Employee stock ownership plan
An employee stock ownership plan (ESOP) is an employee-owner program that provides a company's workforce with an ownership interest in the company. In an ESOP, companies provide their employees with stock ownership, often at no upfront cost to the employees. ESOP shares, however, are part of employees' remuneration for work performed. Shares are allocated to employees and may be held in an ESOP trust until the employee retires or leaves the company. The shares are then either bought back by the company for redistribution or voided.
Some corporations are majority employee-owned; the term "employee-owned corporation" often refers to such companies. Such organizations are similar to worker cooperatives, but unlike cooperatives, control of the company's capital is not necessarily evenly distributed. In many cases, voting rights are given only to certain shareholders, and more senior employees may be allocated more shares than new hires; typically, they are tied to the compensation an employee receives from the company. Compared with cooperatives, ESOP-centered corporations often allow for company executives to have greater flexibility and control in governing and managing the corporation.
Most corporations, however, use stock ownership plans as a form of in-kind benefit as a way to prevent hostile takeovers or to maintain a specific corporate culture. The plans generally prevent average employees from holding too much of the company's stock.
- 1 United Kingdom
- 2 United States
- 3 Other forms of employee ownership
- 4 See also
- 5 References
- 6 Notes
- 7 External links
ESOPs became widespread for a short period in the UK under the government of Margaret Thatcher, particularly following the Transport Act 1985, which deregulated and then privatised bus services. Councils seeking to protect workers ensured that employees accessed shares as privatisation took place, but employee owners soon lost their shares as they were bought up and bus companies were taken over. The disappearance of stock plans was dramatic.
The John Lewis Partnership has been cited as an example of an employee share ownership. However, unlike some other employee ownership arrangements, partners in John Lewis have no proprietary right to their stake and cannot buy or sell their rights or collectively dissolve the entity. ESOPs are almost entirely opposite because at John Lewis, employees get a voice at work but cannot trade an ownership stake; an ESOP typically carries no meaningful voice but allows the interest to be bought and sold.
In July 2012, the Department for Business Innovation and Skills published a report, "The Employee Ownership Advantage, Benefits and Consequences". This report listed several major advantages of employee ownership including stronger longterm focus, increased employee representation at board level and greater preference for internal growth. The report also highlighted that employee owned businesses face greater problems when it comes to raising capital and dealing with regulatory requirements. The study was based on data from a survey of 41 employee-owned businesses and 22 non-employee owned businesses in the United Kingdom, and also draws upon the published financial data of 49 EOBs and 204 non-EOBs in the UK.
The Chancellor of the Exchequer George Osborne announced in a speech at the Conservative Party Conference on 8 October 2012 that the law would be reformed to create a new employment status for "employee-owners". Employee-owners will pay no capital gains tax on any profit made from selling these shares, but they will have to give up certain employment rights in return, including redundancy and unfair dismissal. The consultation by the Department for Business, Innovation and Skills was published on 18 October 2012. Lawyers have suggested that the employee-owner scheme could have significant unintended consequences as, under the existing proposal, it may be possible for entrepreneurs to set themselves up as employee owners in order to avoid capital gains tax. In practice, those entrepreneurs will be far more 'owner' than 'employee' and the employment rights they will be giving up are likely to be of much less value to them than to ordinary employees and so the tax advantages would be of far greater value to them than to ordinary employees.
On 3 December 2012, the government published its response to the consultation. It had decided to press ahead with the changes despite 92% of responses to the consultation being either "negative" or "mixed" and despite it being "widely derided both in the House of Lords and in business chambers across the country." The term "employee owner" was dropped in favour of the more accurate "employee shareholder". Lawyers have commented that uncertainty remains as to how these proposals will operate in practice.
In April 2013, the Enterprise and Regulatory Reform Bill was passed and received Royal Assent. Implementation of the employee-shareholder provisions was expected to take place in October 2013. The employee ownership provisions received significant amendment in the House of Lords, with the unintended consequence possibly being that trade unions may now benefit.
At the end of June 2013, it became clear Osborne's "pet project", it had been the centrepiece of his Conservative party conference speech in 2012, had flopped after it emerged that just four companies had enquired about his shares-for-rights scheme, while only two had gone the further step of asking for information about it; the chancellor had been expecting thousands of firms to actually sign up. One UK official commented that, it was "an outrageously, terribly low figure", and even the Tory-leaning press described the failed idea as "Osborne at his worst".
An employee stock ownership plan is a defined contribution plan, a form of retirement plan as defined by 4975(e)(7)of IRS codes, which became a qualified retirement plan in 1974. It is one of the methods of employee participation in corporate ownership.
ESOPs are regulated by the Employee Retirement Income Security Act (ERISA), a federal law that sets minimum standards for investment plans in private industry. Internal Revenue Code section 404(a)(3) provides for an annual limit on the amount of deductible contributions an employer can make to a tax-qualified stock bonus or profit-sharing plan of 25% of the compensation otherwise paid or accrued during the year to the employees who benefit under the plan.
The Oakland, California-based think tank National Center for Employee Ownership estimates that there are approximately 11,300 employee stock ownership plans for over 13 million employees in the United States. Notable U.S. employee-owned corporations include the 170,000 employee supermarket chain Publix Supermarkets, Hy-Vee, McCarthy Building Company, environmental consulting firm Citadel Environmental Services, Inc., the craft brewery New Belgium Brewery, and photography studio company Lifetouch. Today, most private U.S. companies that are operating as ESOPs are structured as S corporation ESOPs (S ESOPs).
In the mid-19th century, as the United States transitioned to an industrial economy, national corporations like Procter & Gamble, Railway Express Agency, Sears & Roebuck, and others recognized that someone could work for the companies for 20 plus years, reach an old age and then have no income after they could no longer work.The leaders of those 19th century companies decided to set aside stock in the company that would be given to employees when they retired.
In the early 20th century, when the United States sanctioned an income tax on all citizens, one of the biggest debates was about how to treat stock set aside for an employee by his employer under the new US income tax laws.
ESOPs were developed as a way to encourage capital expansion and economic equality. Many of the early proponents of ESOPs believed that capitalism's viability depended upon continued growth and that there was no better way for economies to grow than by distributing the benefits of that growth to the workforce.
In 1956, Louis Kelso invented the first ESOP, which allowed the employees of Peninsula Newspapers to buy out the company founders. Chairman of the Senate Finance Committee, Senator Russell Long, a Democrat from Louisiana, helped develop tax policy for ESOPs within the Employee Retirement Income Security Act of 1974 (ERISA), calling it one of his most important accomplishments in his career. ESOPs also attracted interest of Republican leaders including Barry Goldwater, Richard Nixon, and Gerald Ford, and Ronald Reagan.
In 2001, the United States Congress enacted Internal Revenue Code section 409(p), which effectively requires for ESOP benefits to be shared equitably by investors and workers. This ensures that the ESOP includes everyone from the receptionist to the CFO.
Like other tax-qualified deferred compensation plans, ESOPs must not discriminate in their operations in favor of highly compensated employees, officers, or owners. In an ESOP, a company sets up an employee benefit trust that is funded by contributing cash to buy company stock or contributing company shares directly. Alternately, the company can choose to have the trust borrow money to buy stock (also known as a leveraged ESOP, with the company making contributions to the plan to enable it to repay the loan. Generally, almost every full-time employee with a year or more of service who worked at least 20 hours a week is in an ESOP.
The United States ESOP model is tied to the unique US system encouraging private retirement savings plans and tax policies that reflect that goal. That makes it difficult to compare to other tax codes from other nations.
S corporation ESOP
Most private US companies operating as an ESOP are structured as S corporation ESOPs (S ESOPs). The United States Congress established S ESOPs in 1998, to encourage and expand retirement savings by giving millions more American workers the opportunity to have equity in the companies where they work.
ESOP advocates credit S ESOPs with providing retirement security, job stability and worker retention, by the claimed culture, stability and productivity gains associated with employee-ownership. A study of a cross-section of Subchapter S firms with an Employee Stock Ownership Plan shows that S ESOP companies performed better in 2008 compared to non-S ESOP firms, paid their workers higher wages on average than other firms in the same industries, contributed more to their workers' retirement security, and hired workers when the overall U.S. economy was pitched downward and non-S ESOP employers were cutting jobs. Scholars estimate that annual contributions to employees of S ESOPs total around $14 billion. Critics say, however, that such studies fail to control for factors other than the existence of the ESOP, such as participatory management strategies, worker education, and pre-ESOP growth trends in individual companies. They maintain that no studies have shown that the presence of an ESOP itself causes any positive effects for companies or workers.;:27 One study estimates that the net US economic benefit from S ESOP savings, job stability and productivity totals $33 billion per year.
A study released in July 2012 found that S corporations with private employee stock ownership plans added jobs over the last decade more quickly than the overall private sector.
A 2013 study found that in 2010, 2,643 S ESOPs directly employed 470,000 workers and supported an additional 940,000 jobs, paid $29 billion in labor income to their own employees, with $48 billion in additional income for supported jobs, and tax revenue initiated by S ESOPs amounted to $11 billion for state and local governments and $16 billion for the federal government. Also, the study found that total output was equivalent to 1.7 percent of 2010 U.S. GDP. $93 billion (or 0.6 percent of GDP) came directly from S ESOPs, while output in supported industries totaled $153 billion (or 1.1 percent of GDP).
Advantages and disadvantages to employees
In a US ESOP, just as in every other form of qualified pension plan, employees do not pay taxes on the contributions until they receive a distribution from the plan when they leave the company. They can roll the amount over into an IRA, as can participants in any qualified plan. There is no requirement for a private sector employer to provide retirement savings plans for employees.
Some studies conclude that employee ownership appears to increase production and profitability and improve employees' dedication and sense of ownership. ESOP advocates maintain that the key variable in securing these claimed benefits is to combine an ESOP with a high degree of worker involvement in work-level decisions (employee teams, for instance). Employee stock ownership can increase the employees' financial risk if the company does badly.
ESOPS, by definition, concentrate workers' retirement savings in the stock of a single company. Such concentration is contrary to the central principle of modern investment theory, which is that investors should diversify their investments across many companies, industries, geographic locations, etc.:8–11 Moreover, ESOPs concentrate workers' retirement savings in the stock of the same company on which they depend for their wages and current benefits, such as health insurance, worsening the nondiversification problem.:8–11 High-profile examples illustrate the problem. Employees at companies such as Enron and WorldCom lost much of their retirement savings by overinvesting in company stock in their 401(k) plans, but the specific companies were not employee-owned. Enron, Polaroid and United Airlines, all of which had ESOPs when they went bankrupt, were C corporations.
Most S corporation ESOPs offer their employees at least one qualified retirement savings plan like a 401(k) in addition to the ESOP, allowing for greater diversification of assets. Studies in Massachusetts, Ohio, and Washington State show that on average, employees participating in the main form of employee ownership have considerably more in retirement assets than comparable employees in non-ESOP firms. The most comprehensive of the studies, a report on all ESOP firms in Washington state, found that the retirement assets were about three times as great, and the diversified portion of employee retirement plans was about the same as the total retirement assets of comparable employees in equivalent non-ESOP firms. The Washington study, however, showed that ESOP participants still had about 60% of their retirement savings invested in employer stock. Wages in ESOP firms were also 5-12% higher. National data from Joseph Blasi and Douglas Kruse at Rutgers shows that ESOP companies are more successful than comparable firms and, perhaps as a result, were more likely to offer additional diversified retirement plans alongside their ESOPs.
Opponents to ESOP have criticized these pro-ESOP claims and say many of the studies are conducted or sponsored by ESOP advocacy organizations and criticizing the methodologies used. Critics argue that pro-ESOP studies did not establish that ESOPs results in higher productivity and wages. ESOP advocates agree that an ESOP alone cannot produce such effects; instead, the ESOP must be combined with worker empowerment through participatory management and other techniques. Critics point out that no study has separated the effects of those techniques from the effects of an ESOP; that is, no study shows that innovative management cannot produce the same (claimed) effects without an ESOP. :36
In some circumstances, ESOP plans were designed that disproportionately benefit employees who enrolled earlier by accruing more shares to early employees. Newer employees, even at stable and mature ESOP companies can have limited opportunity to participate in the program, as a large portion of the shares may have already been allocated to longstanding employees.
ESOP advocates often maintain that employee ownership in 401(k) plans, as opposed to ESOPs, is problematic. About 17% of total 401(k) assets are invested in company stock, more in those companies that offer it as an option (although many do not). ESOP advocates concede that it may be an excessive concentration in a plan specifically meant to be for retirement security. In contrast, they maintain that it may not be a serious problem for an ESOP or other options, which they say are meant as wealth building tools, preferably to exist alongside other plans. Nonetheless, ESOPs are regulated as retirement plans, and they are presented to employees as retirement plans, just like 401(k) plans.
Conflicts of interest
Because ESOPs are the only retirement plans allowed by law to borrow money, they can be attractive to company owners and managers as instruments of corporate finance and succession.:14–16 An ESOP formed using a loan, called a "leveraged ESOP," can provide a tax-advantaged means for the company to raise capital.:14–15 According to a pro-ESOP organization, at least 75% of ESOPs are, or were at some time, leveraged. According to citing ESOP Association statistics as cited in.:14–16 In addition, ESOPs can be attractive instruments of corporate succession, allowing a retiring shareholder to diversify the company of stock while deferring capital gains taxes indefinitely.
Company insiders face additional conflicts of interest in connection with an ESOP's purchase of company stock, which most often features company insiders as sellers and in connection with decisions about how to vote the shares of stock held by the ESOP but not yet allocated to participants' accounts.:16–19 In a leveraged ESOP, such unallocated shares often far outnumber allocated shares for many years after the leveraged transaction.:19–21
Other forms of employee ownership
Stock options and similar plans (stock appreciation rights, phantom stock, and restricted stock, primarily) are common in most industrial and some developing countries. Only in the U.S., however, is there a widespread practice of sharing this kind of ownership broadly with employees, mostly (but not entirely) in the technology sector (Whole Foods and Starbucks also do this, for instance). The tax rules for employee ownership vary widely from country to country. Only a few, most notably the U.S., Ireland, and the UK, have significant tax laws to encourage broad-based employee ownership. In India, employee stock option plans are called "ESOPs”.
The most celebrated (and studied) case of a multinational corporation based wholly on worker-ownership principles is the Mondragon Cooperative Corporation. Unlike in the United States, however, Spanish law requires that members of the Mondragon Corporation are registered as self-employed. This differentiates co-operative ownership (in which self-employed owner-members each have one voting share, or shares are controlled by a co-operative legal entity) from employee ownership (where ownership is typically held as a block of shares on behalf of employees using an Employee Benefit Trust, or company rules embed mechanisms for distributing shares to employees and ensuring they remain majority shareholders).
Different forms of employee ownership, and the principles that underlie them, are strongly associated with the emergence of an international social enterprise movement. Key agents of employee ownership, such as Co-operatives UK and the Employee Ownership Association (EOA), play an active role in promoting employee ownership as a de facto standard for the development of social enterprises.
Other varieties of employee ownership include:
Direct purchase plans
Direct purchase plans simply allow employees to buy shares in the company with their own, usually after-tax, money. In the U.S. and several foreign countries, there are special tax-qualified plans, however, that allow employees to buy stock either at a discount or with matching shares from the company. For instance, in the U.S., employees can put aside after-tax pay over some period of time (typically 6–12 months) then use the accumulated funds to buy shares at up to a 15% discount at either the price at the time of purchase or the time when they started putting aside the money, whichever is lower. In the U.K. employee purchases can be matched directly by the company.
Stock options give employees the right to buy a number of shares at a price fixed at grant for a defined number of years into the future. Options, and all the plans listed below, can be given to any employee under whatever rules the company creates, with limited exceptions in various countries.
Restricted stock and its close relative restricted stock units give employees the right to acquire or receive shares, by gift or purchase, once certain restrictions, such as working a certain number of years or meeting a performance target, are met.
Phantom stock pays a future cash bonus equal to the value of a certain number of shares.
Stock appreciation rights
Stock appreciation rights provide the right to the increase in the value of a designated number of shares, usually paid in cash but occasionally settled in shares (this is called a “stock–settled” SAR).
Worker cooperatives are very different from the above mechanisms. They require members to join. Each worker-member buys a membership interest at a fixed price, or buys a share. Only workers can be members, but cooperatives can hire non-worker owners. Each member gets one vote.
- Center on Business and Poverty
- Economics of participation
- Labour law
- List of employee-owned companies
- Timeline of employee stock ownership plan development
- A Pendleton, J McDonald, A Robinson and N Wilson, ‘Employee Participation and Corporate Governance in Employee-owned Firms’ (1996) 10(2) Work, Employment and Society 205-226
- L Trewhitt, 'Employee Buyouts and Employee Involvement: A Case Study of Investigation of Employee Attitudes' (2000) 31(5) Industrial Relations Journal 451, the way they vanished was 'nothing short of dramatic'.
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- See John Lewis Partnership, Constitution
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- Elizabeth Rigby (28 June 2013). "Chancellor's 'shares for rights' plan flops". ft.com. Retrieved 1 July 2013.
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- "Louis O. Kelso, Who Advocated Worker-Capitalism, Is Dead at 77.” New York Times. 21 February 1991.
- "Russell B. Long, 84, Senator Who Influenced Tax Laws." The New York Times. 11 May 2003.
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- Shlomo Benartzi, et al., "The Law and Economics of Company Stock in 401(k) Plans", 50 Journal of Law & Economy, 45, 57 (2007)
- "S Corporations Lead Way on Jobs, Report Says” Brill, Alex. 26 July 2012.
- "Macroeconomic Impact of S ESOPs on the U.S. Economy" Brill, Alex. 17 April 2013.
- Paton, R. (1989) Reluctant Entrepreneurs, London: Sage Publications.
- See also Chris Doucouliagos, Worker participation and productivity in labor-managed and participatory capitalist firms: A Meta-Analysis”, Industrial and Labor Relations Review, Vol. 49, No. 1, Oct., 1995.
- Gates, J. (1998) The Ownership Solution, London: Penguin.
- Blais, J., Freeman, R., Kruse, D. (2010), Shared Capitalism and Work However, NBER Publications.
- Rosen, C., Case, J., Staubus, M., (2005) Equity: Why Employee Ownership Is Good for America, Harvard Business School Press.
- Kurtulus, Fidan An, and Douglas L. Kruse (2017), How Did Employee Ownership Firms Weather the Last Two Recessions? Employee Ownership, Employment Stability, and Firm Survival: 1999-2011, W.E. Upjohn Institute.
- Cornforth, C. (1988) Developing Successful Worker Co-ops, London: Sage Publications.
- Andrew Stumpff and Norman Stein, Repeal Tax Incentives for ESOPS, 125 Tax Notes 337, 339-40 (2009);
- Brett McDonnell, ESOPs' Failures: Fiduciary Duties When Managers of Employee-Owned Companies Vote to Entrench Themselves, 2000 Colum. Bus. L. Rev. 199, 235 (2000).
- Staubus, Martin. "Sustaining Employee Ownership for the Long Term: The Challenge of the Mature ESOP Company". rady.ucsd.edu. Rady School of Management. Retrieved 2016-09-02.
- Internal Revenue Code section 1042.
- National Center for Employee Ownership, Employee Ownership for Multinational Companies, 2010
- Whyte, W. F. and Whyte, K. K. (1991) Making Mondragon, New York: ILR Press/Itchaca.
- Erdal, D. (2008) Local Heroes: How Loch Fyne Oysters Embraced Employee Ownership and Business Success, London: Viking.
- Ron Kind; Erik Paulsen (2012), A model for sound retirement, Washington, DC
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- Joseph Blasi, Douglas Kruse; Bernstein, Aaron (2003), In the company of owners: The Truth about Stock Options (and why Every Employee Should Have Them), New York, NY: Basic Books, ISBN 9780465007004, OCLC 50479205
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- Rosen, Corey, Understanding ESOPs, National Center for Employee Ownership, Oakland, CA, 2010, www.nceo.org
- Curl, John (2009) For All The People: Uncovering the Hidden History of Cooperation, Cooperative Movements, and Communalism in America, PM Press, ISBN 978-1-60486-072-6
- Staubus, Martin (2011), "Creating a High-Performing Workplace", Employee Ownership Insights, The Beyster Institute (Summer 2011)
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