The Effect of Risk in SME Profit Sharing

Some of the effects of profit sharing schemes are that they, for example, can decrease the amount of income fluctuation and increase the income of both employer and employee. The employer and, in the case of a Small and Medium Enterprise (SME), the owner and entrepreneur, is most of the times, if not always, the key-person on taking the decision of implementing a profit sharing scheme.

The simple reason for that is that he or she owns and manages the company, and therefore makes the decisions on issues such as salary schemes. The decision of implementing profit sharing is largely based on the risk seeking behavior of the decision maker. Nevertheless, the introduction of profit sharing in companies is not only depending on the owners risk seeking behavior but also on that of the employees. Logically, this observation will especially become clear in SME’s, first of all because the hierarchy is most of the time shorter and flatter. And second because of the smaller amount of employees on which the owner is relying. Hence the closer the employees stand to the employers, and the smaller the amount of employees is, the more influence their risk seeking behavior will have on implementing or not implementing profit sharing.

Nonetheless, there is still the question “who will, most likely, implement such a scheme?” The owner and employee will, from a rational point of view, always seek to increase their own earnings, but will they take risk for that? The established literature on this topic (cf. Stiglitz 1974; Mukhopadhyay and Pendse 1983; Chang 2006) clearly describes that, when implementing profit sharing, the employees will take over a part of the risk. However, the acceptance and thereby implementation of profit sharing will not take place if the employee shows risk averse behavior. The entrepreneur is by definition the one who takes the risk and thereby the higher return. Most of the employees will not be willing to take this risk, and are employees instead of entrepreneurs because of the stable income. This major issue in profit sharing is either overcome when there is a guaranteed wage that represents the base-wage before profit sharing, or all employees are risk taking, which seams to be more likely with higher earning employees (Samuelson 1977 p.15), or finally, a differentiated system is implemented.


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Intercentar is devoted to dealing and promoting the idea of Employee Financial Participation for a more just society.

2 responses to “The Effect of Risk in SME Profit Sharing”

  1. Christian from Germany says :

    You talk about companies with a profit sharing scheme. Do you know whether employees are included in the decision-making process whether or not, or how much profit is to be distributed at all or reinvested into the company? If they should negotiate the distribution afterwards they should be included in the step before, don’t they? So they probably could better understand the employer’s (personal) situation (personal effort for the company, family problems) his motives for negotiation and not act so rationally selfish during the distribution as you claim.


  2. apieceofthecake says :

    We need to take a more careful look at the forms of employee involvement in the company´s success: being financially rewarded for the performance (profit sharing) and the step beyond this, which is taking them to the negotiation-table. There exist several possible models of decision-making. They from a most rudimentary form of being supplied with the relevant informations on the company´s strategy to the most democratic participation, which is having a vote in the decisions. Profit-sharing-schemes tend to be models, which do not necessarily emphasize the involvement of employees.
    Nevertheless the profit-share itself needs to be settled before it´s distribution. The initiative report of the EESC SOC/371 pointed out, that a predefined formula has to be calculated. Otherwise there is a risk of arbitrariness and can have a negative influence on the relation between employer and employee.
    The question, how big the share should be or if the employees are included in the decision-making, is a question which needs to be analysed individually from company to company.
    A more important question would be, if profit-sharing-schemes are sufficient for fostering the productivity and competitiveness? Some studies show, that the implementation of additional employee participation elements, such as in the case of employee stock ownership plans (ESOPs) have a more positive effect on the companies´ long term success and on stabilising macroeconomic structures.


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