Pirates and football teams

What do pirates and football teams have in common? It may not be obvious, but I would argue they are both examples of human-capital based "firms". Each of these types of "firms" is based upon the skills of their members. What is interesting about them, and what needs to be explained, is the very different organisational forms each of them takes.

Consider first the case of the (illegal) pirates, and compare them with their (legal) counterpart privateers. While both pirates and privateers practiced maritime plunder they had very different organisational forms. What they had in common, apart of their business, was the need for human capital in the form of a crew and the need non-human capital in the form of a ship. However an important difference between privateers and pirates is that although they were both in the same business, privateers were state-sanctioned while, by definition, pirates were not. That is, governments would commission privateers to attack and seize enemy nations' merchant shipping during times of war. As already noted the most obvious piece of non-human (physical in this case) capital for both the pirates and the privateers was their ship.

The role of investors in providing this capital was important to the organisational form that pirates and privateers developed. Pirates had no investors; they simply stole the capital they needed. Privateers, on the other hand, as legal enterprises could not just go out and steal the capital they required, they needed external financiers to supply their capital requirements. This difference in capital supply resulted in very different organisational forms: the privateers having a more autocratic management system than pirates. Pirate crews were equal contributors and equal part owners of the "firm" they worked for. Given they had no investors the pirate's "firm" was based around the relatively homogeneous human capital of the crew. Having no need for investors, pirates did not need to develop mechanisms to protect the interests of the firm's financiers as the privateers needed to. This meant that incentive problems could be dealt with by developing a "worker-owned firm" with the crew (usually) sharing equally in "profit" and electing its leaders and having power dispersed among multiple members of the crew such as the captain and the quartermaster. In contrast the privateer had investors and a management system designed to protect their investments. The investors appointed privateer captains and developed an organisational scheme that in some important respects mirrored the managerial organisation of (also investor backed) merchant ships.

So the relative importance of human capital is an important determinant of organisational form, as long as the human capital is homogeneous. An issue the football team example speaks to.

So what of footballs teams? Here we have a situation where human capital, talent at playing football, is the basis for the "firm" but unlike the pirates, ownership by the human capital, i.e. the players, is extremely rare since, I would argue, a worker-owned team would be at a disadvantage relative to a player-as-employee based team. There are many forms of ownership of football teams, from teams having shareholders and being traded on the stock exchange, to teams being owned by an individual, but one form of ownership not seen (as far as I know -a counter example would be great!) is a labour (in this case, player) owned firm.

Heterogeneity among playing talent and thus earning potential acts as a disincentive to the formation of a worker cooperative, which involves (rough) equality in payment¹, since those players with the greatest earning potential, the largest outside options, will transfer away from the cooperative to maximise their income stream.² Differential payment schemes can occur, especially within partnerships, but they require that the individual employee productivities are sufficiently easy to measure so that a relatively objective method of productivity related pay is possible. Given the team production nature of team sports productivities are difficult, if not impossible, to estimate and thus payment by productivity is not feasible, which argues in favour of equality in payments. Thus a worker-owned team would have few, if any, star players, a handicap in the winner-takes-all world of professional sports.^{3, 4}

Another issue for a cooperative sports team is that while the star players may leave the team too soon, the "average players" may stay too long. The average players will have smaller outside options and thus less incentive to leave but as they are also owners of the team it would be more difficult to get rid of those who are not performing. It would be easier for an employee-based team to remove under performing players as they are not owners of the firm.

Also to the degree that exit barriers are entry barriers a worker-owned organisation is at a disadvantage. Such an organisation could hinder rapid transfers between clubs. Problems with transfers could arise, for example, if the terms of the exit have to be negotiated with the remaining player-owners at the time of exit. Or the remaining owners may be unable or unwilling to buy out the exiting player - under a "right of first refusal" or "right of first offer" scheme - or any of them could veto an incoming replacement player-owner. Also there is the question of the value of a player's interest in the team as well as the question of the time period over which an agreed upon value would be paid. These costs make exit more difficult than it would be under an employment contract and thus tend to lock-in the player/owner to the team. Such lock-in is a disincentive to forming, or joining, a labour-owned firm, especially for the best players.⁵ Many of these problems can, to a degree, be contracted around but this imposes additional negotiation costs at the time of entry into the team, which again is a disincentive to forming an worker-owned team. Utilising a worker-owned organisation results in additional haggling costs, either ex ante or ex post, relative to a player-as-employee team.

Put simply, an employee can leave a organisation more quickly and easily than an owner and in the case of professional sports, transfers between teams, or at least a credible threat to transfer, are particularly valuable to the best players. Therefore a player-owned team would be at a competitive disadvantage compared to teams comprised of employee players.

What this suggests is that a labour-owned, human-capital only, firm with heterogeneous human capital, as in the football example, is likely to be unstable and thus a long lasting human-capital only firm which is labour owned will consist of homogeneous human capital, e.g. the pirate example. Thus the "types" of human capital in a firm is an important determinant of the organisational form the firm will take. This doesn’t mean you cannot have a firm which involves heterogeneous human capital but such a firm will require some “glue”, in the form of non-human capital of some kind, to remain viable. Given the importance of this glue to the firm, ownership of the firm by the owner of the non-human capital is likely. Hart (1995: 56) notes that such non-human capital could be as simple as “[ ... ] patents, client lists, files, existing contracts or the firm's name or reputation.” Or it could be a good location for carrying out the firm's business or a contract preventing the non-owner from working for competitors, etc

So overall we get two basic organisational forms for human-capital based firms: 1) a homogenous human capital firm which could be a labour owned firm and 2) a heterogeneous human capital firm which is owned by the owner of the "glue" that keeps the human capital in place.

Notes:

(1) Some worker cooperatives do require all staff to be paid the same wages while others have a limit on the range of pay offered. Such limit is normally expressed as a ratio of the highest paid worker to the lowest paid, e.g. 3:1 or 4.5:1. Also an owner's allocation of the "profits" of the firm will be proportionate to that owner's labour input, so for similar labour inputs, owners receive a similar allocation of  "profits". Thus overall compensation is commonly roughly equal.

(2) Ricketts (1999: 20) explains the problem as ``[f]urther, to minimise antagonism a rough equality in the division of the residual will be necessary and this may conflict with outside opportunities. Those with high transfer earnings reflecting high productivity elsewhere will desert the co-operative. It is for these reasons that control of the firm by its labour force is usually found in circumstances which permit a high degree of common interest." Jossa (2009: 709-10) explains the basic issue in terms of the management of capitalistic versus co-operative firms: ``[g]iven the tendency of cooperatives to distribute their income equitably among all the members, it is difficult to deny that few cooperatives are in a position to pay the high salaries that able managers can expect to earn in capitalistic firms. Whenever a group of people resolve to work as a team-we may add-the member who outperforms the others in initiative and organizational skills will inevitably take the lead. The crux of the matter is that such a person has no incentive to establish a cooperative and share power and earnings with others. He or she will prefer to found a capitalistic firm, where he or she will hold all authority and, if sole owner, appropriate the whole of the surplus [references deleted]

(3) Scully (2008) notes that there is a relationship between a team's finances and a team's success since better financed teams can buy the best players: ``[h]ow good a professional sports team is depends, of course, on the quality of its players. Because teams compete for better players by offering higher salaries, the quality of a team depends largely on how strong it is financially. The financially stronger teams will, on average, be the better teams."

(4) One way around he problem is to pay all players the amount necessary to retain the best player. But this implies paying most players more than their productivities and has obvious implications for the teams budget constraint. This would also aggravate the problem of non-performing average players-owners not wanting to leave the team.

(5) There are also problems such as those which could arise between the manager or coach and the player/owners in their roles as players and as owners. In addition to this there is the problem that if the players provide any financial capital the team needs themselves they risk being badly underdiversified. If the team goes bankrupt they lose not only their job but also (at least part of) their savings. Given the short time span that a player is likely to be a member of the team there is the issue of the return on any capital the player has invested in the team. To ensure a suitable post playing standard of living players are likely to place an emphasis on high returns on their investments.


Refs.:

• Hart, Oliver D. (1995).  Firms, Contracts, and Financial Structure, Oxford: Oxford University Press.
• Jossa, Bruno (2009). `Alchian and Demsetz's Critique of the Cooperative Firm Thirty-Seven Years After', Metroeconomica, 60(4) November: 686-714.
• Ricketts, Martin (1999).  The Many Ways of Governance: Perspectives on the control of the firm, The Social Affairs Unit, London.
• Scully, Gerald W. (2008). `Sports'. In David R. Henderson (ed.), Concise Encyclopedia of Economics, 2nd edn., available from http://www.econlib.org/library/Enc/Sports.html