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Rescuing and resetting the UK economy after COVID-19 via debt-to-equity swaps

6 May 2020

In our latest post, Dr Jonathan Preminger from Cardiff Business School, Dr Guy Major from Cardiff University’s School of Biosciences and Jenny Rathbone Welsh Labour Member of the Senedd for Cardiff Central tackle the problem of loans and debt finance facing organisations when the UK emerges from the COVID-19 pandemic.

The problem

Government-backed loans and 80% wage grants may ease many companies through COVID-19. But there are two fundamental problems with loans and other kinds of debt finance, which will become increasingly apparent as companies emerge from the crisis: First, most obviously and seriously, loans have to be repaid. Second, the interest payments are a fixed burden, which does not take into account the financial success or difficulties of the company going forward.

To stop large numbers of firms going bust, what the economy could do with now is an injection of explicitly risk-sharing, non-repayable financing: equity investment, i.e. share capital, with variable dividends depending on success. But many firms may be reluctant to cede control of their businesses to external holders of traditional voting shares. And potential investors will be wary of risky investing without the protection provided by some kind of control.

This risk/control dilemma has long been faced by worker co-operatives and employee-owned companies, whose growth can be restricted – or even fail – due to under-investment. However, a viable solution to this dilemma is available which could now be applied to the wider economy as it emerges from the pandemic.

The solution

We argue that all companies should be given the option to swap government-backed debt for initially government-held, tradeable equity shares. This could be combined with other complementary forms of debt relief and risk-sharing, such as temporarily accepting a higher rate of corporation tax in exchange for part of the debt being written off.

How could debt-to-equity swaps benefit the range of different stakeholders? We propose a mechanism that locks together the interests of current owners, workers and investors (including the government), leaving control of the firm in the current owners’ and workers’ hands yet avoiding the risk of wages being raised at the expense of dividends to investors. In essence, this is a pre-agreed formula to split the firm’s value-added (sales minus non-labour costs, also equal to wages + profits) between workers/directors and investors/owners. This means a significant component of wages would be variable, and workers would share in the success (or otherwise) of their firm. But their jobs, hence livelihoods, would be far safer than if their wages were fixed.

How would it work? The firm’s value-added would be split into a number of ‘slices’. Each worker gets a pre-agreed number of slices, effectively their variable pay, and each share gets one slice as its dividend. Workers would have an incentive to increase profit, thus increasing their variable pay, but in doing this, they would also be maximising earnings per share, and would thus automatically work in the interests of investors as well (see Figure 1 and Appendix for details).

Figure 1: Value-added (surplus) sharing scheme.

An illustration of a version of the debt-to-equity swap value-added sharing scheme, which is further explained in the Appendix. The average number of slices per worker, k, is the number of £’s of total variable pay there would have been, running the scheme retrospectively with last year’s numbers, divided by the number of full-time equivalent workers, W.

In exchange for more volatile or temporarily lower pay, employees could also be offered shares and, perhaps, more say in running the firm. According to a growing research literature, the combination of profit-sharing, employee shares and workplace democratisation is mutually reinforcing and highly effective at incentivising workers to innovate and improve productivity. So, by accepting variable pay, and sweetening it with a degree of employee ownership [1] and participation in management (thus improving working conditions and job satisfaction), one can both protect jobs and improve the performance and prospects of companies.

In the uncertain times ahead, it will be unacceptable to keep most workers’ wages fixed at reduced levels but allow owners/directors to reward themselves additional pay and perks unrelated to performance. Senior executives would have to have their remuneration pegged to performance in the same way as workers’ wages. This would also work to protect external investors’ interests.

A great many companies will need all the help and risk-sharing they can get to have any realistic prospect of making it through this crisis. The substantial benefits of profit-sharing, employee ownership and workplace democratisation, coupled with external equity investment, could play a major role in maximising those survival chances.

External investors may be wary of company directors taking bad decisions, although most founder-entrepreneurs know their own businesses and sectors far better than most ‘generalist’ investors. Bad-decision risk can be mitigated by giving investors ‘voice’ rights (feeding in expertise, advice and suggestions), but without normal voting rights. Voting rights could, however, kick in, temporarily at least, after a period of sustained losses, to help get a firm back on track.

A step towards a fundamental reset of the economy

It will take time to convert firms to value-added (surplus) sharing. A viable path would be to add debt-to-equity conversion – including value-added sharing to protect investors – as a flexible medium-term exit strategy from government-backed Corona-loan schemes. This will give firms more survival and growth options as the time approaches to pay back their loans, including much-needed risk-sharing.

Surplus-sharing shares would have prescribed standard form rights including that they are tradeable, which would also give investors themselves – initially banks and the government – a natural exit strategy: they could sell their shares to other investors via secondary markets, which the government could help set up and facilitate. It would be better if such sales were staggered, to avoid massive discounts. The current control structure of the companies concerned, including any benefits from employee ownership and workplace democratisation, would not be undermined or diluted by ‘vulture capitalists’, as surplus-sharing shares are normally non-voting: ownership is separated from control, while investors are protected via the explicit value-added sharing formula. Firms or federations of firms may choose to organise their own secondary share markets, perhaps via trusts, which could allow potential share buyers to be vetted: an additional firewall against corporate predators in the event that emergency voting rights were triggered.

Persuasive working examples, tax breaks and affordable conversion experts (perhaps subsidised by the government) would help get the scheme off the ground. But the net result could be a game-changer: a massive increase in employee ownership, workplace democratisation, innovation and productivity, and tradeable non-voting external equity investment in small and medium businesses, bringing together a more optimal mix of capital, labour, good ideas and entrepreneurship, with fairer pay differentials and better-incentivised workforces, for the benefit of all.

In short, debt-to-equity swaps as firms emerge from this crisis could constitute an important part of a much-needed fundamental reset of our economy – a silver lining for the current cloud.

Dr Jonathan Preminger is Lecturer in Work and Labour Relations at Cardiff Business School.

Dr Guy Major is a Senior Lecturer in the School of Biosciences at Cardiff University.

Jenny Rathbone is a Labour and Co-operative politician, who was elected as a Member of the Senedd for Cardiff Central in 2011.

Thanks to Fieldfisher partner Graeme Nuttall OBE for his comments on a previous draft.

Appendix: the details

a) The workable value-added sharing formula we propose, developed from an idea originally put forward by Professor Roger McCain of Drexel University, is as follows: Pay all workers a pre-agreed fixed ‘base’ pay. This may differ between workers, but the average per worker has to be pre-agreed and each worker’s base pay must be at or above the national minimum wage. Many workers have had to accept 20% salary reductions under the Coronavirus Job Retention Scheme or otherwise as a COVID-19 cost-saving measure and this could provide a benchmark for setting the new level of base pay.

b) Calculate the ‘surplus’ remaining when total base pay costs (including all National Insurance contributions [NI]) are deducted from value-added.

c) Divide the surplus (if positive) into equal ‘slices’, with one slice per share, and a pre-agreed number of slices (k) per average full-time equivalent (FTE) worker. Put simply, for the purpose of splitting the surplus, the average (FTE) worker is made equivalent to an agreed number of ‘virtual’ shares. This is the central idea of the scheme, the main way equity investors are protected and workers incentivised.

d) The number of slices can vary from one worker to another, as long as the average slices per FTE worker is ‘pegged’ to the agreed k. Subject to this constraint, each worker’s personal quota of slices could be chosen to keep their pay – now variable –  close to when it was last fixed.

e) The pre-tax profit per share is then (surplus/total slices), and the average variable component of pay per worker is k x (surplus/total slices). This includes all NI on that pay. Likewise, each individual worker’s variable pay (including all NI) is their particular quota of slices x (surplus/total slices).

f) This scheme automatically allows optimal surplus sharing when the number of workers changes, or more capital is invested, without producing ‘perverse’ incentives as can occur in cruder schemes, such as those allocating fixed fractions of surplus to workers and/or shares (see article cited at the end).

g) Workers can be paid a monthly advance on their predicted annual variable pay component (their ‘cut’ of the predicted surplus), depending on the firm’s predicted and actual income and outgoings to date. It would be prudent to allow a margin of error for unanticipated shortfalls (to avoid asking workers to pay back part of their advance).

h) Up to a maximum pre-agreed ‘reinvestment fraction’ (say 1/3) of any post-tax profit is then reinvested to boost working capital and fund new equipment, etc. The balance is paid out as dividends.

i) Further reinvestment, if needed, can be achieved by part-paying dividends or variable pay using new shares, issued at a fair price, instead of cash – with the consent of recipients.

j) Shares could be priced by an independent valuer, or by a pre-agreed standard formula such as the present discounted value = (projected dividend)/(target rate of return), where the target rate of return is also pre-agreed, typically in the range 5 – 15%, depending on the riskiness, volatility and projected growth of the dividends. To keep things simple, one could use the interest rate on the company’s government-backed loan as a guideline rate of return. If 7% were used, which is close to the average historical long-run rate of return on equity capital, then the share price would be (projected dividend per share)/0.07 or about 14 x (projected dividend per share).

The scheme could be set up initially as follows:

  1. Calculate the pre-tax profit (P) and the total wage bill (including directors’ pay and all NI) over the last year (could use median of last 3 years).
  2. Add total wage bill to pre-tax profit, to obtain the value-added.
  3. Subtract total agreed ‘base’ pay (including all NI), to get last year’s notional surplus, had the scheme been running last year.
  4. Set the total number of slices equal to the number of £’s of notional surplus (£1 per slice, i.e. each slice ‘gets’ £1 of the surplus, to keep the numbers easy).
  5. Suppose the number of FTE workers is W. Set the total number of worker slices (kW) equal to the (total wage bill minus total base pay) in £’s (i.e. total variable part of pay, had the scheme been running last year).
  6. Set the total number of share slices (n1 in Figure 1) to be the total pre-tax profit P in £’s.
  7. Thus, the total number of slices is the total notional surplus in £’s, also equal to kW + P i.e. kW + n1.
  8. Re-allocate the existing share capital of the company into P (i.e. n1) shares, so each gets one slice (i.e. £1, with last year’s numbers) of pre-tax profit (although no money is paid to the holder just yet).
  9. The number of surplus slices per average FTE worker, k, is calculated as (total no. of worker slices)/(no. of FTE workers), i.e. kW/W. This slices-per-worker (k) is now locked into the scheme, as the principal means of protecting external equity investors. It can, if necessary, be renegotiated in the future.
  10. Value the shares by an agreed method (see above).
  11. If a debt-to-equity swap is needed, exchange debt for shares at that price. For example, ignoring taxes for illustrative purposes, if each share initially ‘gets’ £1 of pre-tax profit (with last year’s numbers, as outlined above), then each tranche of loan earning £1 of interest could be turned into one additional share (giving a total of n2 extra shares, as shown in Figure 1 above, where n2 is the total number of £’s of loan interest). Continuing with the 7% interest rate example, that is equivalent to a debt-to-share conversion price of £1/7% = £1/0.07 = £14 roughly. So, at a 7% interest rate, every £14 of loan, roughly, is converted into one share, as £14 x 7% = £1 interest (now potential dividend), near enough. (To account for 20% corporation tax[2] on profits, and the fact that loan interest is not subject to this company’s corporation tax – it is deducted from profits beforehand – it might be fairer/more tax-neutral to convert every tranche of loan earning 80p interest into one share, since £1 pre-tax profit x 0.8 = £0.8 post-tax profit, which is what each share actually ends up with. So that would be one share swapped for every £0.8/0.07 = £11.40 of loan; £11.40 x 7% = 80p).
  12. The debt no longer has to be paid back. The new shares could be redeemable, at the company’s option, at a fair price as discussed above, after a set number of years to provide an exit mechanism for companies.
  13. Instead of a fixed interest burden, the new shares pay a dividend according to the pre-agreed value-added sharing formula outlined above: higher in good years, none in bad years.
  14. Some changes in law would be needed, for instance, to ensure shares issued under this scheme would not prejudice the controlling interest requirement applicable to an employee ownership trust, which otherwise requires, in particular, that the trustee of such a trust holds more than 50% of a company’s ordinary share capital and is entitled to more than 50% of the profits available for distribution.[3]

Further background, details, references, diagrams and worked examples can be found in a peer-reviewed article, Major G. and Preminger J. (2019) “Overcoming the capital investment hurdle in worker-controlled firms”, Journal  of Employee Ownership and Participation, Vol. 2 (No. 2), pp. 133-150 (open access).

[1] Well-known, successful examples of employee-owned (EO) firms include John Lewis + Waitrose, Riverford Organic Farmers, Aardman (makers of Wallace and Gromit), Richer Sounds (hi-fi), Dulas (green energy, in Machynlleth), Aber Instruments (brewing + biotech, in Aberystwyth), Lush (10% EO) and Mooncup. There are around 370 (with at least 25% EO) employee-owned firms in the UK, accounting for £30bn of the economy (see, together with a considerable number of worker co-ops (e.g. see

[2] Near enough the current rate of 19% for many companies: we keep the numbers simple for illustrative purposes.

[3] See: “Neat – Graeme Nuttall OBE sees employee ownership trust as the perfect succession solution” (Sept 2014) Trusts & Estates Law & Tax Journal.


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