Variable Pay, Industrial Relations and Foreign Ownership: Evidence from Germany

AuthorJohn S. Heywood,Uwe Jirjahn
DOIhttp://doi.org/10.1111/bjir.12032
Date01 September 2014
Published date01 September 2014
Variable Pay, Industrial Relations
and Foreign Ownership: Evidence
from Germany
John S. Heywood and Uwe Jirjahn
Abstract
We use a representative sample of German establishments to show that those
with foreign ownership are more likely to use performance appraisal, profit-
sharing and employee share ownership than those with domestic ownership.
Moreover, we show that works councils are associated with an increased prob-
ability of using each of the three practices when under domestic ownership but
not when under foreign ownership. These results inform the ongoing debate over
institutional duality, the extent to which foreign firms adopt uniform practices
independent of local institutions, and the extent to which they adapt and par-
ticipate in those local institutions.
1. Introduction
Recent decades have witnessed an enormous growth in foreign direct invest-
ment (FDI) around the world (UNCTAD 2004). The growth in corporate
globalization has stimulated both substantial public and academic interest in
the consequences for national industrial relations systems. Yet there remains
surprisingly little systematic evidence on how the functioning of a country’s
industrial relations institutions is affected by FDI.1This article provides an
econometric analysis for Germany. It examines the influence of foreign own-
ership and the interaction effect of foreign ownership and works councils on
the use of three types of human resource management (HRM) practices
associated with variable pay: performance appraisal, profit-sharing and
employee share ownership.
This examination reflects our broad interest in the extent to which
foreign multinational firms adapt to local institutions. On the one hand,
John S. Heywood is at the University of Wisconsin-Milwaukee and Lancaster University.
Uwe Jirjahn is at the University of Trier.
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British Journal of Industrial Relations doi: 10.1111/bjir.12032
52:3 September 2014 0007–1080 pp. 521–552
© John Wiley & Sons Ltd/London School of Economics 2013. Published by John Wiley & Sons Ltd,
9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
multinationals in Germany face internal pressure to conform to the standard-
ized personnel policies of their firms, firms that cross international boundar-
ies and are headquartered elsewhere. On the other hand, these personnel
policies of multinationals often involve tensions with the institutional pat-
terns of the host country, including establishment-level co-determination by
works councils. We explore this conflict, a conflict identified by Kostova and
Roth (2002) as ‘institutional duality’.
Examining the interaction effect of foreign ownership with works councils
is particularly interesting as previous work has shown that German works
councils can foster workers’ co-operation and contribute to increased estab-
lishment performance (Freeman and Lazear 1995). Works councils play an
information sharing and contract enforcement role. This role reduces the risk
to workers from unilateral management decisions, making workers more
willing to accept increased supervision and variable pay (Heywood et al.
1998; Heywood and Jirjahn 2002). Yet co-operative and trustful relation-
ships between management and works councils typically take time to
develop, and for domestic firms this occurs in a context without institutional
duality.
We hypothesize that foreign ownership attenuates the influence of works
councils on variable pay. As important managerial decisions are made over-
seas and the works council of the local establishment has only limited access
to information possessed by the parent company’s managers, it is more
difficult to create trust and co-operation. In addition, the parent company’s
managers may lack sufficient information about the local conditions of the
subsidiary and may be more familiar with a less participatory management
style. Taken together, we argue that this makes local solutions less likely
and increases the probability that relationships with works councils will not
mirror those at firms with domestic ownership. Specifically, foreign-owned
establishments may tend to move more unilaterally to adopt variable pay
schemes as part of exploiting the strategic advantages of their parent
company. This would weaken the traditional trust-building role of the works
council, and may leave the relationship between council and management
characterized by increased distrust and antagonism. Ultimately, the rise of
variable pay unilaterally implemented by foreign owners could undermine
the German system of worker representation.
Using the unusually rich data of the IAB Establishment Panel, we provide
the first econometric analysis on the intertwined roles of foreign ownership
and works councils in the use of three important types of personnel policies.
We demonstrate that the use of individual performance appraisal, the use of
profit-sharing and the use of employee stock ownership share important
patterns. Each practice is more likely in establishments with foreign owner-
ship. Confirming past results, we find that among firms with domestic own-
ership, works councils are associated with a greater likelihood of using each
of these HRM practices. For the first time, we show that the presence of
works councils plays no positive role in the use of these practices among
establishments with foreign ownership. We take this result as evidence of
522 British Journal of Industrial Relations
© John Wiley & Sons Ltd/London School of Economics 2013.
institutional duality. Works councils in establishments with foreign owner-
ship appear to play a different role in negotiating over these practices than do
councils in establishments with domestic ownership. Our key result emerges
controlling for a wide range of explanatory variables, and remains true in
alternative specifications that include further interactions, such as the inter-
action of works councils with the establishment’s export activities.
In the next section, we provide a background discussion. We explore
previous literature and establish our testable hypotheses about the role of
works councils and foreign owners. Section 3 presents the data and variables,
while Section 4 presents the results and several robustness checks. Section 5
concludes and makes suggestions for future research.
2. Institutional setting
In this section, we draw on past research to argue for our hypothesis that the
role of works councils in establishing variable pay differs between German
establishments with domestic and foreign ownership. The first subsection
describes the potential and pitfalls associated with adopting variable pay, and
emphasizes that past work, both theoretical and empirical, suggests that
works councils make variable pay more likely among German establishments
with domestic ownership. They do so by using the institutional tools of
co-determination that increase the trust that workers have in the effectiveness
and fairness of the resulting appraisal and variable pay schemes. The second
subsection outlines how institutional duality increases the pressure on local
German subsidiaries to take unilateral action on variable pay, and how
foreign ownership can undermine the institution of co-determination. As a
consequence, workers are less likely to trust that the resulting variable pay
schemes are effective and fair, suggesting that works councils may not be
positively associated with variable pay among foreign-owned firms.
Works Councils and Variable Pay
Variable pay potentially involves both productive and dysfunctional incen-
tive effects. Productive incentives are more likely to dominate if workers are
confident that the process of determining pay accords with procedural fair-
ness norms and that promises will be kept. Hence, institutions contributing to
trustful employer–employee relations might foster the use of variable pay
schemes as they increase the positive incentive effects of these schemes.
Works councils in Germany have been claimed to be such institution. We
briefly describe the productive and dysfunctional incentive effects of variable
pay, and then focus on the role of German works councils.
At their best, variable pay schemes provide incentives to exert effort by
aligning workers’ interests with those of firm owners. While simple piece
rates reward the quantity of produced output, performance appraisal systems
use more comprehensive measurement of worker performance to provide
Variable Pay, Industrial Relations and Foreign Ownership 523
© John Wiley & Sons Ltd/London School of Economics 2013.

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