Thursday, January 26, 2012

Book Review - The Ownership of Enterprise by Henry Hansmann

Given the almost total absence of the cooperative model from mainstream business school discourse, I was recently delighted to hear that an acquaintance was teaching an "Introduction to Cooperatives" course at a college in Connecticut. I was quite curious to see what such a course would consist of, so I went on the website and downloaded the syllabus. While the students were exposed to a diversity of readings, the core of the course seemed to be built around one book, The Ownership of Enterprise by Henry Hansmann. Intrigued, I got my hands on the text and began digging in.

As its title suggests, the purpose of Hansmann's book is, fundamentally, the investigation of the forms of ownership that are prevalent in different sectors of the economy. Using a perspective that leverages tools from both economics and political science (he understands the governance of firms to be subject to similar political dynamics that public choice theory dissects in government), Hansmann starts off by offering a general theory of ownership that relies on two key factors.

First, he argues that "all other things held equal, costs will be minimized [for a firm] if ownership is assigned to the class of patrons for whom the problems of market contracting--that is, the costs of market imperfections--are most severe."1 Thus, if the cost of contracting with workers is higher than the cost of contracting with suppliers, customers, etc., in a particular economic sector, then his theory would predict that employee ownership would be the dominant form of ownership.

However, the story is further complicated by a second major factor: the cost of governance. The more diverse the interests of a patron group, the higher the costs of politically mediating those differences through the structure of the firm. As a result, the optimal form of ownership in an industry is, according to Hansmann's theory, "that which minimizes the sum of all of the costs of a firm's transactions. That is, it minimizes the sum of (1) the costs of market contracting for those classes of patrons that are not owners and (2) the costs of ownership for the class of patrons who own the firm."2

The Ownership of Enterprise then goes on to apply the theory to a number of diverse sectors, including worker co-ops, agricultural co-ops, condominiums, private clubs, non-profits, insurance, and even traditional corporations (which Hansmann intriguingly argues are actually a special case of capital supplier co-ops). In each case, he uses a fairly deep historical perspective to look at how changes in the relative costs of contracting and governance for different groups have influenced the dominant ownership structures over time, and the resulting insights are fascinating and compelling.

While Hansmann uncovers dynamics throughout the whole book that are of great interest to credit union people, his chapter on banking is, for obvious reasons, particularly relevant. Since the book was published in 1996, credit unions themselves get a relatively brief mention, since they'd yet to attain their present stature as the dominant form of cooperative banking in America. However, his discussion of the developmental dynamics of other forms, such as mutual banks and mutual savings and loans, touches on a number of issues that are very relevant to both the study of credit union history as well as to the contemporary movement. While it would be beyond the scope of this review to unpack all of the insights of that chapter, two stood out enough to warrant particular mention.

The first is a confirmation of the hunch that I'd developed (and [statistically demonstrated] to be at play in the most recent financial crisis) that cooperatively owned banks are safer than their investor-owned counterparts. Digging into statistics going back to the 1920s, Hansmann finds that the failure rates of cooperative banks were indeed far lower than those of corporate banks. From 1921-1928, the failure rate of the former varied between 0.04% and 0.22%, while the latter's rate hovered between 1.24% and 3.65%. The statistics from the Great Depression are even more pronounced; in 1933, 27.7% of investor-owned banks failed, while only 0.8% of mutual savings and loans and 0.01% of mutual savings banks closed their doors.3 The reason for this, Hansmann explains, is that "the managers of investor owned-firms are much more willing to speculate with their depositors' funds than are the managers of customer-owned and non-profit firms."4

The second point relates to a question raised by the first: if commercial banks are less safe for consumers than cooperatives, why have the former come to dominate the contemporary financial sector? Hansmann's theory suggests that a factor must have reduced the costs of contracting between depositors and their banks, and he posits a likely culprit: government regulation. As he puts it, "Effective regulation has permitted investor-owned banks to bond themselves not to exploit their customers unduly, while leaving those firms free to take advantage to [sic] their superior access to capital."5 Thus, according to his model, bank regulation acts as an effective subsidy to investor-owned banks by reducing one of the key competitive advantages of credit unions and other co-op financial services providers.

As good theory is an essential component of historical work, Hansmann's book is an essential read for anyone with interest in the history of the credit union movement. Indeed, I wish someone had put a copy of The Ownership of Enterprise in my hands when I started grad school; the lens that it offers would have saved me the great deal of time and work it took to come to rough approximations of many of the ideas that the book presents lucidly and succinctly.

Furthermore, I also strongly recommend it to folks working with contemporary credit unions. The book's intellectual framework offers numerous insights that are very applicable to the modern movement, whether one is considering its stance toward government regulation or the impact of falling information costs on governance costs. Though more than fifteen years old, the ideas in The Ownership of Enterprise continue to be validated by recent events, and the more credit union people come to understand its logic, the stronger our movement will be. Get your hands on a copy, pronto!



1 comment:

  1. A reason not mentioned for the domination of corporate banks over cooperative banks is marketing. Billions are spent to shape the public's mind, bury public mention or discussion of cooperative banks or credit unions and 'train' people to patronize only mainstream banking establishments. Ironically, one of the predictors any consumer can use to determine whether they are likely to be getting a good product or service is whether they are being inundated by advertising. Money spent on massive TV, radio & print advertising is money taken from the portion of budgets that would be better spent on wages, benefits and quality materials.