On February 10, 2011, ESOP Association President, J. Michael Keeling, as part of the 2011 Employee Ownership Executive Briefing series, spoke to students at the Rady School of Management at UC San Diego. You can watch the video of his presentation here.
The following is an excerpt from remarks given by J. Michael Keeling, president of The ESOP Association to attendees at a conference on employee ownership in Granada, Spain on June 5, 2008.
By J. Michael Keeling, President of The ESOP Association and the Employee Ownership Foundation, Washington, DC
Before digging in to the topic at hand, a short introduction of both The ESOP Association and the Employee Ownership Foundation:
The ESOP Association is the national trade association for companies with employee stock ownership plans (ESOPs) in the U.S. The Association has over 2,500 members in all 50 U.S. states, and its primary role is to represent corporations with ESOPs before the U.S. Congress, the U.S. Executive branch, and even before the U.S. courts. The Association began in 1978.
The Employee Ownership Foundation is affiliated with The ESOP Association, and is ten years old. The Foundation leads the ESOP community’s efforts to develop research and data supporting the idea that employee ownership should be wide spread national policy in the US.
Two major points about employee ownership in the U.S.:
Having employees own directly, or indirectly, stock in the company where they work is a very traditional and honored policy in the U.S. In the mid-19th Century, as the U.S. transitioned to an industrial economy with nationwide corporations such as Procter &Gamble, Railway Express, Sears & Roebuck, leaders of these corporations recognized that someone could work for these companies for 20 plus years, reach an old age, and then have no income after they were no longer able to work. The leaders of those 19th companies decided to set aside stock that would be given to the employee when he or she retired. In fact in the early 20th Century, when the U.S. sanctioned an income tax on all citizens, one of the biggest debates was, under the then new U.S. income laws, how to treat stock set aside for an employee by its employer.
So, employee stock ownership is not a “new” development in the U.S.
Second major point and this is probably more important to the topic of employee ownership. There are several arrangements that result in employee stock ownership in the U.S., and the ESOP is just one example, or model, although a very successful model.
Employees can own stock in the company where they work directly by just purchasing it. Employees can be owners in the company where they work by working in an employee-owned cooperative, by being awarded stock options that are converted to stock at some point, by participating in a stock purchase plan where they work, by participating in a 401(k) plan that has company stock as part of its assets, or by being a participant in a company sponsored ESOP.
A major point to remember, no other nation in the world has laws that sanction an arrangement that is the same as the U.S. ESOP. In other words, one cannot go to Spain, Germany, Bangladesh, China, etc., and set up an arrangement that is the same as, or even similar to, a U.S. ESOP. I will return later to why I believe advocates of employee ownership world wide, however, need to know more about the U.S. model, even though it cannot be precisely duplicated in any other nation.
Briefly, both the ESOP model, and company stock ownership in a 401(k) plan are tied to the unique U.S. system of private retirement savings plans. In the U.S., there is no mandatory requirement that a non-government employer, or a so-called private sector employer, provide retirement savings plans for employees. Employees participating in an ESOP, or a 401(k) plan, do not own the company stock directly, but receive the stock, generally when they retire, die, become disabled, or leave the company to work elsewhere. Remember I said that employee stock ownership started in the U.S. in the 19th Century as certain large corporations wanted to provide retired employees income by giving them company stock. So the ESOP and 401(k) models of employee stock ownership tied to a retirement savings program are the progeny of the 19th Century approach.
The broad-based employee stock purchase model was developed in the mid-20th Century as primarily a way to align employee interests with the employer’s. Typically the employee has money withheld from his or her pay check to “purchase” company stock at a set price. Normally, the employee cannot “sell” his or her stock whenever she wishes, but there are exceptions to this approach in some stock purchase companies. One of the more famous U.S. companies with a stock purchase plan is the successful airline company Southwest Airlines.
While providing high paid executives with stock options developed in the 20th century, the providing to a broad-base of employees stock options really took off with the dot.com boom in the U.S., particularly in companies based near San Francisco, California, in the 80s and 90s. In a broad-based stock option program, all company employees are given an option to buy their company stock at a set price, and then a few years later, the employee can buy the stock at a price lower than the market value of the stock, and thus have a significant financial gain. Famous companies with successful broad-based stock option programs are Microsoft, and Google.
The worker owned cooperative, or co-op model has been in the U.S. for a long time as well. Technically, a co-op is not a stock company, and each employee has more or less equal ownership, and equal voice in selecting co-op leaders and managers. For many, the worker owned co-op is the “true” employee ownership model, as it confers a high level of worker control with worker ownership. For several reasons, however, worker owned co-ops have never been a major force in the U.S. economy, and tend to exist, when they do exist, in small employers, often with no more than 20 employees.
There are more successful models of worker-owned co-ops in Europe than in the U.S. In fact, my experience is that when one says employee ownership to a European, he or she assumes I am talking about a worker-owned co-op.
The average North American, and decision makers in the U.S., plus the media, do not realize how much employee stock ownership there is in the U.S. Our Employee Ownership Foundation helps pay for a massive survey every four years conducted by the University of Chicago that has questions about employee ownership. The latest data indicates that approximately 30% of the U.S. private sector work force have some kind of stock ownership in the models I mentioned above. The same survey shows that another 15% to 20% share in some kind of cash profit sharing plan, or what one would call in Europe, financial participation, and what some in the U.S. call “shared capitalism.”
Now turning to the ESOP model.
I am a fan of the ESOP model. I feel it is the most successful, and most sustainable form of employee stock ownership in the U.S. Over the past 30 plus years, the ESOP has transferred more ownership at a higher percentage of the total equity of the companies to average pay employees than any other model of employee ownership.
I will not bore you with the legal details of the U.S. ESOP model but I want you to have some knowledge of the ESOP legal structure.
First ESOPs are in the U.S. laws governing private retirement savings plans. By private plans I mean money set aside for the employee by the employee and/or his or her employer. The private plans are governed by a law that is known as ERISA, for employee retirement income security act.
An ESOP is one form of an ERISA plan.
An ESOP receives stock from the employer or a selling shareholder, and then those responsible for managing the ESOP called “trustees” puts some of the stock in individual employee accounts held by a trust. In U.S. law, a trust is not a person, but a legal entity that holds assets for others, and is managed by a third party who must do things in the best interest of those who will benefit from the trust. These third parties are called “trustees.”
In blunt terms, an ESOP is a trust, with the assets divided up into “individual accounts.”
The company stock is divided up among the employees depending on their pay, up to approximately 30,000 to 35,000 euros a year. Employees are not taxed on their share of the ESOP assets, and as the ESOP stock grows in value the employees are not taxed under U.S. tax laws.
The employee gets the stock when he or she dies, retires, becomes disabled, or leaves the company after a few years, usually only after working 3 to 5 years.
As a rule, additions are made to each individuals stock account annually; so the longer an employee stays with the company, the more value in her or his ESOP account.
When the employee receives the stock, in general he or she pays a U.S. income tax on the value of the stock. If the employee worked for a company whose stock is traded on a public stock exchange, it is just like the employee got cash, as he or she can sell the stock at anytime.
But in the U.S., as in all nations, over 90% of the companies are not so large as to be traded on the nation’s stock exchange, and the stock is not marketable, or liquid as one would say. We estimate that 97 to 98% of the ESOP companies in the U.S. are what are called “private” companies, or “closely held” companies, and there is no ready market for the stock of these closely held companies.
When an employee receives his or her stock from a closely held company, the ESOP company, under U.S. law, must be willing to buy the stock back at its last valuation. A company that does not, or can not, buy back the stock, is in violation of U.S. law, and the penalties for violating the law requiring a repurchase of the ESOP shares from departed employees are very steep.
To put it bluntly, when a participant in a U.S. ESOP leaves the ESOP company, she or he gets the cash value of the stock that was in his or her ESOP account.
Without going into detail, in the U.S. there are several tax laws that encourage the creation of employee ownership through ESOPs.
One law in the U.S. permits the ESOP company to pay no current Federal income taxes if 100% owned by its ESOP.
What is interesting is that these U.S. laws encourage the creation of ESOPs in smaller, closely held companies, by encouraging a current shareholder who probably started the business to exit the business by selling her or his stock to the ESOP. Since 1990, U.S. laws do not encourage large publicly traded companies to create ESOPs. While ESOP advocates such as myself do not agree, it is clear that generally the U.S. Congress thinks ESOPs and employee ownership is a good thing in smaller, closely held companies, but not so positive in large publicly traded companies. This Congressional view is reinforced by the United Airlines experience, and the Enron experience.
It is estimated that 85% of the ESOPs in the U.S. were created when an “exiting” shareholder took advantage of the U.S. tax laws encouraging ESOP creation.
Before turning to the global transferable lessons learned from ESOPs in the U.S., let me note for you the key tension, or conflict about ESOPs in the U.S., and which is probably why nothing like the ESOP model exists in other nations. Note again that in the U.S. the ESOP is a retirement savings plan. The wealth created for an employee by an ESOP is supposed to be saved for use in the employee’s retirement years.
But the ESOP, as a rule is concentrated in one asset—the stock of the company. Everyone knows that finance experts, or retirement planning experts, urge people not to be concentrated in one asset, but to diversify their assets. The ESOP is not truly diversified under U.S. law.
ESOP advocates point out that no one ever got rich diversifying small amounts of assets, and diversification should take place after a person has considerable assets. There is plenty of evidence that the ESOP participants have more wealth in their ESOPs than U.S. citizens’ participating in other, more diversified retirement savings plans.
On the other hand, even if 90% of the U.S. ESOP companies are very successful, and I think the number is more like 70%, this means 10% are like United Airlines, or Enron, or WorldCom, or Adelphia, to name a few bankrupt companies in the U.S., where employee-owned company stock ends up worthless, or near worthless, and thus provide no money for the employees’ retirement years. Critics of ESOPs in the U.S., I call them ESOP cynics, say that even a 10% risk is too much for a retirement savings plan.
Generally, the rest of the world agrees with the U.S. critics of ESOPs; that company stock should not be the primary retirement savings asset, and the retirement plans should have more diversified assets. So, in most others nations, the employee stock plans are in addition to a more traditional retirement plan that is diversified, that the government requires all employers to provide.
In any event there is a significant debate over the use of ESOPs as retirement savings plans in the U.S. Up to this time, ESOP advocates continue to prevail in protecting the laws encouraging ESOPs, although we ESOP advocates understand the criticism.
One thing that supports the continuation of favorable laws for ESOPs in the U.S. is most ESOPs are in smaller employers. For example, out of the near 1,500 ESOP company members of The ESOP Association, which supports the Employee Ownership Foundation, 91% have fewer than 250 employees. Of this number about 60% have fewer than 100 employees. So while we have some ESOP Association members with thousands of employees, ESOP companies this large are not common. Again, part of this reason is due to what kind of companies the U.S. laws encourage having an ESOP.
Of the Association’s 1,500 or so ESOP companies members, the average ownership share of the ESOP of these companies is 68% of the company. The fastest growing segment of our membership are companies that are owned 100% by their ESOPs. Again, there is a unique U.S. law that encourages 100% ownership by the ESOP.
Our Association members employ about 750,000 persons. It is estimated that typical U.S. ESOP companies employ about 5 to 6 million employees.
It is estimated there are over 100 million U.S. residents working for U.S. companies that are for profit companies. Thus you can see, only a small percentage, 5% to 6% are working in typical ESOP companies. We ESOP advocates are proud of our progress, proud of our companies, but realize that we are still only a small part of the U.S. ownership structure.
Now for the human side of U.S. ESOP companies -- the story of the individuals’ working in a company where they have an ownership share, and where leaders of the company care about their human environment.
In my career working for The ESOP Association, and the Employee Ownership Foundation, I have personally visited in over 450 ESOP companies. I have visited in companies with no more than 10 employees, and in companies with thousands of employees. I have visited in companies where the ESOP held less than 10% of the company’s stock, and in many companies where the ESOP held 100% of the company’s stock.
Here is what I have learned, and much of what I say can be true of employee owned companies all across the U.S.
Number one, for the company to really benefit from employee ownership, the employees must feel and think like owners. How does this happen?
One, the employees have to have a say in the decisions that affect their work life. Employee owners are not dumb, and that is the first thing to remember by policy makers and leaders of the employee-owned companies. Average pay employees are not dumb; they know much about their job, and how it should be done. They can help do their jobs better. They know better many times more frequently than their managers, or supervisors.
The employee owner needs to understand what a profit is, what a cost is, how the company makes money, how making money impacts personal wealth that is in the ESOP, and what can be done to help the company be more profitable. To do this, the employee needs to know the financial results of the company, and needs to understand how the economy works, and why some companies fail, and some succeed.
The employee owner needs to know that no one person is as smart as all of the persons in the company. The employee owner needs to know he or she is respected by the top managers, and that his or her views are respected, and that they have an opportunity to express those views.
The employee owner does not need big talk from the leadership and then have the leadership continue to ignore the average pay employees’ voices, and continue a very hierarchical style of management of “my way or the highway.”
Let me tell you what I see as not working in an employee-owned company.
Decisions are not to be decided by votes, with the majority vote winning. Decisions are to be made by the people in the company most qualified to make the decisions, but those persons should listen to all who will be impacted by the decision.
There is a great deal of talk about workplace democracy and in some companies workplace democracy can work; but rarely in a modern, multiple location company, with hundreds of employees, does pure group decision making, or so called workplace democracy, work.
I see different degrees of workplace democracy that are less than having a group vote on each and every decision.
Employee stock owners needs to understand that ownership of stock in a company does not mean control. Owning stock is not like owning your car, your house, or your clothes. Sharing ownership with many other employees in a stock arrangement creates rights and responsibilities, and creates boundaries on what one individual employee can do.
Employee stock ownership does not permit the employee who gets mad at co-workers to just take his or her desk computer home in anger.
Employee stock ownership will not make your co-workers more attractive, less offensive, and or more likeable.
In other words, employees have to understand that employee stock ownership does not create heaven on earth, with every co-owner loving his or her other co-owners.
But I think the Vision of The ESOP Association and the Employee Ownership Foundation, of which I am the President, says it best:
“We believe that employee ownership improves American competitiveness…that it increases productivity through greater employee participation in the workplace… that it strengthens the free enterprise economy and creates a broader distribution of wealth…and that it maximizes human potential by enhancing the self-worth, dignity, and well-being of our people.
Therefore we envision an America where employee ownership is widely recognized as a catalyst for economic prosperity…where the great majority of employee own stock in the companies where they work…and where employee ownership enables employees to share in the wealth that they help create.
And we look for our nation to become for all the world an example of prosperity with justice through employee ownership.”
By having the employee-owned company help employees reach their potential, to be persons of dignity and self worth, requires commitment and hard work by the leaders of the company. The education of what ownership means, and how it is applied in one specific company, with each company having a little bit different style and culture than another, takes time, and time is money.
We have employee owner communications committees; we have seminars and conferences that average pay employee owners attend, not just the top leaders, and lawyers and accountants.
We understand that a well managed employee-owned company is not a destination, it is a journey, as new employees come to the company, and as economic conditions, often beyond the employee owners’ control, change, and new challenges emerge.
But the evidence is overwhelming: Most well-managed employee-owned companies, with average pay employees having a voice and being respected, make more profits, have more sales, last longer, are more productive, and create more wealth for average pay employees than non employee-owned companies.
As our Vision says, the whole world would be a better place with more employee ownership.