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A Profit-Sharing Proposal

by Qing Zhang



Very few would oppose the prospect of economic growth. Most recently, the example of the Covid-19 outbreak and its devastating impact on our economy highlights the neglect of lower-income individuals in society, and the need for better economic conditions is further desired. In the words of Joseph Stiglitz, a Nobel-prize-winning economist, “We built an economy with no shock absorbers—We made a system that looked like it was maximizing profits but had higher risks and lower resiliency” (1). However, as grim as our circumstances may be, we can still hope to take a proactive approach to the lessons of the pandemic. The right implementation of profit-sharing could play a future role in tackling income inequality while satisfying people with concerns about deviating from the system we have now. In the following essay, we look at successful examples of profit-sharing companies and explore the correlation between profit sharing and honesty in reporting.


The right implementation of profit-sharing could play a future role in tackling income inequality while satisfying people with concerns about deviating from the system we have now.

Ideally, profit sharing is the practice of a company sharing a portion of the profits they make with their employees, whether it’s through stock grants or cash. This is a way for companies to incentivize employees to produce results. A list of benefits would include goal congruence between employees and the firm, a sense of entrepreneurial control, and the bolstering of creativity (Hanif). The long-term prospects are an overall increase in labor force participation, productivity, and an overall better economic condition. In other words, profit sharing can work to equalize income, without sacrificing concerns of lowering economic activity. To support whether this economic hypothesis is feasible, a few well-known companies have already integrated profit sharing (successfully) into their business plan. An article from the New York Times titled At Chobani, Now It’s Not Just the Yogurt That’s Rich mentions how Chobani’s CEO, Mr. Ulukaya, attributes the success of his business to the 10 percent stake they grant to workers of the company plant. Mr. Ulukaya states that “’ I cannot think of Chobani being built without all these people,’” (Strom). Another good example of successful implementation of the profit-sharing plan is Huawei, a Chinese telecom corporation that is privately owned by its employees. The founder, Ren Zheng Fei “himself holds only 1.4% of the company’s total share capital, with 82,471 employees holding the rest,” and the company has proven its success with “more than 3 billion customers worldwide. It is the only Chinese company that receives more sales revenue from markets outside China (67%) than from inside it” (Cremer 1). This is not including the U.S market, as they’ve banned Huawei products due to security threats. If there were any reservations on the success of an employee-owned profit-sharing company, Huawei and Chobani may persuade other companies as to the efficacy of profit sharing.


One major reason there are reservations about profit-sharing is dishonest reporting on profits by management/employees of a company.

Despite the listed benefits, this is not to say that profit sharing is a perfect cure-all. One major reason there are reservations about profit-sharing is dishonest reporting on profits by management/employees of a company. Some speculators argue that if workers are incentivized by profit sharing, we put them in a position where they must deliberate between honesty and personal wealth. The more cynical will argue that many individuals would opt for the latter since it is easier to adjust numbers than increase productivity. The assumption is rooted in the economic theory of rational behavior, that people will naturally make decisions that provide them with optimal satisfaction. However, research shows that this may not be completely accurate. In a paper titled “Honesty in Managerial Reporting” by John H. Evans III from the Katz Graduate School of Business, the writer conducts a string of experiments testing the level of honesty among a group of MBA students. In their first experiment, Evans compared the reported profits and the actual profits produced by the group. According to Evans, if the theory of rational behavior holds true, the percentage of honesty should be close to 0%. To his surprise, the results of the experiment show a 48.7% level of honesty (9). Although it may appear that the group was only partially honest, considering that subjects were told dishonest reporting would result in a bigger payoff and no repercussions, it is a relatively high percentage. The experiments conducted in succession also proved that implementing other factors, such as monitoring, auditing and reputation can increase the level of honesty. Overall, “The Revelation Principle establishes that firms can always get honest reporting if they pay enough for it” (Evans 22). Evidence from Evan’s experiments concludes that even without incentives in place, a good portion of people will still choose honesty over personal gain. Although the system is not perfect, promoting goal congruence is something that can be improved upon. Profit-sharing is not a perfect system, there will always be outliers when we are dealing with human beings. However, if we can incentivize a good majority of employees, to be honest with reporting, profit-sharing can be very worthwhile.


Basically, a pooled profit-sharing plan can encourage individuals to check upon one another, thus increasing honesty levels.

Studies show that increasing the pool of individuals participating in profit sharing can also increase honesty in reporting. Charles Boster, an assistant professor at Salisbury University wrote an article titled, “The Effect of Individual and Pooled Profit-Sharing Plans on Honesty in Managerial Reporting” concludes just that (1). The article mentions the theory of crowding effects, “which predicts that an external monetary incentive can change the framing of managerial reporting by signaling distrust and by shifting perceptions of the appropriateness of opportunistic behavior, and can thus crowd out a preference for honesty” (Boster 712). Basically, a pooled profit-sharing plan can encourage individuals to check upon one another, thus increasing honesty levels. The theory and hypothesis were proved by the experiments Boster conducted on individuals and pooled groups. Boster summarized that the mean percentage of honesty in his experiments was “59.5 percent in the individual condition, and 67.0 percent in the pooled condition” (719), thus congruent with the aforementioned theory. As of now, the population of employees who practice profit sharing is fairly small; they are mostly reserved for those in managerial positions. Going by the logic of this experiment, then, making profit-sharing more broadly practiced can further promote honesty. The study by Boster shows that increasing the pool will work hand in hand with increasing honesty and serves the interest of the majority.


In conclusion, by encouraging profit-sharing to be widely practiced, we can promote not only goal congruence and productivity, but also honesty in business practices. This is supported by separate experiments performed by John H. Evans III and Charles Boster. But other than being rationally sound, profit-sharing provides hope to those who may feel a lack of control in their occupations or their economic situations. And there are policies that we can implement to incentivize companies to adopt a profit-sharing model. Research conducted by the IMF in 2019 describes a negative correlation between growth in GDP per capita and income inequality. The summary states that “excessive income inequality depresses investment in both human and physical capital, two key sources of long-term growth” (Aiyar). Therefore, it may be beneficial to the overall economy to find ways to redistribute wealth and stimulate economic growth.


 

References


Boster, Charles, et al. “The Effect of Individual and Pooled Profit Sharing Plans on Honesty in Managerial Reporting.” Contemporary Accounting Research, vol. 35, no. 2, 2018, pp. 696–715., doi:10.1111/1911-3846.12400.


Cremer, David De, and Tian Tao. “Huawei: A Case Study of When Profit Sharing Works.” Harvard Business Review, 24 Sept. 2015, hbr.org/2015/09/huawei-a-case-study-of-when-profit-sharing-works.


Evans, John H., et al. “Honesty in Managerial Reporting.” SSRN Electronic Journal, 2001, doi:10.2139/ssrn.269448.


Hanif H, Rakhman A, Nurkholis M. Building a Concept of Entrepreneurial Control. TEM Journal. 2019;8(4):1198-1206. doi:10.18421/TEM84-13.


Stiglitz, J. 1974. Alternative theories of wage determination and unemployment in LDC’s: The

labor turnover model. Quarterly Journal of Economics. 88 (2):194-227.


Wolfers, Justin. “‘Job Creation and a Healthy Economy.’” National Bureau of Economic Research, 2015, users.nber.org/~jwolfers/policy/Wolfers%20testimony_Senate%20Finance%20_Jobs%20and%20a%20Healthy%20Economy.pdf.

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