Profit-sharing is an incentive pay system where the employees are entitled to a predetermined part of the company’s profits. It can be applied in various ways and for various reasons. In the theoretical literature, profit-sharing is often seen as an arrangement with the purpose of aligning the interests of employees and capital owners. Profit-sharing was known already in the 19th century and has become particularly common in countries where legislative measures have prescribed or encouraged its application. A defining feature of profit-sharing is that the employees’ share of the company’s performance is determined beforehand and not in a discretionary fashion. Usually, profit-sharing is thought of as remuneration in addition to the base wage covering all or most employees.
Three basic types of schemes are commonly distinguished. In cash-based schemes, profit shares are paid immediately in ready money. In share-based schemes, employees are encouraged to become part owners of the company. In deferred profit-sharing, employees cannot take part of the profit shares until a certain time has passed. Gains-sharing can be regarded as a bonus incentive system related to, but distinguished from, profit-sharing. In gains-sharing schemes, employees are entitled to a predetermined part of efficiency gains. Generally, gains-sharing runs on a monthly basis, whereas profit-sharing usually runs on an annual or quarterly basis.
In theory, there are several reasons why some employers apply profit-sharing. An important motive is to link the employees’ interests to the company owners’. By connecting a part of the remuneration to the company’s performance, employees get incentives to perform at their best and encourage their colleagues to do the same. However, some economists argue that the positive incentive effect is hampered by a free-riding problem. If the profits are shared between a large number of individuals and the contribution of each individual to the company’s results is small, profit-sharing has weak prospects of boosting employee effort.
Another property of profit-sharing that may be attractive for employers is that it has the potential of reducing personnel turnover and making investments in firm-specific training more worthwhile. As labor costs automatically adjust to the business cycle, firms can avoid layoffs in bad times and employees will be less inclined to quit voluntarily in good times. In empirical research it has proven hard to establish an effect of profit-sharing on productivity. This is partly because of problems with establishing the direction of causality; it is difficult to know whether companies become more productive by imposing profit-sharing or if more productive companies are more inclined to impose profit-sharing.
Historically, profit-sharing has its origins in the 19th century or even farther back in time. A pioneer company was Redouly & Co., whose owner, Edme Jean Leclaire, introduced a profit-sharing scheme in 1842, along with participation in management, for a selected group of employees. Some decades later, profit-sharing had spread to such countries as France, Great Britain, and the United States. The idea had several famous advocates among scholars and intellectuals, and it was discussed in 1889 at a congress in Paris. This congress, among others, established the definition of profit-sharing that basically is still in use today.
During the 19th and early 20th centuries, profit-sharing was seen as a way of reconciling the interests of workers and capital owners. The incentive system was often used by employers alongside corporate welfare systems, such as pension schemes, company housing, and healthcare. Politically, profit-sharing had advocates among both conservatives and progressive-liberals, but generally, the idea was regarded with suspicion by socialists.
By the late 20th century, profit-sharing was a well-known business practice, though more common in some countries than in others. This is partly related to institutional differences. Two countries have made profit-sharing compulsory for certain categories of firms and other countries have introduced legislation that encourages the remuneration form.
Mexico is the country with the longest tradition of statutory profit-sharing. According to the constitution, a national commission establishes the percentage of company profits that is to be shared with employees. The profits share received by each employee is governed by number of days worked during the year and wages received during the year. Directors, general managers, and administrative staff are not included in the statutory profit-sharing in Mexico. The other country with statutory profit-sharing is France, where legislation prescribing schemes with deferred payment for companies with 100 employees or more was introduced in 1967. The threshold was later lowered to 50 employees.
Legislation that encourages profit-sharing, for example, by means of tax concessions, is more common. In the United Kingdom, for example, legislation for cash-based schemes was passed in 1987. This legislation includes prescriptions for how schemes should be designed in order to qualify for concessions. Among others, schemes have to be approved by the workforce, include at least 80 percent of the employees, and payments have to be allocated according to a uniform procedure.
Tax concessions for profit-sharing are also given in the United States and Canada, but here the legislation encourages schemes with deferred payment. In the United States, the legislation allows schemes where companies, at their own discretion, decide how much of the profits to distribute among the employees. In Canada it has been observed that cash-based schemes have proliferated, although not encouraged by tax concessions.
Japan is thought of as a country with a comparatively high incidence of profit-sharing. However, empirical inquiries have shown that while various forms of bonus payment are encouraged by legislation, and commonly applied by large Japanese firms, only a small part of these bonus systems can be defined as profit-sharing. A recent study indicates that about 25 percent of traded firms in Japan apply profit-sharing.
- Joseph R. Blasi, Creating a Bigger Pie? The Effects of Employee Ownership, Profit Sharing, and Stock Options on Workplace Performance (National Bureau of Economic Research, 2008);
- Alex Bryson and Richard B. Freeman, How Does Shared Capitalism Affect Economic Performance in the UK? (National Bureau of Economic Research, 2008);
- Su-Fen Chiu and Wei-Chi Tsai, “The Linkage Between Profit Sharing and Organizational Citizenship Behavior,” International Journal of Human Resource Management (v.18/6, 2007);
- Luci Ellis and Kathryn Smith, The Global Upward Trend in the Profit Share (Bank for International Settlements, 2007);
- Saul Estrin et al., “Profit-Sharing in OECD Countries: A Review and Some Evidence,” Business Strategy Review (v.8/4, 1997);
- Douglas Kruse, Richard B. Freeman, and Joseph R. Blasi, Do Workers Gain by Sharing?: Employee Outcomes Under Employee Ownership, Profit Sharing, and Broad-Based Stock Options (National Bureau of Economic Research, 2008);
- Derek Matthews, “The British Experience of Profit-Sharing,” Economic History Review (v.42/4, 1989);
- Michele Moretto and Paola Valbonesi, “Firm Regulation and Profit Sharing: A Real Option Approach,” B E Journal of Economic Analysis and Policy (v.7/1, 2007).
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