The two most common uses of ESOPs are to buy the stock of a retiring owner in a closely held company, and as an extra employee benefit or incentive plan. These two uses probably account for over two thirds of all the ESOPs now in existence. The proportion of ESOPs created to buy out a retiring owner can be expected to increase with time, because tax provisions encourage retiring owners to sell to an ESOP. Other companies have used ESOPs as a technique of corporate finance for a variety of purposes--to finance expansion, make an acquisition, spin off a division, take a company private, etc. In a small number of cases—about 2%—ESOPs have been used to buy out a failing firm that would otherwise close.
Buying The Stock Of A Retiring Owner
Many closely held companies have no plans, or incomplete plans, for business continuity after the departure of retirement of the founder or major shareholder. If the company repurchases a retiring or departing owner's shares, the departing owner sells his or her stock to another company, the proceeds will be taxed as ordinary income, or as capital gains if certain requirements are met, and, finding a buyer is not always easy even for a profitable closely-held company. Even if possible, it is not always desirable; furthermore in a family business, a retiring owner may face an unpleasant choice between selling to a competitor or conglomerate, or liquidating.
An ESOP can provide a market for the equity of a retiring owner—or any interested major shareholder—of a closely held company, and provide a benefit and job security for employees in the process. Retiring owners of closely held companies incur no taxable gain on a sale of stock to an ESOP, provided that the ESOP owns at least 30% of the company immediately after the sale (sales by two or more stockholders may be counted in this 30% if these sales are part of an integrated transaction), and that the sale's proceeds are reinvested in qualified securities within a fifteen month period beginning 3 months before the date of the sale. This tax-deferred rollover is a most tax favored way for an owner of a closely held company to sell his or her stock.
Employee Benefit Or Incentive
Most ESOP companies had the desire to set up an employee benefit or incentive as one reason for starting their plan, but for many companies that's the only reason. Some companies hope that by making employees owners they will increase their dedication to the firm, improve work effort, reduce turnover, and generally bring a more harmonious atmosphere to the company. Research has shown that giving workers a significant stake in their companies can improve employees' attitudes towards their companies, and that these improved attitudes towards their companies can translate into bottom line improvements. Other companies want to set up some kind of benefit plan, and find that an ESOP is the best choice.
A 1993 ESOP Association study found that 54% of member companies cite an overall productivity increase due to their ESOP. Eighty-one percent of those surveyed believed the ESOP was a "good decision" that helped the company; only 2% responded that it was a "bad decision". A 1993 study by the North east Ohio Center on Employee Ownership found that 49% of Ohio ESOP companies reported outper-forming their industry in job creation and retention during the previous three years; 50% said they were the same as their industry; and 1% fared worse.
A study of publicly-traded companies by Joseph Blasi and Douglas Kruse of Rutgers University and Michael Conte of the University of Baltimore found a positive relationship between employee ownership and stock performance. The unweighted Employee Ownership Stock Ownership Index reflects the average stock price of the 355 companies listened on the NYSE, AMEX, and NASDAQ exchanges with more than 10% of stock owned by employees. In 1991, the index was up 35.9% compared to increases of 26.3% for the Standard & Poor's 500-index and 20.3% for the Dow Jones industrial average. In 1992, the Employee Ownership Stock Ownership Index increased 22.9% versus gains of less than 4.5% for the other two indices.
In addition to other empirical studies that yield a similar positive correlation between ESOPs and company performance, much anecdotal evidence lends itself favorably to ESOPs. In the landmark business book The 100 Best Companies to Work for in America (by Robert Levering and Milton Moskowitz, published by Doubleday, 1993) 30 of the "best" corporations had ESOPs of 10% or greater. In 1992, all of the finalists for Inc. magazine's "Entrepreneurs of the Year Award" were ESOP companies.