SOUTHERN CALIFORNIA JOB MARKET : CHALLENGES OF THE WORKING LIFE : COMMITMENT : RAISING STAKES FOR WORKERS : Stock Plans Strengthen Loyalty When Employees Get Real Control
Like many small-business owners, Irv Levine wanted to boost his employees’ loyalty. He also wanted to boost his retirement nest egg by selling an ownership stake in his firm. His answer to both desires: An employee stock ownership plan.
The plan, formed last year, gave a 30% ownership stake to the 200 employees of Multiquip, a fast-growing Carson-based distributor of construction equipment. It also gave Levine a nice personal tax break--he can defer capital gains taxes on his profit from selling stock to the ESOP.
“I owe a lot to my employees,” Levine said, noting that if the firm’s growth and stock value keeps rising, “we’re going to have some very wealthy employees here.”
Thanks to business owners like Levine, ESOPs are booming. The plans, the fastest growing form of employee ownership, were created at the rate of four every day in 1987. That’s twice the rate of the previous year, said Corey Rosen, executive director of the National Center for Employee Ownership, based in Oakland.
Nearly 10 million workers in 10,000 U.S. companies--predominantly small, privately held concerns such as Multiquip--have ESOPs, which operate like pensions: an employer contributes to a trust that principally buys company shares for workers.
(Profit-sharing plans are similar in that companies also make contributions to workers. But those contributions can be made into cash accounts for workers or into tax-deferred trusts that may invest in stocks, bonds or other cash equivalents.)
Some companies are forming ESOPs to enhance worker productivity and loyalty while also giving workers another source of retirement benefits. Staunch ESOP proponents see the plans as a way to spur American firms’ competitiveness in world markets.
But other companies are forming them for reasons less related to enhancing their workers’ well-being. Some are using ESOPs primarily as a vehicle for corporate restructurings, paying off debt or thwarting hostile takeovers. These abuses, and a loss of some $300 million to $500 million in federal tax revenue each year because of breaks afforded ESOPs, are triggering a backlash in Congress. Some lawmakers want to rein in the plans’ tax benefits.
“The idea has tremendous potential if used well, but they are not always used well,” admitted Rosen.
If used well, however, ESOPs do enhance productivity and worker morale, several studies indicate. Just granting shares to workers through ESOPs alone does little to enhance productivity. But when employee stock ownership is combined with giving employees meaningful decision-making powers in day-to-day company affairs--such as through management-worker committees that decide production schedules and work rules--the boost to productivity can be dramatic.
One recent study by Rosen, for example, found that companies with ESOPs that give meaningful decision-making to employees grew an average of 11% to 17% faster in both sales and employment than they would have otherwise. Companies putting in ESOPs without added worker decision-making performed on average less than 1% better in sales and employment.
“Having an ESOP alone does not seem to be the key to improving productivity,” said Patrick G. Grasso, who directed a study of ESOPs for the General Accounting Office, the research arm of Congress, which came to a somewhat similar conclusion.
“It is absolutely clear that ownership creates an identification between worker and company, but until labor and management focus on joint problem solving, there is not much practical (effect) on productivity,” said Joseph R. Blasi, management professor at California Polytechnic State University at San Luis Obispo and author of “Employee Ownership: Revolution or Ripoff?”
As an example of an ESOP done the right way, Blasi cited Science Application International Corp., a high-technology company based in La Jolla.
The firm is nearly 90% employee owned, although most shares are owned by workers directly, not just through an ESOP. Employees participate in committees that seek to improve job satisfaction, recognize good technical work, provide adequate financial incentives and make other improvements, according to Chuck Nichols, a senior vice president.
At Multiquip, the Carson-based construction equipment distributor, Levine said the firm seeks to involve employees in part through monthly meetings to discuss costs, customer relations and other issues that might affect performance.
“It’s a constant awareness that this is their business,” Levine said, noting that if the firm’s sales keep growing and it eventually goes public, “everybody from the sweeper on up can have a big nest egg and big retirement” through appreciation in their stock value.
Unfortunately, however, not all ESOP companies treat employees like true owners, studies show. The typical company sets up an ESOP purely as a financial transaction for a retiring owner, making only a minimal effort to inform employees about financial details and virtually no effort to integrate them as owners, Rosen said.
Only about a third of ESOP firms give employees any significant participation in day-to-day management, according to the GAO study. It found that 70% of companies with ESOPs said they expected higher worker productivity, but only 36% said they actually achieved it.
Companies clearly have other incentives to form ESOPs besides granting greater employee participation.
The tax breaks can be quite generous. Companies get tax deductions for issuing new shares into an ESOP. Lenders providing financing for ESOPs can shelter half of the interest income from taxes, enabling them to offer such loans at lower interest rates.
Individual or family owners of closely held companies can defer capital gains taxes if they sell at least 30% of their business to employees through an ESOP, as long as they invest the proceeds in securities of other American corporations.
Such a situation has tempted some managements to use ESOPs principally to protect or enrich themselves, sometimes at the expense of workers in the form of lost jobs, lower morale or endangered pension benefits.
One often-cited case of ESOP disappointment, Rosen said, is Dan River, a textile firm that formed a plan in 1983 principally to fight off a takeover bid from corporate raider Carl C. Icahn. Workers, who owned about 70% of the company’s stock through the plan, were given little say-so in management, resulting in lower morale.
One of the most blatant examples of ESOP abuse, Rosen said, is Hall-Mark Electronics, a Dallas-based firm that grossly undervalued ESOP shares. Hall-Mark executives arranged to have the ESOP’s shares sold back to the company for $4 shortly before they helped arrange to sell the company for $100 a share in 1981. That move was subsequently challenged by the Labor Department and by employees in a class-action suit.
Fortunately, however, such cases--while well publicized--are more the exception rather than the rule. Congress has cracked down on some abusive practices, clarifying, for example, that all privately held companies must use outside specialists to determine the value of their stock. Privately held firms also must buy back stock from departing employees.
Also, two-thirds of firms forming ESOPs give shares to workers as a supplemental benefit, not as a replacement for an existing pension plan. So if the company’s stock--and thus the ESOP--became worthless, the workers would still have other pension benefits, Rosen said.
Only about 8% of companies form ESOPs by terminating existing pension plans, he said. And only about 2% of firms have employees pay for ESOP shares by giving up part of their wages.
“From that standpoint, you have nothing to lose” by participating in the two-thirds of ESOPs that are supplements to existing pension plans, Rosen said. “It just means you get more money, which for most workers is the most important thing anyway.”