Definition, Incidence and Determinants of Profit Sharing (p. 6)

Definition

The concept that employees might be paid in part out of profits is not new. The German economist Johann Heinrich von Thünen proposed theoretical arguments for profit sharing as early as 1850 (Thünen, 1850). First profit sharing plans in the United States were reported in 1794 (Coates, 1991). In a strict sense, profit sharing means that profits are shared between capital owners and employees by giving employees in addition to a fixed wage a variable part of income directly related to profits or some other measure of company performance. As opposed to traditional bonuses which are linked to individual performance, profit sharing is a collective scheme applied to all or most employees in a firm or establishment. The rules determining the level of the profit sharing bonus and its distribution between employees are usually determined in advance (Uvalic, 1991, OECD, 1995).

In practice, profit sharing can take different forms. The main differences concern the timing of the benefits and the mode of payment: profit sharing can provide employees with immediate or deferred benefits and it can be paid in cash, company shares or other securities. Cash-based profit sharing links employee bonuses directly to some measure of firm performance (e.g. profits, sales or value added) and most frequently provides an immediate payment. It can, however, also be designed as a deferred scheme where cash bonuses are frozen on special accounts for a determined amount of time or where a certain percentage of profits is allocated to company funds which are then invested in the name of employees.

Share-based profit sharing, on the other hand, involves the possibility of employees acquiring shares in the company free or on preferential terms. Usually, they are frozen in a fund for a certain time period before employees are allowed to dispose of them and can therefore be considered as a deferred scheme. By definition, employee shareholding schemes are only included if the share allocation can be regarded as profit sharing bonus. Regular distributions of share or stock options which are independent of firm performance are excluded (Uvalic, 1991, OECD, 1995).

Incidence

Data on the international incidence of profit sharing is extremely sparse. According to the statistics of the European Commission (Poutsma, 2001) and the OECD (1995), the percentage of firms with a profit sharing system is everywhere quite low except for the cases of France and the United Kingdom which both have a long tradition of encouraging financial participation (Table 1). Historically, the system of financial participation in France has Gaullist right-wing roots. De Gaulle’s vision on the cooperation between capital and labour motivated him to introduce financial participation after World War II. The system was, however, never supported by left-wing socialist ideology and so financial participation was never really associated with the idea of participative structures.

Despite the changes of left- and right-wing governments in France, the French legislation has continuously offered a legal framework and generous tax advantages to cash-based and deferred profit sharing since the end of the 1950s (Poutsma, 2001).