Are Labor-managed Firms Superior to Capital-Managed Firms? A Two-sided Adverse Selection Model to Explain the Simultaneous Low Formation Rate and Enhanced Productivity of Labor-managed Firms

Abstract

The current theory of the labor-managed firm is ill-equipped to explain recent empirical observations of simultaneous low formation rates and superior productivity by labor-managed firms. My thesis extends existing theory regarding the formation of labor-managed firms based on the choice of firm structure by entrepreneurs. Specifically, I extend the model of Dow 2010 to include heterogeneous workers and let worker selection be the underlying driver for productivity differences. Using standard equilibrium analysis from game theory to analyze the model, I find that conditioning the formation of labor-managed firms on both the selection of workers and the management of worker trust towards entrepreneurs can explain why labor-managed firms are hard to form. I also find that labor-managed firms can be shown to have a productivity advantage over conventional firms due to their selection of workers, without any other structural differences in production. Overall, my model is consistent with observed behavior of labor-managed firms. These firms tend to 1) require specific conditions to form, 2) have slightly higher productivity when they are formed, 3) care more about employment stability, and 4) cluster in industries and areas. My model has distinct advantages over existing similar explanations for these observations, as it provides a formalized model that can be empirically tested for its validity and extended to cover more features and complexities of reality