implications of various degrees of power in terms of their effects on the basic resource allocational decisions of the firm such as choice of capital/labor ratio (K/N) and investments in growth (g) such as in firm specific training, marketing and adjustment costs in input acquisition which may be paid out of the firm's revenue and affect the present discounted value of the remunerable organizational rents.

Mitazaki acknowledges that "it would seem that under efficient bargaining rational bargainers would agree" on a choice of (K, N, g) to "maximize the whole of the expected business rent, only then to haggle over the division." To begin, however, the decision on (N,K) "cannot be dichotimized from eventual claims to the rent (i.e. because the worker's gain depends on both its size and the number of workers within whom labor's claim will be shared. Similarly, labor will prefer a lower growth rate and firm size because the allocation of current growth cost will depress labor's per capita remunerable share while management, in turn, will prefer a higher growth rate and K/N ratios (Mitazaki, 1984a, p. 391).

With the DR approach, however, distributional conflicts (bargaining) need not impede realization of the maximization of business rent, even though results would reflect the varying time and risks preferences of shareholders and workers alike. To achieve a perfect DR equilibrium (zero penalty taxes), however, the allocator must arrange compensation or a division of the rent both horizontally (between shareholders and workers) and vertically (between groups of workers) to take account of differing time and risk preferences.

How this might be achieved can be illustrated best by focusing on the vertical (worker's) distribution or on the problem of distribution in the "pure" LMF where the objective of maximizing income per worker is traditionally viewed as impeding the basic value or rent maximizing objective. With reference to an example advanced by Meade (in Clayre, 1980), the decision to use a part of net labor earnings (E) during a particular year might involve a situation in which elderly Mr. Smith is about to reach retiring age, while young Mr. Jones has just joint the cooperative. If part of this year's E is ploughed back into the concern, Mr. Jones will gain from the future yield of the machine at the expense of Mr. Smith who will lose part of his share of this year's E. Yet the Smiths may outnumber the Jones; and choose, through a traditional vote, not to invest even though the overall benefit to the cooperative may be positive.

Of course, demand revelation ensures that the efficient decision (to invest) will be made even though the Jones may have to pay penalty taxes as a result. To avoid this outcome, the allocator must specify an appropriate adjustment to the relative wage differential between Jones and Smith or, in this case, simply issue new debt at some acceptable rate of interest to all the existing members to represent that part of each member's E which had been retained by the cooperative, accompanied by an appropriate arrangement that would permit Mr. Smith to sell or recover the amount of the debt he owns at retirement.

As demonstrated by Meade (in Clayre, 1980), there are numerous other problems of participation and value-added sharing ranging between simple accounting procedures (e.g. the treatment of capital gains and losses which could raise the same issues of unfairness between old and young members), economic issues regarding the infusion of appropriate amounts of outside equity capital for capital intensive technologies (e.g. appropriate spreading of risks) and the dismissal or exit of workers from the cooperative (when the individual or collective interest in exit may diverge) and efficiency/distributional issues regarding the setting of differentials for payments to different grades of workers in the cooperative.

In essence, demand revealing procedures ensure efficient decisions regarding those issues as long as the allocator (and the overseeing trustees) can retain control over distributional outcomes, including adjustments to compensation associated with different alternative outcomes (e.g. pay-out or retention of E for future investment). By control of the distribution, I mean determining the distribution of E between workers and adjustments to future profit sharing in the form of bonuses, share equity and the like.

The basic approach is illustrated by Figure 1 where the problem might be viewed as either how to make compensating adjustment between shareholders and workers or among different groups of workers for efficiency moves that will increase business rent. Figure 1 could be viewed as a continuum of increases in growth cost (g) with the overall benefits taken as changes in the present value of organizational rent. The problem for the allocator is to find the adjustments to compensation or to share equity, for shareholders or workers, that will balance, at the margin, the group's expectation of what it will receive in increased rent. If this is achieved perfectly, there will be unanimity and zero penalty taxes (the DR equilibrium). If it is not achieved, we will still arrive at the desired efficient outcome, but penalty taxes of the amount in the shaded areas of Figure l will be incurred. Nevertheless, the desired outcome is generated independent of the distribution and/or the relative bargaining power or numerical voting power of the participant groups.

The basic approach can, of course, be extended to a wide range of decisions affecting the internal labor market within the firm. These extend not only to the types of decisions over working conditions illustrated by Duncan and Stafford (1980) but also for the determination of efficient contract arrangements that provide for insurance against uncertain events (layoffs, sickness, accidents) and for the provision of retirement security. To an increasing extent, governments have encouraged the voluntary establishment of these arrangements within the enterprise as an option to mandatory social insurance and have made the worker's funds portable across enterprises. /

Efficient insurance arrangements, however, depend upon information from workers concerning alternatives. For example, the efficient level of the internal wages fund for self insurance in the internal bargaining literature (Miyazaki, 1984a, 1984b) depends on alternative reservation wages available in the event of layoffs.

The problems of distribution become more complicated as we introduce various elements of the share economy, ranging from simple bonus add-ons to fixed wages, all the way to the "pure" LMF. However, as noted by Meade (1979) and others, the LMF creates additional requirements for collective economic security as "there will be dangers of extreme fluctuations in income per head in industries which are capital intensive, for which entry of new cooperatives are difficult, in which substitutability between capital and labor is high, and for the products of which the elasticity of demand is low."

In these settings, however, the DR approach offers a means of making efficient joint determinations that will divide the enterprise pie between current consumption, deferred compensation whether in the form of shares or insurance against uncertain events, and investments in enterprise growth.

In addition to providing a source of funds for enterprise growth, an appropriately tailored DR compensation system also encourages efficient collective tradeoffs between workplace conditions (occupational safety and health protections) and alternative compensation. Workers, for example, are encouraged to determine what degree of precaution can be taken individually or collectively as an alternative to investments in workplace safety and make the savings available for health protections in a worker's individual deferred compensation account.

Essentially, the DR approach motivates managers and workers to undertake intensive search activities, with an eye to risky and uncertain events to find the most efficient state-contingent contracts that will maximize enterprise value and the expected utility of the workers for contracts that will adequately protect

them against risky and uncertain states. In achieving these results, there will be many potential conflicts (of the Mr. Smith

and Mr. Jones variety) but these can be resolved as long as the allocator is empowered to make appropriate adjustments to compen-

sation as illustrated in Figure 1. Even if there is not perfect agreement (a perfect DR equilibrium), the efficient contract result will be achieved with the incidence of some penalty taxes.

More fundamentally, the approach outlined here motivates individuals to become informed and take initiative to actively search alternatives that will contribute to increases in their share of the labor income of the enterprise over time.

This is particularly important in the structuring of efficient contract arrangements that will improve the design of jobs and the workplace so as to improve long run productivity and job satisfaction through learning. Although there is overwhelming evidence of the contribution that such investments in organization and human capital improvement can make to the value of the enterprise, it is often difficult to obtain agreement within the enterprise on the implementation measures.

The demand revealing approach motivates a search for efficient contract arrangements that will promote agreement. As indicated earlier, this will involve managers and the allocator in determining adjustments to compensation that will lead to agreement concerning any particular composition of investment in human capital. For example, suppose that the investment favored by Mr. Jones is in programs involving education and use of computers in the workplace. The contract arrangement for Mr. Jones may, in turn, require a training adjustment to his current compensation on to his deferred compensation account. However, if his training results in faster job promotion or work team productivity in the future, he will receive additional compen- sation and/or bonuses. This adjustment process also results in agreement within the enterprise (or penalty taxes to resolve differences) in that the "training investment" for Mr. Jones and like individuals is not perceived to disadvantage Mr. Smith and other like workers.

The encouragement of efficient social contracts for human capital

development might be viewed in a broader context of the evolution

of the entrepreneurial firm where all workers are encouraged to develop entrepreneurial skills. It is useful to also consider

this objective in the context of cooperative endeavors that depend critically on the provision of information, including the incentive to provide it truthfully and accurately, from sub-units or groups within the enterprise.

Loeb and Magat (1978) have given particular attention to this problem as it related to the problem of incentives and efficient allocations and the structuring of desirable "success indicators"

for enterprise management in the Soviet Union. These success indicators determine bonuses which are the prime source of income to enterprise managers and their incentive properties have been subject to extensive analysis by Western economists.

Loeb and Magat pointed out that while many of the success indicators and incentive arrangements have desirable properties from the standpoint of local profit maximization, they can motivate extensive manipulation in terms of biased and untruthful forecasts regarding alternative allocations of capital from a Central Planning Board (CPB). In turn, Loeb and Magat demonstrated how the demand revealing approach can motivate the provision of truthful forecasts, by specifying a "success indicator" that will make the i^th (or subunits') indicator independent of its forecasted profits (at its allocated level of capital).

This approach to determining compensation would be important when workers not only have utility for protection against risky or uncertain states (through a wages fund) but also to share in the future success of their enterprise. Also, it points to ways in which individual entrepreneurship can be translated into effective collective decisions where we wish to bring individual knowledge about risk and reward into the making of efficient enterprise investment and risk spreading decisions. Although in most cases, such decision might be relegated to professional management, there also might be differences in preferences for alternative risk/reward combinations that would warrant reliance on demand revealing procedures.

Suppose, for example, the Joneses in our cooperative have reached the point where they are able to attract independent sources of capital and they run a sub-unit that has a preference for longer-term and highly profitable but also risky investment alterna- tives. Whereas these preferences might be accommodated by appropriately structured bonus arrangements up to a point, the time might come when differences in risk and reward preferences within the enterprise would argue for a relatively autonomous unit or even exit from the enterprise. This might be achieved by setting up independent share classifications (analogous to our Class A, Class B example in Section I), or

determining the terms under which independence of the sub-unit is to be achieved. Again, the share allocator and the Trustees play a crucial role in the distributional decisions, so as to ensure that any demand revealing vote will minimize penalty taxes.

In a like manner, the procedures would ensure the infusion of new capital for any type of cooperative when the proceeds would finance an addition to the collective's real assets sufficient to produce an addition to its net value added (NVA) greater than the existing ratio of NVA/S where S reflects the share of value added by workers or by other capital shares.

Similarly, the share allocator should be able to arrange for the entry and exit of workers in a manner similar to the arrange- ments described earlier for optimum investments in training with suitable adjustments for compensation.

For example, as suggested by Meade (in Clayre, 1980), there could be deleretious effects on existing workers of new entry in some situations where average labor earnings (ALE) the marginal revenue product (MRP) of a new worker earnings of that worker outside of the cooperative (OE). In such situations,

an outsider should be able to buy his way into a cooperative by an annual payment B₁ where ALE - OE B₁ ALE - MRP. Conversely, where ALE OE MRP, the existing members ought to be able to bribe an existing member to leave by an annual payment B₂ where ALE - OE B₂ ALE - MRP. The same calculations would apply to more complex cases involving an income distribution schedule within the enterprise involving a set of ALEs by worker class.

As Duncan and Stafford (1980, p. 360) have suggested, however, the existence of search and mobility costs suggests that irrespective of the degree of worker control, they will want an effective demand revealing mechanism to reach such decisions (on bribing coworkers to leave and hiring new coworkers). The difficulties here are exacerbated when we consider moving from one compensation system (e.g. a fixed wage system) to another (e.g. a share based compensation system). As noted by pro- ponents of such shifts in compensation systems (Weitzman, 1984), there is an important social externality effect in terms of its income generating potential (e.g. the marginal cost of hiring a new worker under such an arrangement is significantly lower than the average cost) and employers are thus motivated to aggresively

seek new workers. Weitzman also acknowledges that it would be difficult to implement such a system because entrenched labor interests benefit differentially from conventional wage deter- mination which inflates labor incomes for certain classes of workers.

It is this type of circumstance that usually provides the most significant impediment to privatization of nationalized industries whether in developed or developing countries. In most cases, the result is some provision for mandatory labor protection as in the case of the U.S. railroads such as Amtrak and Conrail (see Medorf, 1983) or the government requires as a condition of divestment that the labor force of the privatized industry be maintained at the same level for a specified period after the private sector assumes control, as was the case in the denationalized jute mills in Bangladesh (Cowan, 1985).

The demand revealing approach to privatization would deal with this situation in a manner similar to that outlined in Section I. For example, the government could create an "enterprise adjustment fund" out of the proceeds of funds received from partial or full divestment of state enterprises with the stipulation that any "excess costs" of labor protection would be financed out of the fund. Of course, this would also increase the amount tendered for equity participation and divestment because the shareholders would not be forced to shoulder these labor protection costs.

In a similar manner to that illustrated by the OSHA example in Section I, the labor adjustment would be carried out in the most efficient manner. The firm and a union that had its own demand revealing procedures could, for example, determine a voluntary approach incorporating internal firm adjustments, temporary layoff and compensation or severance pay procedures that might realize substantial savings vis-a-vis any mandatory program (as in the case of the OSHA example where the costs were halved). The government would in turn calculate the benefits in terms of transfers and penalties from its "enterprise adjustment fund" of the voluntary vs. mandatory alternatives, including possible resort to other alternatives for absorbing or retraining workers if it chooses voluntary alternatives that result in significantly

large displacements of workers.

The approach taken here would also appear to have applicability in the design of "industrial policy" in a wide variety of settings involving economic growth and adjustment problems in declining industries. For example, it might foster efficient change where countries seek to maintain open trading systems while adjusting efficiently to these changes by ameliorating the adjustment impacts on specific subsectors and classes of workers.

A study of corporatist political economic decision-making in Austria and Switzerland (Katzenstein, 1984) is suggestive also of the potential for the administration of demand-revealing adjustment programs by "peak associations" of business and/or labor groups that are broadly representative not only of the impacted subsectors (e.g. Swiss watches, Austrian textiles, and

steel in both countries) but of a larger financial, business and labor consistency. Such contexts suggests the finance of an "enterprise adjustment fund" by the government with resort to private associational activities to define adjustment alterna- tives that would achieve the adjustment and open trading objectives both within particular firms and adversely affected sectors as well as across sectors of the economy.

1/ Book II of Berle and Means (l932) basically portrayed the loss of shareholder control over management decisions involving: (i) changes in participation accruing to shares, (ii) routing of earnings as between shares of stock, and (iii) alteration of the original contract rights of security holders. Legal procedures designed to protect, for example, against unwarranted dilutions had become too time consuming or expensive or, as in the case of the pre-emptive right of shareholders to purchase new stock, legal experts had determined there was no (satisfactory) way to provide such a right where there were complex classifications of stock in the corporate structure. The Standard Gas and Electric case, discussed in the body of this paper appears at page 215-16 of Book II.

/ It will also be superior to other demand revealing approaches (Groves and Ledyard, 1976) that seek "budget balance" or to eliminate penalties, but which can give rise to strategic, non-truth telling behavior when preferences are not symmetrically distributed in accordance with the median voter result (Clarke, 1979, 1980).

/ In contrast to the literature on shareholder voting or unanimity, this version of political (voting) equilibrium within the firm contrasts with the traditional literature where equilibrium is defined as decisions preferred by the majority where the firm is immune from take-over or, as stated, more precisely by Grossman and Stiglitz (1977): "a majority voting equilibrium is a proposal which cannot be defeated by some other proposal." (p. 401, footnote 4)

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