Management Research News

Employee Stock Ownership Plans: Popularity, Productivity, and Prospects

Gianna Durso
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Gianna Durso, (1991),"Employee Stock Ownership Plans: Popularity, Productivity, and Prospects", Management Research
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 10 Management Research News Volume 14 Number 3 1991

Employee Stock Ownership Plans: Popularity,

Productivity, and Prospects
by Gianna Durso or as a means for companies to borrow money in a tax
favoured manner. Ten percent of all plans are in publicly
Employee ownership has a rich tradition throughout the traded companies, and of those, about half may be re-
world in the form of co-operative enterprises, however, garded as having anti-takeover characteristics.
the concept has received a new boost in the form of em-
ployee stock ownership plans (ESOPs). In order to un- Although ESOPs have not always fulfilled the role of
derstand why the stock model of ownership has received creating new capital for companies, because many com-
so much attention worldwide, one must examine the panies contribute existing stock to the ESOP instead of
known and potential benefits of this model. As the United issuing new shares, they have taken on a dimension that
States provides the most widespread example of em- was not necessarily part of the original intention. Em-
ployee stock ownership, we shall begin our discussion ployee ownership is now seen as a way to improve pro-
there. The next section addresses in depth the corporate ductivity by tying the interests of the workers more closely
performance benefits of employee ownership and out- to those of the company. The logic is simple: one is like-
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lines additional benefits of interest throughout the world. ly to take much better care of one's own car than a rent-
The final section offers a brief look at employee owner- al car. Whether or not this logic extends to companies has
ship worldwide. been the subject of intense discussion and research.

THE AMERICAN ESOP BENEFITS OF EMPLOYEE OWNERSHIP

Employee stock ownership plans are becoming more and Corporate Productivity
more common in the American economy. There are now
over 10,200 companies with ESOPs covering 11.5 million From 1978 to 1984 over six separate studies using varying
employees. The plans are popular for two main reasons: methodologies studied the linkage between employee
they are extremely tax efficient, and when implemented ownership and corporate performance. The definitive
properly, they can have a dramatic impact on productiv- governmental study was issued in 1987whenthe General
ity. Accounting Office (GAO) of the United States reported
their findings that employee ownership alone had no sig-
ESOPs fall under the category of qualified pension nificant effect on corporate performance. Yet when the
plan, qualified in that they are eligible for tax incentives. GAO examined employee ownership in conjunction with
The basic mechanism is that stock is held in trust for the employee participation, they did find significant corpor-
employees who receive equitable allocations of shares. ate performance enhancements.
The employees then earn ownership rights to the stock,
typically over a period of 5-10 years, through a process Let us turn now to the study Employee Ownership
known as vesting. The employees reap the financial bene- and Corporate Performance by NCEO performed in 1986.
fits of ownership when they leave the company either The most significant finding of the study was that em-
through voluntary or involuntary termination. ployee ownership is related to corporate performance,
and that employee participation programmes are signifi-
Owners of private companies wishing to sell to their cantly and highly correlated with enhanced corporate
employees can defer taxes on the gains from the sale by growth. Constraints of space prevent a thorough discus-
"rolling over" the proceeds into qualified replacement se- sion of the findings of the study, but the highlights are ad -
curities. In addition, the ESOP may borrow money (usually dressed.
with a guarantee to the bank provided by the sponsoring
company) and deduct both principle and interest pay- Methodology
ments on the loan. Finally, the lender to an ESOP that
holds 50% or more of a company can deduct from taxes The study relies on data from 45 ESOP firms for an ana-
half the interest income on the loan. For publicly traded lysis of the before-and-after impact of employee owner-
companies, ESOPs are considered to have the additional ship on corporate performance. Also studied are the
benefit of placing blocks of stock into the presumably differences between highly successful and less success-
friendly hands of the employees, which may be useful for ful employee ownership companies. Each of the com-
defending against a hostile takeover. panies in the sample is matched to five or more non-ESOP
companies in the same industry by size and region. Time
About half of all ESOPs are used to buy out the de- series data are collected on the economic performance
parting owner of a closely held company. Most of the re- of ESOP companies and of their matched comparison
mainder are used either as a supplemental benefit plan companies. The performance measures are sales growth,
 Management Research News Volume 14 Number 3 1991 11

employment growth, and growth in the ratio of sales per

employee (a rough productivity measure). Table 1

Results Before After Confidence

Measure ESOP* ESOP* Change Level
This study examined two related but separate questions
Employment
about employee ownership and corporate performance.
First, do ESOP companies improve their performance Growth 1.21 5.05 3.84 .99
Sales
after they set up employee ownership plans; and second, Growth 1.89 5.40 3.51 .95
what factors are most associated with successful econ- * Difference in rate between ESOP and
omic performance in ESOP companies? non-ESOP companies expressed in total
percentage points per year.
It turns out that one can answer both questions with
a high degree of statistical certainty. The findings show While these findings are very positive, it is clear from
that companies improve their performance after estab- our data that not all employee ownership companies do
lishing ESOPs by about 3.5% per year. This is a statisti- equally well and that some actually do worse than their
cally significant result at or above the generally accepted industry and competitors. Next the study looked at what
95% confidence level. When one distinguishes between makes employee ownership work better in one company
ESOP companies, those with the best performance are than in another.
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companies that provide employees with opportunities for

participating in decision making. This employee partici- What Makes Employee Ownership Work?
pation is generally not through board representation or
stock voting rights, but rather through a variety of formal Company contribution to employee accounts was the
and informal mechanisms that encourage employees to most important factor in predicting employee satisfaction
exercise judgement and take on additional responsibility. with employee ownership in prior studies. But employee
satisfaction with the ESOP is not necessarily the same as
While these findings appear sensible, perhaps even increased productivity. In fact, the size of the contribution
"obvious", one should remember that they are the result is not related to corporate performance. This result is ac-
of the careful analytical process described previously and tually quite striking. It suggests that employee motivation
that other apparently plausible explanations did not turn does not translate directly to enhanced productivity.
out to be valid. Let us turn now to a step-by-step discus-
sion of these results. It is the two measures of employee participation that
have the strongest correlations with the performance im-
ESOP Performance provements. The measure of management's perceived
worker influence in decision making is highly positively
With our data one could answer the simplest and most di- correlated with all eight measures of corporate success
rect question about the performance of the sample ESOP used in the study above the 95% confidence level.
companies, that is do they outperform the non-ESOP
companies? The answer is a resounding "yes". Compared From these data, it seems that when companies pro-
with the comparison, non-ESOP companies the ESOP vide employees with more opportunities for participation,
companies on average grow 6.5% faster per year in the the companies do relatively better in economic terms.
number of employees and 7.1% faster per year in sales.
Both these figures are significant at the 99.9% confidence The following independent variables were not suc-
level. cessful predictors of enhanced corporate performance:
ESOP communications, percent owned, plan features,
(By "6.5% faster" it is meant 6.5 percentage points voting rights, board representation, company size,
faster. That is, if the comparison companies grow on aver- change in management, or ESOP tax preference.
age 10% per year in the number of employees, then the
ESOP companies grow 16.5% per year, not 10% plus 6.5% Other Employee Ownership Benefits
of 10%, or 10.65%, which would be another meaning of
"6.5% faster". This convention is used throughout this ar- In addition to the benefits for corporate performance, em-
ticle, unless otherwise noted). ployee ownership has other advantages, which have
become of interest to leaders in many countries.
Before and After Analysis
Preventing Plant Closures
The chart above shows the before and after performance
of the ESOP firms relative to their comparison companies. The implementation of employee ownership to prevent a
On measures of sales growth and employment growth, plant closing or to save a failing firm is rare. However un-
the ESOP companies do appear to improve their perfor- common, this is a highly publicised and interesting type
mance after industry effects are removed. of employee ownership and one that has been used in
 12 Management Research News Volume 14 Number 3 1991

several countries. The European Community faces being considered as a major alternative in Eastern Eu-
sweeping changes as 1992 approaches and has ex- rope, and leaders in many other countries have expressed
pressed an interest in this use of ESOPs. interest in the idea.

Privatisation Employee ownership has also been implemented in

Western Europe, although still much more the exception
For many countries, privatisation through employee than the rule. French law mandates that companies with
ownership is a means for economic reform. In the Soviet over 100 employees have some sort of gainsharing plan,
Union, planners are looking for ways to loosen the state's which can include stock ownership. Ireland offers tax in-
grip on resources and pricing without losing sight of the centives to both employee ownership companies and
ideological reasons state ownership was implemented in their employees. Britain has passed legislation promoting
the first place. With employee ownership through collec- "Employee Share Ownership Plans". The (West) German
tive share accounts, the workers can own the means of government provides incentives for employees to buy
stock and requires that employees have representation
production while still having capitalistic motivations to
on the boards of corporations.
produce efficiently. In Argentina, privatisation through
employee ownership will hopefully mean increased effi- Other developed countries also have employee
ciency and a greater sharing of the wealth. ownership, although relatively few companies have sub-
stantial ownership by a broad cross section of employees.
Anchoring Capital Japanese workers can own stock through employee
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stock ownership associations, and Canadian workers can

Developing nations have expressed an interest in em- buy stock through labour-sponsored venture capital cor-
ployee ownership because it stresses local development. porations. Australia has had a long tradition of employee
Local ownership of companies not only provides local ownership, and some major companies there, including
jobs, but it also gives local people the money to buy con- Cadbury Schweppes, have substantial plans. Multina-
sumer goods, a way to "prime the pump". Employee tional corporations have started employee share owning
ownership companies maintain employment levels better schemes, including Barclays Bank PLC and Wellcome
in economic downturns than traditional companies. Em- PLC, which has employees in 22 countries.
ployee ownership companies also create more new jobs Employee ownership is also well suited to less de-
than traditional firms. veloped countries. The Solidardista movement
throughout Central America allows employees to gain
Obstacles to Employee Ownership ownership in their companies by pooling their invest-
ments and by getting matching contributions from their
As appealing as the idea may sound, broad implementa- company. Costa Rica appears likely to pass ESOP legis-
tion of employee ownership has several difficulties that lation, and Mexico and Argentina requires employee
must be faced. First, national laws almost invariably must ownership of newly privatised firms. President Aquino of
be created to provide adequate legal structures and econ- the Philippines has signed legislation allowing employee
omic incentives. For many Eastern European countries, ownership. Employee ownership there is found in both in-
this must be preceded by the creation of corporate law in dustrial corporations such as the Manila Electric Com-
general. Second, employee ownership itself will generally pany (Meralco) and as a means of land reform, as in
not add significantly to corporate capital, except through Hacienda Luisita. Although employee ownership through
possible employee wage concessions. Outside investors stock mechanisms is not widespread in any of these coun-
are usually needed, and they may want more ownership tries, the idea does seem to have taken root.
and control than employees think desirable. Third, em-
Conclusion
ployee ownership will not itself turn around troubled com-
panies. If used too often this way, the idea will attain a Employee stock ownership plans in the United States can
reputation for failure. Fourth, employees may have no ex- have important benefits for employee morale and corpor-
perience with, and no interest in, being stock owners. ate performance. These and other benefits have made the
Companies must be willing to make substantial invest- idea of employee ownership increasingly attractive to
ments of time and money to provide adequate worker leaders from such diverse countries as Australia and Po-
education. Finally, the relationship between ownership land, South Africa and Costa Rica. Whether or not the in-
and performance described here is based on US experi- terest in employee ownership increases will depend upon
ence. This may or may not translate to other countries the success of ventures already underway, from Moscow
and cultures. Catering in the Soviet Union to Alexandria Tyre Company
in Egypt. The potential, however, is tremendous.
Overview of International Application

Although less common outside the US, employee owner- Gianna Durso is the Director of International Research at
ship can also be found in such diverse countries as Ire- The National Center for Employee Ownership in Oakland,
land, Egypt, the Philippines, South Africa, Costa Rica, California and co-author of International Developments
Sweden, Japan, and Australia. Employee ownership is in Employee Ownership, NCEO 1990.