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Debt-to-equity swaps: towards a fairer post-pandemic world

Firms are likely to emerge from this crisis with large debts, and it will be workers that pay the price. But there is another way to protect businesses and jobs.

Guy Major Jonathan Preminger
14 May 2020
Dominic Lipinski/PA Wire/PA Images

As the world reels from the Covid-19 pandemic, states have moved with impressive speed to support businesses with grants and loans. Such assistance during a crisis is crucial for protecting basic social structures, but – as many commentators have emphasised – the kinds of support now bestowed by governments will have an enormous impact on the societies that emerge from the crisis.

The financial crisis of 2008 amply demonstrated this: firms and financial institutions tumbled towards oblivion and were saved by unprecedented state intervention. Yet bailouts left basic structures intact – this was a massive, coordinated, global effort to rescue the capitalist system and re-establish it with precious little reform.

Therefore we must bear in mind that, while the current crisis is a great opportunity for the Left, progressive change will not happen automatically. It requires political engagement and collective action to shape, disseminate and implement the policies that will underpin the post-pandemic world.

In this spirit, we address one problem with current government assistance, and propose a radical solution that potentially increases employee ownership and control of the firms they work in, while encouraging a fairer distribution of wealth.

Debt-to-equity swaps combined with non-voting, surplus-sharing shares

Government assistance is currently channelled through firms, with few strings attached, leaving existing wealth distribution, ownership structures and inequalities intact. Crucially, this support is liable to leave firms heavily in debt. As each firm emerges from the crisis, this debt will have to be repaid, regardless of the financial success or otherwise of the firm. The workers are likely to bear the brunt of this debt, in the form of wage erosion or even pay cuts and dismissals. Moreover, the firm’s efforts to repay the debt are liable to impact re-investment, undermining the firm’s ability to ensure an optimal mix of labour and capital and further weakening it.

One way around this problem is equity investment, with the firm paying variable dividends (depending on its success) instead of servicing debt. Therefore, we join others in calling for debt to be converted to share financing: as companies emerge from the pandemic, they should be given the option to swap government-backed debt for initially government-held, tradeable equity shares.

However, many firms may be reluctant to cede control of their businesses to external holders of traditional voting shares, while potential investors will be wary of investing without the protection provided by some kind of control. Therefore we go a step further than previous calls, and propose a mechanism that locks together the interests of current owners, workers and investors (including the government), leaving control of the firm in the current owners’ and workers’ hands yet avoiding the risk of wages being raised at the expense of dividends to investors. In essence, this is a pre-agreed formula to split the firm’s value-added (sales minus non-labour costs, also equal to wages + profits) between workers/directors and investors/owners. This means a significant component of wages would be variable, and workers would share in the fortunes of their firm.

How would it work?

As we have explained elsewhere in more detail, after subtracting a pre-agreed fixed component of pay, the firm’s value-added would be split into a number of ‘slices’. Each worker gets a pre-agreed number of slices, effectively their variable pay, and each share gets one slice as its dividend. Workers would have an incentive to increase profit, thus increasing their variable pay, but in doing this, they would also be maximising earnings per share, and would thus automatically work in the interests of investors as well (a fully referenced peer-reviewed article with worked-through examples is freely available here). In firms that adopt this mechanism, workers will have more unpredictable wages. However, this should be offset by offering them shares and participation in management.

These “surplus-sharing shares” would have prescribed standard form rights, including that they are tradeable, which would also give investors themselves – initially banks and the government – a natural exit strategy: they could sell their shares to other investors via secondary markets, which the government could help set up and facilitate. The current control structure of the companies concerned, including any benefits from employee ownership and workplace democratisation, would not be undermined as surplus-sharing shares would be normally non-voting: ownership is separated from control, while investors are protected via the explicit value-added sharing formula.

The below diagram illustrates how the scheme would work (a more detailed explanation of the diagram can be found here).

Screen Shot 2020-05-14 at 15.56.45.png

Each share gets one slice of any surplus (initially allocate one share, thus slice, per £1 of surplus, running the scheme retrospectively with last year’s numbers). The average number of surplus slices per worker is the number of £’s of total variable pay there would have been, running with last year’s numbers, divided by the number of full time equivalent workers.

In short, a debt-to-equity swap combined with the surplus-sharing, non-voting share mechanism we propose would increase the chances of survival for firms emerging from the crisis, by eliminating the debt burden, thereby protecting jobs. At the same time, it would lock together investor interests with worker interests while leaving control in the hands of workers/directors.

As such, it can be readily applied to employee-owned or employee-controlled firms, and could be combined with the most rapidly-growing form of employee ownership: the employee ownership trust. Indeed, a more radical proposal could condition such (initially) government-backed investment on some form of employee ownership and participation in management.

This would only be one step of many. However, in addressing the unavoidability of massive injection of public capital into private firms, the urgent need for employee democracy, and the importance of sustainable business rooted in – and answerable to – the community, the proposed step could be crucial in resetting the economy in a post-pandemic world.

Who's getting rich from COVID-19?

Boris Johnson's government stands accused of 'COVID cronyism', after handing out staggering sums of money to controversial private firms to fight COVID-19. Often the terms of these deals are kept secret, with no value-for-money checks or penalties for repeated failures which cost lives. And many major contracts have gone directly to key Tory donors and allies – without competition.

As COVID rates across the country surge, how can we hold our leaders accountable? Meet the lawyers, journalists and politicians leading the charge in our free live discussion on Thursday 1 October at 5pm UK time.

Hear from:

Peter Geoghegan Investigations editor, openDemocracy, and author of 'Democracy for Sale: Dark Money and Dirty Politics'

Jolyon Maugham Barrister and founder of the Good Law Project.

Layla Moran Liberal Democrat MP (TBC)

Chair: Mary Fitzgerald Editor-in-chief of openDemocracy

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