The Incentives in a Cooperative Corporation

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Mondragon Cooperative Corporation (MCC or Mondragon) can be defined as an association of worker-cooperative firms based in the Basque town of Arrasate-Mondragon, Spain. When it was founded in 1956, it consisted on a technical school linked to a small firm producing electrical appliances.

In the last fifty years the group has experienced a huge growth, and currently, 256 cooperative firms make up the MCC, most of them employee-owned. MCC is ranked as the seventh largest Spanish corporation with 33.334 million Euros in total assets and total revenue of 14.780 million Euros in 2009. The transformation from a small worker cooperative into a large corporation has been lead by the huge growth of the early cooperative businesses and the inclusion of new small-medium size worker cooperatives into MCC.

Historical evolution

Mondragon's first business started up from a small educational institution in the 50's. It experienced a moderate growth until the late 70's, when the group was formed by few cooperative businesses that succeed within the protected Spanish market.

As the domestic market started to open for foreign investors and multinational companies during the 80's, an increasing number of small and medium size firms joined the Mondragon group. Most of them were looking for synergies and economies of scale in order to keep being profitable in an increasingly competitive domestic market. Meanwhile the early cooperative firms grew considerably and got leadership positions in some sectors of the Spanish market (quote: Fagor, Eroski…). This phase of expansion ended with the creation of a new structure in 1991, which gathered all the enterprises and support organizations under one corporate roof: Mondragon Cooperative Corporation.

After some adjustments during the 90's, all the member firms were grouped in four main divisions according to the sector where they operate: Financial/Insurance Services, Retail, Industry and Knowledge (education and research). With this corporate structure, in the last 15 years, MCC has faced an internationalization process with the aim of being able to compete in the global arena. MCC's investment has focused on constructing a network of companies around the world in order to reduce production costs and access to international markets. Competition in international markets often leads to an increasing volatility in business performance, which has induced MCC to use a more flexible employment policy. Thus, the group had the necessity of hiring non-owner workers and start using temporary contracts in order to reduce risk.

[Gráfico sobre la evolución de resultados, empleo y número de socios]

Jesus Larrañaga, co-founder of Mondragon, defined as "Neocooperativism" the shift towards a more flexible model of human resource structure (Larrañaga 1996). Defourny&Develtere (1999) use the term "coopitalism" to describe the tendency of large cooperative firms to adopt capitalist business practices.

Explanations to Mondragons' success so far

Many authors have analyzed the advantaged and disadvantages of the cooperative ownership from different theoretical frameworks, such us, Agency theory, Transaction Cost theory, Property Rights theory or Voting theory.

Even though it has been argued that under certain conditions cooperative organizations could perform better than outside investor owned companies; the fact that generally cooperative organizations tend to be less efficient can be seen as a common conclusion suggested by economic theory.

However, this is in contradiction with the results that MCC has obtained along its 54 years of existence. Besides, many institutions, researchers and the society in general have recognized the success of Mondragon (see apendix). Therefore, many economists have focused their research effort in analyzing Mondragon's organization, structure and business model, in order to identify the key factors that allow this cooperative corporation to be an exception. The following are the most relevant ones.

From a sociological perspective, Whyte (1995) attributes part of MCC's success to the leadership of the founder, J.M. Arizmendiarreta, and to the cooperative culture developed by his followers at the technical school. However, Kasmir (1996) is critic with the cooperative spirit of MCC and analyzes Basque politics and working-class to find an explanation to the expansion of the company.

Ormaechea (1993) and Cancelo (1999) refer to the capability of adapting to a constantly changing environment, without deviating from the basic cooperative principles, as a key factor for MCC's success.

Among other explanations focused on business management, it is worthy to mention Forcadell (2000, 2005) and Smith (2001). The former argues that MCC's model combines worker participation in managerial decisions with an agile and efficient corporate structure. The latter highlights the importance of the synergies achieved by the association of cooperative firms, that allow for scale production and increase investment in innovation (joint ventures).

However, most of the previous explanations do not take into account MCC's transformation towards "neocooperativism". Among the papers that analyze MCC in the context of globalization, it is important to mention one by Casadesus-Masanell & Khanna (2003). They argue that, under increasing uncertainty, a decentralized cooperative organization like MCC might perform better than outside-owned corporations due to the higher level of trust created among employees.

However, none of the possible explanations given so far is based on the explicit incentives for non-owner workers. As the purpose of this paper is to analyze those incentives using tournament and incentive theory as a framework, first, it is essential to understand how human resources and governance are managed within MCC.

Personnel Structure and Governance at Mondragon

Corporate governance at Mondragon is based on Cooperative principles (quote), which imply that decisions are made in basis of one worker one vote. However, currently, only around 38% of the 85.066 workers employed by Mondragon are actual members of the Cooperative, that is, employee-owners. Therefore, not all the workers are allowed to participate in management neither to vote on corporate decisions.

As the main objective of this paper is to analyze the explicit incentives for non-owner workers within MCC, it is important to distinguish among the three main types of contract that exist between the Corporation and its employees:

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Outsider Employee: the contractual relation between Outsiders and shareholders is the common one in regular companies (outside owned firms): the owner(s) pay a wage (fixed and/or variable) in exchange of employee's effort.

Self-Employee (non-owner Employee): these workers are legally considered as self-employed, associated with (or working for) one of the Mondragon Group's cooperative businesses. The wage range, bonuses, profit sharing and other features of their contract are similar to the Employee-owner's ones, but they have no 100% job security. As they are not owners, if the cooperative business they work for is no longer profitable, they could get fired.

Employee-owner: these are the workers who own shares of Mondragon Corporation, as well as being employed by at least one of the cooperative businesses of the group. To get this contractual situation, first, a worker has to be a Self-Employee in a cooperative business; after an undefined period of time, the Employee-owners of that cooperative business can decide to promote him/her to an Employee-owner position and get a (almost) 100% job security.

The fact that the majority of the employees at Mondragon are not Employee-owners makes this paper to focus on how does the incentive of a prospective promotion affect non-owner workers' effort.

To analyze the nature of promotions, it is important to recall that in opposition to "centralized conglomerates" MCC is a decentralized federation of mixed (consumer and worker) cooperative firms. Although the Corporation can impose some common rules, strategic and operational decisions can only be taken by each cooperative's Employee-Owners. Individual cooperative firms are autonomous businesses, which can even decide to quit from Mondragon group and continue on themselves. The main implication of all this for our incentive analysis is that every single decision about promotions is taken at an individual firm level (current Employee-Owners decide on this).

The theoretical framework, mainly tournament and incentive theory, is presented in the following section. Later, in section four, this theory will be adapted to MCC's structure and compared to a more common incentive model for Partnership firms.